Intercompany profit transactions bonds

Chapter 7

INTERCOMPANY PROFIT TRANSACTIONS — BONDS

Answers to Questions

1 Intercompany borrowing gives rise to notes or advances receivable from and payable to affiliates, as well as reciprocal interest receivable and interest payable accounts and interest income and interest expense accounts.

2 Direct lending and borrowing transactions do not give rise to unrealized gains and losses. Any income reported by the lender is precisely reciprocal to an expense reported by the borrower, and the transactions are complete on the date consummated. Similarly, direct lending and borrowing transactions do not give rise to unrecognized gains and losses since intercompany amounts received and paid are both realized and recognized from the viewpoint of the separate legal entities.

3 Constructive gains and losses are gains and losses from the viewpoint of the consolidated entity but not from the viewpoint of the separate affiliated companies involved. The purchase of a parent company’s outstanding bonds by its subsidiary at a price below the book value of the bonds on the parent company’s books results in a constructive gain. Although the bonds are not actually retired, they are constructively retired from the viewpoint of the consolidated entity because they are no longer liabilities of the consolidated entity to outside parties.

4 The book value of the liability is $1,004,700, computed as $1,000,000 plus $10,000 minus $5,300. If an affiliated company purchases half of the bonds at 98, it will record a bond investment of $490,000. From the viewpoint of the consolidated entity, the purchase of the bonds results in a constructive retirement of $500,000 par of bonds payable. The constructive gain on the bonds is $12,350 [($1,004,700 50%) – $490,000].

5 A constructive gain on bonds is a gain for consolidated statement purposes that is not recorded on the books of the separate affiliated companies. The affiliated companies continue to carry the bonds as a liability (issuer) and investment (purchaser) on their separate books. Alternatively, an unrealized gain on the sale of land is recorded on the books of the selling affiliate, but it is not recognized as a gain for consolidated statement purposes because the land is still held within the consolidated entity. Thus, a constructive gain on bonds is realized and recognized from the viewpoint of the consolidated entity but it is not recognized on the books of the affiliated companies. An unrealized gain on the sale of land is recognized on the books of the selling affiliate but is not realized or recognized from the viewpoint of the consolidated entity.

6 Constructive gains on intercompany bonds are realized and recognized through the interest income and interest expense reported on the separate books of the affiliated companies. The difference between the interest income reported by the investing affiliate and the interest expense reported by the issuing affiliate on the intercompany bonds is the amount of constructive gain recognized in each period. Constructive gains and losses are recognized in the consolidated financial statements before they are recognized on the books of the affiliated companies.

7 If a subsidiary purchases parent company bonds in excess of their book value, a constructive loss results. The loss is attributed to the parent company since it is the parent company bonds that are constructively retired. This approach of associating constructive gains and losses on intercompany bonds with the issuing company is consistent with the procedures used in earlier chapters of associating gains and losses on intercompany sales transactions with the selling affiliates.

8a Assume bonds were purchased at the beginning of the current year

10% bonds payable	52,000
Interest income	5,250
Interest payable	2,500
Investment in S bonds		49,000
Interest expense		4,500
Interest receivable		2,500
Constructive gain on bonds		3,750
To eliminate reciprocal bond investment and bond liability amounts, reciprocal interest income and interest expense amounts, reciprocal interest receivable and interest payable amounts, and enter the constructive gain on bonds. The constructive gain is computed as the $52,500 book value of bonds that were retired for $48,750.

8b Assume bonds were purchased one year earlier

10% bonds payable	52,000
Interest income	5,250
Interest payable	2,500
Investment in S bonds		49,000
Interest expense		4,500
Interest receivable		2,500
Investment in S stock (90%)		3,375
Noncontrolling interest		375
To eliminate reciprocal bond investment and bond liability amounts, reciprocal interest income and interest expense amounts, reciprocal interest receivable and interest payable amounts, and adjust majority and noncontrolling interest holdings for constructive gain less piecemeal recognition. The constructive gain is computed as: $53,000 book value - $48,500 cost = $4,500 of which $750 was recognized on the books of the separate affiliated companies in the prior year.

9 Separate entries are as follows:

Investment in S	40,000
Income from S		40,000
To recognize income equal to 80% of reported subsidiary income.

Investment in S	4,000
Income from S		4,000
To recognize gain on constructive retirement of bonds (parent’s books).

The full amount of the constructive gain on bonds is recognized as investment income because the full amount is assigned to the parent company issuer.

10 Investment income from subsidiary

	75% of subsidiary’s $100,000 reported income	$75,000
	Less: 75% of $8,000 constructive loss on retirement of subsidiary bonds	6,000

	Investment income	$69,000

11a A constructive gain will result when interest income exceeds interest expense on the bonds that are constructively retired.

11b The constructive gain is associated with the parent company since the issuer reports interest expense.

11c The $200 difference between interest income and interest expense represents a piecemeal recognition of the constructive gain on the books of the separate companies.

12 Intercompany receivables and payables of associated companies (equity investees) are generally aggregated with the investments in such companies. In other words, receivables from associates are usually added to the investments in associates and payables are generally deducted from the investments in order to show the equity of the investor in its equity investees in a single amount, with separate disclosure of the components of such equity, either parenthetically or in statement notes.

SOLUTIONS TO EXERCISES

Solution E7-1

1	c	3	D
2	a	4	A

Solution E7-2

1	a
	Book value of Pavone bond’s acquired by
	Showalter ($900,000 + $48,000) 2/3	$632,000
	Cost to Showalter	602,000
	Constructive gain	$ 30,000
2	d
	Nominal interest on Pavone’s remaining
	outstanding bonds $300,000 8%	$ 24,000
	Less: Amortization of premium ($48,000 1/3)/ 4 years	4,000
	Interest expense on consolidated income statement	$ 20,000

Solution E7-3

1	c
	Cost of $80,000 par of Palmer bonds January 1, 2005	$ 76,000
	Book value acquired ($400,000 par - $8,000 discount) 20%	78,400
	Constructive gain	$ 2,400
2	d
	Par value of bonds payable	$400,000
	Less: Unamortized discount ($8,000 - $2,000)	(6,000)
	Book value of bonds	394,000
	Percent outstanding	80%
	Bonds payable	$315,200
3	c
	Constructive gain $2,400/4 years 3 years	$ 1,800
4	c
	Nominal interest	$ 40,000
	Add: Amortization of discount	2,000
		42,000
	Percent outstanding	80%
	Interest expense	$ 33,600

5 b

Piecemeal recognition of gain is $2,400 25% in 2006.

Solution E7-4

1 Consolidated net income

	Paul’s separate income			$ 800,000
	Add: Income from Sally
	Share of Sally’s income
	($500,000 80%)		$400,000
	Less: Loss on bonds constructively retired
	Book value ($1,000,000 - $40,000) 40%	$384,000
	Cost to Sally	400,000	(16,000)
	Add: Piecemeal recognition of loss
	($16,000/4 years)		4,000	388,000
	Consolidated net income			$1,188,000

2	Noncontrolling interest expense

	Sally’s reported income
	$500,000 20%			$ 100,000

Solution E7-5

Prim Corporation and Subsidiary

Consolidated Income Statement

for the year ended December 31, 2014

Sales	$1,500,000
Less: Cost of sales	(870,000)

Gross profit	630,000
Add: Gain on constructive retirement of bondsb	6,000
Less: Operating expenses	(250,000)

Operating profit	386,000
Other Items:
Bond interest expensea	(30,000)
Consolidated net income	$ 356,000

a Parent’s bond interest expense $50,000 less interest on bonds held intercompany $20,000 = $30,000.

b Book value of parent’s bonds purchased $200,000 less purchase price $194,000 = $6,000 gain on constructive retirement.

Solution E7-6

1 Constructive loss

	Cost paid to retire 1/2 of Smedley’s bonds	$503,000
	Book value of bonds retired ($990,000 .5)	495,000
	Constructive loss on bond retirement	$ 8,000

2 Income from Smedley

	Share of Smedley’s reported income $14,000 70%	$ 9,800
	Less: Constructive loss $8,000 70%	(5,600)
	Add: Piecemeal recognition of constructive loss
	($8,000/4 years) 70%	1,400
	Income from Smedley	$ 5,600

Solution E7-7

1 a

	January 1, 2006 cost of $200,000 par bonds	$195,500
	Book value acquired ($1,000,000 + $45,000 premium) 20%	209,000
	Constructive gain	$ 13,500

2 b

Constructive gain $13,500/5 years 4 years

$ 10,800

3 c

Book value $1,036,000 80% outstanding

$828,800

Solution E7-8

1a Constructive gain

	Book value of bonds January 1, 2007	$970,000
	Amortization for 6 months ($30,000/5 years 1/2 year)	3,000
	Book value of bonds July 1, 2007	973,000
	Percent purchased by Saydo	60%

	Book value of bonds purchased	$583,800
	Purchase price	574,800

	Constructive gain	$ 9,000

1b Consolidated bond interest expense for 2007

	Bond interest expense January 1 to July 1
	($1,000,000 8% 1/2 year) + $3,000 amortization	$ 43,000

	Bond interest expense July 1 to December 31
	[($1,000,000 8% 1/2 year) + $3,000 amortization] 40%	17,200

	Consolidated bond interest expense	$ 60,200

1c Bond liability of Partie

	Par	Discount	Book Value
January 1, 2007	$1,000,000	$30,000	$970,000
Amortization 2007		- 6,000	+ 6,000
December 31, 2007	$1,000,000	$24,000	$976,000

Consolidated bond liability $976,000 40% outstanding $390,400

2 The amounts would not be different if Saydo had been the issuer and Partie the purchaser. However, the constructive retirement gains would ‘belong’ to Saydo and would have been allocated to both Partie and the noncontrolling interests in Saydo.

Solution E7-9

Subsidiary purchases parent company bonds:

1a	Gain on constructive retirement of bonds

	Book value of Picker’s bonds constructively
	retired ($5,000,000 - $100,000 unamortized discount) 40%	$1,960,000
	Purchase price of $1,000,000 par bonds	1,900,000
	Gain on constructive bond retirement	$ 60,000

1b	Consolidated interest payable

	($3,000,000 + $1,000,000) 10% interest 1/2 year	$ 200,000

1c	Bonds payable at par ($3,000,000 + $1,000,000)	$4,000,000

1d None But Skidden’s investment in Picker bonds will be $1,920,000.

	Cost January 2	$1,900,000
	Add: Amortization ($100,000/5 years)	20,000
		$1,920,000
	Parent company purchases subsidiary bonds:

2a	Loss on constructive retirement of bonds

	Skidden’s bonds payable ($1,000,000 + $20,000)		$1,020,000
	Price paid by Picker		1,030,000
	Loss on constructive retirement of Skidden’s bonds		$ (10,000)

2b	Consolidated interest expense

	Picker bonds ($5,000,000 10% interest) + $20,000 amortization		$ 520,000

2c None Interest receivable of $50,000 is eliminated in consolidation.

2d	Book value of bonds payable

	Picker’s bonds December 31, 2006	$4,900,000
	Add: Amortization for 2007 ($100,000/5 years)	20,000

	Book value of bonds payable	$4,920,000

Solution E7-10

1 Gain from constructive retirement of bonds

	Book value of bonds purchased by Shelly
	($2,000,000 + $60,000) 25%	$515,000
	Price paid by Shelly	490,000

	Gain from constructive retirement of bonds	$ 25,000

2 Working paper entry to eliminate effect of intercompany bond holdings

12% bonds payable	512,000
Interest incomea	62,000
Interest payable	30,000
Investment in Perdue bonds		492,000
Gain on retirement of bonds		25,000
Interest expenseb		57,000
Interest receivable		30,000

a ($500,000 12% interest) + $2,000 amortization = $62,000

b [($2,000,000 12%) - $12,000 amortization] 25% intercompany = $57,000

3 Consolidated income statement amounts — 2007

a	Constructive gain	None

b	Noncontrolling interest expense ($300,000 20%)	$ 60,000

c	Bond interest expense
	[($2,000,000 12%) - $12,000] 75% outsiders	$ 171,000

d	Bond interest income	None

4 Consolidated balance sheet amounts — December 31, 2007

a	Investment in Perdue bonds	None

b	Book value of bonds payable
	($2,000,000 + $36,000) 75% outsiders	$1,527,000

c	Bond interest receivable	None

d	Bond interest payable
	$2,000,000 12% 75% outsiders 1/2 year	$ 90,000

Solution E7-11

Preliminary computations:

Book value of Sandwood bonds on January 1, 2007	$1,000,000
Purchase price paid by Parrish	783,000

Gain on constructive retirement of Sandwood bonds	$ 217,000

Amortization of discount on bonds ($217,000/7 years)	$ 31,000

Computation of noncontrolling interest expense:

Share of Sandwood’s reported income ($140,000 20%)	$ 28,000
Add: Share of constructive gain ($217,000 20%)	43,400
Less: Piecemeal recognition of constructive gain ($31,000 20%)	(6,200)

Noncontrolling interest expense	$ 65,200

Parrish Corporation and Subsidiary

Consolidated Income Statement

for the year ended December 31, 2007

Sales	$1,800,000
Less: Cost of sales	950,000

Gross profit	850,000
Add: Gain from constructive retirement of Sandwood	217,000
Less: Operating expenses	400,000
Less: Noncontrolling interest expense	65,200

Consolidated net income	$ 601,800

Solution E7-12

1 Public Corporation and Subsidiary, December 31, 2006

		Amounts Appearing in Consolidated Financial Statements
	Interest receivable	0

	Investment in Spede bonds	0

	Interest payable ($40,000 90%)	36,000

	8% bonds payable (($1,000,000 90%)- 13,500 discount)	886,500

	Interest income	0

	Interest expense ($86,000/2) + .9(86,000/2)	81,700

	Loss on intercompany bonds	7,800a

Solution E7-12 (continued)

a Computation of loss on intercompany bonds

	Balance of investment in bonds at December 31, 2006	$105,000
	Add: Amount amortized for July 1 to December 31, 2006
	($5,000 balance at December 31 30/36 months = $6,000 unamortized
	at July 1)	1,000
	Investment cost July 1, 2006	$106,000
	Less: Book value acquired [$1,000,000 - ($15,000
	unamortized discount at December 31 30/36 months)] 10%	98,200
	Loss on constructive retirement of bonds	$ 7,800

2 Consolidation working paper entries at December 31, 2006

Interest income	3,000
8% bonds payable	98,500
Loss on retirement of bonds	7,800
Investment in Spede bonds		105,000
Interest expense		4,300

To eliminate intercompany bonds and record constructive loss on retirement of bonds, and eliminate intercompany interest income and interest expense.

	Interest payable	4,000
	Interest receivable		4,000

To eliminate reciprocal interest payable and interest receivable amounts.

3 Consolidation working paper entries at December 31, 2007

Investment in Spede (90%)	5,850
Noncontrolling interest	650
Interest income	6,000
8% bonds payable	99,100
Investment in Spede bonds		103,000
Interest expense		8,600

To eliminate intercompany bonds, interest income and interest expense, and to charge the unrecognized portion of the constructive loss at the beginning of the period 90% to the investment in Spede and 10% to the noncontrolling interest.

	Interest payable	4,000
	Interest receivable		4,000

To eliminate reciprocal interest payable and interest receivable amounts.

Solution E7-13

1	Gain on constructive retirement of bonds

	Purchase price of bonds	$48,800
	Book value	50,000
	Gain on constructive retirement of bonds	$ 1,200

2 Sonny accounts for its investment in Pappy bonds

January 1, 2008
Investment in Pappy bonds	48,800
Cash		48,800

To record investment in $50,000 par, 8% Pappy bonds.

July 1, 2008
Cash	2,000
Investment in Pappy bonds	200
Interest income		2,200

To record interest and amortization.

December 31, 2008
Interest receivable	2,000
Investment in Pappy bonds	200
Interest income		2,200

To accrue interest and record amortization.

3	Pappy accounts for its bonds payable

	July 1, 2008
	Interest expense	4,000
	Cash		4,000
	To record interest payable for 6 months.

	December 31, 2008
	Interest expense	4,000
	Interest payable		4,000
	To accrue interest for 6 months.

4	Pappy accounts for its investment in Sonny

	December 31, 2008
	Investment in Sonny	40,800
	Income from Sonny		40,800

To record income from Sonny

(80% $50,000) + $1,200 constructive gain - $400 piecemeal recognition of gain.

5	Noncontrolling interest expense ($50,000 20%)	$ 10,000

	Consolidated net income ($200,000 + $40,800)	$240,800

SOLUTIONS TO PROBLEMS

Solution P7-1

1 Loss on constructive retirement of bonds

Purchase price of $50,000 par bonds April 1, 2006		$53,600
Book value of bonds acquired:
Par value	$100,000
Less: Unamortized discount $1,800 for 27
of 36 months ($1,800 .75)	2,400
Book value of bonds	97,600
Intercompany bonds	50%	48,800

Loss on constructive retirement of bonds		$ 4,800

2 Interest income and interest expense

	Interest income in consolidated income statement — 2006	0
	Interest expense in consolidated income statement — 2006
	$8,800 - ($8,800 3/4 year 50%)	$ 5,500

3 Interest receivable and interest payable

	Interest receivable in consolidated balance sheet
	at December 31, 2006	0

	Interest payable in consolidated balance sheet at
	December 31, 2006	$ 1,000

4 Consolidation working paper entries

Loss on constructive retirement of bonds	4,800
8% bonds payable	49,100
Interest income	2,100
Investment in Pongo bonds		52,700
Interest expense		3,300

To eliminate reciprocal interest income and interest expense amounts and reciprocal bond investment and bond liability amounts and enter unrecognized constructive loss.

	Interest payable	1,000
	Interest receivable		1,000

To eliminate reciprocal payables and receivables.

Solution P7-2

Pewter Corporation and Steel Corporation

Schedule to Determine Pewter’s Net Income and Consolidated Net Income

	2006	2007	2008	2009	Total
Pewter’s separate income	$500,000	$375,000	$460,000	$510,000	$1,845,000

80% of Steel’s net income	+ 80,000	+ 96,000	+ 88,000	+ 96,000	+ 360,000

$5,000 unrealized profit in
Steel’s December 31, 2006
Inventory	- 5,000	+ 5,000

$10,000 unrealized profit in
Steel’s December 31, 2007
Inventory		- 10,000	+ 10,000

$15,000 unrealized profit in
2008 on sale of land
upstream 80%			- 12,000		- 12,000

$30,000 unrealized profit on
sale of equipment in 2008			- 30,000		- 30,000

$7,500 depreciation on
unrealized profit on
equipment in 2008 and 2009			+ 7,500	+ 7,500	+ 15,000

$8,000 constructive loss on
purchase of Pewter’s bonds
in 2009				- 8,000	- 8,000

$2,000 piecemeal recognition of
constructive loss in 2009				+ 2,000	+ 2,000

Pewter’s net income	$575,000	$466,000	$523,500	$607,500	$2,172,000

Solution P7-3

Income from Storm for 2006:

Share of reported income of Storm ($200,000 75%)	$ 150,000
Add: Unrealized profit in beginning inventory of Storm	24,000
Less: Unrealized profit in ending inventory of Storm	(30,000)
Add: Piecemeal recognition of gain on sale of equipment
to Paar ($48,000/6 years) 75%	6,000
Less: Unrealized gain on sale of land to Storm	(20,000)
Less: Unrealized gain on sale of building to Storm less
piecemeal recognition through depreciation ($40,000 - $2,000)	(38,000)
Add: Gain on constructive retirement of Paar bonds
($200,000 - $188,000)	12,000

Income from Storm for 2006	$ 104,000

Solution P7-3 (continued)

Investment in Storm at December 31, 2006:

Underlying equity in Storm ($1,040,000 75%)	$780,000
Less: Unrealized profit in Storm’s ending inventory	(30,000)
Less: Unrealized gain on equipment sold to Placid
($48,000 - $24,000 recognized) 75%	(18,000)
Less: Unrealized gain on sale of land to Storm	(20,000)
Less: Unrealized gain on sale of building to
Storm ($40,000 - $2,000 recognized)	(38,000)
Add: Gain on constructive retirement of Placid’s bonds	12,000

Investment in Storm December 31, 2006	$686,000

Noncontrolling interest expense:

Net income of Storm	$200,000
Add: Piecemeal recognition of gain on
equipment ($48,000/6 years)	8,000
Storm’s realized income	208,000
Noncontrolling interest percentage	25%

Noncontrolling interest expense	$ 52,000

Solution P7-3 (continued)

Placid Corporation and Subsidiary

Consolidation Working Papers

for the year ended December 31, 2006

(in thousands)

	Placid	Storm 75%	Adjustments and Eliminations		Consolidated Statements
Income Statement Sales	$ 1,260	$ 1,000	b 100		$2,160
Gain on land	20		f 20
Gain on building	40		f 40
Income from Sahl	104		h 104
Gain on bonds				g 12	12
Cost of sales	700*	600*	d 30	b 100
				c 24	1,206*
Depreciation expense	152*	80*		e 8
				f 2	222*
Interest expense	40*				40*
Operating expense	92*	120*			212*
Noncontrolling int. exp.			k 52		52*
Net income	$ 440	$ 200			$ 440

Retained Earnings Retained earnings — Placid	$ 300				$ 300
Retained earnings — Storm		$ 200	i 200
Net income	440ü	200ü			440
Dividends	320*	160*		h 120
				k 40	320*
Retained earnings December 31	$ 420	$ 240			$ 420

Balance Sheet Cash	$ 54	$ 162	a 20		$ 236
Bond interest receivable		10		j 10
Other receivables	80	60		a 20	120
Inventories	160	100		d 30	230
Land	180	140		f 20	300
Buildings — net	300	360		f 38	622
Equipment — net	280	180		e 24	436
Investment in Storm stock	686		c 24	i 750
			e 24
			h 16
Investment in Placid bonds		188		g 188
	$1,740	$1,200			$1,944

Accounts payable	$ 100	$ 160			$ 260
Bond interest payable	20		j 10		10
10% bonds payable	400		g 200		200
Common stock	800	800	i 800		800
Retained earnings	420ü	240ü			420
	$1,740	$1,200
Noncontrolling interest January 1			e 8	i 250
Noncontrolling interest December 31				k 12	508
					$1,944

Solution P7-4

1	Loss is from the constructive retirement of bonds

	Purchase price of bonds	$106,000
	Book value of bonds ($100,000 + $3,000 premium)	103,000

	Loss on retirement of bonds	$ 3,000

2	Consolidated sales

	Combined sales	$280,000
	Less: Intercompany sales	50,000

	Consolidated sales	$230,000

3	Consolidated cost of goods sold

	Combined cost of goods sold	$170,000
	Less: Intercompany sales	(50,000)
	Less: Unrealized profits in beginning inventory	(20,000)
	Add: Unrealized profits in ending inventory	10,000

	Consolidated cost of goods sold	$110,000

4	Unrealized profit in beginning inventory

	Forced computations ($170,000 + $10,000) - ($50,000 + $110,000)	$ 20,000

5	Unrealized profit in ending inventory

	Combined inventories ($100,000 + $50,000)	$150,000
	Less: Consolidated inventories	140,000

	Unrealized profit in ending inventory	$ 10,000

6	Consolidated accounts receivable

	Combined accounts receivable ($120,000 + $60,000)	$180,000
	Less: Intercompany receivables	15,000

	Consolidated accounts receivable	$165,000

7	Noncontrolling interest expense

	Sher’s reported income	$ 30,000
	Add: Unrealized profit in beginning inventory	20,000
	Less: Unrealized profit in ending inventory	(10,000)
	Sher’s realized income	40,000
	Noncontrolling interest percentage	20%

	Noncontrolling interest expense	$ 8,000

Solution P7-4 (continued)

8	Noncontrolling interest December 31, 2008

	Beginning noncontrolling interest ($335,000 20%)	$ 67,000
	Less: Unrealized profit in beginning inventory ($20,000 20%)	(4,000)
	Less: Noncontrolling interest dividends ($15,000 20%)	(3,000)
	Add: Noncontrolling interest expense	8,000

	Noncontrolling interest December 31, 2008	$ 68,000

	Alternative computation:
	Ending equity of Sher ($350,000 20%)	$ 70,000
	Less: Unrealized profit in ending inventory ($10,000 20%)	2,000

	Noncontrolling interest December 31, 2009	$ 68,000

9	Investment in Sher stock at December 31, 2007

	Investment in Sher stock at cost	$320,000
	Add: Changes in retained earnings to December 31, 2007
	($135,000 - $100,000) 80%	28,000
	Less: Excess of $80,000/8 years = $10,000 per year 2 years	(20,000)
	Less: Unrealized profit in beginning inventory ($20,000 80%)	(16,000)

	Investment in Sher stock December 31, 2007	$312,000

	Alternative computation:
	Investment in Sher stock December 31, 2008	$320,000
	Less: Income from Sher for 2008	(20,000)
	Add: Dividends from Sher ($15,000 80%)	12,000

	Investment in Sher stock December 31, 2007	$312,000

10	Income from Sher

	Share of Sher’s reported net income ($30,000 80%)	$ 24,000
	Less: Depreciation on excess ($80,000/8 years)	(10,000)
	Add: Unrealized profit in beginning inventory ($20,000 80%)	16,000
	Less: Unrealized profit in ending inventory ($10,000 80%)	(8,000)
	Less: Constructive loss on retirement of bonds ($3,000 - $1,000)	(2,000)

	Peter’s income from Sher	$ 20,000

Solution P7-5 [AICPA adapted]

1	Consolidated cash ($50,000 + $15,000)	$ 65,000

2	Equipment — net ($800,000 equipment - $320,000 accumulated
	depreciation - $21,000 unrealized profit + $7,000 profit
	realized through depreciation of excess)	$466,000

3	Investment in Shaw does not appear in consolidated statements.

4	Bonds payable (Shaw’s bonds payable of $200,000 1/2 held
	outside the consolidated entity)	$100,000

5	Common stock (Poe’s stock)	$100,000

6	Beginning retained earnings (Poe’s retained earnings)	$272,000

7	Dividends paid (Poe’s dividends)	$ 80,000

8	Gain on retirement of bonds (Book value of Shaw’s
	bonds acquired by Poe $100,000 less acquisition cost
	of $91,000. Since bonds were acquired on December 31,
	2006, none of the $9,000 gain has been amortized.)	$ 9,000

9	Cost of goods sold ($860,000 combined - $60,000 intercompany sales + $10,000 unrealized profit in
	ending inventory)	$810,000

10	Interest expense (Shaw paid interest for the entire year to
	outside entities so all of Shaw’s interest is reported)	$ 16,000

11	Depreciation expense ($45,000 combined - depreciation on
	the unrealized gain $7,000)	$ 38,000

Solution P7-6

Income from Sahl for 2007:

Share of reported income of Sahl ($100,000 75%)	$ 75,000
Add: Unrealized profit in beginning inventory of Sahl	12,000
Less: Unrealized profit in ending inventory of Sahl	(15,000)
Add: Piecemeal recognition of gain on sale of equipment
to Paar ($24,000/6 years) 75%	3,000
Less: Unrealized gain on sale of land to Sahl	(10,000)
Less: Unrealized gain on sale of building to Sahl less
piecemeal recognition through depreciation ($20,000 - $1,000)	(19,000)
Add: Gain on constructive retirement of Paar bonds
($100,000 - $94,000)	6,000

Income from Sahl for 2007	$ 52,000

Solution P7-6 (continued)

Investment in Sahl at December 31, 2007:

Underlying equity in Sahl ($520,000 75%)	$390,000
Less: Unrealized profit in Sahl’s ending inventory	(15,000)
Less: Unrealized gain on equipment sold to Paar
($24,000 - $12,000 recognized) 75%	(9,000)
Less: Unrealized gain on sale of land to Sahl	(10,000)
Less: Unrealized gain on sale of building to
Sahl ($20,000 - $1,000 recognized)	(19,000)
Add: Gain on constructive retirement of Paar’s bonds	6,000

Investment in Sahl December 31, 2007	$343,000

Noncontrolling interest expense:

Net income of Sahl	$100,000
Add: Piecemeal recognition of gain on
equipment ($24,000/6 years)	4,000
Sahl’s realized income	104,000
Noncontrolling interest percentage	25%

Noncontrolling interest expense	$ 26,000

Solution P7-6 (continued)

Paar Corporation and Subsidiary

Consolidation Working Papers

for the year ended December 31, 2007

	Paar	Sahl 75%	Adjustments and Eliminations		Consolidated Statements
Income Statement Sales	$ 630,000	$ 500,000	b 50,000		$1,080,000
Gain on plant	30,000		f 30,000
Income from Sahl	52,000		h 52,000
Gain on bonds				g 6,000	6,000
Cost of sales	350,000*	300,000*	d 15,000	b 50,000
				c 12,000	603,000*
Depreciation expense	76,000*	40,000*		e 4,000
				f 1,000	111,000*
Interest expense	20,000*				20,000*
Operating expense	46,000*	60,000*			106,000*
Noncontrolling int. exp.			k 26,000		26,000*
Net income	$ 220,000	$ 100,000			$ 220,000

Retained Earnings Retained earnings — Paar	$ 150,000				$ 150,000
Retained earnings — Sahl		$ 100,000	i 100,000
Net income	220,000ü	100,000ü			220,000
Dividends	160,000*	80,000*		h 60,000
				k 20,000	160,000*
Retained earnings December 31	$ 210,000	$ 120,000			$ 210,000

Balance Sheet Cash	$ 27,000	$ 81,000	a 10,000		$ 118,000
Bond interest receivable		5,000		j 5,000
Other receivables	40,000	30,000		a 10,000	60,000
Inventories	80,000	50,000		d 15,000	115,000
Land	90,000	70,000		f 10,000	150,000
Buildings — net	150,000	180,000		f 19,000	311,000
Equipment — net	140,000	90,000		e 12,000	218,000
Investment in Sahl stock	343,000		c 12,000	i 375,000
			e 12,000
			h 8,000
Investment in Paar bonds		94,000		g 94,000
	$ 870,000	$ 600,000			$ 972,000

Accounts payable	$ 50,000	$ 80,000			$ 130,000
Bond interest payable	10,000		j 5,000		5,000
10% bonds payable	200,000		g 100,000		100,000
Common stock	400,000	400,000	i 400,000		400,000
Retained earnings	210,000ü	120,000ü			210,000
	$ 870,000	$ 600,000

Noncontrolling interest January 1			e 4,000	i 125,000
Noncontrolling interest December 31				k 6,000	127,000
					$ 972,000

* Deduct

Source: http://www.sba.oakland.edu/faculty/bazaz/acc401/beams9esm_ch07.doc

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