Chapter 6 ADVACC 2

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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 Company’s common stock. During 2011, Storey sold $400,000
of merchandise to Pratt. At December 31, 2011, one-fourth of the merchandise remained in Pratt’s
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 interest’s share of the selling affiliate’s 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 interest’s 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
subsidiary’s 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 company’s 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 Company’s 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 arm’s 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 subsidiary’s net income times 20%.
b. (the subsidiary’s net income x 20%) + unrealized profits in the beginning inventory –
unrealized profits in the ending inventory.
c. (the subsidiary’s net income + unrealized profits in the beginning inventory – unrealized profits
in the ending inventory) × 20%.
d. (the subsidiary’s 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 S’s inventory at December 31, 2011. S reported net income of $120,000
for 2011. P’s 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 S’s 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 S’s December 31, 2011 inventory. Selected income statement
information for the two affiliates for the year 2011 is as follows:
P _ S _
Sales Revenue $2,250,000 $1,125,000
Cost of Goods Sold 1,800,000 937,500
Gross profit $450,000 $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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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 P’s inventory. Income
statements for P and S are summarized below:
P __ S __
Sales $1,200,000 $600,000
Cost of Sales (600,000) (400,000)
Operating Expenses (300,000) ( 80,000)
Net Income (2011) $300,000 $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 S’s inventory at December 31, 2011. S reported net income of $200,000
for 2011. P’s income from S for 2011 is:
a. $60,000.
b. $90,000.
c. $120,000.
d. $102,000.
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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 S’s 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 S’s December 31, 2011 inventory. Selected income statement
information for the two affiliates for the year 2011 is as follows:
P _ S _
Sales Revenue $1,800,000 $900,000
Gross profit $ 360,000 $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.
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 P’s inventory. Income
statements for P and S are summarized below:
P __ S __
Sales $900,000 $450,000
Cost of Sales (450,000) (300,000)
Operating Expenses (225,000) ( 60,000)
Net Income (2011) $225,000 $ 90,000
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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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 $ 80,000
Plant and equipment (net) 240,000
Goodwill 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. Smyth’s 2012 ending inventory contained one-fourth of that
year’s 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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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 $225,000 $189,000 $414,000
Smiley $180,000 216,000 396,000
Toro 180,000 135,000 315,000
Merchandise Remaining in Ending Inventory

Powers Smiley Toro Total
Sold by
Powers $207,000 $138,000 $345,000
Smiley $144,000 198,000 342,000
Toro 195,000 150,000 345,000
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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6-5 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 Company’s 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 S’s
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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P Corporation and Subsidiary

Consolidated Statements Workpaper
at December 31, 2011
P S Eliminations Noncontrolling Consolidated

Corp. Corp. Dr. Cr. Interest Balances
Income Statement
Sales 200,000 150,000
Dividend Income 16,000
Cost of Sales (92,000) (47,000)
Other Expenses (23,000) (40,000)
Noncontrolling Interest in Income
Net Income 101,000 63,000
Retained Earnings Statement
Retained Earnings 1/1 110,000 30,000
Add: Net Income 101,000 63,000
Less: Dividends ( 30,000) (20,000)
Retained Earnings 12/31 181,000 73,000
Balance Sheet
Cash 20,000 19,000
Accounts Receivable-net 120,000 55,000
Inventories 140,000 80,000
Patent
Land 270,000 420,000
Equipment and Buildings-net 600,000 430,000
Investment in S Corporation 240,000
Total Assets 695,000 1,004,000
Equities
Accounts Payable 909,000 831,000
Common Stock 300,000 100,000
Retained Earnings 181,000 73,000
1/1 Noncontrolling Interest in Net
Assets
12/31 Noncontrolling Interest in
Net Assets
Total Equities 1,390,000 1,004,000
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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 $400,000
Land 200,000
Inventory 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 Company’s 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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PORTER COMPANY AND SUBSIDIARY

For the Year Ended December 31, 2012
Porter Shilo Eliminations Noncontrolling Consolidated
Company Company Dr. Cr. Interest Balances
Income Statement
Sales 4,400,000 1,800,000
Dividend Income 192,000
Total Revenue 4,592,000 1,800,000
Depreciation Expense 160,000 120,000
Other Expenses 240,000 200,000
Total Cost & Expenses 4,000,000 1,120,000
Net/Consolidated Income 592,000 680,000
Noncontrolling Interest in Income
Net Income to Retained Earnings 592,000 680,000
1/1 Retained Earnings
Porter Company 2,000,000
Shilo Company 920,000
Net Income from above 592,000 680,000
Dividends Declared
Porter Company (360,000)
Shilo Company (240,000)
12/31 Retained Earnings to
Balance Sheet 2,232,000 1,360,000
Balance Sheet
Cash 280,000 260,000
Accounts Receivable 1,040,000 760,000
Inventory 960,000 700,000
Investment in Shilo Company 3,400,000
Difference between Implied and Book Value
Land 1,280,000
Plant and Equipment 1,440,000 1,120,000
Total Assets 7,120,000 4,120,000
Accounts Payable 528,000 440,000
Notes Payable 360,000 120,000
Common Stock:
Porter Company 4,000,000
Shilo Company 2,200,000
Retained Earnings from above 2,232,000 1,360,000
1/1 Noncontrolling Interest in Net Assets
12/31 Noncontrolling Interest in Net Assets
Total Liabilities & Equity 7,120,000 4,120,000
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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 $13,800,000
Cost of Sales $9,000,000
Operating Expenses 1,800,000 10,800,000
Consolidated Income 3,000,000
Less Noncontrolling Interest in Consolidated Income 190,000
Controlling Interest in Consolidated Net Income $2,810,000
During your audit you discover that intercompany sales transactions were not reflected in the
controller’s draft of the consolidated income statement. Information relating to intercompany sales
and unrealized intercompany profit is as follows:
Selling Unsold at
Cost Price Year-End
2010 Sales—Slater to Pool $1,500,000 $1,800,000 1/4
2011 Sales—Pool to Slater 900,000 1,350,000 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 Company’s 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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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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ANSWER KEY
Multiple Choice
1. d 5. a 9. c 13. a 17. b 21. c 25. c

2. b 6. c 10. b 14. c 18. c 22. a
3. c 7. d 11. c 15. a 19. d 23. c
4. c 8. d 12. c 16. c 20. a 24. b
Problems
6-1 A. Depreciation Expense (240,000/10) 24,000

Plant and Equipment (net) (240,000 – 24,000) 216,000
1/1 Inventory 80,000
Goodwill 591,111
Difference Between Implied and Book Value 911,111
B. Palmer’s net income from independent operations $1,600,000

Less: unrealized profit on sales to Sauder
[180,000 – (180,000/1.20)] (30,000)
Palmer’s income from independent operations that has
been realized in transactions with third parties 1,570,000
Palmer’s share of Sauder’s income (600,000 × .90) 540,000
Less: amortization of difference between implied
and book value (104,000)*
Controlling Interest in Consolidated Net Income for 2011 $2,006,000
* 80,000 + (240,000/10)
6-2 A. 2011
Sales 1,080,000
Purchases (Cost of Goods Sold) 1,080,000
12/31 Inventory (Income Statement)

[216,000 – (216,000/1.20)] 36,000
12/31 Inventory(Balance Sheet) 36,000
2012
Sales 1,200,000
Purchases (Cost of Goods Sold) 1,200,000
12/31 Inventory (Income Statement)

[300,000 – (300,000/1.20)] 50,000
12/31 Inventory (Balance Sheet) 50,000
Beginning R/E – Percy 36,000

1/1 Inventory (Income Statement) 36,000
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B. Percy’s Income from independent operations $760,000

Less: Unrealized profit in ending inventory (50,000)
Add: Unrealized profit in beginning inventory 36,000
Percy’s Income Realized in Transactions with
third parties 746,000
Percy’s Share of Subsidiary Income $368,000
6-3 A. Sales 1,020,000

Purchases (Cost of Sales) 1,020,000
To eliminate intercompany sales.
12/31 Inventory (Income Statement) 51,000

Inventory (Balance Sheet) 51,000
To eliminate unrealized intercompany profit in ending inventory.
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 $600,000
Less: Unrealized profit in ending inventory (51,000)
Add: Realized profit in beginning inventory 40,000
Subsidiary income included in consolidated income
Noncontrolling interest ownership percentage 589,000
× .1
Noncontrolling interest in consolidated income $ 58,900
C. Controlling Interest in Consolidated Net Income:

Payton Company’s net income from
independent operations $1,720,000
Reported net income of Sanders Company $600,000
Less: Unrealized profit on sales of 2011 (51,000)
Add: Profit on intercompany sales to Payton
realized in transactions with third parties 40,000
Subsidiary income realized in
transactions with third parties $589,000
Payton Company’s share of subsidiary income
(589,000 × .9) 530,100
Controlling interest in consolidated net income $2,250,100
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6-4 Smiley Toro

A. Reported subsidiary income $1,500,000 $2,400,000
Add: Unrealized profit in beginning inventory 66,000 63,000
Less: Unrealized profit in ending inventory (57,000) (69,000)
Subsidiary income included in consolidated income 1,509,000 2,394,000
Noncontrolling interest ownership percentage × .2 × .1
Noncontrolling interest in consolidated income $301,800 $239,400
Total noncontrolling interest:$301,800 + $239,400 = $541,200
B. Power’s Company’s income independent operations $3,600,000

Add: Unrealized profit considered realized in 2011
($414,000 – $414,000/1.15) 54,000
Less: Unrealized profit in 2011 income
($345,000 – $345,000/1.15) (45,000)
Power’s income realized in transactions with third parties $3,609,000
Smiley Company’s Reported Net Income $1,500,000

Add: Unrealized profit considered realized
in 2011 ($396,000 – $396,000/1.2) 66,000
($342,000 – $342,000/1.20) (57,000)
Subsidiary income realized in transactions
with third parties 1,509,000
Power’s share of subsidiary income (.8 × 1,509,000) 1,207,200

Toro Company’s reported net income $2,400,000
Add: Unrealized profit considered realized
in 2011 ($315,000 – $315,000/1.25) 63,000
($345,000 – $345,000/1.25) (69,000)
Subsidiary income realized in transactions
with third parties $2,394,000
Power’s share of subsidiary income (.9 × 2,394,000) 2,154,600
6-5
A. Sales 4,000,000
Cost of Goods Sold 4,000,000
Cost of Goods Sold 250,000

Ending Inventory (Balance Sheet) 250,000
[$1,250,000 - ($1,250,000/1.25)]
1/1 Retained Earnings – P Company (1) 84,000

Noncontrolling intrest (2) 21,000
Cost of Goods Sold (Beginning Inventory) 105,000
[$525,000 – ($525,000/1.25)] = $105,000
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(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 P Corporation and Subsidiary

at December 31, 2011
Eliminations
P S Dr Cr Noncontrolli Consolidated
ng
Corp. Corp. Interest Balances
Income Statement
Sales $200,000 $ 150,000 (a) 30,000 320,000
Dividend Income 16,000 (c) 16,000
Cost of Sales (92,000) (47,000) (b) 4,000 (a) 30,000 (113,000)
Other Expenses (23,000) (40,000) (e) 17,000 (80,000)
Noncontrolling Interest in Income 9,200 (9,200)
Net income 101,000 63,000 67,000 30,000 9,200 117,800
Retained Earnings 1/1 110,000 30,000 (d) 30,000 110,000
Add: Net Income 101,000 63,000 67,000 30,000 9,200 117,800
Less: Dividends ( 30,000) (20,000) (c) 16,000 (4,000) (30,000)
Retained Earnings 12/31 181,000 73,000 97,000 46,000 5,200 197,800
Balance Sheet
Cash 20,000 19,000 39,000
Accounts Receivable-net 120,000 55,000 175,000
Inventories 140,000 80,000 (b) 4,000 216,000
Patent (d)170,000 (e) 17,000 153,000
Land 270,000 420,000 690,000
Equipment and Buildings-net 600,000 430,000 1,030,000
Investment in S Corporation 240,000 (d)240,000
Total Assets 1,390,000 1,004,000 2,303,000
Equities
Accounts Payable 909,000 831,000 1,740,000
Common Stock 300,000 100,000 (d)100,000 300,000
Retained Earnings from above 181,000 73,000 97,000 46,000 5,200 197,800
Assets (d)60,000 60,000
Assets 65,200 65,200
Total Equities 1,390,000 1,004,000 367,000 367,000 2,303,000
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6-7 PORTER COMPANY AND SUBSIDIARY


Income Statement
Sales 4,400,000 1,800,000 6,200,000
Dividend Income 192,000 (a) 192,000 ----
Total Revenue 4,592,000 1,800,000 6,200,000
Cost of Goods Sold 3,600,000 800,000 4,400,000
Depreciation Expense 160,000 120,000 (d) 80,000 360,000
Other expense 240,000 20,000 440,000
Total Cost & Expenses 4,000,000 1,120,000 5,200,000
Net/Consolidated Income 592,000 680,000 1,000,000
Noncontrolling Interest in Income 120,000 120,000
Net Income to Retained Earnings 592,000 680,000 272,000 120,000 880,000
Statement of Retained Earnings
1/1 Retained Earnings
(c) 64,000
Porter Company 2,000,000 (d) 64,000 (e) 240,000 2,112,000
Shilo Company 920,000 (b) 920,000
Net Income from above 592,000 680,000 272,000 120,000 880,000
Dividends Declared
Porter Company (360,000) (360,000)

Shilo Company (240,000) (a) 192,000 (48,000)
12/31 Retained Earnings to
Balance Sheet 2,232,000 1,360,000 1,320,000 432,000 72,000 2,632,000
Balance Sheet
Cash 280,000 260,000 540,000
Accounts Receivable 1,040,000 760,000 1,800,000
Inventory 960,000 700,000 1,660,000
Investment in Shilo Company 3,400,000 (e) 240,000 (b)3,640,000 ---
Difference between Implied and
Book Value (b) 1,430,000 (c)1,430,000
Land 1,280,000 (c) 200,000 1,480,000
Plant and Equipment 1,440,000 1,120,000 (c) 400,000 (d) 160,000 2,800,000
Goodwill (c) 750,000 750,000
Total Assets 7,120,000 4,120,000 9,030,000
Accounts Payable 528,000 440,000 968,000
Notes Payable 360,000 120,000 480,000
Common Stock:
Porter Company 4,000,000 4,000,000
Shilo Company 2,200,000 (b) 2,200,000
Retained Earnings from above 2,232,000 1,360,000 1,320,000 432,000 72,000 2,632,000
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Assets (c) 16,000 (b) 910,000 878,000
(d) 16,000
Assets 950,000 950,000
Total Liabilities & Equity 7,120,000 4,120,000 6,572,000 6,572,000 712,000 9,030,000
6-8 POOL COMPANY AND SUBSIDIARY

Consolidated Income Statement
Sales ($13,800,000 – $1,350,000) $12,450,000

Cost of Goods Sold (a) $7,755,000
Operating Expenses 1,800,000 9,555,000
Consolidated Income 2,895,000
Less Noncontrolling Interest in Consolidated Income (b) 197,500
(a) Reported Cost of Goods Sold $9,000,000

Less intercompany sales in 2011 (1,350,000)
Plus unrealized profit in ending inventory (2/5 x ($1,350,000 - $900,000)) 180,000
Less realized profit in beginning inventory (1/4 x ($1,800,000 - $1,500,000)) (75,000)
Corrected cost of goods sold $7,755,000
(b) Reported net income of subsidiary $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
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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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 subsidiary’s 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 company’s 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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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 client’s 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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1. Sales from one subsidiary to another are called

2. Noncontrolling interest in consolidated income is never affected by

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

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-3

Use the following information for Questions 15 & 16:

Use the following information for Questions 17 & 18:

17. Controlling interest in consolidated net income for 2011 is:

18. Noncontrolling interest in income for 2011 is:

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-5

Use the following information for Questions 22 & 23:

Use the following information for Questions 24 & 25:

24. Controlling interest in consolidated net income for 2011 is:

25. Noncontrolling interest in income for 2011 is:

B. Calculate controlling interest in consolidated net income for 2011.

B. Calculate controlling interest in consolidated net income for 2012.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-7

C. Calculate controlling interest in consolidated net income for 2011.

Merchandise Remaining in Beginning Inventory

Merchandise Remaining in Ending Inventory

B. Calculate the controlling interest in consolidated net income for 2011.

B. Compute noncontrolling interest in consolidated income for 2011.

C. Compute noncontrolling interest in consolidated net assets on December 31, 2011.

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-9

P Corporation and Subsidiary

P S Eliminations Noncontrolling Consolidated

Fair Value in Excess of Book Value

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

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-11

PORTER COMPANY AND SUBSIDIARY

Pool Company and Subsidiary

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

Short Answer Questions from the Textbook

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-13

1. d 5. a 9. c 13. a 17. b 21. c 25. c

6-1 A. Depreciation Expense (240,000/10) 24,000

B. Palmer’s net income from independent operations $1,600,000

12/31 Inventory (Income Statement)

12/31 Inventory (Income Statement)

Beginning R/E – Percy 36,000

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-15

B. Percy’s Income from independent operations $760,000

6-3 A. Sales 1,020,000

12/31 Inventory (Income Statement) 51,000

Beginning Retained Earnings – Payton

B. Noncontrolling Interest Calculation:

C. Controlling Interest in Consolidated Net Income:

6-4 Smiley Toro

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

B. Power’s Company’s income independent operations $3,600,000

Smiley Company’s Reported Net Income $1,500,000

Power’s share of subsidiary income (.8 × 1,509,000) 1,207,200

Cost of Goods Sold 250,000

1/1 Retained Earnings – P Company (1) 84,000

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-17

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

6-6 P Corporation and Subsidiary

6-7 PORTER COMPANY AND SUBSIDIARY

Porter Shilo Eliminations Noncontrolling Consolidated

Porter Company (360,000) (360,000)

Chapter 6 Elimination of Unrealized Profit on Intercompany Sales of Inventory 6-19

1/1 Noncontrolling Interest in Net

6-8 POOL COMPANY AND SUBSIDIARY