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ACCT 501 (All examples are from the textbook by J. Larson) Chapter 8 Consolidated Financial statements: Intercompany Transactions.

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Presentation on theme: "ACCT 501 (All examples are from the textbook by J. Larson) Chapter 8 Consolidated Financial statements: Intercompany Transactions."— Presentation transcript:

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2 ACCT 501 (All examples are from the textbook by J. Larson) Chapter 8 Consolidated Financial statements: Intercompany Transactions

3 Consolidated FS-Intercompany Transactions2 Objectives of the Chapter n To discuss the accounting and working paper eliminations for related party transactions between a parent company and its subsidiaries for: I. intercompany transactions not involving profit or loss such as loans on promissory notes, leases of property under operating leases and rendering of services;

4 Consolidated FS-Intercompany Transactions3 Objectives of the Chapter (Contd.) II.intercompany transactions involving profit or loss such as intercompany sale of merchandise, plant assets, intangible assets and leases of property (under capital/sales-type leases).

5 Consolidated FS-Intercompany Transactions4 Principle to follow to account for the intercompany transactions for the consolidated financial statements: n The consolidated financial statements should include only transactions resulting from the consolidated group’s dealings with outsiders.

6 Consolidated FS-Intercompany Transactions5 Principle to follow to account for the intercompany transactions for the consolidated financial statements: (Contd.) n Separate ledger accounts are established for all intercompany assets, liabilities, revenue and expenses. n These separate accounts clearly identify the intercompany items that should be eliminated in the preparation of consolidated financial statements.

7 Consolidated FS-Intercompany Transactions6 I. Accounting for Intercompany Transactions Not Involving Profit (Gain) or Loss n loans on Notes or Open Accounts u The parent company may make loans to its subsidiaries. u The interest rate charged by the parent company usually exceeds the parent company’s borrowing rate.

8 Consolidated FS-Intercompany Transactions7 I. Accounting for Intercompany Transactions Not Involving Profit (Gain) or Loss (Contd.) u Intercompany ledger accounts are used by the parent and the subsidiary to account for these intercompany transactions in order to differentiate intercompany loans and loans with outsiders.

9 Consolidated FS-Intercompany Transactions8 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) n Assume that Palm Corp. made the following cash loans to its wholly owned subsidiary, Starr Company, on promissory notes: Date of Note Term of Note, Months Interest Rates, % Amount Feb.1, $10,00 0 Apr.1, ,000 Sept.1, ,000 Nov.1, ,000

10 Consolidated FS-Intercompany Transactions9 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) n Palm Corp. and Starr Company will use the following ledger accounts to record the foregoing transactions (assuming all notes were paid by Starr when due): PALM CORPORATION Intercompany Notes Receivable /0110,000 08/01 04/0115,000 10/01 09/0121,000 11/0124,000 Bal on 11/01 45,000 STARR COMPANY Intercompany Notes Payable /0110,000 02/01 10/0115,000 04/01 21,00009/01 24,00011/01 45,000 Bal on 11/01

11 Consolidated FS-Intercompany Transactions10 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) Intercompany Interest Receivable /311,100 Intercompany Interest Payable ,10012/31 Intercompany Interest Revenue / /01 1,10012/31 2,350 Bal on 12/31 Intercompany Interest Expense / / /311,100 Bal on 12/31 2,350

12 Consolidated FS-Intercompany Transactions11 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) n In the working paper for consolidated financial statements for Palm and subsidiary for the year ended 12/31/2001, the foregoing ledger accounts appear as shown below:

13 Consolidated FS-Intercompany Transactions12 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Palm Corporation Starr Company Eliminations Inc. (Dec.) Consolidated Income Statement Intercompany rev. (exp.)2,350(2,350) Balance Sheet Intercompany rec. (pay.)46,100*(46,100) *45,000 + $1,100 = $46,100

14 Consolidated FS-Intercompany Transactions13 Discounting of Intercompany Notes n If an intercompany note receivable is discounted at a bank (by the payee, i.e., Palm in example 8.1), the note becomes payable to an outsider – the bank. n Therefore, discounted intercompany notes are not eliminated in the working paper.

15 Consolidated FS-Intercompany Transactions14 Example 8.2: Discounting of Intercompany Notes n Continued with Example 8.1 and Assumed that on 12/1/2001, Palm had discounted at a 12% discount rate the $24,000 note receivable from Starr. Palm would record the following entry: Cash 23,940 Interest Expense ($1,260 discount – 1,000*)260 Intercompany Notes Receivable24,000 Intercompany Interest Revenue 200 ($24,000 x 0.10 x 1/12)

16 Consolidated FS-Intercompany Transactions15 Example 8.2: Discounting of Intercompany Notes (Contd.) To record discounting of 10%,six-month note receivable from Starr Company dated Nov. 1,2001, at a discount rate of 12%. Cash proceeds are computed as follows: Maturity value of note [$24,000 + ($24,000 x 0.10 x 6/12)]25,200 Less: Discount ($25,200 x 0.12 x 5/12)1,260 Proceeds $23,940 *Interest on note that accrues to discounting bank during discounting period.

17 Consolidated FS-Intercompany Transactions16 Example 8.2: Discounting of Intercompany Notes (Contd.) n Palm should inform Starr of the discounting. Starr would prepare the following journal entry on 12/1/2001: Intercompany Notes Payable24,000 Intercompany Interest Expense200 Notes Payable24,000 Interest Payable200 To transfer 10%, six-month note payable to Palm Corporation dated Nov. 1, 2001, from intercompany notes to outsider notes.

18 Consolidated FS-Intercompany Transactions17 Example 8.2: Discounting of Intercompany Notes (Contd.) n Under the note discounting assumption, the ledger accounts related to the intercompany notes would appear in the 12/31/2001 working paper for consolidated financial statements as follows:

19 Consolidated FS-Intercompany Transactions18 Example 8.2: Discounting of Intercompany Notes (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Palm Corporation Starr Company Eliminations Inc. (Dec.) Consolidated Income Statement Intercompany rev. (exp.)2,150*(2,150)* Balance Sheet Intercompany rec. (pay.)21,700†(21,700) † *$200 less than in illustration on page 348 because $24,000 discounted note earned interest for one month rather than two months. † $21,000 note dated Sept. 1, 2001, plus $700 accrued interest.

20 Consolidated FS-Intercompany Transactions19 Leases of Property under Operating Leases n When both the parent and subsidiary account the lease as an operating lease, the lessee will record the lease payment as intercompany rent expense, while the lessor will record the lease payment received as intercompany rent revenue.

21 Consolidated FS-Intercompany Transactions20 Leases of Property under Operating Leases (Contd.) n For an intercompany operating lease, there is no profit or loss involved. n The inercompany rent revenue would be offset against intercompany rent expense in the manner similar to the offset of intercompany interest revenue and expense illustrated earlier.

22 Consolidated FS-Intercompany Transactions21 Rendering of Services n One affiliate may render services to another and result in intercompany fee revenue and expense (i.e., management fee charged to subsidiaries by a parent company).

23 Consolidated FS-Intercompany Transactions22 Rendering of Services (Contd.) n The intercompany fee revenue and expense are offset in the working paper. n Both the parent company and the subsidiary should record the fee billing in the same accounting period.

24 Consolidated FS-Intercompany Transactions23 Income Texas Applicable to Intercompany Transactions n No income tax effects associated with the elimination of the intercompany revenue or expenses since no profit or loss involved in these intercompany transactions. n It does not matter whether the parent company and its subsidiaries file separate income tax returns or a consolidated tax return.

25 Consolidated FS-Intercompany Transactions24 II. Accounting for Intercompany Transactions Involving Profit (Gain) or Loss n For intercompany transactions involving profit or loss, the unrealized profits or losses must be eliminated in the preparation of consolidated financial statements until they are realized.

26 Consolidated FS-Intercompany Transactions25 The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses n Failure to eliminate unrealized profits and losses would result in consolidated income statements that report not only results of transactions with outsiders but also the results of related party activities within the affiliated group.

27 Consolidated FS-Intercompany Transactions26 The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses (Contd.) n Similarly, no recognition of realized gains (losses) would misstate the consolidated net income. n The management can manipulate consolidated net income if unrealized intercompany profits and losses were not eliminated.

28 Consolidated FS-Intercompany Transactions27 Intercompany Sales of Merchandise n Types of Sales u Downstream intercompany sales u Upstream intercompany sales u Lateral intercompany sales

29 Consolidated FS-Intercompany Transactions28 Intercompany Sales of Merchandise (Contd.) a. Intercompany Sales at Cost n Example 8.3: Intercompany sale at cost u Assume that Palm sold merchandise costing $150,000 to Starr during the year ended 12/31/2001 at a selling price equals to Palm’s cost. u The ending inventories of Starr on 12/31/2001 included $25,000 of merchandise obtained form Palm.

30 Consolidated FS-Intercompany Transactions29 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.) u By 12/31/2001, Starr still owed Palm $15,000 for merchandise purchased during 12/31/2001. u Assuming perpetual inventory system for both companies, the following aggregate entries would be prepared by both companies for the foregoing transactions:

31 Consolidated FS-Intercompany Transactions30 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.) n Palm Corporation Journal Entries Intercompany Accounts Receivable150,000 Intercompany Sales 150,000 To record sales to Starr Company Intercompany Cost of Goods Sold150,000 Inventories150,000 To record cost of goods sold to Satrr Company. Cash135,000 Intercompany Accounts Receivable135,000 To record payments received from Starr Company

32 Consolidated FS-Intercompany Transactions31 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.) n Starr Company Journal Entries Inventories150,000 Intercompany Accounts Payable 150,000 To record purchases from Palm Corporation. Intercompany Accounts Payable135,000 Cash135,000 To record payments made to Palm Corporation. Trade Accounts Receivable160,000 Sales160,000 To record sales. Cost of Goods Sold125,000 Inventories125,000 To record cost of goods sold.

33 Consolidated FS-Intercompany Transactions32 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.) n The following is a partial working paper for consolidated financial statements of Palm and subsidiary (include only the data related to this intercompany sale of merchandise at cost):

34 Consolidated FS-Intercompany Transactions33 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Palm Corporation Starr Company Eliminations Inc. (Dec.) Consolidated Income Statement Intercompany rev. (exp.)* Balance Sheet Intercompany rec. (pay.)15,000(15,000) *Palm Corporation’s $15,000 intercompany sales and intercompany cost of goods sold are offset in Palm’s separate income statement in the working paper.

35 Consolidated FS-Intercompany Transactions34 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.) n Note: Starr Company’s cost of goods sold and inventories are not affected by working paper eliminations. Both Starr’s cost of goods sold and inventories are stated at cost.

36 Consolidated FS-Intercompany Transactions35 Intercompany Sales of Merchandise (Contd.) b.Intercompany Sales with Unrealized Intercompany Profit in Ending Inventories n Without the working paper elimination, the consolidated ending inventory and cost of goods sold are both overstated.

37 Consolidated FS-Intercompany Transactions36 Intercompany Sales of Merchandise (Contd.) n The ending inventory is overstated for the mark up of the unsold ending inventory (the unrealized gain). n The cost of goods sold is overstated for the mark up of the cost of goods sold (the realized gain).

38 Consolidated FS-Intercompany Transactions37 Intercompany Sales of Merchandise (Contd.) Example 8.4:Intercompany sales at a mark up n During 2001, Sage company (the 95%- owned subsidiary) sold merchandize to Post at a gross profit margin of 20% on sales price. n Sales by Sage to Post totaled $120,000 in year 2001, of which $40,000 remained unsold by Post on 12/31/2001.

39 Consolidated FS-Intercompany Transactions38 Intercompany Sales of Merchandise (Contd.) Example 8.4: (Contd.) n On 12/31/2001, Post still owed $30,000 to Sage for merchandise. Both companies use the perpetual inventory system. n The foregoing transactions are recorded in summary form by the two companies as follows:

40 Consolidated FS-Intercompany Transactions39 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) n Post Company Journal Entries Inventories120,000 Intercompany Accounts Payable 120,000 To record purchases from Sage. Intercompany Accounts Payable90,000 Cash90,000 To record payments made to Sage Company. Trade Accounts Receivable100,000 Sales100,000 To record sales. Cost of Goods Sold80,000 Inventories80,000 To record cost of goods sold.

41 Consolidated FS-Intercompany Transactions40 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) n Sage Corporation Journal Entries Intercompany Accounts Receivable120,000 Intercompany Sales 120,000 To record sales to Post Corporation Intercompany Cost of Goods Sold96,000 Inventories96,000 To record cost of goods sold to Post Corporation. Cash90,000 Intercompany Accounts Receivable90,000 To record payments received from Post Corporation.

42 Consolidated FS-Intercompany Transactions41 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) The intercompany gross profit in Sage’s sale to Post in year 2001 is analyzed as follows: Selling Price Cost Gross Profit (25% of Cost; 20%Of Selling Price) Beginning inventories Add: Sales$120,000$96,000$24,000 Subtotals $120,000$96,000$24,000 Less: Ending inventories40,00032,0008,000 Cost of goods sold$80,00064,000$16,000

43 Consolidated FS-Intercompany Transactions42 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) n The following working paper elimination is required for Sage’s intercompany’s sales of merchandise to Post for the year ended 12/31/2001: (b) Intercompany Sales--Sage120,000 Intercompany Cost of Goods Sold—Sage96,000 Cost of Goods Sold—Post16,000 Inventories--Post8,000 To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories. (Income tax effects are disregarded.)

44 Consolidated FS-Intercompany Transactions43 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) n Entering the preceding eliminations in the working paper for consolidated financial statements results in the consolidated amounts shown below (amounts for total sales to outsiders and cost of goods sold are assumed):

45 Consolidated FS-Intercompany Transactions44 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) Income Statement Post Corp. Sage Company Eliminations Inc.(Dec.) Consolidated Revenue: Sales:5,800,0001,200,0007,000,000 Intercompany sales120,000(b)(120,000) Costs and expenses: Cost of goods sold4,100,000760,000(b) (16,000)4,844,000 Intercompany cost of goods sold96,000(b) (96,000) POST CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001

46 Consolidated FS-Intercompany Transactions45 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.) n Contd. Post Corp. Sage Company Eliminations Inc.(Dec.) Consolidated Balance Sheet Assets Intercompany rec.(pay.)(30,000)30,000 Inventories900,000475,000(b) (8,000)1,367,000

47 Consolidated FS-Intercompany Transactions46 Notes to the Intercompany Sales of Merchandise at a Mark Up by a Partially Own Subsidiary 1.The $8,000 unrealized intercompany profit is attributable to Sage (the seller, a partially-owned subsidiary). This unrealized intercompany profit should be taken into account in the computation of the minority interest in Sage’s net income for year 2001 (would be illustrated in Example 8.9).

48 Consolidated FS-Intercompany Transactions47 Notes to the Intercompany Sales of Merchandise at a Mark Up by a Partially Own Subsidiary (Contd.) 2.Also, this $8,000 would be entered into the Sage’s portion of consolidated retained earnings on 12/31/ If the intercompany sales of merchandise are made by a parent company or by a wholly owned subsidiary, the unrealized intercompany profit will not have any effect on any minority interest in net income. This is because the selling agent does not have minority stockholders.

49 Consolidated FS-Intercompany Transactions48 Intercompany (Unrealized) Profit in Beginning and Ending Inventories n It is assumed that, on a FIFO basis, the intercompany profit in the purchaser’s beginning inventories is realized through sales of the merchandise to outsiders during the following accounting period.

50 Consolidated FS-Intercompany Transactions49 Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) n Only the intercompany profit in ending inventories remains unrealized at the end of the period. n Continuing with Example 8.4, assume that Sage’s intercompany sales of merchandise to Post Corporation during the year ended 12/31/2002, are analyzed as follows:

51 Consolidated FS-Intercompany Transactions50 Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) Analysis of Gross Profit Selling Price Cost Gross Profit (25% of Cost; 20%Of Selling Price) Beginning inventories$40,000$32,000$8,000 Add: Sales150,000120,00030,000 Subtotals $190,000$152,000$38,000 Less: Ending inventories60,00048,00012,000 Cost of goods sold$130,000$104,000$26,000

52 Consolidated FS-Intercompany Transactions51 Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) n Sage’s intercompany sales ($120,000) and intercompany cost of goods sold ($96,000) for the year ended 12/31/2001 had been closed to Sage’s retained earnings at the end of Thus, from a consolidated point of view Sage’s 12/31/2001 retained earnings was overstated by $7,600 (95% * $8,000).

53 Consolidated FS-Intercompany Transactions52 Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) n The remaining $400 unrealized profit on 12/31/2001 is attributable to the minority interest in net assets of Sage. n The following working paper elimination would be prepared on 12/31/2002 to reflect the above facts:

54 Consolidated FS-Intercompany Transactions53 Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) (b) Retained Earnings—Sage ($8,000 x 0.95)* 7,600 Minority Interest in Net Assets of Subsidiary ($8,000 x 0.05) 400 Intercompany Sales--Sage150,000 Intercompany Cost of Goods Sold-Sage120,000 Cost of Goods Sold—Post26,000 Inventories—Post12,000 To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories. (Income tax effects are disregarded.) * As indicated in Chapter 7 (Page 29), this elimination is posted to the beginning-of-year retained earnings in the statement of retained earnings section of the working paper for consolidated financial statements.

55 Consolidated FS-Intercompany Transactions54 Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest n A general principle is that all the unrealized intercompany profit in the ending inventory of the buyer (i.e., a partially owned or wholly owner subsidiary or a parent), should be eliminated for the consolidated financial statement as long as the seller is either the parent or other wholly owned subsidiaries.

56 Consolidated FS-Intercompany Transactions55 Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) n On the other hand, when the seller is a partially owned subsidiary (either to its parent or to other subsidiaries), there is no general agreement regarding whether the unrealized intercompany profit in the ending inventory of the buyer (a parent or other subsidiaries) should be all eliminated.

57 Consolidated FS-Intercompany Transactions56 Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) n The argument is : The intercompany sale to the minority stockholder is considered as a sale to outsiders. Therefore the unrealized intercompany profit in the ending inventory attributes to minority stockholder’s interest should be treated as realized. It should not to be eliminated in the consolidated financial statements.

58 Consolidated FS-Intercompany Transactions57 Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) n The following table illustrates the types of intercompany sales and the related issues of the unrealized intercompany profit in the ending inventory:

59 Consolidated FS-Intercompany Transactions58 Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) Type Seller BuyerIssue Current Practice A Parent or wholly own Subsidiary Partially- own subsidiary Should all unrealized intercompany profit in the ending inventory of the buyer be eliminated? All unrealized intercompany profit in the ending inventory is eliminated B (as in Example 8.4) Partially- own a subsidiary Parent or subsidiary Should all unrealized intercompany profit in the ending inventory of the buyer be eliminated? Same as for type A due to FASB’s preference

60 Consolidated FS-Intercompany Transactions59 Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) Note to the above table: a.The unrealized intercompany profit is attributable to the seller (the partially- own sub.) and must be considered in the computation of the minority interest in net income of the partially own sub. of the year (see Example 8.4 and Example 8.9).

61 Consolidated FS-Intercompany Transactions60 Intercompany Sales of Plant Assets n Intercompany sales of plant assets differ from intercompany sales of merchandise in two ways: 1.Intercompany sales of plant assets between affiliated companies are rare transactions.

62 Consolidated FS-Intercompany Transactions61 Intercompany Sales of Plant Assets (Contd.) 2. Due to the long economic lives of plant assets, it requires many accounting periods before the intercompany gains (losses) on sales of these assets are realized in transactions with outsiders.

63 Consolidated FS-Intercompany Transactions62 Intercompany Gain on Sale of Land n Example 8.5: Assume that on 12/31/2001, Post (the parent company) sold to Sage (the partially owned subsidiary) a parcel of land costing $125,000 for $175,000. The two companies would record the following entries:

64 Consolidated FS-Intercompany Transactions63 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) Post Corporation Journal EntrySage Company Journal Entry Cash175,000Land175,000 Land125,000 Cash175,000 Intercompany Gain on Sale of Land50,000 To record acquisition of land from Post Corporation. To record sale of land to Sage Company

65 Consolidated FS-Intercompany Transactions64 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n In the consolidated financial statement, the land should be reported at the historical cost and the intercompany gain should be eliminated until it is realized (i.e., sold to an outsider by Sage).

66 Consolidated FS-Intercompany Transactions65 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n The working paper elimination prepared on 12/31/2001 for the intercompany sale of land with gain transaction is as follows: (c) Intercompany Gain on Sale of Land—Post 50,000 Land--Sage50,000 To eliminate unrealized intercompany gain on Sale of land. (Income Tax effects are disregarded.)

67 Consolidated FS-Intercompany Transactions66 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n The above working paper elimination is entered in the working paper for consolidated financial statements for the year ended 12/31/2001 as follows:

68 Consolidated FS-Intercompany Transactions67 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) POST CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Post Corp. Sage Company Eliminations Inc. (Dec.) Consolidated Income Statement Intercompany gain on sale of land50,000(c)(50,000) Balance Sheet Land (for building site)175,000(c)(50,000)125,000

69 Consolidated FS-Intercompany Transactions68 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n No journal entries affecting land would be made by Sage in the subsequent years due to land is not depreciable. n In the consolidated financial statements of subsequent years, the land should always be reported at the historical cost of $125,000 as long as it is not sold to an outsider.

70 Consolidated FS-Intercompany Transactions69 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n Therefore, the following working paper elimination applies to all subsequent years as long as Sage does not sell the land to an outsider: (c) Retained Earnings—Post50,000 Land—Sage50,000 To eliminate unrealized intercompany gain in land. (Income tax effects are disregarded.)

71 Consolidated FS-Intercompany Transactions70 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n Note: The foregoing working paper elimination has no effect on the minority interest in net income or net assets of the subsidiary, because the unrealized gain is attributable to the seller that is not a partially own subsidiary.

72 Consolidated FS-Intercompany Transactions71 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n Assume that, Sage sold the land to an outsider for $200,000 in the year ended 12/31/2003, the following entry would be recorded by Sage: Cash200,000 Land175,000 Gain on Sale of Land25,000 To record sale of land to an outsider.

73 Consolidated FS-Intercompany Transactions72 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.) n A realized gain of $75,000 ($25,000 + $50,000) should be reported on the consolidated financial statement of Thus, the following working paper elimination is needed: (c) Retained Earnings—Post50,000 Gain on Sale of Land— Post50,000 To recognize $50,000 gain on Post Corporation’s sale of land to Sage Company resulting from sale of land by Sage to an outsiders. (Income tax effects are disregarded.)

74 Consolidated FS-Intercompany Transactions73 Intercompany Gain on Sale of Depreciable Plant Asset n Assume that Sage (the partially owned subsidiary) sold machinery to Post (the parent) on 12/31/2001. Details of the sale and depreciation policy of the machinery are as follows:

75 Consolidated FS-Intercompany Transactions74 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) Selling price of machinery to Post Corp.$ 60,000 Cost of machinery to Sage Company when acquired Jan. 2,199950,000 Estimated residual value: To Sage Company, Jan.2,1999$ 4,000 To Post Corporation, Dec. 31,20014,000 Economic life: To Sage Company, Jan.2, years To Post Corporation, Dec. 31,20015 years Annual depreciation expense (straight- line method): To Sage Company ($46,000 x 0.10)$ 4,600 To Post Corporation($56,000 x 0.20)11,200

76 Consolidated FS-Intercompany Transactions75 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) Post Corp. Journal EntrySage Company Journal Entry Machinery60,000Cash60,000 Cash60,000Accumulated Depreciation ($4,600 x 3)13,800 Machinery50,000 To record acquisition of machinery from Sage Company. Intercompany Gain on Sale of Machinery23,800 To record sale of machinery to Post Corp.. n The two companies would account for the sale on 12/31/2001 as follows:

77 Consolidated FS-Intercompany Transactions76 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) n The following working paper elimination is required for the consolidated financial statements on 12/31/2001: (d) Intercompany Gain on Sale of Machinery—Sage 23,800 Machinery-Post23,800 To eliminate unrealized intercompany gain on sale of machinery.(Income tax effects are disregarded.)

78 Consolidated FS-Intercompany Transactions77 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) n The elimination results the machine to be reported on the consolidated financial statements at its carrying amount to Sage as follows: Cost of machinery to Post Corporation $ 60,000 Less:Amount of elimination— intercompany gain 23,800 Difference– equal to carrying amount $ 36,200

79 Consolidated FS-Intercompany Transactions78 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.) n Note: the elimination of the $23,800 gain should be taken into account in the minority interest in the net income of Sage (the seller) for year The $23,800 is also included in the Sage’s retained earnings, for consolidation purposes, on 12/31/2001 I (see textbook ).

80 Consolidated FS-Intercompany Transactions79 Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset n The following working paper elimination is required for the consolidated financial statements of 12/31/2002: (d) Retained Earnings—Sage ($23,800 x 0.95) 22,610 Minority Interest in Net Assets of Subsidiary ($23,800 x 0.05) 1,190 Accumulated Depreciation—Post4,760 Machinery—Post23,800 Depreciation Expense-Post4,760 To eliminate unrealized intercompany gain in machinery and in related depreciation.(Income tax effects are disregarded.) Gain element in straight- line depreciation computed as $23,800 x 0.2 = $4,760,based on five-year economic life.

81 Consolidated FS-Intercompany Transactions80 Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset (Contd.) n The elimination of the Post’s depreciation expense can also be verified as follows: Post’s annual straight-line depreciation expense [($60,000-$4,000) x 0.2] $ 11,200 Less:Straight-line depreciation expense for a five-year economic life, based on Sage’s carrying amount on date of sale [(36,200-$4,000) x 0.20] 6,440 Difference– equal to intercompany gain element in Post’s annual depreciation expense$ 4,760

82 Consolidated FS-Intercompany Transactions81 Intercompany Gain in Depreciation and Minority Interest n From the consolidation view point, the intercompany gain element of the acquiring affiliate’s annual depreciation expense represents a realization of a portion of the total intercompany gain by the selling affiliate.

83 Consolidated FS-Intercompany Transactions82 Intercompany Gain in Depreciation and Minority Interest (Contd.) n Thus the $4,760 credit to Post’s depreciation expense in the 12/31/2001 working paper elimination increases Sage’s net income for consolidated purposes. n This increase must be considered in the computation of the minority interest in the subsidiary’s net income for the year ended 12/31/2002.

84 Consolidated FS-Intercompany Transactions83 Intercompany Gain in later Years n The following working paper elimination is required for the consolidated financial statements on 12/31/2003: (d) Retained Earnings—Sage [($23,800-$4,760) x 0.95] 18,088 Minority Interest in Net Assets of Subsidiary [ ($23,800-$4,760) x 0.05] 952 Accumulated Depreciation—Post ($4,760 x 2) 9,520 Machinery—Post23,800 Depreciation Expense-Post4,760 To eliminate unrealized intercompany gain in machinery and in related depreciation.(Income tax effects are disregarded.)

85 Consolidated FS-Intercompany Transactions84 Intercompany Gain in later Years (Contd.) n Note to the working paper elimination: The sum of the debit amounts for retained earnings and minority interest in net assets of subsidiary is $4,760 less that that in n This is because $4,760 intercompany gain has been realized in 2002 through the depreciation process in 2002.

86 Consolidated FS-Intercompany Transactions85 Intercompany Gain in later Years (Contd.) n The sum of the debit amounts for retained earnings and minority interest in net assets represents the unrealized portion of the intercompany gain at the beginning of the year. n For each succeeding year, the unrealized position of the intercompany gain decreases (in the amount of $4,760), as indicated in the following summary of the working paper elimination debits for those years:

87 Consolidated FS-Intercompany Transactions86 Intercompany Gain in later Years (Contd.) POST CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations-Debits Only December 31,2004 though 2006 Year Ended Dec. 31, Debits (d)Retained earnings- Sage$13,566$ 9,044$ 4,522 Minority interest in net assets of subsidiary Accumulated depreciation-Post14,28019,04023,800

88 Consolidated FS-Intercompany Transactions87 Intercompany Gain in later Years (Contd.) n Similar working paper elimination will be prepared for year 2004,2005 and The changes are only in the debit accounts as indicated in the above table.

89 Consolidated FS-Intercompany Transactions88 Intercompany Gain in later Years (Contd.) n At the end of year 2006, the entire intercompany gain of $23,800 has been realized through Post’s annual depreciation expense. The following working paper elimination is required for the machine until it is sold: Accumulated Depreciation- Post 23,800 Machinery-Psot23,800 To eliminate intercompany gain in machinery and related accumulated depreciation.(Income tax effects are disregarded.)

90 Consolidated FS-Intercompany Transactions89 Intercompany Lease of Property under Capital/Sale-Type Lease n Land, building, machinery, equipment and other property may be transferred between affiliate entities in the form of a sales-type lease to the lessor and a capital lease to the lessee.

91 Consolidated FS-Intercompany Transactions90 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) n Example 8.6 : u Assume that Palm leased equipment to Starr (the wholly owned subsidiary) on 1/2/2001 under a sales-type lease requiring Starr to pay Palm $10,000 at beginning of each year starting 1/2/2001 through 2004, with a bargain purchase option of $1,000 payable on 1/2/2005.

92 Consolidated FS-Intercompany Transactions91 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) u Palm’s implicit interest rate, which was known to Starr and was less than Starr’s incremental borrowing rate, was 8%. u The economic life of the equipment to Starr was 6 years, with no residual value. u The cost of the leased equipment was $30,000. u There were no initial direct costs under the lease.

93 Consolidated FS-Intercompany Transactions92 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) n The present value of the minimum lease payment is computed as follows: Present value of $10,000 each year for four years at 8% ($10,000 x ) $ 35,711 Present value of $1,000 in four years at 8% (1,000 x ) 735 Palm Corporation’s net investment in the lease$ 36,506

94 Consolidated FS-Intercompany Transactions93 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) n Journal entries of Palm Corporation for Year 2001: 1/2 Intercompany Lease Receivables [($10,000 x 4)+$1,000] 41,000 Intercompany Cost of Goods Sold30,000 Intercompany Sales36,506 Unearned Intercompany Interest Revenue ($41,000-$36,506) 4,494 Inventories30,000 To record Sales-type lease with Starr Company at inception and cost of leased equipment.

95 Consolidated FS-Intercompany Transactions94 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) n Contd. 1/2Cash10,000 Intercompany Lease Receivable10,000 To record receipt of first payment on intercompany lease. 12/31 Unearned Intercompany Interest Revenue [(31,000-$4,494) x 0.08] 2,120 Intercompany Interest Revenue2,120 To recognize interest earned for first year of intercompany sales-type lease.

96 Consolidated FS-Intercompany Transactions95 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) n Journal entries of Starr Company for Year 2001: 1/2Lease Equipment-Capital Lease36,506 Intercompany Liability under Capital Lease (net)36,506 To record intercompany capital lease at inception. 1/2 Intercompany Liability under Capital Lease(net)10,000 Cash10,000 To record lease payment for first year of intercompany lease.

97 Consolidated FS-Intercompany Transactions96 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) n Contd. 12/31 Intercompany Interest Expense [($36,506-$10,000) x 0.08] 2,120 Intercompany Interest Payable2,120 To record accrued interest on intercompany lease obligation on 12/31/ /31 Depreciation Expense ($36,560/6) 6,084 Lease Equipment-Capital Lease6,084 To record depreciation expense (straight-line method) for first year of intercompany lease. (Six-year economic life of leased equipment is used because lease contains a bargain purchase option.)

98 Consolidated FS-Intercompany Transactions97 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) n The selected ledger accounts for both companies relative to the lease are as follows: PALM CORPORATION Intercompany Lease Receivable 01/02/0141,000 a 10,000 b 01/02/01 10,000 c 01/02/02 10,000 d 01/02/03 10,000 e 01/02/04 1,000 f 01/02/05 0 Bal on 01/02/05

99 Consolidated FS-Intercompany Transactions98 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) a. Inception of lease b. Receipt of first payment c. Receipt of second payment d. Receipt of third payment e. Receipt of fourth payment f. Receipt of purchase option

100 Consolidated FS-Intercompany Transactions99 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) Unearned Intercompany Interest Revenue 4,494 a 01/02/01 12/31/01 2,120 b Bal. 2,374 12/31/021,490 c Bal /31/03809 d Bal /31/0475 e Bal. 0 Bal on 12/31/04 0

101 Consolidated FS-Intercompany Transactions100 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) a. Inception of lease ($41,000 - $36,506) b. Interest for year [($31,000 - $4,494) x 0.08)] c. Interest for year [($21,000 - $2,374) x 0.08)] d. Interest for year [($11,000 - $884) x 0.08)] e. Interest for year [($1,000 - $75) x 0.08)]; Adjusted $1 for rounding.

102 Consolidated FS-Intercompany Transactions101 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) Intercompany Interest Revenue 2,120 a 12/31/01 2,120 b 1,490 c 12/31/02 1,490 d 809 e 12/31/ f 75 g 12/31/04 75 h Bal on 12/31/04 0

103 Consolidated FS-Intercompany Transactions102 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) a. Interest for Year 2001 b. Closing entry c. Interest for Year 2002 d. Closing entry e. Interest for Year 2003 f. Closing entry g. Interest for Year 2004;Adjusted $ 1 for rounding. h. Closing entry

104 Consolidated FS-Intercompany Transactions103 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) STARR COMPANY Leased Equipment—Capital Lease 01/02/0136,506 a 6,084 b 12/31/01 6,084 c 12/31/02 6,084 d 12/31/03 6,084 e 12/31/04 6,085 f 12/31/05 6,085 g 12/31/06 0 Bal on 01/02/06

105 Consolidated FS-Intercompany Transactions104 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) a. Capital lease at Inception b. Depreciation for Year 2001 c. Depreciation for Year 2002 d. Depreciation for Year 2003 e. Depreciation for Year 2004 f. Depreciation for Year 2001;Adjusted $1 for rounding. g. Depreciation for Year 2001;Adjusted $1 for rounding.

106 Consolidated FS-Intercompany Transactions105 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) Intercompany Liability under Capital Lease 36,506 a 01/02/01 10,000 b Bal. 26,506 01/02/027,880 c Bal. 18,626 01/02/038,510 d Bal. 10,116 01/02/049,191 e Bal /02/05925 f Bal. 0 Bal on 01/02/05 0

107 Consolidated FS-Intercompany Transactions106 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) a. Capital lease at inception b. First lease payment c. ($10,000-$2,120 interest) d. ($10,000-$1,490 interest) e. ($10,000-$890 interest) f. ($10,000-$75 interest)

108 Consolidated FS-Intercompany Transactions107 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) Intercompany Interest Expense 12/31/012,120 a 2,120 b 12/31/01 12/31/021,490 c 1,490 d 12/31/02 12/31/03809 e 809 f 12/31/03 12/31/0475 g 75 h 12/31/04 0 Bal on 12/31/04

109 Consolidated FS-Intercompany Transactions108 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) a. ($26,506 x 0.08) b. Closing entry c. ($18,626 x 0.08) d. Closing entry e. ($10,116 x 0.08) f. Closing entry g. ($925 x 0.08); Adjusted $ 1 for rounding. h. Closing entry

110 Consolidated FS-Intercompany Transactions109 Intercompany Lease of Property under Capital/Sale- Type Lease (Contd.) Example 8.6: (Contd.) Depreciation Expense 12/31/016,084 a 6,084 b 12/31/01 12/31/026,084 c 6,084 d 12/31/02 12/31/036,084 e 6,084 f 12/31/03 12/31/046,084 g 6,084 h 12/31/04 12/31/056,085 i 6,085 j 12/31/05 12/31/066,085 k 6,085 l 12/31/06 0Bal on 12/31/06

111 Consolidated FS-Intercompany Transactions110 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) a. ($36,506/6) b. Closing entry c. ($36,506/6) d. Closing entry e. ($36,506/6) f. Closing entry g. ($36,506/6) h. Closing entry i. ($36,506/6); Adjusted $1 for rounding. j. Closing entry k. ($36,506/6);Adjusted $1 for rounding. l. Closing entry

112 Consolidated FS-Intercompany Transactions111 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) n Partial working paper eliminations (in journal entry format) for the consolidated financial statements for year 2001 and year 2002 are as follows (note: intercompany interest revenue and intercompany interest expense are self-eliminated on the same line of the income statement section of the working paper for consolidated financial statements):

113 Consolidated FS-Intercompany Transactions112 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2001 (b) Intercompany Liability under Capital Lease-Starr26,506 Intercompany Interest Payable-Starr2,120 Unearned Intercompany Interest Revenue- Palm2,374 Intercompany Sales-Palm36,506 Intercompany Cost of Goods Sold-Palm30,000 Intercompany Lease Receivables-Palm31,000 Leased Equipment-Capital Lease-Starr ($36,506-$30,000-$1,084) 5,422 Depreciation Expense-Starr [($36,506-$30,000)/6] 1,084 To eliminate intercompany accounts assciated with intercompany lease and to defer unrealized portion of intercompany gross profit on sales-type lease.(Income tax effects are disregarded.)

114 Consolidated FS-Intercompany Transactions113 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2002 (b) Intercompany Liability under Capital Lease- Starr18,626 Intercompany Interest Payable-Starr1,490 Unearned Intercompany Interest Revenue- Palm884 Retained Earnings-Palm [($36,506-$30,000)-$1,084] 5,422 Intercompany Lease Receivables-Palm21,000 Leased Equipment-Capital Lease-Starr ($5,422-$1,084) 4,388 Depreciation Expense-Starr1,084 To eliminate intercompany accounts assciated with intercompany lease and to defer unrealized portion of intercompany gross profit on sales-type lease.(Income tax effects are disregarded.)

115 Consolidated FS-Intercompany Transactions114 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) n Note: u The elimination of 12/31/2001 removes the parent company’s intercompany sale and cost of goods sold. u The subsidiary’s depreciation expense of $1,084 for 2001 represents the realization of a portion of the parent’s gross profit margin on the intercompany sale.

116 Consolidated FS-Intercompany Transactions115 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) u In Year 2002 elimination, the original $6,506 unrealized gross profit element in the subsidiary’s leased equipment has been reduced by $1,084 (the reduction of the subsidiary’s year 2001 depreciation expense).

117 Consolidated FS-Intercompany Transactions116 Intercompany Sales of Intangible Assets n The working paper eliminations for intercompany gains on sales of intangible assets are similar to those for intercompany gains in depreciable plant assets, except that no accumulated amortization is involved.

118 Consolidated FS-Intercompany Transactions117 Intercompany Sales of Intangible Assets(Contd.) Example 8.7: n On 1/2/2002 Palm sold a patent to its wholly own subsidiary,Starr, for $40,000. The carrying amount of this patent for Palm is $32,000. n The patent had a remaining economic life of 4 years on 1/2/2002 and was amortized by the straight-line method. n The working paper elimination for year 2002 and year 2003 related to this intercompany transaction is as follows:

119 Consolidated FS-Intercompany Transactions118 Intercompany Sales of Intangible Assets(Contd.) Example 8.7: (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2002 (c) Intercompany Gain on Sale of Patent--Palm ($40,000- $32,000) 8,000 Amortization Expense— Starr($8,000/4)2,000 Patent-Starr ($8,000-2,000) 6,000 To eliminate unrealized intercompany gain in patent and related amortization.(Income tax effects are disregarded.)

120 Consolidated FS-Intercompany Transactions119 Intercompany Sales of Intangible Assets(Contd.) Example 8.7: (Contd.) PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations December 31, 2003 (c) Retained Earnings--Palm ($8,000-$2,000) 6,000 Amortization Expense— Starr ($8,000/4) 2,000 Patent-Starr ($6,000-$2,000) 4,000 To eliminate unrealized intercompany gain in patent and related amortization.(Income tax effects are disregarded.)

121 Consolidated FS-Intercompany Transactions120 Acquisition of Affiliate’s Bonds in An Open Market n Intercompany gains and losses may be realized by the consolidated entity when one affiliate acquires outstanding bonds of another affiliate in the open market. n No realized or unrealized gain or loss would result from the direct acquisition of one affiliate’s bonds by another affiliate.

122 Consolidated FS-Intercompany Transactions121 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) n Example 8.8: Assume that on 1/2/2001, Sage (the partially owned subsidiary) issued to the public $500,000 face account of 10% bonds due 1/1/2006. The effective interest rate (market yield rate) is 12%. Interest was payable annually on 1/1.

123 Consolidated FS-Intercompany Transactions122 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n The net proceeds of the bond issue to Sage were $463,952, computed as follows (bond issue costs are disregarded): Present value of $500,000 in five years at 12%, with interest paid annually ($500,000 x ) $ 283,713 Add: Present value of $50,000 each year for five years at 12% ($50,000 x ) 180,239 Proceeds of bond issue$ 463,952

124 Consolidated FS-Intercompany Transactions123 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n The following entries were recorded by Sage for year 2001 regarding the issuance of the bond and the accrued interest:

125 Consolidated FS-Intercompany Transactions124 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n 2001 Sage Company Journal Entries 1/2 Cash463,952 Discount on Bonds Payable36,048 Bonds Payable 500,000 To record issuance of 10% bonds due Jan. 1, 2006, at a discount to yield 12%. 12/31 Interest Expense ($463,952 x 0.12) 55,674 Interest Payable ($500,000 x 0.10) 50,000 Discount on Bonds Payable5,674 To record accrual of annual interest on 10% bonds.

126 Consolidated FS-Intercompany Transactions125 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n Assume that on 12/31/2001, Post (the parent company) had cash available for investment. n The effective interest rate at the time is 15%. Thus, Sage’s bonds can be purchased in the open market at a substantial discount. n Post acquired 60% of Sage’s bonds on 12/31/2001 at $257,175 plus $30,000 accrued interest.

127 Consolidated FS-Intercompany Transactions126 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n The acquisition cost of 60% of Sage’s bonds is computed as follows: Present value of $300,000 in four years at 15%, with interest paid annually ($300,000 x ) $ 171,526 Add: Present value of $30,000 each year for four years at 15% ($30,000 x ) 85,649 Cost to Post Corporation of $300,000 face amount of bonds$ 257,175

128 Consolidated FS-Intercompany Transactions127 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n Post prepared the following journal entry on 12/31/2001 to record the acquisition of Sage’s bonds: Investment in Sage Company Bonds257,175 Intercompany Interest Receivable30,000 Cash 287,175 To record acquisition of $300,000 face amount of Sage Company’s 10% bonds due Jan. 1, 2006, and accrued interest for one year.

129 Consolidated FS-Intercompany Transactions128 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n The following entry is prepared by Sage (the bond issuer) on 12/31/2001 when notified by the parent company of this acquisition: Bonds Payable300,000 Discount on Intercompany Bonds Payable ($30,374 x 0.6) 18,224 Interest Payable ($50,000 x 0.6) 30,000 Intercompany Bonds Payable300,000 Discount on Bonds Payable18,224 Intercompany Interest Payable 30,000 To transfer to intercompany accounts all amounts attributable to bonds acquired by parent company in open market.

130 Consolidated FS-Intercompany Transactions129 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n From the viewpoint of the consolidated entity, Post’s acquisition of Sage’s bonds is equivalent to the extinguishment of the bonds at a realized gain of $24,601, computed as follows: Carrying amount of Sage Company’s bonds acquired by Post Corporation on Dec.31,2001 ($300,000 –18,224) $ 281,776 Less: Cost of Post Corporation’s investment257,175 Realized gain on extinguishment of bonds$ 24,601

131 Consolidated FS-Intercompany Transactions130 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) n The $24,601 realized gain is not recorded in the accounting records of either the parent company or the subsidiary. n However, it is recognized in the working paper elimination (in journal entry format) on 12/31/2001, shown as follows:

132 Consolidated FS-Intercompany Transactions131 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) POST CORPORATION AND SUBSIDIARY Partial Working Paper Elimination December 31,2001 (e) Intercompany Bonds Payable— Sage 300,000 Discount on Intercompany Bonds Payable-Sage18,224 Investment in Sage Company Bonds-Post257,175 Gain on Extinguishment of Bonds-Sage24,601 To eliminate subsidiary’s bonds acquired by parent and to recognize gain on the extinguishment of the bonds.(Income tax effects are disregarded.)

133 Consolidated FS-Intercompany Transactions132 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) n Notes to the partial working paper elimination: 1.The intercompany interest receivable -- Post ($30,000) and intercompany interest payable-Sage ($30,000) are offset in the working paper elimination.

134 Consolidated FS-Intercompany Transactions133 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) 2.The gain is attributes to Sage – the bond issuer (the subsidiary). This treatment assumes that parent’s open market acquisition of the subsidiary’s bonds was, in substance, the extinguishment of the bonds by the subsidiary.

135 Consolidated FS-Intercompany Transactions134 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) 3.The gain is included in the consolidated income statement of Post and subsidiary for the year ended 12/31/2001. If the gain is material, it is displayed as an extraordinary item.

136 Consolidated FS-Intercompany Transactions135 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Minority interest in Gain on Extinguishemtn of Bonds n Since the gain is attributed to the partially owned subsidiary, the gain should be considered in the computation of the minority interest in the subsidiary’s net income for the year ended 12/31/2001.

137 Consolidated FS-Intercompany Transactions136 Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Minority interest in Gain on Extinguishemtn of Bonds(Contd.) n This gain is also included in the subsidiary’s retained earnings to be included in the consolidated retained earnings on 12/31/2001. n See Example 8.9 for example.

138 Consolidated FS-Intercompany Transactions137 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years n In the following four years, the realized gain which is unrecorded by either affiliate on the date of acquisition,is reported by the consolidated entity through the differences in the two affiliates’ interest expense and the interest revenue.

139 Consolidated FS-Intercompany Transactions138 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) n The accounting for the bond interest by the two affiliates for the year ended 12/31/2002 and related ledger accounts for four remaining years for both companies are as follows:

140 Consolidated FS-Intercompany Transactions139 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) n 2002 Post Corporation Journal Entries 1/2Cash30,000 Intercompany Interest Receivable 30,000 To record receipt of accrued interest on Sage Company’s 10% bonds. 12/31 Intercompany Interest Receivable30,000 Investment in Sage Company Bonds8,576 Intercompany Interest Revenue38,576 To accrue annual interest on Sage Company’s 10% bonds ($257,175 x 0.15 =$38,576).

141 Consolidated FS-Intercompany Transactions140 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) n 2002 Sage Company Journal Entries 1/2Intercompany Interest Payable30,000 Interest Payable20,000 Cash 50,000 To record payment of accrued interest on 10% bonds. 12/31Intercompany Interest Expense33,813 Interest Expense22,542 Intercompany Interest Payable30,000 Interest Payable20,000 Discount on Intercompany Bonds Payable3,813 Discount on Bonds Payable2,542 To accrue annual interest on 10% bonds. Interest is computed as follows: Intercompany ($300,000-$18,224) x 0.12= $33,813 Other ($200,000- $12,150) x 0.12= $22,542

142 Consolidated FS-Intercompany Transactions141 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) POST CORPORATION Investment in Sage Company Bonds 12/31/01257,175 a 12/31/02 8,576 b 12/31/039,863 c 12/31/0411,342 d 12/31/0513,044 e Bal on 12/31/05 300,000

143 Consolidated FS-Intercompany Transactions142 a.Acquisition of $300,000 face amount of bonds b.Accumulation of discount ($38,576-$ 30,000) c.Accumulation of discount ($39,863-$30,000) d.Accumulation of discount ($41,342-$30,000) e.Accumulation of discount ($43,044-$30,000) Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

144 Consolidated FS-Intercompany Transactions143 Intercompany Interest Revenue 38,576 a 12/31/02 38,576 b 39,863 c 12/31/03 39,863 d 41,342 e 12/31/04 41,342 f 43,044 g 12/31/05 43,044 h Bal on 12/31/05 0 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

145 Consolidated FS-Intercompany Transactions144 a.($257,175 x 0.15) b.Closing entry c.($265,751 x 0.15) d.Closing entry e.($275,614 x 0.15) f. Closing entry g.($286,956 x 0.15),Adjusted $ 1 for rounding. h. Closing entry Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

146 Consolidated FS-Intercompany Transactions145 Sage Company Intercompany Bonds Payable 300,000 a 12/31/01 300,000 Bal on 12/31/01 a. Bonds acquired by parent company Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

147 Consolidated FS-Intercompany Transactions146 Discount on Intercompany Bonds Payable 12/31/0118,224 a 3,813 b 12/31/02 4,271 c 12/31/03 4,783 d 12/31/04 5,357 e 12/31/05 0 Bal on 12/31/05 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

148 Consolidated FS-Intercompany Transactions147 a.Bonds acquired by parent company b.Amortization ($33,813-$30,000) c.Amortization ($34,271-$30,000) d.Amortization ($34,783-$30,000) e.Amortization ($35,357-$30,000) Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

149 Consolidated FS-Intercompany Transactions148 Intercompany Interest Expense 12/31/0233,813 a 33,813 b 12/31/02 12/31/0334,271 c 34,271 d 12/31/03 12/31/0434,783 e 34,783 f 12/31/04 12/31/0535,357 g 35,357 h 12/31/05 0 Bal on 12/31/05 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

150 Consolidated FS-Intercompany Transactions149 a.[($300,000-$18,224) x 0.12] b.Closing entry c.[($300,000-$14,411) x 0.12] d.Closing entry e.[($300,000-$10,140) x 0.12] f. Closing entry g.[($300,000-$5,357) x 0.12] h. Closing entry Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

151 Consolidated FS-Intercompany Transactions150 n A summary of the differences between the intercompany interest revenue – Post and intercompany interest expense – Sage is as follows: Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

152 Consolidated FS-Intercompany Transactions151 Year Ended Dec. 31, Post Corporation’s Intercompany Interest Revenue Sage Company’s Intercompany Interest Expense Difference- Representing Recording of Realized Gain 2002$ 38,576$ 33,813$ 4, ,86334,2715, ,34234,7836, ,04435,3577,687 Totals$ 162,825$138,224$ 24,601 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

153 Consolidated FS-Intercompany Transactions152 n Notes to the above summary table: 1.Although the acquisition gain is not recognized by either affiliate at acquisition, the gain is recognized by the consolidated entities in the following four years through the differences in the intercompany interest revenue – Post and the intercompany interest expense – Sage. Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

154 Consolidated FS-Intercompany Transactions153 2.The total of differences between parent’s intercompany interest revenue and subsidiary intercompany interest expense is equal to the realized gain on parent’s acquisition of subsidiary’s bonds. Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)

155 Consolidated FS-Intercompany Transactions154 Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) n The working paper elimination for the bonds and interest on 12/31/2002 is as follows: (e)Intercompany Interest Revenue-Post38,576 Intercompany Bonds Payable-Sage300,000 Discount on Intercompany Bonds Payable- Sage14,411 Investment in Sage Company Bonds- Post265,751 Intercompany Interest Expense-Sage33,813 Retained Earnings-Sage ($24,601 x 0.95) 23,371 Minority Interest in Net Assets of Subsidiary ($24,601 x 0.05) 1,230 To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.)

156 Consolidated FS-Intercompany Transactions155 Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) (Contd.) n Note to the above working paper elimination: The foregoing working paper elimination reduces the consolidated income (before minority interest) by $4,796 (the difference between the intercompany interest revenue and intercompany interest expense for year 2002).

157 Consolidated FS-Intercompany Transactions156 Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) (Contd.) n Note (contd.): n This is because the entire gain of $24,601 had been recognized in the consolidated income statement of year n This is evident by the credit of retained earnings and the minority interest in net assets of subsidiary of $23,371 and $1,230, respectively. n If the gain of $4,796 is not eliminated, the consolidated income of year 2002 will be overstated by $4,796.

158 Consolidated FS-Intercompany Transactions157 Working paper elimination on 12/31/2002 n Similar working paper elimination for years 2004 and 2005 would be prepared. Assume that Sage paid the bonds in full on maturity 1/2/2006. Therefore, no further working paper eliminations for the bonds would be required.

159 Consolidated FS-Intercompany Transactions158 Working paper elimination on 12/31/2002 (Contd.) n The working paper elimination on 12/31/2003 is as follows: (e)Intercompany Interest Revenue-Post39,863 Intercompany Bonds Payable-Sage300,000 Discount on Intercompany Bonds Payable- Sage10,140 Investment in Sage Company Bonds- Post275,614 Intercompany Interest Expense-Sage34,271 Retained Earnings-Sage [($24,601-$4,763) x 0.95] 18,846 Minority Interest in Net Assets of Subsidiary [($24,601-$4,763) x 0.05] 992 To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.)

160 Consolidated FS-Intercompany Transactions159 Effect of Intercompany Profits on Minority Interest in Net Income n The following working paper eliminations for Post and its 95%-owned subsidiary (Sage) are taken from p138and p139 of chapter 7, and from pages 42,65,76, and 131of this chapter. n These eliminations are followed by a revised elimination (which differs from the one on p150 of chapter 7) for minority interest in net income of subsidiary.

161 Consolidated FS-Intercompany Transactions160 Intercompany Profits on Minority Interest in Net Income (contd.) POST CORPORATION AND SUBSIDIARY Working Paper Eliminations December 31, 2001 (a)Common Stock –Sage400,000 Additional Paid-in Capital-Sage235,000 Retained Earnings-Sage ($384,000-$4,750) 379,250 Retained Earnings of Subsidiary-Post4,750 Intercompany Investment Income-Post81,700 Plant Assets(net)-Sage ($176,000-$14,000) 162,000 Leasehold(net)-Sage ($25,000-$5,000) 20,000 Goodwill (net)-Post ($37,050-$950) 36,100 Cost of Goods Sold-Sage17,000 Operating Expenses-Sage2,000

162 Consolidated FS-Intercompany Transactions161 Intercompany Profits on Minority Interest in Net Income (contd.) n Contd. Investment in Sage Company Common Stock-Post1,229,300 Dividends Declared-Sage50,000 Minority Interest in Net Assets of Subsidiary ($61,000 - $2,500) 58,500

163 Consolidated FS-Intercompany Transactions162 Intercompany Profits on Minority Interest in Net Income (contd.) n The above working paper elimination (a) is to carry out the following: (1) Eliminate intercompany investment and equity accounts of subsidiary at the beginning of year,and subsidiary dividends. (2) Provide for Year 2001 depreciation and amortization on differences between current fair values and carrying amounts of Sage's identifiable net assets as follows:

164 Consolidated FS-Intercompany Transactions163 Intercompany Profits on Minority Interest in Net Income (contd.) Cost of Goods Sold Operating Expenses Building depreciation$ 2,000 Machinery depreciation10,000 Leasehold amortization5,000$ 2,000 Totals$ 17,000$ 2,000

165 Consolidated FS-Intercompany Transactions164 Intercompany Profits on Minority Interest in Net Income (contd.) (3) Allocate unamortized differences between combination date current fair values and carrying amounts to appropriate assets. (4) Establish minority interest in net assets of subsidiary at beginning of year ($61,000), less minority interest in dividends declared by subsidiary during year ($50,000 x 0.05=$2,500). (Income tax effects are disregarded.)

166 Consolidated FS-Intercompany Transactions165 Intercompany Profits on Minority Interest in Net Income (contd.) (b)Intercompany Sales-Sage120,000 Intercompany Cost of Goods Sold-Sage96,000 Cost of Goods Sold- Post16,000 Inventories-Post8,000 To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.)

167 Consolidated FS-Intercompany Transactions166 Intercompany Profits on Minority Interest in Net Income (contd.) (c)Intercompany Gain on Sale of Land- Post50,000 Land-Sage50,000 To eliminate unrealized intercompany gain on sale of land.(Income tax effects are disregarded.) (d)Intercompany Gain on Sale of Machinery- Sage23,800 Machinery-Post23,800 To eliminate unrealized intercompany gain on sale of machinery.(Income tax effects are disregarded.)

168 Consolidated FS-Intercompany Transactions167 Intercompany Profits on Minority Interest in Net Income (contd.) (e)Intercompany Bonds Payable -Sage300,000 Discount on Intercompany Bonds Payable-Sage18,224 Investment in Sage Company Bonds- Post257,175 Gain on Extinguishment of Bonds-Sage 24,601 To eliminate subsidiary’s bonds acquired by parent, and to recognize gain on the extinguishments of the bonds.(Income tax effects are disregarded.)

169 Consolidated FS-Intercompany Transactions168 Intercompany Profits on Minority Interest in Net Income (contd.) (f)Minority Interest in Net Income of subsidiary3,940 Minority Interest in Net Assets of Subsidiary3,940 To establish minority interest in subsidiary’s adjusted net incomes for Year 2001 as follows: Net income of subsidiary$ 105,000 Adjustments for working paper eliminations: (a) ($17,000+$2,000)(19,000) (b)(8,000) (d)(23,800) (e)24,601 Adjusted net income of subsidiary$ 78,801 Minority interest share ($78,801 x 0.05)$ 3,940

170 Consolidated FS-Intercompany Transactions169 Working Paper for Consolidated Financial Statements (for Year 2001) n The following is a partial working paper for Post Corporation and subsidiary for the year ended 12/31/2001. n The amounts for Post and Sage are the same as those on p145,146 of Chapter 7.

171 Consolidated FS-Intercompany Transactions170 Working Paper for Consolidated Financial Statements (contd.) Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Statement of Retained Earnings Post Corp.Sage Company Elimination Inc. (Dec.) Consolidated Retained earnings, beginning of year1,348,500384,000(a)(379,250)1,353,250 Net income352,600105,000(161,839)*295,761 Subtotals1,701,000489,000(541,089)1,649,011 Dividends declared158,55050,000(a)(50,000)†158,550 Retained earnings, end of year1,542,550439,000(491,089)1,490,461

172 Consolidated FS-Intercompany Transactions171 Working Paper for Consolidated Financial Statements (contd.) n Contd. Balance Sheet / Liabilities & Stockholders’ Equity Post Corp. Sage Company Elimination Inc. (Dec.) Consolidated Minority interest in net assets of subsidiary (a) 58,500 (f) 3,940 62,440 Total liabilitiesx,xxx,xxxxxx,xxx62,440x,xxx,xxx Common stock, $ 1 par1,057,000 Common stock, $ 10 par400,000(a) (400,000) Additional paid-in capital1,560,250235,000(a) (235,000)1,560,250 Retained earnings1,542,550439,000(491,089)1,490,461 Retained earnings of subsidiary4,750(a) (4,750) Total stockholder’s equity4,164,5501,074,000(1,130,839) Total liabilities & stockholders equityx,xxx,xxx (1,068,399)x,xxx,xxx Net decrease in revenue ( and gains): $81,700 + $120,000 + $50,000 + $23,800 - $24,601$250,899 Less: Net decrease in costs and expenses: $96,000 + $16,000 -$19,000 - $3,940 89,060 Decrease in combined net incomes to compute consolidated net income$161,839 # A decrease in dividends and an increase in retained earnings

173 Consolidated FS-Intercompany Transactions172 Working Paper for Consolidated Financial Statements(contd.) n The foregoing working paper indicates that when intercompany profits exist, consolidated net income is not the same as the parent company's net income n The consolidated retained earnings are not the same as the total of the parent company's two retained earnings amounts.

174 Consolidated FS-Intercompany Transactions173 Working Paper for Consolidated Financial Statements ( for Year 2002) n Continued with the example of Post and its subsidiary (Sage), the followings are selected Post's t-accounts(investment in Sage, retained earnings) and Sage's t-account of retained earnings. n Review of these accounts will help in understanding the working paper for consolidated financial statements of Year 2002.

175 Consolidated FS-Intercompany Transactions174 Working Paper for Consolidated Financial Statements ( for Year 2002)(cont.) POST CORPORATION Investment in Sage Company Common Stock 12/31/991,192,250 a 38,000 b 11/24/00 12/31/0085,500 c 42,750 d 12/31/ e 12/31/00 47,500 f 11/22/01 12/31/0199,750 g 18,050 h 12/31/ i 12/31/01 57,000 j 11/25/02 12/31/02109,250 k l 12/31/ m 12/31/02 Bal on 2/31/02 1,262,550

176 Consolidated FS-Intercompany Transactions175 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.) a.Total cost of business combination b.Dividend declared by Sage c.Net income of Sage d.Amortization of differences e.Amortization of goodwill f. Dividend declared by Sage g.Net income of Sage h.Amortization of differences i.Amortization of goodwill j. Dividend declared by Sage k.Net income of Sage l.Amortization of differences m. Amortization of goodwill

177 Consolidated FS-Intercompany Transactions176 Retained Earnings 1,050,000 a 12/31/99 457,050 b 12/31/00 158,550 c 318,400 d 12/31/01 158,550 e 1,508,350 Bal on 12/31/01 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

178 Consolidated FS-Intercompany Transactions177 a.Balance b.Close net income available for dividends c.Close Dividends Declared account d. Close net income available for dividends e.Close Dividends Declared account Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

179 Consolidated FS-Intercompany Transactions178 Retained Earnings of Subsidiary 4,750 a 12/31/00 34,200 b 12/31/01 38,950 Bal on 12/31/01 a.Close net income not available for dividends b.Close net income not available for dividends Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

180 Consolidated FS-Intercompany Transactions179 SAGE COMPANY Retained Earnings 334,000 a 12/31/99 90,000 b 12/31/00 40,000 c 105,000 d 12/31/01 50,000 e 439,000 Bal on 12/31/01 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

181 Consolidated FS-Intercompany Transactions180 a.Balance b.Close net income c.Close Dividends Declared account d. Close net income e.Close Dividends Declared account Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

182 Consolidated FS-Intercompany Transactions181 The following is the working paper for consolidated financial statements for year 2002 of Post and its 95%-partially owned subsidiary: Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

183 Consolidated FS-Intercompany Transactions182 POST CORPORATION AND SUBSIDIARY Working paper for Consolidated Financial Statements For Year Ended December 31, 2002 Income Statement Post Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Revenue: Net Sales 5,900,0001,400,0007,300,000 Intercompany sales 150,000(b)(150,000) Intercompany interest revenue 38,576(e) (38,576) Intercompany investment income 91,200(a) (91,200) Intercompany revenue(expenses) 14,000(14,000) Total revenue 6,043,7761,536,000(279,776)7,300,000 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

184 Consolidated FS-Intercompany Transactions183 n Contd. Income Statement (contd.) Post Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Costs and expenses: (a) 17,000 (b) (26,000) Cost of goods sold 4,300,000950,000(d) (4,760)5,236,240 Intercompany cost of goods sold 120,000(b)(120,000) Operating expenses 986,058217,978(a) 2,0001,206,036 Intercompany interest expense 33,813(e) (33,813) Interest expense 51,51822,54274,060 Income taxes expense 246,00076,667322,667 Minority interest in net income of subsidiary (f) 4,6004,600 Total costs and expenses 5,583,5761,421,000*(160,973)6,843,603 Net income 460,200115,000(118,803)456,397 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

185 Consolidated FS-Intercompany Transactions184 n Contd. Statement of Retained Earnings Post Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Retained earnings, beginning of year 1,508,350439,000 (a) (400,050) (b) (7,600) (c) (50,000) (d) (22,610) (e) 23,371 1,490,461 Net income 460,200115,000(118,803)456,397 Subtotal 1,968,550554,000(575,692)1,946,858 Dividends declared 158,55060,000(a) (60,000)*158,550 Retained earnings, end of year 1,810,000494,000(515,692)1,788,308 * A decrease in dividends and an increase in retained earnings. Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

186 Consolidated FS-Intercompany Transactions185 n Contd. Balance Sheet/AssetsPost Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Intercomapny receivables (payables) (3,500)3,500 Inventories 950,000500,000(b) (12,000)1,438,000 Other current assets 760,000428,9921,188,992 Investment in Sage Company stock 1,262,550(a)(1,262,550) Investment in Sage Company bonds 265,751 (e) (265,751) (a) 148,000 Plant assets (net) 3,700,0001,300,000(d) (19,040)5,128,960 Land(for building site) 175,000(c) (50,000)125,000 Leasehold (net) (a) 15,00015,000 Goodwill (net) 85,000(a) 35,150120,150 Total assets 7,019,8012,407,492(1,411,191)8,016,102 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

187 Consolidated FS-Intercompany Transactions186 n Contd. Balance Sheet/AssetsPost Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Intercomapny receivables (payables) (3,500)3,500 Inventories 950,000500,000(b) (12,000)1,438,000 Other current assets 760,000428,9921,188,992 Investment in Sage Company stock 1,262,550(a)(1,262,550) Investment in Sage Company bonds 265,751 (e) (265,751) (a) 148,000 Plant assets (net) 3,700,0001,300,000(d) (19,040)5,128,960 Land(for building site) 175,000(c) (50,000)125,000 Leasehold (net) (a) 15,00015,000 Goodwill (net) 85,000(a) 35,150120,150 Total assets 7,019,8012,407,492(1,411,191)8,016,102 Working Paper for Consolidated Financial Statements ( for Year 2002) (cont.)

188 Consolidated FS-Intercompany Transactions187 Working Paper Elimination (for year 2002) POST CORPORATION AND SUBSIDIARY Working Paper Eliminations December 31, 2002 (a)Common Stock-Sage400,000 Additional Paid-in Capital-Sage235,000 Retained Earnings-Sage ($439,000-$38,950) 400,050 Retained Earnings of Subsidiary-Post38,950 Intercompany Investment Income-Post91,200 Plant Assets(net)-Sage ($162,000-$14,000) 148,000 Leasehold(net)-Sage ($20,000-$5,000) 15,000 Goodwill (net)-Post ($36,100-$950) 35,150 Cost of Goods Sold-Sage17,000 Operating Expenses-Sage2,000

189 Consolidated FS-Intercompany Transactions188 Working Paper Elimination (for year 2002) (contd.) n Contd. Investment in Sage Company Common Stock-Post1,262,550 Dividends Declared-Sage60,000 Minority Interest in Net Assets of Subsidiary59,800

190 Consolidated FS-Intercompany Transactions189 n The above elimination is to carry out the following: (1) Eliminate intercompany investment and equity accounts of subsidiary at beginning of year,and subsidiary dividends. (2) Provide for Year 2002 depreciation and amortization on differences between current fair values and carrying amounts of Sage's identifiable net assets as follows: Working Paper Elimination (for year 2002) (contd.)

191 Consolidated FS-Intercompany Transactions190 Cost of Goods Sold Operating Expenses Building depreciation$ 2,000 Machinery depreciation10,000 Leasehold amortization5,000$ 2,000 Totals$ 17,000$ 2,000 Working Paper Elimination (for year 2002) (contd.)

192 Consolidated FS-Intercompany Transactions191 (3) Allocate unamortized differences between combination date current fair values and carrying amounts to appropriate assets. (4) Establish minority interest in net assets of subsidiary at beginning of year,excluding intercompany profits effects ($62,800), less minority interest in dividendsdeclared by subsidiary during year ($60,000 x 0.05 = $3,000). (Income tax effects are disregarded.) Working Paper Elimination (for year 2002) (contd.)

193 Consolidated FS-Intercompany Transactions192 (b) Retained earnings-Sage76,000 Minority Interest in Net Assets of Subsidiary400 Intercompany Sales-Sage150,000 Intercompany Cost of Goods Sold-Sage120,000 Cost of Goods Sold- Post26,000 Inventories-Post12,000 To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.) Working Paper Elimination (for year 2002) (contd.)

194 Consolidated FS-Intercompany Transactions193 (c)Retained Earnings- Post50,000 Land-Sage50,000 To eliminate unrealized intercompany gain in land.(Income tax effects are disregarded.) (d)Retained Earnings-Sage22,610 Minority Interest in Net Assets of Subsidiary1,190 Accumulated Depreciation-Post4,760 Machinery- Post23,800 Depreciation Expense- Post4,760 To eliminate unrealized intercompany gain in machinery and in related depreciation (Income tax effects are disregarded.) Working Paper Elimination (for year 2002) (contd.)

195 Consolidated FS-Intercompany Transactions194 (e) Intercompany Interest Revenue- Post 38,576 Intercompany Bonds Payable- Sage300,000 Discount on Intercompany Bonds Payable-Sage14,411 Investment in Sage Company Bonds-Post265,715 Intercompany Interest Expense-Sage33,813 Retained Earnings- Sage23,371 Minority Interest in Net Assets of Subsidiary1,230 To eliminate subsidiary’s bonds owned by parent company, and related interest revenue and expense; and to increase subsidiary’s beginning retained earnings by amount of unamortized realized gain on the extinguishments of the bonds.(Income tax effects are disregarded.) Working Paper Elimination (for year 2002) (contd.)

196 Consolidated FS-Intercompany Transactions195 (f)Minority Interest in Net Income of Subsidiary4,600 Minority Interest in Net Assets of Subsidiary4,600 To establish minority interest in subsidiary’s adjusted net income for Year 2002 as follows: Net income of subsidiary$ 115,000 Adjustments for working paper eliminations: (a) ($17,000+$2,000)(19,000) (b) ($150,000-$120,000-$26,000)(4,000) (d) Depreciation expense reduced4,760 (e) ($38,576-$33,813)(4,763) Adjusted net income of subsidiary$ 91,997 Minority interest share ($91,997 x 0.05)$ 4,600 Working Paper Elimination (for year 2002) (contd.)


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