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Consolidated Financial statements: Intercompany Transactions

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1 Consolidated Financial statements: Intercompany Transactions
Chapter 8 Consolidated Financial statements: Intercompany Transactions

2 Objectives of the Chapter
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; Consolidated FS-Intercompany Transactions

3 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). Consolidated FS-Intercompany Transactions

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

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

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

7 Consolidated FS-Intercompany Transactions
I. Accounting for Intercompany Transactions Not Involving Profit (Gain) or Loss (Contd.) 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. Consolidated FS-Intercompany Transactions

8 Consolidated FS-Intercompany Transactions
Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) 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, 2001 6 10 $10,000 Apr.1, 2001 15,000 Sept.1, 2001 21,000 Nov.1, 2001 24,000 Consolidated FS-Intercompany Transactions

9 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.)
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 2001 02/01 10,000 08/01 04/01 15,000 10/01 09/01 21,000 11/01 24,000 Bal on 11/01 45,000 STARR COMPANY Intercompany Notes Payable 2001 08/01 10,000 02/01 10/01 15,000 04/01 21,000 09/01 24,000 11/01 45,000 Bal on 11/01 Consolidated FS-Intercompany Transactions

10 Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.)
Intercompany Interest Receivable 2001 12/31 1,100 Intercompany Interest Payable 2001 1,100 12/31 Intercompany Interest Revenue 2001 500 08/01 750 10/01 1,100 12/31 2,350 Bal on 12/31 Intercompany Interest Expense 2001 08/01 500 10/01 750 12/31 1,100 Bal on 12/31 2,350 Consolidated FS-Intercompany Transactions

11 Consolidated FS-Intercompany Transactions
Example 8.1: Intercompany Loans from Palm (the parent company) to Starr (the subsidiary) (Contd.) 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: Consolidated FS-Intercompany Transactions

12 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 rec. (pay.) 46,100* (46,100) *45,000 + $1,100 = $46,100 Consolidated FS-Intercompany Transactions

13 Discounting of Intercompany Notes
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. Therefore, discounted intercompany notes are not eliminated in the working paper. Consolidated FS-Intercompany Transactions

14 Example 8.2: Discounting of Intercompany Notes
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 ,940 Interest Expense ($1,260 discount – 1,000*) 260 Intercompany Notes Receivable 24,000 Intercompany Interest Revenue ($24,000 x 0.10 x 1/12) Consolidated FS-Intercompany Transactions

15 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. Consolidated FS-Intercompany Transactions

16 Example 8.2: Discounting of Intercompany Notes (Contd.)
Palm should inform Starr of the discounting. Starr would prepare the following journal entry on 12/1/2001: Intercompany Notes Payable 24,000 Intercompany Interest Expense 200 Notes Payable Interest Payable To transfer 10%, six-month note payable to Palm Corporation dated Nov. 1, 2001, from intercompany notes to outsider notes. Consolidated FS-Intercompany Transactions

17 Example 8.2: Discounting of Intercompany Notes (Contd.)
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: Consolidated FS-Intercompany Transactions

18 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 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. Consolidated FS-Intercompany Transactions

19 Leases of Property under Operating Leases
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. Consolidated FS-Intercompany Transactions

20 Leases of Property under Operating Leases (Contd.)
For an intercompany operating lease, there is no profit or loss involved. 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. Consolidated FS-Intercompany Transactions

21 Consolidated FS-Intercompany Transactions
Rendering of Services 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). Consolidated FS-Intercompany Transactions

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

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

24 Consolidated FS-Intercompany Transactions
II. Accounting for Intercompany Transactions Involving Profit (Gain) or Loss 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. Consolidated FS-Intercompany Transactions

25 Consolidated FS-Intercompany Transactions
The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses 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. Consolidated FS-Intercompany Transactions

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

27 Intercompany Sales of Merchandise
Types of Sales Downstream intercompany sales Upstream intercompany sales Lateral intercompany sales Consolidated FS-Intercompany Transactions

28 Intercompany Sales of Merchandise (Contd.)
a. Intercompany Sales at Cost Example 8.3: Intercompany sale at cost 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. The ending inventories of Starr on 12/31/2001 included $25,000 of merchandise obtained form Palm. Consolidated FS-Intercompany Transactions

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

30 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)
Palm Corporation Journal Entries Intercompany Accounts Receivable 150,000 Intercompany Sales To record sales to Starr Company Intercompany Cost of Goods Sold Inventories To record cost of goods sold to Satrr Company. Cash 135,000 To record payments received from Starr Company Consolidated FS-Intercompany Transactions

31 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)
Starr Company Journal Entries Inventories 150,000 Intercompany Accounts Payable To record purchases from Palm Corporation. Intercompany Accounts Payable 135,000 Cash To record payments made to Palm Corporation. Trade Accounts Receivable 160,000 Sales To record sales. Cost of Goods Sold 125,000 To record cost of goods sold. Consolidated FS-Intercompany Transactions

32 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)
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): Consolidated FS-Intercompany Transactions

33 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 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. Consolidated FS-Intercompany Transactions

34 Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)
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. Consolidated FS-Intercompany Transactions

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

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

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

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

39 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.)
Post Company Journal Entries Inventories 120,000 Intercompany Accounts Payable To record purchases from Sage. Intercompany Accounts Payable 90,000 Cash To record payments made to Sage Company. Trade Accounts Receivable 100,000 Sales To record sales. Cost of Goods Sold 80,000 To record cost of goods sold. Consolidated FS-Intercompany Transactions

40 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.)
Sage Corporation Journal Entries Intercompany Accounts Receivable 120,000 Intercompany Sales To record sales to Post Corporation Intercompany Cost of Goods Sold 96,000 Inventories To record cost of goods sold to Post Corporation. Cash 90,000 To record payments received from Post Corporation. Consolidated FS-Intercompany Transactions

41 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 Less: Ending inventories 40,000 32,000 8,000 Cost of goods sold $80,000 64,000 $16,000 Consolidated FS-Intercompany Transactions

42 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.)
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--Sage 120,000 Intercompany Cost of Goods Sold—Sage 96,000 Cost of Goods Sold—Post 16,000 Inventories--Post 8,000 To eliminate intercompany sales, cost of goods sold, and unrealized intercompany profit in inventories. (Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

43 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.)
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): Consolidated FS-Intercompany Transactions

44 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.)
POST CORPORATION AND SUBSIDIARY Partial Working Paper for Consolidated Financial Statements For Year Ended December 31, 2001 Income Statement Post Corp. Sage Company Eliminations Inc.(Dec.) Consolidated Revenue: Sales: 5,800,000 1,200,000 7,000,000 Intercompany sales 120,000 (b)(120,000) Costs and expenses: Cost of goods sold 4,100,000 760,000 (b) (16,000) 4,844,000 cost of goods 96,000 (b) (96,000) Consolidated FS-Intercompany Transactions

45 Intercompany Sales of Merchandise (Contd.) Example 8.4 : (Contd.)
Post Corp. Sage Company Eliminations Inc.(Dec.) Consolidated Balance Sheet Assets Intercompany rec.(pay.) (30,000) 30,000 Inventories 900,000 475,000 (b) (8,000) 1,367,000 Consolidated FS-Intercompany Transactions

46 Consolidated FS-Intercompany Transactions
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). Consolidated FS-Intercompany Transactions

47 Consolidated FS-Intercompany Transactions
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 12/31/2001. 3.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. Consolidated FS-Intercompany Transactions

48 Intercompany (Unrealized) Profit in Beginning and Ending Inventories
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. Consolidated FS-Intercompany Transactions

49 Consolidated FS-Intercompany Transactions
Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) Only the intercompany profit in ending inventories remains unrealized at the end of the period. 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: Consolidated FS-Intercompany Transactions

50 Analysis of Gross Profit
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: Sales 150,000 120,000 30,000 Subtotals $190,000 $152,000 $38,000 Less: Ending inventories 60,000 48,000 12,000 Cost of goods sold $130,000 $104,000 $26,000 Consolidated FS-Intercompany Transactions

51 Consolidated FS-Intercompany Transactions
Intercompany (Unrealized) Profit in Beginning and Ending Inventories(contd.) 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 2001. Thus, from a consolidated point of view Sage’s 12/31/2001 retained earnings was overstated by $7,600 (95% * $8,000). Consolidated FS-Intercompany Transactions

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

53 Consolidated FS-Intercompany Transactions
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--Sage 150,000 Intercompany Cost of Goods Sold-Sage 120,000 Cost of Goods Sold—Post 26,000 Inventories—Post 12,000 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. Consolidated FS-Intercompany Transactions

54 Consolidated FS-Intercompany Transactions
Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest 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. Consolidated FS-Intercompany Transactions

55 Consolidated FS-Intercompany Transactions
Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) 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. Consolidated FS-Intercompany Transactions

56 Consolidated FS-Intercompany Transactions
Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) 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. Consolidated FS-Intercompany Transactions

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

58 Consolidated FS-Intercompany Transactions
Issues in Intercompany Profit in Ending Inventories and Amount of Minority Interest (Contd.) Type Seller Buyer Issue 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-owna subsidiary Parent or subsidiary Same as for type A due to FASB’s preference Consolidated FS-Intercompany Transactions

59 Consolidated FS-Intercompany Transactions
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). Consolidated FS-Intercompany Transactions

60 Intercompany Sales of Plant Assets
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. Consolidated FS-Intercompany Transactions

61 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. Consolidated FS-Intercompany Transactions

62 Intercompany Gain on Sale of Land
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: Consolidated FS-Intercompany Transactions

63 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
Post Corporation Journal Entry Sage Company Journal Entry Cash 175,000 Land 125,000 Intercompany Gain on Sale of Land 50,000 To record acquisition of land from Post Corporation. To record sale of land to Sage Company Consolidated FS-Intercompany Transactions

64 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
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). Consolidated FS-Intercompany Transactions

65 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
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--Sage To eliminate unrealized intercompany gain on Sale of land. (Income Tax effects are disregarded.) Consolidated FS-Intercompany Transactions

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

67 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 land 50,000 (c)(50,000) Balance Sheet Land (for building site) 175,000 125,000 Consolidated FS-Intercompany Transactions

68 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
No journal entries affecting land would be made by Sage in the subsequent years due to land is not depreciable. 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. Consolidated FS-Intercompany Transactions

69 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
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—Post 50,000 Land—Sage To eliminate unrealized intercompany gain in land. (Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

70 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
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. Consolidated FS-Intercompany Transactions

71 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
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: Cash 200,000 Land 175,000 Gain on Sale of Land 25,000 To record sale of land to an outsider. Consolidated FS-Intercompany Transactions

72 Intercompany Gain on Sale of Land (Contd.) Example 8.5: (Contd.)
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—Post 50,000 Gain on Sale of Land— Post 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.) Consolidated FS-Intercompany Transactions

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

74 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. 2,1999 50,000 Estimated residual value: To Sage Company, Jan.2,1999 $ 4,000 To Post Corporation, Dec. 31,2001 4,000 Economic life: 10 years 5 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 Consolidated FS-Intercompany Transactions

75 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)
The two companies would account for the sale on 12/31/2001 as follows: Post Corp. Journal Entry Sage Company Journal Entry Machinery 60,000 Cash Accumulated Depreciation ($4,600 x 3) 13,800 50,000 To record acquisition of machinery from Sage Company. Intercompany Gain on Sale of Machinery 23,800 To record sale of machinery to Post Corp.. Consolidated FS-Intercompany Transactions

76 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)
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-Post To eliminate unrealized intercompany gain on sale of machinery.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

77 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)
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 Consolidated FS-Intercompany Transactions

78 Intercompany Gain on Sale of Depreciable Plant Asset (Contd.)
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 ). Consolidated FS-Intercompany Transactions

79 Consolidated FS-Intercompany Transactions
Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset 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—Post 4,760 Machinery—Post 23,800 Depreciation Expense-Post 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. Consolidated FS-Intercompany Transactions

80 Consolidated FS-Intercompany Transactions
Intercompany Gain subsequent to Date of Sale of Depreciable Plant Asset (Contd.) 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 Consolidated FS-Intercompany Transactions

81 Intercompany Gain in Depreciation and Minority Interest
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 . Consolidated FS-Intercompany Transactions

82 Intercompany Gain in Depreciation and Minority Interest (Contd.)
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. 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. Consolidated FS-Intercompany Transactions

83 Intercompany Gain in later Years
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—Post 23,800 Depreciation Expense-Post 4,760 To eliminate unrealized intercompany gain in machinery and in related depreciation.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

84 Intercompany Gain in later Years (Contd.)
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 2002. This is because $4,760 intercompany gain has been realized in 2002 through the depreciation process in 2002. Consolidated FS-Intercompany Transactions

85 Intercompany Gain in later Years (Contd.)
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. 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: Consolidated FS-Intercompany Transactions

86 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, 2004 2005 2006 Debits (d)Retained earnings- Sage $13,566 $ 9,044 $ 4,522 Minority interest in net assets of subsidiary 714 476 238 Accumulated depreciation-Post 14,280 19,040 23,800 Consolidated FS-Intercompany Transactions

87 Intercompany Gain in later Years (Contd.)
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. Consolidated FS-Intercompany Transactions

88 Intercompany Gain in later Years (Contd.)
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-Psot To eliminate intercompany gain in machinery and related accumulated depreciation.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

89 Intercompany Lease of Property under Capital/Sale-Type Lease
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. Consolidated FS-Intercompany Transactions

90 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)
Example 8.6 : 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. Consolidated FS-Intercompany Transactions

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

92 Consolidated FS-Intercompany Transactions
Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) 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 Consolidated FS-Intercompany Transactions

93 Consolidated FS-Intercompany Transactions
Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) 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 Sold 30,000 Intercompany Sales 36,506 Unearned Intercompany Interest Revenue ($41,000-$36,506) 4,494 Inventories To record Sales-type lease with Starr Company at inception and cost of leased equipment. Consolidated FS-Intercompany Transactions

94 Consolidated FS-Intercompany Transactions
Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) Contd. 1/2 Cash 10,000 Intercompany Lease Receivable 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 Revenue To recognize interest earned for first year of intercompany sales-type lease. Consolidated FS-Intercompany Transactions

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

96 Consolidated FS-Intercompany Transactions
Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) Contd. 12/31 Intercompany Interest Expense [($36,506-$10,000) x 0.08] 2,120 Intercompany Interest Payable To record accrued interest on intercompany lease obligation on 12/31/2001. Depreciation Expense ($36,560/6) 6,084 Lease Equipment-Capital Lease 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.) Consolidated FS-Intercompany Transactions

97 Intercompany Lease Receivable
Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) The selected ledger accounts for both companies relative to the lease are as follows: PALM CORPORATION Intercompany Lease Receivable 01/02/01 41,000a 10,000b 10,000c 01/02/02 10,000d 01/02/03 10,000e 01/02/04 1,000f 01/02/05 Bal on 01/02/05 Consolidated FS-Intercompany Transactions

98 Consolidated FS-Intercompany Transactions
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 Consolidated FS-Intercompany Transactions

99 Unearned Intercompany Interest Revenue
4/8/2017 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 12/31/02 1,490 c Bal 12/31/03 809 d Bal 12/31/04 75 e Bal Bal on 12/31/04 Consolidated FS-Intercompany Transactions

100 Consolidated FS-Intercompany Transactions
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. Consolidated FS-Intercompany Transactions

101 Intercompany Interest Revenue
4/8/2017 Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) Intercompany Interest Revenue 2,120a 12/31/01 2,120b 1,490c 12/31/02 1,490d 809e 12/31/03 809f 75g 12/31/04 75h Bal on 12/31/04 Consolidated FS-Intercompany Transactions

102 Consolidated FS-Intercompany Transactions
4/8/2017 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 Consolidated FS-Intercompany Transactions

103 Leased Equipment—Capital Lease
Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) STARR COMPANY Leased Equipment—Capital Lease 01/02/01 36,506a 6,084b 12/31/01 6,084c 12/31/02 6,084d 12/31/03 6,084e 12/31/04 6,085 f 12/31/05 6,085g 12/31/06 Bal on 01/02/06 Consolidated FS-Intercompany Transactions

104 Consolidated FS-Intercompany Transactions
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. Consolidated FS-Intercompany Transactions

105 Intercompany Liability under Capital Lease
4/8/2017 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 10,000b Bal. 26,506 01/02/02 7,880c Bal. 18,626 01/02/03 8,510d Bal. 10,116 01/02/04 9,191e Bal 01/02/05 925f Bal Bal on 01/02/05 Consolidated FS-Intercompany Transactions

106 Consolidated FS-Intercompany Transactions
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) Consolidated FS-Intercompany Transactions

107 Intercompany Interest Expense
4/8/2017 Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) Intercompany Interest Expense 12/31/01 2,120a 2,120b 12/31/02 1,490c 1,490d 12/31/03 809e 809f 12/31/04 75g 75h Bal on 12/31/04 Consolidated FS-Intercompany Transactions

108 Consolidated FS-Intercompany Transactions
4/8/2017 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 Consolidated FS-Intercompany Transactions

109 Consolidated FS-Intercompany Transactions
4/8/2017 Intercompany Lease of Property under Capital/Sale Type Lease (Contd.) Example 8.6: (Contd.) Depreciation Expense 12/31/01 6,084a 6,084b 12/31/02 6,084c 6,084d 12/31/03 6,084e 6,084 f 12/31/04 6,084g 6,084h 12/31/05 6,085i 6,085 j 12/31/06 6,085k 6,085 l Bal on 12/31/06 Consolidated FS-Intercompany Transactions

110 Consolidated FS-Intercompany Transactions
4/8/2017 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 Consolidated FS-Intercompany Transactions

111 Consolidated FS-Intercompany Transactions
4/8/2017 Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) 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): Consolidated FS-Intercompany Transactions

112 PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations
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-Starr 26,506 Intercompany Interest Payable-Starr 2,120 Unearned Intercompany Interest Revenue- Palm 2,374 Intercompany Sales-Palm 36,506 Intercompany Cost of Goods Sold-Palm 30,000 Intercompany Lease Receivables-Palm 31,000 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.) Consolidated FS-Intercompany Transactions

113 PALM CORPORATION AND SUBSIDIARY Partial Working Paper Eliminations
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- Starr 18,626 Intercompany Interest Payable-Starr 1,490 Unearned Intercompany Interest Revenue- Palm 884 Retained Earnings-Palm [($36,506-$30,000)-$1,084] 5,422 Intercompany Lease Receivables-Palm 21,000 Leased Equipment-Capital Lease-Starr ($5,422-$1,084) 4,388 Depreciation Expense-Starr 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.) Consolidated FS-Intercompany Transactions

114 Consolidated FS-Intercompany Transactions
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) Note: The elimination of 12/31/2001 removes the parent company’s intercompany sale and cost of goods sold. 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. Consolidated FS-Intercompany Transactions

115 Consolidated FS-Intercompany Transactions
Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.) Example 8.6: (Contd.) 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). Consolidated FS-Intercompany Transactions

116 Intercompany Sales of Intangible Assets
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. Consolidated FS-Intercompany Transactions

117 Intercompany Sales of Intangible Assets(Contd.) Example 8.7:
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. The patent had a remaining economic life of 4 years on 1/2/2002 and was amortized by the straight-line method. The working paper elimination for year 2002 and year 2003 related to this intercompany transaction is as follows: Consolidated FS-Intercompany Transactions

118 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.) Consolidated FS-Intercompany Transactions

119 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.) Consolidated FS-Intercompany Transactions

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

121 Acquisition of Affiliate’s Bonds in An Open Market (Contd.)
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. Consolidated FS-Intercompany Transactions

122 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) 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 Consolidated FS-Intercompany Transactions

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

124 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) 2001 Sage Company Journal Entries 1/2 Cash 463,952 Discount on Bonds Payable 36,048 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 Payable 5,674 To record accrual of annual interest on 10% bonds. Consolidated FS-Intercompany Transactions

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

126 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) 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 Consolidated FS-Intercompany Transactions

127 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) Post prepared the following journal entry on 12/31/2001 to record the acquisition of Sage’s bonds: Investment in Sage Company Bonds 257,175 Intercompany Interest Receivable 30,000 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. Consolidated FS-Intercompany Transactions

128 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) The following entry is prepared by Sage (the bond issuer) on 12/31/2001 when notified by the parent company of this acquisition: Bonds Payable 300,000 Discount on Intercompany Bonds Payable ($30,374 x 0.6) 18,224 Interest Payable ($50,000 x 0.6) 30,000 Intercompany Bonds Payable Discount on Bonds Payable Intercompany Interest Payable To transfer to intercompany accounts all amounts attributable to bonds acquired by parent company in open market. Consolidated FS-Intercompany Transactions

129 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Example 8.8: (Contd.) 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 investment 257,175 Realized gain on extinguishment of bonds $ 24,601 Consolidated FS-Intercompany Transactions

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

131 POST CORPORATION AND SUBSIDIARY Partial Working Paper Elimination
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-Sage 18,224 Investment in Sage Company Bonds-Post 257,175 Gain on Extinguishment of Bonds-Sage 24,601 To eliminate subsidiary’s bonds acquired by parent and to recognize gain on the extinguishment of the bonds.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

132 Acquisition of Affiliate’s Bonds in An Open Market (Contd.)
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. Consolidated FS-Intercompany Transactions

133 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. Consolidated FS-Intercompany Transactions

134 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. Consolidated FS-Intercompany Transactions

135 Consolidated FS-Intercompany Transactions
Acquisition of Affiliate’s Bonds in An Open Market (Contd.) Minority interest in Gain on Extinguishemtn of Bonds 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. Consolidated FS-Intercompany Transactions

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

137 Consolidated FS-Intercompany Transactions
Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years 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. Consolidated FS-Intercompany Transactions

138 Consolidated FS-Intercompany Transactions
Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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: Consolidated FS-Intercompany Transactions

139 Consolidated FS-Intercompany Transactions
Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 2002 Post Corporation Journal Entries 1/2 Cash 30,000 Intercompany Interest Receivable To record receipt of accrued interest on Sage Company’s 10% bonds. 12/31 Investment in Sage Company Bonds 8,576 Revenue 38,576 To accrue annual interest on Sage Company’s 10% bonds ($257,175 x 0.15 =$38,576). Consolidated FS-Intercompany Transactions

140 Consolidated FS-Intercompany Transactions
Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 2002 Sage Company Journal Entries 1/2 Intercompany Interest Payable 30,000 Interest Payable 20,000 Cash 50,000 To record payment of accrued interest on 10% bonds. 12/31 Intercompany Interest Expense 33,813 Interest Expense 22,542 Intercompany Interest Payable Discount on Intercompany Bonds Payable 3,813 Discount on Bonds Payable 2,542 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 Consolidated FS-Intercompany Transactions

141 Investment in Sage Company Bonds
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) POST CORPORATION Investment in Sage Company Bonds 12/31/01 257,175 a 12/31/02 8,576 b 12/31/03 9,863 c 12/31/04 11,342 d 12/31/05 13,044 e Bal on 12/31/05 300,000 Consolidated FS-Intercompany Transactions

142 Consolidated FS-Intercompany Transactions
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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) Consolidated FS-Intercompany Transactions

143 Intercompany Interest Revenue
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) Intercompany Interest Revenue 38,576a 12/31/02 38,576b 39,863c 12/31/03 39,863d 41,342e 12/31/04 41,342f 43,044g 12/31/05 43,044h Bal on 12/31/05 Consolidated FS-Intercompany Transactions

144 Consolidated FS-Intercompany Transactions
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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 Consolidated FS-Intercompany Transactions

145 Intercompany Bonds Payable
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) Sage Company Intercompany Bonds Payable 300,000a 12/31/01 300,000 Bal on 12/31/01 a. Bonds acquired by parent company Consolidated FS-Intercompany Transactions

146 Discount on Intercompany Bonds Payable
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) Discount on Intercompany Bonds Payable 12/31/01 18,224a 3,813b 12/31/02 4,271c 12/31/03 4,783d 12/31/04 5,357e 12/31/05 Bal on 12/31/05 Consolidated FS-Intercompany Transactions

147 Consolidated FS-Intercompany Transactions
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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) Consolidated FS-Intercompany Transactions

148 Intercompany Interest Expense
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) Intercompany Interest Expense 12/31/02 33,813a 33,813b 12/31/03 34,271c 34,271d 12/31/04 34,783e 34,783f 12/31/05 35,357g 35,357h Bal on 12/31/05 Consolidated FS-Intercompany Transactions

149 Consolidated FS-Intercompany Transactions
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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 Consolidated FS-Intercompany Transactions

150 Consolidated FS-Intercompany Transactions
4/8/2017 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) A summary of the differences between the intercompany interest revenue – Post and intercompany interest expense – Sage is as follows: Consolidated FS-Intercompany Transactions

151 Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.)
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 $ 4,763 2003 39,863 34,271 5,592 2004 41,342 34,783 6,559 2005 43,044 35,357 7,687 Totals $ 162,825 $138,224 $ 24,601 Consolidated FS-Intercompany Transactions

152 Consolidated FS-Intercompany Transactions
Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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. Consolidated FS-Intercompany Transactions

153 Consolidated FS-Intercompany Transactions
Accounting for Gain (from Acquisition of Affiliate’s Bonds) in Subsequent Years (Contd.) 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. Consolidated FS-Intercompany Transactions

154 Consolidated FS-Intercompany Transactions
Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) The working paper elimination for the bonds and interest on 12/31/2002 is as follows: (e)Intercompany Interest Revenue-Post 38,576 Intercompany Bonds Payable-Sage 300,000 Discount on Intercompany Bonds Payable- Sage 14,411 Investment in Sage Company Bonds- Post 265,751 Intercompany Interest Expense-Sage 33,813 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.) Consolidated FS-Intercompany Transactions

155 Consolidated FS-Intercompany Transactions
Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) (Contd.) 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). Consolidated FS-Intercompany Transactions

156 Consolidated FS-Intercompany Transactions
Working Paper Elimination on 12/31/2002 (One Year Subsequently to Acquisition of Bonds) (Contd.) Note (contd.): This is because the entire gain of $24,601 had been recognized in the consolidated income statement of year 2001. 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. If the gain of $4,796 is not eliminated, the consolidated income of year 2002 will be overstated by $4,796. Consolidated FS-Intercompany Transactions

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

158 Working paper elimination on 12/31/2002 (Contd.)
The working paper elimination on 12/31/2003 is as follows: (e)Intercompany Interest Revenue-Post 39,863 Intercompany Bonds Payable-Sage 300,000 Discount on Intercompany Bonds Payable- Sage 10,140 Investment in Sage Company Bonds- Post 275,614 Intercompany Interest Expense-Sage 34,271 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.) Consolidated FS-Intercompany Transactions

159 Effect of Intercompany Profits on Minority Interest in Net Income
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. 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. Consolidated FS-Intercompany Transactions

160 Intercompany Profits on Minority Interest in Net Income (contd.)
POST CORPORATION AND SUBSIDIARY Working Paper Eliminations December 31, 2001 (a)Common Stock –Sage 400,000 Additional Paid-in Capital-Sage 235,000 Retained Earnings-Sage($384,000-$4,750) 379,250 Retained Earnings of Subsidiary-Post 4,750 Intercompany Investment Income-Post 81,700 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-Sage 17,000 Operating Expenses-Sage 2,000 Consolidated FS-Intercompany Transactions

161 Intercompany Profits on Minority Interest in Net Income (contd.)
Investment in Sage Company Common Stock-Post 1,229,300 Dividends Declared-Sage 50,000 Minority Interest in Net Assets of Subsidiary ($61,000 - $2,500) 58,500 Consolidated FS-Intercompany Transactions

162 Intercompany Profits on Minority Interest in Net Income (contd.)
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: Consolidated FS-Intercompany Transactions

163 Intercompany Profits on Minority Interest in Net Income (contd.)
Cost of Goods Sold Operating Expenses Building depreciation $ 2,000 $ 2,000 Machinery depreciation 10,000 Leasehold amortization 5,000 Totals $ 17,000 Consolidated FS-Intercompany Transactions

164 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.) Consolidated FS-Intercompany Transactions

165 Intercompany Profits on Minority Interest in Net Income (contd.)
(b)Intercompany Sales-Sage 120,000 Intercompany Cost of Goods Sold-Sage 96,000 Cost of Goods Sold- Post 16,000 Inventories-Post 8,000 To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

166 Intercompany Profits on Minority Interest in Net Income (contd.)
(c)Intercompany Gain on Sale of Land- Post 50,000 Land-Sage To eliminate unrealized intercompany gain on sale of land.(Income tax effects are disregarded.) (d)Intercompany Gain on Sale of Machinery- Sage 23,800 Machinery-Post To eliminate unrealized intercompany gain on sale of machinery.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

167 Intercompany Profits on Minority Interest in Net Income (contd.)
(e)Intercompany Bonds Payable -Sage 300,000 Discount on Intercompany Bonds Payable-Sage 18,224 Investment in Sage Company Bonds- Post 257,175 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.) Consolidated FS-Intercompany Transactions

168 Intercompany Profits on Minority Interest in Net Income (contd.)
(f)Minority Interest in Net Income of subsidiary 3,940 Minority Interest in Net Assets of Subsidiary 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 Consolidated FS-Intercompany Transactions

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

170 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 year 1,348,500 384,000 (a)(379,250) 1,353,250 Net income 352,600 105,000 (161,839)* 295,761 Subtotals 1,701,000 489,000 (541,089) 1,649,011 Dividends declared 158,550 50,000 (a)(50,000)† Retained earnings, end of year 1,542,550 439,000 (491,089) 1,490,461 Consolidated FS-Intercompany Transactions

171 Working Paper for Consolidated Financial Statements (contd.)
Balance Sheet / Liabilities & Stockholders’ Equity Post Corp. Sage Company Elimination Inc. (Dec.) Consolidated Minority interest in net assets of subsidiary (a) ,500 (f) ,940 62,440 Total liabilities x,xxx,xxx xxx,xxx Common stock, $ 1 par 1,057,000 Common stock, $ 10 par 400,000 (a) (400,000) Additional paid-in capital 1,560,250 235,000 (a) (235,000) Retained earnings 1,542,550 439,000 (491,089) 1,490,461 Retained earnings of subsidiary 4,750 (a) (4,750) Total stockholder’s equity 4,164,550 1,074,000 (1,130,839) Total liabilities & stockholders equity (1,068,399) 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, ,060 Decrease in combined net incomes to compute consolidated net income $161,839 # A decrease in dividends and an increase in retained earnings Consolidated FS-Intercompany Transactions

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

173 Working Paper for Consolidated Financial Statements( for Year 2002)
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. Review of these accounts will help in understanding the working paper for consolidated financial statements of Year 2002. Consolidated FS-Intercompany Transactions

174 Investment in Sage Company Common Stock
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002)(cont.) POST CORPORATION Investment in Sage Company Common Stock 12/31/99 1,192,250a 38,000b 11/24/00 12/31/00 85,500c 42,750d 950e 47,500f 11/22/01 12/31/01 99,750g 18,050h 950i 57,000j 11/25/02 12/31/02 109,250k 18.050l 950m Bal on 2/31/02 1,262,550 Consolidated FS-Intercompany Transactions

175 Consolidated FS-Intercompany Transactions
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 Consolidated FS-Intercompany Transactions

176 Consolidated FS-Intercompany Transactions
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) Retained Earnings 1,050,000a 12/31/99 457,050b 12/31/00 158,550 c 318,400d 12/31/01 158,550 e 1,508,350 Bal on 12/31/01 Consolidated FS-Intercompany Transactions

177 Consolidated FS-Intercompany Transactions
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) 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 Consolidated FS-Intercompany Transactions

178 Retained Earnings of Subsidiary
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) Retained Earnings of Subsidiary 4,750a 12/31/00 34,200b 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 Consolidated FS-Intercompany Transactions

179 Consolidated FS-Intercompany Transactions
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) SAGE COMPANY Retained Earnings 334,000a 12/31/99 90,000b 12/31/00 40,000 c 105,000d 12/31/01 50,000 e 439,000 Bal on 12/31/01 Consolidated FS-Intercompany Transactions

180 Consolidated FS-Intercompany Transactions
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) a.Balance b.Close net income c.Close Dividends Declared account d. Close net income e.Close Dividends Declared account Consolidated FS-Intercompany Transactions

181 Consolidated FS-Intercompany Transactions
4/8/2017 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) The following is the working paper for consolidated financial statements for year 2002 of Post and its 95%-partially owned subsidiary: Consolidated FS-Intercompany Transactions

182 Working Paper for Consolidated Financial Statements( for Year 2002) (cont.)
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 5,900,000 1,400,000 7,300,000 Intercompany sales 150,000 (b)(150,000) Intercompany interest revenue 38,576 (e) (38,576) investment income 91,200 (a) (91,200) revenue(expenses) 14,000 (14,000) Total revenue 6,043,776 1,536,000 (279,776) Consolidated FS-Intercompany Transactions

183 Eliminations Inc.(Dec.)
Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) 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 4,300,000 950,000 (d) (4,760) 5,236,240 Intercompany cost of goods sold 120,000 (b)(120,000) Operating expenses 986,058 217,978 (a) ,000 1,206,036 Intercompany interest expense 33,813 (e) (33,813) Interest expense 51,518 22,542 74,060 Income taxes expense 246,000 76,667 322,667 Minority interest in net income of subsidiary (f) ,600 4,600 Total costs and expenses 5,583,576 1,421,000 *(160,973) 6,843,603 Net income 460,200 115,000 (118,803) 456,397 Consolidated FS-Intercompany Transactions

184 Statement of Retained Earnings Eliminations Inc.(Dec.)
Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) Contd. Statement of Retained Earnings Post Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Retained earnings, beginning of year 1,508,350 439,000 (a) (400,050) (b) (7,600) (c) (50,000) (d) (22,610) (e) 23,371 1,490,461 Net income 460,200 115,000 (118,803) 456,397 Subtotal 1,968,550 554,000 (575,692) 1,946,858 Dividends declared 158,550 60,000 (a) (60,000)* end of year 1,810,000 494,000 (515,692) 1,788,308 * A decrease in dividends and an increase in retained earnings. Consolidated FS-Intercompany Transactions

185 Eliminations Inc.(Dec.)
Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) Contd. Balance Sheet/Assets Post Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Intercomapny receivables (payables) (3,500) 3,500 Inventories 950,000 500,000 (b) (12,000) 1,438,000 Other current assets 760,000 428,992 1,188,992 Investment in Sage Company stock 1,262,550 (a)(1,262,550) Company bonds 265,751 (e) (265,751) (a) ,000 Plant assets (net) 3,700,000 1,300,000 (d) (19,040) 5,128,960 Land(for building site) 175,000 (c) (50,000) 125,000 Leasehold (net) (a) ,000 15,000 Goodwill (net) 85,000 (a) ,150 120,150 Total assets 7,019,801 2,407,492 (1,411,191) 8,016,102 Consolidated FS-Intercompany Transactions

186 Eliminations Inc.(Dec.)
Working Paper for Consolidated Financial Statements( for Year 2002) (cont.) Contd. Balance Sheet/Assets Post Corporation Sage Company Eliminations Inc.(Dec.) Consolidated Intercomapny receivables (payables) (3,500) 3,500 Inventories 950,000 500,000 (b) (12,000) 1,438,000 Other current assets 760,000 428,992 1,188,992 Investment in Sage Company stock 1,262,550 (a)(1,262,550) Company bonds 265,751 (e) (265,751) (a) ,000 Plant assets (net) 3,700,000 1,300,000 (d) (19,040) 5,128,960 Land(for building site) 175,000 (c) (50,000) 125,000 Leasehold (net) (a) ,000 15,000 Goodwill (net) 85,000 (a) ,150 120,150 Total assets 7,019,801 2,407,492 (1,411,191) 8,016,102 Consolidated FS-Intercompany Transactions

187 Working Paper Elimination (for year 2002)
POST CORPORATION AND SUBSIDIARY Working Paper Eliminations December 31, 2002 (a)Common Stock-Sage 400,000 Additional Paid-in Capital-Sage 235,000 Retained Earnings-Sage($439,000-$38,950) 400,050 Retained Earnings of Subsidiary-Post 38,950 Intercompany Investment Income-Post 91,200 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-Sage 17,000 Operating Expenses-Sage 2,000 Consolidated FS-Intercompany Transactions

188 Working Paper Elimination (for year 2002) (contd.)
Investment in Sage Company Common Stock-Post 1,262,550 Dividends Declared-Sage 60,000 Minority Interest in Net Assets of Subsidiary 59,800 Consolidated FS-Intercompany Transactions

189 Working Paper Elimination (for year 2002) (contd.)
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: Consolidated FS-Intercompany Transactions

190 Working Paper Elimination (for year 2002) (contd.)
Cost of Goods Sold Operating Expenses Building depreciation $ 2,000 $ 2,000 Machinery depreciation 10,000 Leasehold amortization 5,000 Totals $ 17,000 Consolidated FS-Intercompany Transactions

191 Working Paper Elimination (for year 2002) (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,excluding intercompany profits effects ($62,800), less minority interest in dividends declared by subsidiary during year ($60,000 x 0.05 = $3,000). (Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

192 Working Paper Elimination (for year 2002) (contd.)
(b) Retained earnings-Sage 76,000 Minority Interest in Net Assets of Subsidiary 400 Intercompany Sales-Sage 150,000 Intercompany Cost of Goods Sold-Sage 120,000 Cost of Goods Sold- Post 26,000 Inventories-Post 12,000 To eliminate intercompany sales, cost of goods sold, and unrealized profit in inventories.(Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

193 Working Paper Elimination (for year 2002) (contd.)
(c)Retained Earnings- Post 50,000 Land-Sage To eliminate unrealized intercompany gain in land.(Income tax effects are disregarded.) (d)Retained Earnings-Sage 22,610 Minority Interest in Net Assets of Subsidiary 1,190 Accumulated Depreciation-Post 4,760 Machinery- Post 23,800 Depreciation Expense- Post To eliminate unrealized intercompany gain in machinery and in related depreciation (Income tax effects are disregarded.) Consolidated FS-Intercompany Transactions

194 Working Paper Elimination (for year 2002) (contd.)
(e)Intercompany Interest Revenue- Post 38,576 Intercompany Bonds Payable- Sage 300,000 Discount on Intercompany Bonds Payable-Sage 14,411 Investment in Sage Company Bonds-Post 265,715 Intercompany Interest Expense-Sage 33,813 Retained Earnings- Sage 23,371 Minority Interest in Net Assets of Subsidiary 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.) Consolidated FS-Intercompany Transactions

195 Working Paper Elimination (for year 2002) (contd.)
(f)Minority Interest in Net Income of Subsidiary 4,600 Minority Interest in Net Assets of Subsidiary 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 reduced 4,760 (e) ($38,576-$33,813) (4,763) Adjusted net income of subsidiary $ 91,997 Minority interest share ($91,997 x 0.05) $ 4,600 Consolidated FS-Intercompany Transactions


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