CHAPTER SIX

ELIMINATION OF UNREALIZEDPROFIT

ON INTERCOMPANY SALES OF INVENTORY

Updates

The concepts that are introduced and detailed in this chapter are not affected by the changes brought about by SFAS No. 141 and 142. However, several of the homework problems are comprehensive in nature and thus are affected by the elimination of goodwill amortization. The revised homework problems affected are shown here. The revised solutions are available in the solutions manual on the Website and are labeled as 2nd edition solutions.

Problem 6-8 Upstream Eliminating Entries and Consolidated Net Income

On January 2, 2002, Patten Company purchased a 90% interest in Sterling Company for $1,400,000. At that time Sterling Company had capital stock outstanding of $800,000 and retained earnings of $425,000. The difference between cost and book value was assigned to the following assets:

Inventory / $ 37,500
Plant and equipment (net) / 180,000
Excess of cost over fair value / 80,000

The inventory was sold in 2002. The plant and equipment had a remaining useful life of 12 years on January 2, 2002.

During 2002 Sterling sold merchandise with a cost of $950,000 to Patten at a 20% markup above cost. At December 31, 2002, Patten still had merchandise in its inventory that it purchased from Sterling for $576,000.

In 2002, Sterling Company reported net income of $410,000 and declared no dividends.

Required:

A. Prepare in general journal form all entries necessary on the consolidated financial statements workpaper to eliminate the effects of the intercompany sales, to eliminate the investment account, and to assign the difference between cost and book value.

B. Assume that Patten Company reports net income of $2,000,000 from its independent operations. Calculate consolidated net income.

C. Calculate noncontrolling interest in combined income.

Problem 6-9 Upstream and Downstream Worksheet

On January 1, 2002, Perry Company purchased 80% of Selby Company for $990,000. At that time Selby had capital stock outstanding of $350,000 and retained earnings of $375,000.

The fair value of Selby Company's assets and liabilities is equal to their book value except for the following:

Fair Value / Book Value
Inventory / $210,000 / $160,000
Plant and equipment (10-year life) / 780,000 / 630,000

One-half of the inventory was sold in 2002; the remainder was sold in 2003.

At the end of 2002, Perry Company had in its ending inventory $60,000 of merchandise it had purchased from Selby Company during the year. Selby Company sold the merchandise at 25% above cost. During 2003, Perry Company sold merchandise to Selby Company for $310,000 at a markup of 20% of the selling price. At December 31, 2003, Selby still had merchandise that it purchased from Perry Company for $82,000 in its inventory.

Financial data for 2003 are presented here:

Perry Company / Selby Company
Sales / $1,400,000 / $ 800,000
Dividend income / 20,000 / ------
Total revenue / 1,420,000 / 800,000
Cost of goods sold:
Beginning inventory / 230,000 / 145,000
Purchases / 900,000 / 380,000
Cost of Goods Available / 1,130,000 / 525,000
Less: Ending inventory / 450,000 / 200,000
Cost of goods sold / 680,000 / 325,000
Other expenses / 250,000 / 195,000
Total cost and expense / 930,000 / 520,000
Net Income / $ 490,000 / $ 280,000
1/1 Retained earnings / $1,500,000 / $ 480,000
Net income / 490,000 / 280,000
Dividends declared / (50,000) / (25,000)
12/31 Retained earnings / $1,940,000 / $ 680,000
Cash / $ 95,000 / $ 70,000
Accounts receivable (net) / 302,000 / 90,000
Inventory / 450,000 / 200,000
Investment in Selby Company / 990,000
Plant and equipment (net) / 850,000 / 582,000
Other assets (net) / 390,000 / 230,000
Total assets / $3,077,000 / $1,175,000
Accounts payable / $ 75,000 / $ 30,000
Other liabilities / 102,000 / 60,000
Common stock / 960,000 / 350,000
Retained earnings / 1,940,000 / 735,000
Total liabilities and equity / $3,077,000 / $1,175,000

Required:

A. Prepare the consolidated statements workpaper for the year ended December 31, 2003.

B. Calculate consolidated retained earnings on December 31, 2003, using the analytical or T-account approach.

Problem 6-14 Omit the sentence that states that goodwill should be amortized over 40 years.

Problem 6-18 Comprehensive Complete Equity Problem, Cost Greater than Fair Value with Intercompany Sales of Inventory

(Note that this is the same problem as Problem 6-14, but assuming the use of the complete equity method.) On January 1, 2003, Perry Company purchased 80% of Selby Company for $960,000. At that time Selby had capital stock outstanding of $400,000 and retained earnings of $400,000.

The fair value of Selby Company's assets and liabilities is equal to their book value except for the following:

FAIR VALUE / BOOK VALUE
Inventory / $ 230,000 / $ 155,000
Plant and equipment (10-year life) / 800,000 / 600,000

One-half of the inventory was sold in 2003; the remainder was sold in 2004.

At the end of 2003, Perry Company had in its ending inventory $54,000 of merchandise it had purchased from Selby Company during the year. Selby Company sold the merchandise at 20% above cost. During 2004, Perry Company sold merchandise to Selby Company for $300,000 at a markup of 20% of the selling price. At December 31, 2004, Selby still had merchandise that it purchased from Perry Company for $78,000 in its inventory.

Financial data for 2004 are presented here:

PERRY / SELBY
COMPANY / COMPANY
Sales / $ 1,385,000 / $ 720,000
Equity in subsidiary income / 153,600
Total revenue / 1,538,600 / 720,000
Cost of goods sold:
Beginning inventory / 210,000 / 155,000
Purchases / 875,000 / 360,000
Cost of goods available / 1,085,000 / 515,000
Less: Ending inventory / 400,000 / 225,000
Cost of goods sold / 685,000 / 290,000
Other expenses / 225,000 / 170,000
Total cost and expense / 910,000 / 460,000
Net income / $ 628,600 / $ 260,000
1/1 Retained earnings / 1,417,000 / 450,000
Net income / 628,600 / 260,000
Dividends declared / (40,000) / (30,000)
12/31 Retained earnings / $ 2,008,100 / $ 680,000
Cash / $ 90,000 / $ 65,000
Accounts receivable / 297,000 / 85,000
Inventory / 400,000 / 225,000
Investment in Selby Company / 1,076,400
Plant and equipment (net) / 880,000 / 540,000
Other assets / 384,000 / 230,000
Total assets / $ 3,127,400 / $1,145,000
Accounts payable / 24,300 / 25,000
Other current liabilities / 95,000 / 40,000
Common stock / 1,000,000 / 400,000
Retained earnings / 2,008,100 / 680,000
Total liabilities and equity / $ 3,127,400 / $1,145,000

Required:

A. Prepare the consolidated statements workpaper for the year ended December 31, 2004.

B. Calculate consolidated retained earnings on December 31, 2004, using the analytical approach or T-account approach.

C. If you completed Problem 6-14, compare the consolidated balances obtained in part (A) with those obtained in that problem.