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Chapter 6
Elimination of Unrealized Profit on Intercompany Sales of Inventory
Multiple Choice
1.

Sales from one subsidiary to another are called


a. downstream sales.
b. upstream sales.
c. intersubsidiary sales.
d. horizontal sales.

2.

Noncontrolling interest in consolidated income is never affected by


a. upstream sales.
b. downstream sales.
c. horizontal sales.
d. Noncontrolling interest is affected by all sales.

3.

Failure to eliminate intercompany sales would result in an overstatement of consolidated


a. net income.
b. gross profit.
c. cost of sales.
d. all of these.

4.

Pratt Company owns 80% of Storey Companys common stock. During 2011, Storey sold $400,000
of merchandise to Pratt. At December 31, 2011, one-fourth of the merchandise remained in Pratts
inventory. In 2011, gross profit percentages were 25% for Pratt and 30% for Storey. The amount of
unrealized intercompany profit that should be eliminated in the consolidated statements is
a. $80,000.
b. $24,000.
c. $30,000.
d. $25,000.

5.

The noncontrolling interests share of the selling affiliates profit on intercompany sales is
considered to be realized under
a. partial elimination.
b. total elimination.
c. 100% elimination.
d. both total and 100% elimination.

6.

The workpaper entry in the year of sale to eliminate unrealized intercompany profit in ending
inventory includes a
a. credit to Ending Inventory (Cost of Sales).
b. credit to Sales.
c. debit to Ending Inventory (Cost of Sales).
d. debit to Inventory - Balance Sheet.

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6-2

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

7.

Perez Company acquired an 80% interest in Seaman Company in 2010. In 2011 and 2012, Sutton
reported net income of $400,000 and $480,000, respectively. During 2011, Seaman sold $80,000 of
merchandise to Perez for a $20,000 profit. Perez sold the merchandise to outsiders during 2012 for
$140,000. For consolidation purposes, what is the noncontrolling interests share of Seaman's 2011
and 2012 net income?
a. $90,000 and $96,000.
b. $100,000 and $76,000.
c. $84,000 and $92,000.
d. $76,000 and $100,000.

8.

A 90% owned subsidiary sold merchandise at a profit to its parent company near the end of 2010.
Under the partial equity method, the workpaper entry in 2011 to recognize the intercompany profit
in beginning inventory realized during 2011 includes a debit to
a. Retained Earnings - P.
b. Noncontrolling interest.
c. Cost of Sales.
d. both Retained Earnings - P and Noncontrolling Interest.

9.

The noncontrolling interest in consolidated income when the selling affiliate is an 80% owned
subsidiary is calculated by multiplying the noncontrolling minority ownership percentage by the
subsidiarys reported net income
a. plus unrealized profit in ending inventory less unrealized profit in beginning inventory.
b. plus realized profit in ending inventory less realized profit in beginning inventory.
c. less unrealized profit in ending inventory plus realized profit in beginning inventory.
d. less realized profit in ending inventory plus realized profit in beginning inventory.

10.

In determining controlling interest in consolidated income in the consolidated financial statements,


unrealized intercompany profit on inventory acquired by a parent from its subsidiary should:
a. not be eliminated.
b. be eliminated in full.
c. be eliminated to the extent of the parent companys controlling interest in the subsidiary.
d. be eliminated to the extent of the noncontrolling interest in the subsidiary.

11.

P Company sold merchandise costing $240,000 to S Company (90% owned) for $300,000. At the
end of the current year, one-third of the merchandise remains in S Companys inventory. Applying
the lower-of- cost-or-market rule, S Company wrote this inventory down to $92,000. What amount
of intercompany profit should be eliminated on the consolidated statements workpaper?
a. $20,000.
b. $18,000.
c. $12,000.
d. $10,800.

12.

The material sale of inventory items by a parent company to an affiliated company:


a. enters the consolidated revenue computation only if the transfer was the result of arms length
bargaining.
b. affects consolidated net income under a periodic inventory system but not under a perpetual
inventory system.
c. does not result in consolidated income until the merchandise is sold to outside parties.
d. does not require a working paper adjustment if the merchandise was transferred at cost.

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-3

13.

A parent company regularly sells merchandise to its 80%-owned subsidiary. Which of the
following statements describes the computation of noncontrolling interest income?
a. the subsidiarys net income times 20%.
b. (the subsidiarys net income x 20%) + unrealized profits in the beginning inventory
unrealized profits in the ending inventory.
c. (the subsidiarys net income + unrealized profits in the beginning inventory unrealized profits
in the ending inventory) 20%.
d. (the subsidiarys net income + unrealized profits in the ending inventory unrealized profits in
the beginning inventory) 20%.

14.

P Corporation acquired a 60% interest in S Corporation on January 1, 2011, at book value equal to
fair value. During 2011, P sold merchandise that cost $135,000 to S for $189,000. One-third of this
merchandise remained in Ss inventory at December 31, 2011. S reported net income of $120,000
for 2011. Ps income from S for 2011 is:
a. $36,000.
b. $50,400.
c. $54,000.
d. $61,200.

Use the following information for Questions 15 & 16:


P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2010, P sold
merchandise that cost $240,000 to S for $300,000. Half of this merchandise remained in Ss December 31,
2010 inventory. During 2011, P sold merchandise that cost $375,000 to S for $468,000. Forty percent of
this merchandise inventory remained in Ss December 31, 2011 inventory. Selected income statement
information for the two affiliates for the year 2011 is as follows:

Sales Revenue
Cost of Goods Sold
Gross profit

P _
$2,250,000
1,800,000
$450,000

S _
$1,125,000
937,500
$187,500

15.

Consolidated sales revenue for P and Subsidiary for 2011 are:


a. $2,907,000.
b. $3,000,000.
c. $3,205,500.
d. $3,375,000.

16.

Consolidated cost of goods sold for P Company and Subsidiary for 2011 are:
a. $2,260,500.
b. $2,268,000.
c. $2,276,700.
d. $2,737,500.

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6-4

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

Use the following information for Questions 17 & 18:


P Company owns an 80% interest in S Company. During 2011, S sells merchandise to P for $200,000 at a
profit of $40,000. On December 31, 2011, 50% of this merchandise is included in Ps inventory. Income
statements for P and S are summarized below:
P __
$1,200,000
(600,000)
(300,000)
$300,000

Sales
Cost of Sales
Operating Expenses
Net Income (2011)

S __
$600,000
(400,000)
( 80,000)
$120,000

17.

Controlling interest in consolidated net income for 2011 is:


a. $300,000.
b. $380,000.
c. $396,000.
d. $420,000.

18.

Noncontrolling interest in income for 2011 is:


a. $4,000.
b. $19,200.
c. $20,000.
d. $24,000.

19.

The amount of intercompany profit eliminated is the same under total elimination and partial
elimination in the case of
1.
upstream sales where the selling affiliate is a less than wholly owned subsidiary.
2.
all downstream sales.
3.
horizontal sales where the selling affiliate is a wholly owned subsidiary.
a. 1.
b. 2.
c. 3.
d. both 2 and 3.

20.

Paige, Inc. owns 80% of Sigler, Inc. During 2011, Paige sold goods with a 40% gross profit to
Sigler. Sigler sold all of these goods in 2011. For 2011 consolidated financial statements, how
should the summation of Paige and Sigler income statement items be adjusted?
a. Sales and cost of goods sold should be reduced by the intercompany sales.
b. Sales and cost of goods sold should be reduced by 80% of the intercompany sales.
c. Net income should be reduced by 80% of the gross profit on intercompany sales.
d. No adjustment is necessary.

21.

P Corporation acquired a 60% interest in S Corporation on January 1, 2011, at book value equal to
fair value. During 2011, P sold merchandise that cost $225,000 to S for $315,000. One-third of this
merchandise remained in Ss inventory at December 31, 2011. S reported net income of $200,000
for 2011. Ps income from S for 2011 is:
a. $60,000.
b. $90,000.
c. $120,000.
d. $102,000.

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-5

Use the following information for Questions 22 & 23:


P Company regularly sells merchandise to its 80%-owned subsidiary, S Corporation. In 2010, P sold
merchandise that cost $192,000 to S for $240,000. Half of this merchandise remained in Ss December 31,
2010 inventory. During 2011, P sold merchandise that cost $300,000 to S for $375,000. Forty percent of
this merchandise inventory remained in Ss December 31, 2011 inventory. Selected income statement
information for the two affiliates for the year 2011 is as follows:
P _
$1,800,000
1,440,000
$ 360,000

Sales Revenue
Cost of Goods Sold
Gross profit

S _
$900,000
750,000
$150,000

22.

Consolidated sales revenue for P and Subsidiary for 2011 are:


a. $2,325,000.
b. $2,400,000.
c. $2,565,000.
d. $2,700,000.

23.

Consolidated cost of goods sold for P Company and Subsidiary for 2011 are:
a. $1,809,000.
b. $1,815,000.
c. $1,821,000.
d. $2,190,000.

Use the following information for Questions 24 & 25:


P Company owns an 80% interest in S Company. During 2011, S sells merchandise to P for $150,000 at a
profit of $30,000. On December 31, 2011, 50% of this merchandise is included in Ps inventory. Income
statements for P and S are summarized below:
P __
$900,000
(450,000)
(225,000)
$225,000

Sales
Cost of Sales
Operating Expenses
Net Income (2011)
24.

Controlling interest in consolidated net income for 2011 is:


a. $225,000.
b. $285,000.
c. $297,000.
d. $315,000.

25.

Noncontrolling interest in income for 2011 is:


a. $3,000.
b. $14,400.
c. $15,000.
d. $18,000.

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S __
$450,000
(300,000)
( 60,000)
$ 90,000

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6-6

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

Problems
6-1

On January 1, 2011, Palmer Company purchased a 90% interest in Sauder Company for $2,800,000.
At that time, Sauder had $1,840,000 of common stock and $360,000 of retained earnings. The
difference between implied and book value was allocated to the following assets of Sauder
Company:
Inventory
Plant and equipment (net)
Goodwill

$ 80,000
240,000
591,111

The plant and equipment had a 10-year remaining useful life on January 1, 2011.
During 2011, Palmer sold merchandise to Sauder at a 20% markup above cost. At December 31,
2011, Sauder still had $180,000 of merchandise in its inventory that it had purchased from Palmer.
In 2011, Palmer reported net income from independent operations of $1,600,000, while Sauder
reported net income of $600,000.
Required:
A. Prepare the workpaper entry to allocate, amortize, and depreciate the difference between
implied and book value for 2011.
B. Calculate controlling interest in consolidated net income for 2011.

6-2

Percy Company owns 80% of the common stock of Smyth Company. Percy sells merchandise to
Smyth at 20% above cost. During 2011 and 2012, intercompany sales amounted to $1,080,000 and
$1,200,000 respectively. At the end of 2011, Smyth had one-fifth of the goods purchased that year
from Percy in its ending inventory. Smyths 2012 ending inventory contained one-fourth of that
years purchases from Percy. There were no intercompany sales prior to 2011.
Percy reported net income from its own operations of $720,000 in 2011 and $760,000 in 2012.
Smyth reported net income of $400,000 in 2011 and $460,000 in 2012. Neither company declared
dividends in either year.
Required:
A. Prepare in general journal form all entries necessary on the consolidated statements workpapers
to eliminate the effects of the intercompany sales for both 2011 and 2012.
B. Calculate controlling interest in consolidated net income for 2012.

6-3

Payton Company owns 90% of the common stock of Sanders Company. Sanders Company sells
merchandise to Payton Company at 25% above cost. During 2010 and 2011 such sales amounted to
$800,000 and $1,020,000, respectively. At the end of each year, Payton Company had in its
inventory one-fourth of the amount of goods purchased from Sanders Company during that year.
Payton Company reported income of $1,500,000 from its independent operations in 2010 and
$1,720,000 in 2011. Sanders Company reported net income of $600,000 in each year and did not
declare any dividends in either year. There were no intercompany sales prior to 2010.

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-7

Required:
A. Prepare, in general journal form, all entries necessary on the 2011 consolidated statements
workpaper to eliminate the effects of intercompany sales.
B. Calculate the amount of noncontrolling interest to be deducted from consolidated income in the
consolidated income statement in 2011.
C. Calculate controlling interest in consolidated net income for 2011.

6-4

Powers Company owns an 80% interest in Smiley Company and a 90% interest in Toro Company.
During 2010 and 2011, intercompany sales of merchandise were made by all three companies.
Total sales amounted to $2,400,000 in 2010, and $2,700,000 in 2011. The companies sold their
merchandise at the following percentages above cost.
Powers
15%
Smiley
20%
Toro
25%
The amount of merchandise remaining in the 2011 beginning and ending inventories of the
companies from these intercompany sales is shown below.
Merchandise Remaining in Beginning Inventory
Powers
Smiley
Toro
Total
Sold by
Powers
Smiley
Toro

$225,000
$180,000
180,000

$189,000
216,000

135,000

$414,000
396,000
315,000

Merchandise Remaining in Ending Inventory


Powers
Smiley
Toro
Total
Sold by
Powers
Smiley
Toro

$207,000
$144,000
195,000

$138,000
198,000

150,000

$345,000
342,000
345,000

Reported net incomes (from independent operations including sales to affiliates) of Powers, Smiley,
and Toro for 2011 were $3,600,000, $1,500,000, and $2,400,000, respectively.
Required:
A. Calculate the amount noncontrolling interest to be deducted from consolidated income in the
consolidated income statement for 2011.
B. Calculate the controlling interest in consolidated net income for 2011.

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6-8
6-5

Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
The following balances were taken from the records of S Company:
Common stock
$2,500,000
Retained earnings, 1/1/11
$1,450,000
Net income for 2011
3,000,000
Dividends declared in 2011
(1,550,000)
Retained earnings, 12/31/11
2,900,000
Total stockholders equity, 12/31/11
$5,400,000
P Company owns 80% of the common stock of S Company. During 2011, P Company purchased
merchandise from S Company for $4,000,000. S Company sells merchandise to P Company at cost
plus 25% of cost. On December 31, 2011, merchandise purchased from S Company for $1,250,000
remains in the inventory of P Company. On January 1, 2011, P Companys inventory contained
merchandise purchased from S Company for $525,000. The affiliated companies file a consolidated
income tax return. There was no difference between the implied value and the book value of net
assets acquired.
Required:
A. Prepare all workpaper entries necessitated by the intercompany sales of merchandise.
B. Compute noncontrolling interest in consolidated income for 2011.
C. Compute noncontrolling interest in consolidated net assets on December 31, 2011.

6-6
P Corporation acquired 80% of S Corporation on January 1, 2011 for $240,000 cash when Ss
stockholders equity consisted of $100,000 of Common Stock and $30,000 of Retained Earnings.
The difference between the price paid by P and the underlying equity acquired in S was allocated
solely to a patent amortized over 10 years.
P sold merchandise to S during the year in the amount of $30,000. $10,000 worth of
inventory is still on hand at the end of the year with an unrealized profit of $4,000. The separate
company statements for P and S appear in the first two columns of the partially completed
consolidated workpaper.
Required:
Complete the consolidated workpaper for P and S for the year 2011.

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-9

P Corporation and Subsidiary


Consolidated Statements Workpaper
at December 31, 2011

Income Statement
Sales
Dividend Income
Cost of Sales
Other Expenses
Noncontrolling Interest in Income
Net Income
Retained Earnings Statement
Retained Earnings 1/1
Add: Net Income
Less: Dividends
Retained Earnings 12/31
Balance Sheet
Cash
Accounts Receivable-net
Inventories
Patent
Land
Equipment and Buildings-net
Investment in S Corporation
Total Assets
Equities
Accounts Payable
Common Stock
Retained Earnings
1/1 Noncontrolling Interest in Net
Assets
12/31 Noncontrolling Interest in
Net Assets
Total Equities

P
Corp.

S
Corp.

200,000
16,000
(92,000)
(23,000)

150,000
(47,000)
(40,000)

101,000

63,000

110,000
101,000
( 30,000)
181,000

30,000
63,000
(20,000)
73,000

20,000
120,000
140,000

19,000
55,000
80,000

270,000
600,000
240,000
695,000

420,000
430,000
1,004,000

909,000
300,000
181,000

831,000
100,000
73,000

1,390,000

1,004,000

Eliminations
Dr.
Cr.

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Noncontrolling
Interest

Consolidated
Balances

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6-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-7

On January 1, 2011, Porter Company purchased an 80% interest in the capital stock of Shilo
Company for $3,400,000. At that time, Shilo Company had common stock of $2,200,000 and
retained earnings of $620,000. Porter Company uses the cost method to record its investment in
Shilo Company. Differences between the fair value and the book value of the identifiable assets of
Shilo Company were as follows:
Fair Value in Excess of Book Value
Equipment
Land
Inventory

$400,000
200,000
80,000

The book values of all other assets and liabilities of Shilo Company were equal to their fair values
on January 1, 2011. The equipment had a remaining life of five years on January 1, 2011; the
inventory was sold in 2011.
Shilo Companys net income and dividends declared in 2011 were as follows:

Year 2011 Net Income of $400,000; Dividends Declared of $100,000


Required:
Prepare a consolidated statements workpaper for the year ended December 31, 2012 using the
partially completed worksheet.

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-11

PORTER COMPANY AND SUBSIDIARY


Consolidated Statements Workpaper
For the Year Ended December 31, 2012

Porter
Shilo
Eliminations Noncontrolling Consolidated
Company Company Dr.
Cr.
Interest
Balances
Income Statement
Sales
Dividend Income
Total Revenue
Cost of Goods Sold
Depreciation Expense
Other Expenses
Total Cost & Expenses
Net/Consolidated Income
Noncontrolling Interest in Income
Net Income to Retained Earnings
Retained Earnings Statement
1/1 Retained Earnings
Porter Company
Shilo Company
Net Income from above
Dividends Declared
Porter Company
Shilo Company
12/31 Retained Earnings to
Balance Sheet

4,400,000 1,800,000
192,000
4,592,000 1,800,000
3,600,000
800,000
160,000
120,000
240,000
200,000
4,000,000 1,120,000
592,000
680,000
592,000

680,000

2,000,000
592,000

920,000
680,000

(360,000)
(240,000)
2,232,000 1,360,000
Porter
Shilo
Eliminations Noncontrolling Consolidated
Company Company Dr.
Cr.
Interest
Balances

Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Shilo Company
Difference between Implied and Book Value
Land
Plant and Equipment
Total Assets
Accounts Payable
Notes Payable
Common Stock:
Porter Company
Shilo Company
Retained Earnings from above
1/1 Noncontrolling Interest in Net Assets
12/31 Noncontrolling Interest in Net Assets
Total Liabilities & Equity

280,000
1,040,000
960,000
3,400,000

1,440,000
7,120,000
528,000
360,000

260,000
760,000
700,000

1,280,000
1,120,000
4,120,000
440,000
120,000

4,000,000
2,200,000
2,232,000 1,360,000

7,120,000 4,120,000

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6-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-8

Pool Company owns a 90% interest in Slater Company. The consolidated income statement drafted
by the controller of Pool Company appeared as follows:
Pool Company and Subsidiary
Consolidated Income Statement
for Year Ended December 31, 2011
Sales
Cost of Sales
Operating Expenses
Consolidated Income
Less Noncontrolling Interest in Consolidated Income
Controlling Interest in Consolidated Net Income

$13,800,000
$9,000,000
1,800,000

10,800,000
3,000,000
190,000
$2,810,000

During your audit you discover that intercompany sales transactions were not reflected in the
controllers draft of the consolidated income statement. Information relating to intercompany sales
and unrealized intercompany profit is as follows:

2010 SalesSlater to Pool


2011 SalesPool to Slater

Cost

Selling
Price

Unsold at
Year-End

$1,500,000
900,000

$1,800,000
1,350,000

1/4
2/5

Required:
Prepare a corrected consolidated income statement for Pool Company and Slocum Company for the
year ended December 31, 2011.

Short Answer
1.

Past and proposed GAAP agree that unrealized intercompany profit should not be included in
consolidated net income or assets. Briefly explain the preferred approach of eliminating
intercompany profit.

2.

Determination of the noncontrolling interest in consolidated net income differs depending on


whether intercompany sales are downstream or upstream. Explain the difference in calculating
noncontrolling interest for downstream and upstream sales.

Short Answer Questions from the Textbook


1.

Does the elimination of the effects of intercompany sales of merchandise always affect the amount
of reported consolidated net income? Explain.

2.

Why is the gross profit on intercompany sales, rather than profit after deducting selling and
administrative expenses, ordinarily eliminated from consolidated inventory balances?

3.

P Company sells inventory costing $100,000 to its subsidiary, S Company, for $150,000. At the end
of the current year, one-half of the goods re-mains in S Companys inventory. Applying the lower of
cost or market rule, S Company writes down this inventory to $60,000. What amount of
intercompany profit should be eliminated on the consolidated statements workpaper?

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-13

4.

Are the adjustments to the noncontrolling interest for the effects of intercompany profit eliminations
illustrated in this text necessary for fair presentation in accordance with generally accepted
accounting principles? Explain.

5.

Why are adjustments made to the calculation of the noncontrolling interest for the effects of
intercompany profit in upstream but not in down-stream sales?

6.

What procedure is used in the consolidated statements workpaper to adjust the noncontrolling
interest in consolidated net assets at the be-ginning of the year for the effects of intercompany
profits?

7.

What is the essential procedural difference between workpaper eliminating entries for unrealized
intercompany profit made when the selling affiliate is a less than wholly owned subsidiary and those
made when the selling affiliate is the parent company or a wholly owned subsidiary?

8.

Define the controlling interest in consolidated net income using the t-account or analytical approach.

9.

Why is it important to distinguish between up-stream and downstream sales in the analysis of
intercompany profit eliminations?

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6-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
ANSWER KEY
Multiple Choice

1.
2.
3.
4.

d
b
c
c

5.
6.
7.
8.

a
c
d
d

9.
10.
11.
12.

c
b
c
c

13.
14.
15.
16.

a
c
a
c

17.
18.
19.
20.

b
c
d
a

21.
22.
23.
24.

c
a
c
b

25. c

Problems
6-1

A. Depreciation Expense (240,000/10)


Plant and Equipment (net) (240,000 24,000)
1/1 Inventory
Goodwill
Difference Between Implied and Book Value

24,000
216,000
80,000
591,111
911,111

B. Palmers net income from independent operations


Less: unrealized profit on sales to Sauder
[180,000 (180,000/1.20)]
Palmers income from independent operations that has
been realized in transactions with third parties
Palmers share of Sauders income (600,000 .90)
Less: amortization of difference between implied
and book value
Controlling Interest in Consolidated Net Income for 2011

$1,600,000
(30,000)
1,570,000
540,000
(104,000)*
$2,006,000

* 80,000 + (240,000/10)

6-2

A. 2011
Sales

1,080,000
Purchases (Cost of Goods Sold)

12/31 Inventory (Income Statement)


[216,000 (216,000/1.20)]
12/31 Inventory(Balance Sheet)
2012
Sales

1,080,000

36,000
36,000

1,200,000
Purchases (Cost of Goods Sold)

1,200,000

12/31 Inventory (Income Statement)


[300,000 (300,000/1.20)]
12/31 Inventory (Balance Sheet)

50,000

Beginning R/E Percy


1/1 Inventory (Income Statement)

36,000

50,000

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory


B. Percys Income from independent operations
Less: Unrealized profit in ending inventory
Add: Unrealized profit in beginning inventory
Percys Income Realized in Transactions with
third parties
Percys Share of Subsidiary Income
Controlling Interest in Consolidated Net Income

6-3

A. Sales

$760,000
(50,000)
36,000
746,000
$368,000
$1,114,000

1,020,000

Purchases (Cost of Sales)


To eliminate intercompany sales.

1,020,000

12/31 Inventory (Income Statement)


51,000
Inventory (Balance Sheet)
To eliminate unrealized intercompany profit in ending inventory.

51,000

Beginning Retained Earnings Payton


(.90 $40,000)
36,000
Noncontrolling interest
4,000
1/1 Inventory (Balance Sheet)
40,000
To recognize unrealized profit in beginning inventory realized during the year.
B. Noncontrolling Interest Calculation:
Sanders Company reported net income
Less: Unrealized profit in ending inventory
Add: Realized profit in beginning inventory
Subsidiary income included in consolidated income
Noncontrolling interest ownership percentage

$600,000
(51,000)
40,000
589,000
.1
$ 58,900

Noncontrolling interest in consolidated income


C. Controlling Interest in Consolidated Net Income:
Payton Companys net income from
independent operations
Reported net income of Sanders Company
Less: Unrealized profit on sales of 2011
Add: Profit on intercompany sales to Payton
realized in transactions with third parties
Subsidiary income realized in
transactions with third parties
Payton Companys share of subsidiary income
(589,000 .9)
Controlling interest in consolidated net income

$1,720,000
$600,000
(51,000)
40,000
$589,000

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530,100
$2,250,100

6-15

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6-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6-4

Smiley
Toro
$1,500,000
$2,400,000
66,000
63,000
(57,000)
(69,000)
1,509,000
2,394,000
.2
.1
$301,800
$239,400

A. Reported subsidiary income


Add: Unrealized profit in beginning inventory
Less: Unrealized profit in ending inventory
Subsidiary income included in consolidated income
Noncontrolling interest ownership percentage
Noncontrolling interest in consolidated income

Total noncontrolling interest:$301,800 + $239,400 = $541,200


B. Powers Companys income independent operations
Add: Unrealized profit considered realized in 2011
($414,000 $414,000/1.15)
Less: Unrealized profit in 2011 income
($345,000 $345,000/1.15)
Powers income realized in transactions with third parties
Smiley Companys Reported Net Income
Add: Unrealized profit considered realized
in 2011 ($396,000 $396,000/1.2)
Less: Unrealized profit in 2011 income
($342,000 $342,000/1.20)
Subsidiary income realized in transactions
with third parties

$3,600,000
54,000
(45,000)
$3,609,000
$1,500,000
66,000
(57,000)
1,509,000

Powers share of subsidiary income (.8 1,509,000)


Toro Companys reported net income
Add: Unrealized profit considered realized
in 2011 ($315,000 $315,000/1.25)
Less: Unrealized profit in 2011 income
($345,000 $345,000/1.25)
Subsidiary income realized in transactions
with third parties
Powers share of subsidiary income (.9 2,394,000)
Controlling Interest in Consolidated Net Income

1,207,200
$2,400,000
63,000
(69,000)
$2,394,000
2,154,600
$6,970,800

6-5
A. Sales

4,000,000
Cost of Goods Sold

Cost of Goods Sold


Ending Inventory (Balance Sheet)
[$1,250,000 - ($1,250,000/1.25)]
1/1 Retained Earnings P Company (1)
Noncontrolling intrest (2)
Cost of Goods Sold (Beginning Inventory)
[$525,000 ($525,000/1.25)] = $105,000

4,000,000
250,000
250,000

84,000
21,000

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-17

(1) .8($105,000)
(2) .2($105,000)
B. $3,000,000 .20 = $600,000 noncontrolling interest in consolidated income.
C. [(.20 $5,400,000) -.20($1,250,000 $1,250,000/1.25)] = $1,030,000 noncontrolling interest in
consolidated net assets on December 31, 2011.

6-6

Income Statement
Sales
Dividend Income
Cost of Sales
Other Expenses
Noncontrolling Interest in Income
Net income
Retained Earnings Statement
Retained Earnings 1/1
Add: Net Income
Less: Dividends
Retained Earnings 12/31
Balance Sheet
Cash
Accounts Receivable-net
Inventories
Patent
Land
Equipment and Buildings-net
Investment in S Corporation
Total Assets
Equities
Accounts Payable
Common Stock
Retained Earnings from above
1/1 Noncontrolling Interest in Net
Assets
12/31 Noncontrolling Interest in Net
Assets
Total Equities

P Corporation and Subsidiary


Consolidated Statements Workpaper
at December 31, 2011

Corp.

Corp.

Eliminations
Dr
Cr

$200,000 $ 150,000 (a) 30,000


16,000
(c) 16,000
(92,000)
(47,000) (b) 4,000
(23,000)
(40,000) (e) 17,000
101,000

63,000

67,000

110,000
101,000
( 30,000)
181,000

30,000
63,000
(20,000)
73,000

(d) 30,000
67,000

20,000
120,000
140,000

19,000
55,000
80,000

(a) 30,000

30,000

30,000
(c) 16,000
46,000

831,000
100,000
73,000

9,200
9,200

9,200
(4,000)
5,200

110,000
117,800
(30,000)
197,800
39,000
175,000
216,000
153,000
690,000
1,030,000

(d)240,000
2,303,000

(d)100,000
97,000

46,000

5,200

(d)60,000

60,000
65,200

1,390,000 1,004,000

Balances

(113,000)
(80,000)
(9,200)
117,800

(b) 4,000
(e) 17,000

270,000
420,000
600,000
430,000
240,000
1,390,000 1,004,000
909,000
300,000
181,000

Consolidated

320,000

97,000

(d)170,000

Noncontrolli
ng
Interest

367,000

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367,000

1,740,000
300,000
197,800

65,200
2,303,000

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6-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

6-7

PORTER COMPANY AND SUBSIDIARY


Consolidated Statements Workpaper
For the Year Ended December 31, 2012

Porter
Shilo
Company Company
Income Statement
Sales
Dividend Income
Total Revenue
Cost of Goods Sold
Depreciation Expense
Other expense
Total Cost & Expenses
Net/Consolidated Income
Noncontrolling Interest in Income
Net Income to Retained Earnings
Statement of Retained Earnings
1/1 Retained Earnings

Eliminations
Dr.
Cr.

Noncontrolling
Interest

Consolidated
Balances

120,000
120,000

6,200,000
---6,200,000
4,400,000
360,000
440,000
5,200,000
1,000,000
120,000
880,000

4,400,000 1,800,000
192,000
(a) 192,000
4,592,000 1,800,000
3,600,000
800,000
160,000
120,000 (d) 80,000
240,000
20,000
4,000,000 1,120,000
592,000
680,000
592,000

Porter Company
Shilo Company
Net Income from above
Dividends Declared

2,000,000

Porter Company
Shilo Company
12/31 Retained Earnings to
Balance Sheet
Balance Sheet
Cash
Accounts Receivable
Inventory
Investment in Shilo Company
Difference between Implied and
Book Value
Land
Plant and Equipment
Goodwill
Total Assets
Accounts Payable
Notes Payable
Common Stock:
Porter Company
Shilo Company
Retained Earnings from above

(360,000)

592,000

680,000

272,000

(c) 64,000
(d) 64,000 (e) 240,000
920,000 (b) 920,000
680,000
272,000

120,000

880,000

(360,000)
(240,000)

2,232,000 1,360,000
280,000
1,040,000
960,000
3,400,000

2,112,000

1,320,000

(a) 192,000

(48,000)

432,000

72,000

260,000
760,000
700,000

2,632,000

(e) 240,000 (b)3,640,000

540,000
1,800,000
1,660,000
---

(b) 1,430,000 (c)1,430,000


1,280,000 (c) 200,000
1,440,000 1,120,000 (c) 400,000 (d) 160,000
(c) 750,000
7,120,000 4,120,000
528,000
440,000
360,000
120,000

1,480,000
2,800,000
750,000
9,030,000
968,000
480,000

4,000,000

4,000,000

2,200,000 (b) 2,200,000


2,232,000 1,360,000
1,320,000

432,000

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2,632,000

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory


1/1 Noncontrolling Interest in Net
Assets

(c) 16,000 (b) 910,000


(d) 16,000

12/31 Noncontrolling Interest in Net


Assets
Total Liabilities & Equity
7,120,000 4,120,000

6-8

6,572,000

6,572,000

6-19

878,000

950,000
712,000

950,000
9,030,000

POOL COMPANY AND SUBSIDIARY


Consolidated Income Statement
For the Year Ended December 31, 2011
Sales ($13,800,000 $1,350,000)
Cost of Goods Sold (a)
Operating Expenses
Consolidated Income
Less Noncontrolling Interest in Consolidated Income (b)
Controlling Interest in Consolidated Net Income

$12,450,000
$7,755,000
1,800,000

(a) Reported Cost of Goods Sold


Less intercompany sales in 2011
Plus unrealized profit in ending inventory (2/5 x ($1,350,000 - $900,000))
Less realized profit in beginning inventory (1/4 x ($1,800,000 - $1,500,000))
Corrected cost of goods sold

9,555,000
2,895,000
197,500
$2,697,500
$9,000,000
(1,350,000)
180,000
(75,000)
$7,755,000

$190,000
$1,900,000
0.1
Plus unrealized profit on subsidiary sales in 2010 that is considered realized in 2011
(1/4 x ($1,800,000 - $1,500,000))
75,000
Less unrealized profit on subsidiary sales in 2011 (there were no upstream sales in 2011)
0
Income realized in transactions with third parties
1,975,000
0.10
Noncontrolling interest in consolidated income
$197,500

(b) Reported net income of subsidiary

Short Answer
1.

Both current and proposed GAAP require 100% elimination of intercompany profit in the
preparation of consolidated financial statements. Under 100% elimination, the entire amount of
unconfirmed intercompany profit is eliminated from consolidated net income and the related asset
balance. This approach is logical under the proposed view of consolidated financial statements,
based on the entity concept.

2.

For downstream sales, no modification to the noncontrolling interest in consolidated income is


needed. For upstream sales, the noncontrolling interest must be adjusted. The reported income of
the subsidiary is reduced by the amount of gross profit remaining in ending inventory of the
purchasing affiliate before multiplying by the noncontrolling percentage interest; it is increased for
gross profit realized from beginning inventory.

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6-20 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
Short Answer Questions in Textbook Solutions
1. No. If all of the merchandise sold by one affiliate to another has subsequently been sold to outsiders, the
only effect that the elimination of intercompany sales of merchandise will have on the consolidated
financial statements is to reduce consolidated sales and consolidated cost of sales by an equal amount.
Consolidated net income will be unaffected.
2. The effect of eliminating profit on intercompany sales after deducting selling and administrative
expenses rather than gross profit is to include selling and administrative expenses associated with the
intercompany sale in consolidated inventories. Support for the gross profit approach is based on the
proposition that consolidated inventory balances should include manufacturing costs only and that
generally accepted accounting standards normally preclude the capitalization of selling and
administrative costs.
3. $10,000 in intercompany profit should be eliminated on the consolidated statements workpaper ($60,000

$100,000
= $10,000). After this elimination the merchandise will be included in the consolidated
2
$100,000
statements at its cost to the affiliated group of $50,000 (
).
2

4. Yes. Although 100 percent elimination of intercompany profit has long been required in the preparation
of consolidated financial statements, the adjustments to the noncontrolling interest described in this text
were discretionary prior to the current standard. The FASB requires that these adjustments be allocated
between the noncontrolling and controlling interests.
5. When the subsidiary is the intercompany seller, the unrealized profit is shown in the accounts of the sub
(S Company). These accounts provide the starting point for the calculation of the noncontrolling share
of current year earnings. Failure to eliminate unrealized profit would result in the overstatement of the
noncontrolling share in profits. However, when the parent is the intercompany seller, the unrealized
profit is shown in the accounts of the parent (P Company). Since the noncontrolling interest does not
share in the earnings of P Company, the noncontrolling interest is not affected by the unrealized profit
therein.
6. Noncontrolling interest in consolidated net assets at the beginning of the year is adjusted by debiting or
crediting the subsidiarys beginning retained earnings in the consolidated statements workpaper.
7. The only procedural difference in the workpaper entries relating to the elimination of intercompany
profits when the selling affiliate is a less than wholly owned subsidiary is that the noncontrolling interest
in the amount of intercompany profit in beginning inventory must be recognized by debiting or crediting
the noncontrolling shareholders percentage interest in such adjustments to the beginning retained
earnings of the subsidiary.
8. Controlling interest in consolidated net income is equal to the parent companys income from its
independent operations that has been realized in transactions with third parties plus its share of reported
subsidiary income that has been realized in transactions with third parties and adjusted for its share of
the amortization of the difference between implied and book value for the period.
9. It is important to distinguish between upstream and downstream sales because the calculation of
noncontrolling interest in the consolidated financial statements differs depending on whether the
intercompany sale giving rise to unrealized intercompany profit is upstream or downstream.
10. Profit relating to the intercompany sale of merchandise is recognized in the consolidated financial
statements in the period in which the merchandise is sold to outsiders. It is recognized in the
consolidated financial statements by reducing cost of goods sold (thus increasing gross profit and net
income).

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Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory

6-21

Answers to Business Ethics Case


1.
Independence of the auditor is essential in maintaining effective audits. When auditors are involved
in non-audit services, their independence may be impaired (in essence they may be viewed as
auditing their own work).
Many times auditors have to rely on management representation when no supporting evidence is
available. Auditors involvement in non-audit services can help them gain sufficient familiarity with
their clients business and operational activities to reduce such dependencies and perhaps to lower
audit risk.
2.
The growing importance of non-audit service fees to the audit firms over time may have increased
the potential for the auditors to lose independence, even to the extent of financial fraud involvement.
The increasing effort to reduce costs (in a competitive marketplace for audit services) imposes
limitations on the scope of the audit work involved-- to avoid operating at a loss. Subsidizing any
shortfall between audit revenues and audit costs with non-audit fees can help in overcoming such
limitations.
3.
Audit fees would have to increase if auditors are held liable to a greater degree. The increased fees
would cover both increased auditor effort to detect errors and to cover the increased litigation
settlements/insurance premiums. The additional benefits would be weighed against the costs.
Timeliness and accuracy present constant tradeoffs in any audit. Time and budget constraints may
potentially result in an audit staff not performing sufficient work to meet deadlines. Further,
excessive cost-cutting may cause audit work to be inappropriately reduced, which leads to increased
reliance by auditors on client presentations to document areas where the data are not easily
available. Such reliance can cause audit judgments to be inappropriately influenced. When factors
outside their control cause auditors to rely on the representations of others, they should not be solely
responsible for resulting errors. Legislation aimed at protecting auditors to some extent also serves
to keep audits from becoming prohibitively expensive.

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