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True/False Questions A parent or subsidiary company's acquisition of its affiliate's outstanding bonds in the open market may result in an unrealized gain or loss to the consolidated entity. Answer: False Intercompany sales of merchandise by a parent company to a subsidiary are similar to the intrac...

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions True/False Questions 1. A parent or subsidiary company's acquisition of its affiliate's outstanding bonds in the open market may result in an unrealized gain or loss to the consolidated entity. Answer: False 2. Intercompany sales of merchandise by a parent company to a subsidiary are similar to the intracompany shipments of merchandise by a home office to a branch. Answer: True 3. If a parent company has a partially owned subsidiary, there is no effect on the minority interest in net assets of the subsidiary if the subsidiary sells a plant asset to the parent company at a gain. Answer: False 4. If a subsidiary sells merchandise to the parent company at a markup above subsidiary cost, the Cost of Goods Sold ledger account of the subsidiary is not affected by working paper eliminations. Answer: True 5. Intercompany profits in both the beginning and the ending inventories of the purchasing affiliate are unrealized at the end of the accounting period. Answer: False 6. The FASB requires the economic unit concept of consolidated financial statements with respect to the elimination of intercompany profits in inventories resulting from a partially owned subsidiary's sales of merchandise to the parent company. Answer: False 7. In the preparation of consolidated financial statements subsequent to the year in which a subsidiary sold land to the parent company, the unrealized gain on the sale is removed by a working paper elimination (in journal entry format) that debits Intercompany Gain on Sale of LandSubsidiary and credits LandParent. Answer: False

8. In working paper eliminations (in journal entry format) for the intercompany gain in a depreciable plant asset subsequent to the year in which the asset was sold, the credits to the acquirer's Plant Assets and Depreciation Expense ledger accounts always are the same Modern Advanced Accounting by Larsen 10/e 91

Chapter 8: Consolidated Financial Statements: Intercompany Transactions for each year. Answer: False 9. Working paper eliminations are not required after the end of the economic life of a depreciable plant asset sold by a subsidiary to the parent company at a gain, although the asset is continued in use. Answer: False 10. A gain or loss generally is realized if a parent company acquires outstanding bonds of the subsidiary in the open market at an amount that differs from the carrying amount of the bonds in the subsidiary's accounting records. Answer: True 11. The realized gain or loss on a subsidiary's acquisition of outstanding bonds of the parent company in the open market is recognized in the accounting records of the subsidiary. Answer: False 12. A material realized gain or loss on an intercompany investment in bonds is displayed as an extraordinary item in the consolidated income statement. Answer: True 13. Intercompany profits or losses in inventories resulting from sales of merchandise by a partially owned subsidiary need not be considered in the computation of minority interest in net income of the subsidiary. Answer: False 14. Intercompany gains or losses on depreciable plant assets are realized through the annual depreciation expense of the acquiring affiliate. Answer: True 15. If a parent company sells merchandise to a subsidiary at parent company cost, the inventories and cost of goods sold of the subsidiary are not affected by working paper eliminations. Answer: True

16. The debit to Intercompany Liability under Capital Lease is for the same amount as the credit to Intercompany Lease Receivables in a working paper elimination (in journal entry format) for an intercompany sales-type/capital lease. Answer: False Modern Advanced Accounting by Larsen 10/e

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions 17. A working paper elimination must be prepared to remove the intercompany profit element of intercompany management fee revenue and expense accounts. Answer: False Multiple Choice Questions 18. The realized but unrecognized gain on extinguishment of debt resulting from a parent company's open-market acquisition of the subsidiary's outstanding bonds is recorded in subsequent journal entries by: A) The parent company for intercompany interest revenue B) The subsidiary for intercompany interest expense C) Both a and b D) Neither a nor b Answer: C 19. Included in a working paper elimination (in journal entry format) for intercompany sales was a credit of $60,000 to Cost of Goods SoldSubsidiary. The credit indicates that, for the accounting period involved: A) The unrealized intercompany profit in the subsidiary's cost of goods sold was $60,000 B) The realized intercompany profit in the subsidiary's cost of goods sold was $60,000 C) The cost of goods sold by the subsidiary to the parent company was $60,000 D) The gross margin on intercompany sales was $60,000 E) None of the foregoing was true Answer: B

20. On March 31, 2006, Pong Corporation paid its wholly owned subsidiary, Sung Company, $222,500 for a plant asset having a carrying amount to Sung of $200,000. Pong established an economic life of five years, no residual value, and the sum-of-the-years'digits method of depreciation for the plant asset. The appropriate working paper elimination (in journal entry format) for Pong Corporation and subsidiary for the fiscal year ended March 31, 2007, includes a credit to Depreciation ExpensePong in the amount of: Modern Advanced Accounting by Larsen 10/e

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions A) B) C) D) E)

$0 $4,500 $6,000 $7,500 Some other amount

Answer: C Response: ($22,500 x 4/15 = $6,000) 21.

A material realized gain on a subsidiary's open-market acquisition of its parent company's outstanding bonds at a discount currently is displayed in the consolidated income statement as: A) An extraordinary item, net of income tax effects B) An ordinary item, gross of income tax effects C) Either an extraordinary item or an ordinary item, net or gross of income tax effects, depending on the circumstances D) None of the foregoing Answer: A

22. Included in a working paper elimination (in journal entry format) for intercompany sales of merchandise was a debit to Minority Interest in Net Assets of Subsidiary. This debit indicates that: A) The parent company sold merchandise to a partially owned subsidiary B) A wholly owned subsidiary sold merchandise to a partially owned subsidiary C) A partially owned subsidiary sold merchandise to the parent company or to another subsidiary D) Either a or b took place Answer: C 23. From a consolidated point of view, the intercompany gain on a parent company's sale of a depreciable plant asset to the subsidiary is realized when: A) The parent company sells the plant asset to the subsidiary B) The subsidiary abandons the plant asset C) The subsidiary resells the plant asset to the parent company D) Some other transaction or event takes place Answer: D

Response: (the subsidiary depreciates the plant asset)

24. On December 1, 2006, Passey Corporation sold a machine with a carrying amount of $150,000 to its 80%-owned subsidiary, Scully Company, for $200,000. Scully adopted a four-year economic life, no residual value, and the sum-of-the-years'-digits method of depreciation for the machine. If correct working paper eliminations are prepared for Passey Corporation and subsidiary on November 30, 2007, the end of the fiscal year, Passey's net income to be included in consolidated net income is (disregarding income taxes): A) Decreased a net of $30,000 Modern Advanced Accounting by Larsen 10/e

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions B) Increased a net of $20,000 C) Decreased a net of $50,000 D) Decreased a net of $40,000 Answer: A Response: [$50,000 – [($50,000 x 4/10) = $30,000] 25. Stubbs Company, the 80%-owned subsidiary of Petrill Corporation, sells merchandise to Petrill at a gross margin rate of 25%. Intercompany sales during the fiscal year ended June 30, 2006, were $100,000. Petrill's ending inventory of merchandise obtained from Stubbs was $60,000 at billed prices, an amount $20,000 larger than the beginning inventory. The June 30, 2006, working paper elimination (in journal entry format) for Petrill Corporation and subsidiary includes a: A) Debit of $25,000 to Gross Margin on Sales-Stubbs B) Debit of $2,000 to Minority Interest in Net Assets of Subsidiary C) Debit of $80,000 to Sales-Stubbs D) Credit of $10,000 to Inventories-Petrill Answer: B Response: [($40,000 x 0.25) x 0.20 = $2,000] 26. In APB No. 51 "Consolidated Financial Statements," the requirement for complete elimination of intercompany profit (gains) or losses is consistent with the: A) Parent company concept of consolidated financial statements B) Equity method of accounting C) Economic unit concept of consolidated financial statements D) Cost method of accounting Answer: C 27. In the measurement of minority interest in net income of a partially owned subsidiary, the credit for Depreciation ExpenseParent in the working paper elimination (in journal entry format) for intercompany gain in a depreciable plant asset is attributed to net income of: A) The parent company B) The subsidiary C) The consolidated entity D) None of the foregoing Answer: B 28. The working paper elimination (in journal entry format) for a second year of intercompany sales made at a markup over subsidiary cost by a partially owned subsidiary to the parent company includes: A) A debit to Retained EarningsSubsidiary B) A credit to Minority Interest in Net Assets of Subsidiary C) A credit to Cost of Goods SoldSubsidiary D) None of the foregoing Answer: A Modern Advanced Accounting by Larsen 10/e

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions

29. Which of the following is not an effect of a working paper elimination for intercompany sales of merchandise by a parent company to a subsidiary? A) It eliminates the overstatement of the subsidiary's Sales ledger account balance. B) It removes the intercompany profit portion of the subsidiary's Cost of Goods Sold ledger account balance. C) It reduces consolidated inventories to the cost incurred by the consolidated entity. D) It eliminates the parent's Intercompany Sales and Intercompany Cost of Goods Sold ledger accounts balances. E) None of the foregoing Answer: A 30. If a gain on an intercompany transaction is attributable to a partially owned subsidiary, working paper eliminations (in journal entry format) for accounting periods subsequent to the period of the intercompany transaction will include a debit to Minority Interest in Net Assets of Subsidiary unless the gain arose from: A) A sale of plant assets B) A sale of merchandise C) An acquisition of outstanding bonds in the open market D) A sale of intangible assets E) None of the foregoing Answer: C 31. The gross profit on an intercompany sale of merchandise costing $500,000 at a gross margin rate of 16 2/3% based on selling price is: A) $100,000 B) $120,000 C) $200,000 D) $240,000 E) Some other amount Answer: A Response: ($500,000 x 0.20 = $100,000)

32. In the working paper elimination (in journal entry format) prepared on the date a parent company acquires outstanding bonds of its wholly owned subsidiary in the open market at a cost less than the subsidiary's carrying amount for the bonds, the difference between the subsidiary's carrying amount and the parent company's cost is: A) Credited to Gain on Extinguishment of BondsSubsidiary B) Credited to Investment in Subsidiary's BondsParent C) Credited to Retained EarningsSubsidiary D) Accounted for in some other manner Answer: A Modern Advanced Accounting by Larsen 10/e

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions

33. During the fiscal year ended March 31, 2006, Sol Company, the 90%-owned subsidiary of Pal Corporation, sold merchandise for the first time to Pal at a billed price of $160,000, representing a 25% markup on subsidiary cost. On March 31, 2006, $40,000 of the merchandise remained unsold. There were no other intercompany transactions during the year ended March 31, 2006, and Sol had a net income of $80,000 for that year. In the working paper elimination (in journal entry format) of Pal Corporation and subsidiary for the year ended March 31, 2006, Minority Interest in Net Income of Subsidiary is debited for: A) $0 B) $7,000 C) $7,200 D) $8,000 E) Some other amount Answer: C Response: [($80,000 – $8,000) x 0.10 = $7,200] 34. Is the minority interest in net income of a partially owned subsidiary affected by: Elimination of depreciation attributable to intercompany gain on machinery acquired by parent from subsidiary?

A) B) C) D)

Yes Yes No No

Elimination of intercompany gain on land sold by parent to subsidiary?

Yes No Yes No

Answer: B

35.

A working paper elimination to remove an intercompany profit or gain is not relevant for an intercompany: A) Sale of merchandise B) Sale of plant asset or intangible asset C) Sales-type/capital lease D) Acquisition of an affiliate's outstanding bonds payable in the open market Answer: D

36. On October 23, 2006, Pastore Corporation loaned $100,000 to its subsidiary, Selma Company, on a 60-day, 12% promissory note. On November 4, 2006, Pastore discounted the Selma note at Second State Bank at a discount rate of 15%, The cash proceeds of the Modern Advanced Accounting by Larsen 10/e 97

Chapter 8: Consolidated Financial Statements: Intercompany Transactions discounting is computed as: A) $100,000 – ($100,000 x 0.15 x 12/360) B) $102,000 – ($102,000 x 0.15 x 12/360) C) $102,000 – ($102,000 x 0.15 x 48/360) D) $100,000 – ($100,000 x 0.15 x 48/360) Answer: C 37. Refer to the facts in 36. In its journal entry to record the discounting of the note, Selma: A) Debits Interest Expense B) Debits Notes Payable C) Credits Interest Payable D) Credits Intercompany Interest Payable Answer: C 38. On March 1, 2006, Picadilly Corporation loaned $12,000 to its subsidiary, Soho Company, on a 90-day, 12% promissory note. On March 3l, 2006, Picadilly discounted the Soho note at National Bank at a 15% discount rate. In its journal entry to record the discounting, Picadilly credits Intercompany Interest Revenue in the amount of: A) $0 B) $51 C) $120 D) $360 E) Some other amount Answer: C Response: ($12,000 x 0.12 x 30/360 = $120)

39. Intercompany loans, operating leases of property, and rendering of services do not include an element of intercompany profit gain or loss for the consolidated entity because: A) The affiliated companies do not profit at each other's expense B) The revenue of one affiliate exactly offsets the expense of the other affiliate C) The transactions are not with outsiders D) The intercompany amounts are eliminated in the working paper for consolidated financial statements Answer: B

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions Problems 40. A working paper elimination (in journal entry format) for Pigot Corporation and its wholly owned subsidiary, Soper Company, on December 31, 2005, was as follows: Intercompany Interest RevenuePigot ($85,097 x 0.12) 10,212 Intercompany Bonds PayableSoper 100,000 Discount on Intercompany Bonds PayableSoper ($5,335 – $467) Investment in Soper Company BondsPigot ($85,097 + $1,212) Intercompany Interest ExpenseSoper [($100,000 – $5,335) x 0.10] Retained EarningsSoper [($100,000 – $5,335) – $85,097] To eliminate subsidiary's 9% bonds (due December 31, 20012, interest payable each December 31) owned by parent company and related interest revenue and expense; and to increase subsidiary's beginning retained earnings by the amount of unamortized realized gain on the extinguishment of the bonds December 31, 2004. (Income tax effects are disregarded.)

4,868 86,309 9,467 9,568

Prepare a comparable working paper elimination (in journal entry format) for Pigot Corporation and subsidiary on December 31, 2006. Omit explanation and disregard income taxes. Answer: PIGOT CORPORATION AND SUBSIDIARY Working Paper Elimination December 31, 2006 Intercompany Interest RevenuePigot ($86,309 x 0.12) Intercompany Bonds PayableSoper Discount on Intercompany Bonds PayableSoper ($4,868 – $513) Investment in Soper Company BondsPigot ($86,309 + $1,357) Intercompany Interest ExpenseSoper [($100,000 – $4,868) x 0.10] Retained EarningsSoper [$9,568 – ($10,212 – $9,467)]

Modern Advanced Accounting by Larsen 10/e

10,357 100,000 4,355 87,666 9,513 8,823

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions 41. Patch Corporation accounts for the investment in its 70%-owned subsidiary, Scalar Company, by the equity method. Amounts in the financial statements of the two companies for the fiscal year ended December 31, 2006, after closing entries, included the following: Patch Scalar Corporation Company Net income $320,000 $150,000 Retained earnings 580,000 340,000 Retained earnings of subsidiary 80,000 Working paper eliminations for the consolidated financial statements of Patch Corporation and subsidiary included the following intercompany profit items: Patch Corporation In beginning inventories: Scalar sales to Patch Patch sales to Scalar

$10,000

In ending inventories: Scalar sales to Patch Patch sales to Scalar

28,000

Scalar Company $15,000

20,000

Prepare a working paper to compute the following: a. Consolidated net income for the year ended December 31, 2006 b. Consolidated retained earnings, December 31, 2006 Answer: a. Patch Corporation net income Less: Intercompany profit related to Patch's sales to Scalar ($20,000 – $15,000) Patch's share of intercompany profit related to Scalar's sales to Patch [($28,000 – $10,000) x 0.70] Consolidated net income, year ended Dec. 31, 2006 b.

$320,000 (5,000) (12,600) $302,400

Patch Corporation Retained Earnings ledger account balance $580,000 Patch Corporation Retained Earnings of Subsidiary ledger account balance 80,000 Subtotal $660,000 Less: Adjustments for consolidated net income (17,600) Intercompany profit in Patch's beginning retained earnings resulting from Patch's sales to Scalar (15,000) Patch's share of intercompany profit in Scalar's beginning retained earnings resulting from Scalar's sales to Patch ($10,000 x 0.70) (7,000) Consolidated retained earnings, Dec. 31, 2006 $620,400

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Chapter 8: Consolidated Financial Statements: Intercompany Transactions 42. On May 1, 2003, Spe Company sold to Pub Corporation, its parent company, for $120,000 machinery with a carrying amount of $90,000 (net of $10,000 accumulated depreciation), a remaining economic life of six years, and no residual value. Pub adopted the straight-line method of depreciation for the machinery. Pub owns 80% of Spe's outstanding common stock. a. Prepare Spe Company's May 1, 2003, journal entry to record the sale of the machinery. Omit explanation and disregard income taxes. b. Prepare a working paper for Pub Corporation and subsidiary summarizing the working paper eliminations (in journal entry format) with respect to the machinery for the three fiscal years ending April 30, 2006. Omit explanations and disregard income taxes. Use the following format:

Ledger Accounts

Fiscal Year Ending April 30, 2004 2005 2006 Dr Cr Dr Cr Dr Cr

Intercompany Gain on Sale of Machinery —Spe Retained Earnings— Spe Minority Interest in Net Assets of Subsidiary Accumulated Depreciation—Pub Machinery—Pub Depreciation Expense—Pub Answer: a. Cash Accumulated Depreciation Machinery Intercompany Gain on Sale of Machinery

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120,000 10,000 100,000 30,000