ELECTRONIC SUPPLEMENT TO CHAPTER 5 -...

ELECTRONIC SUPPLEMENT TO CHAPTER 5

Consolidation working papers for parent company equity method of accountingwere discussed in Chapter 5. Those illustrations are repeated here for an incom-

plete equity method and the cost method of parent company accounting.As in the supplement to Chapter 4, this supplement departs from the normal numeri-

cal sequencing to make it easier to compare the alternative working paper formats. Theexhibits labeled Exhibit I5-7 and I5-8 are for incomplete equity method accounting, andExhibit C5-7 is for cost method accounting with an initial conversion to equity methodaccounting. Exhibit T5-8 provides an illustration of the traditional cost method accountingapproach, without the initial conversion to the equity method. These exhibits correspond toequity method Exhibits 5-7 and 5-8 in the chapter.

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CONSOLIDATION EXAMPLE—INTERCOMPANY PROFIT FROMDOWNSTREAM SALESSeay Corporation is a 90%-owned subsidiary of Peak Corporation, acquired for $94,500cash on July 1, 2003, when Seay’s net assets consisted of $100,000 capital stock and $5,000retained earnings. The cost of Peak’s 90% interest in Seay was equal to book value and fairvalue of the interest acquired ($105,000 � 90%), and accordingly, no allocation to identifi-able and unidentifiable assets was necessary.

Peak sells inventory items to Seay on a regular basis, and the intercompany transactiondata for 2007 are as follows:

Sales to Seay in 2007 (cost $15,000), selling price $20,000Unrealized profits in Seay’s inventory at December 31, 2006 2,000Unrealized profits in Seay’s inventory at December 31, 2007 2,500Seay’s accounts payable to Peak at December 31, 2007 10,000

Incomplete Equity MethodAssume that Peak failed to consider its intercompany transactions in accounting for itsinvestment in Seay during 2006 and 2007. In that case, both Peak’s investment in Seayand its retained earnings account balances at December 31, 2006, would be $2,000 greaterthan under the equity method. This $2,000 overstatement is the result of failing to reduceinvestment and investment income amounts for the $2,000 unrealized profit in 2006. Theamount of overstatement of Peak’s investment in Seay and retained earnings balances

Electronic Supplement to Chapter 5 1

C H A P T E R 5

2 ADVANCED ACCOUNTING

would increase by $500 to $2,500 at December 31, 2007, because the $2,000 unrealized profitsdeferred in 2006 would not be recognized in Peak’s 2007 income and the $2,500 unrealized profitat year-end 2007 would not be excluded from Peak’s income. The following table summarizesthese observations.

IncompleteEquity � Overstated � EquityMethod + Understated Method

Investment balance atDecember 31, 2006 $130,500 �$2,000 $128,500

Income from Seay in 2007 27,000 +2,000 ��2,500 26,500

Dividends received in 2007 (9,000) (9,000)Investment balance at

December 31, 2007 $148,500 �$2,500 $146,000

The errors of omitting the intercompany inventory profits affect the investment in Seay andretained earnings accounts of Peak by the same amount.

CONVERSION TO EQUITY METHOD APPROACH We convert the working papers for Peak and Seay for2007 to the equity method with the following working paper entry to correct for the omissions onPeak’s books:

a Income from Seay (�R, �SE) 500

Retained earnings—Peak (beginning) (�SE) 2,000

Investment in Seay (�A) 2,500

After entering this working paper correction, the other working paper entries would be the sameas those illustrated in the consolidation working papers of Exhibit 5-7. Peak could also record thisentry on its separate books before closing in 2007 to correct for all prior errors resulting from themisapplication of the equity method.

TRADITIONAL WORKING PAPER SOLUTION FOR INCOMPLETE EQUITY METHOD The initial approachto consolidating Peak and Seay financial statements under an incomplete equity method convertsthe income from subsidiary, investment in subsidiary, and retained earnings balances to a completeequity basis. Alternatively, we can adjust the consolidation working paper entries to accommodatean incomplete equity method without conversion to the equity basis. Exhibit I5-7 illustrates thisalternative working paper approach.

Only entries b and d differ from those appearing in Exhibit 5-7 under the equity method. Wereproduce these two working paper entries for convenient reference:

b Retained earnings—Peak January 1 (�SE) 2,000

Cost of goods sold (�E, +SE) 2,000

To adjust cost of goods sold and Peak’s beginning-of-the-period retained earnings for unrealized profits inthe beginning inventory.

d Income from Seay (�R, �SE) 27,000

Dividends (+SE) 9,000


To eliminate investment income (as recorded by Peak) and90% of Seay’s dividends and to reduce the investment accountto its beginning-of-the-period balance.

Beginning parent company retained earnings is overstated because Peak failed to eliminate the$2,000 unrealized profits in 2006. The overstatement amount is the difference between the transferprice and historical cost of the merchandise sold downstream. Entry b decreases Peak’s beginningretained earnings and cost of goods sold for realized profits in the beginning inventory. Entry deliminates the investment income recognized on Peak’s books and dividends received from Seay.Entry d also adjusts the investment account to its beginning-of-the-period balance.


EXHIBIT I5-7Intercompany Profitson Downstream Sales—IncompleteEquity Method

PEAK CORPORATION AND SUBSIDIARY CONSOLIDATION WORKING PAPERSFOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS)

Adjustmentsand Eliminations

90% ConsolidatedPeak Seay Debits Credits Statements

Income StatementNet sales $1,000 $300 a 20 $1,280

Income from Seay 27 d 27

Cost of goods sold (550) (200) c 2.5 a 20b 2 (730.5)

Other expenses (350) (70) (420)

Minority interest expense($30,000 � 10%) e 3 (3)

Net income $ 127 $ 30 $ 126.5

Retained EarningsRetained earnings—Peak $ 196 b 2 $ 194

Retained earnings—Seay $ 45 f 45

Net income 127 30 126.5

Dividends (50) (10) d 9e 1 (50)

Retained earnings—December 31 $ 273 $ 65 $ 270.5

Balance SheetCash $ 30 $ 5 $ 35

Accounts receivable 70 20 g 10 80

Inventories 90 45 c 2.5 132.5

Other current assets 64 10 74

Plant and equipment 800 120 920

Investment in Seay 148.5 d 18f 130.5

$1,202.5 $200 $1,241.5

Accounts payable $ 80 $ 15 g 10 $ 85

Other liabilities 49.5 20 69.5

Capital stock 800 100 f 100 800

Retained earnings 273 65 270.5

$1,202.5 $200

Minority interest January 1 f 14.5

Minority interest December 31 e 2 16.5

$1,241.5


RetainedEarnings Investment Income Dividend12/31/06 in Seay from Seay Income

Prior Year’s Effect90% of Seay’s increase in

undistributed earnings fromJuly 1, 2003, to December 31,2006 ($45,000 � $5,000) � 90% $36,000 $36,000

Unrealized profit in Seay’s inventoryat December 31, 2006 (2,000) (2,000)

Current Year’s EffectReclassify dividend income as

investment decrease($10,000 � 90%) (9,000) $(9,000)

Equity in Seay’s income for 2009($30,000 � 90%) 27,000 $27,000

Unrealized profit in Seay’sDecember 31, 2006, inventory 2,000 2,000

Unrealized profit in Seay’sDecember 31, 2007, inventory (2,500) (2,500)

2007 working paper adjustmentsto convert from cost to equity $34,000 $51,500 $26,500 $(9,000)

EXHIBIT C5-6Peak and SubsidiaryCost-to-EquityConversion Schedule

Cost MethodIf Peak accounts for its investment in Seay using the cost method, the investment account and theDecember 31, 2007, retained earnings are understated by equal amounts in the parent’s separatebalance sheet. Also, instead of income from Seay, the income statement for 2007 shows dividendincome of $9,000. The investment in Seay account is $94,500—the original amount paid by Peakfor its investment.

CONVERSION TO EQUITY METHOD APPROACH The cost-to-equity conversion schedule in Exhibit C5-6is based on the same data as under the equity method for Peak and Seay, except that Peak maintainsits investment in Seay account using the cost method. The schedule provides information necessary toadjust the working paper accounts to what they would have been had Peak used the equity method.

We prepare the following consolidation working paper entry from the schedule:

a Dividend income (�R, �SE) 9,000

Investment in Seay (+A) 51,500

Retained earnings—Peak (+SE) 34,000

Income from Seay (R, +SE) 26,500

To eliminate dividend income, enter income from Seay, adjust the investment in Seayaccount to an equity basis, and convert Peak’s retained earnings to beginningconsolidated retained earnings.

After we enter this working paper adjustment, the other working paper entries are exactly thesame as those in Exhibit 5-7 under the equity method. The parent company may also record thisentry on its books before closing in 2007 to convert the parent company records to an equity basis.

TRADITIONAL WORKING PAPER SOLUTION FOR COST METHOD When Peak accounts for its invest-ment in Seay by the cost method, the financial statements of Peak and Seay are consolidated with-out converting to the equity method. Exhibit C5-7 illustrates consolidation working papers whenthe parent company accounts for its investment under the cost method without a working paperentry for conversion to the equity method.

Working paper entries from Exhibit C5-7 are reproduced for convenient reference:

a Sales (�R, �SE) 20,000


To eliminate intercompany sales and related cost of goods sold.


EXHIBIT C5-7Intercompany Profitson Downstream Sales—Cost Methodwith Init ial Conversionto Equity

PEAK CORPORATION AND SUBSIDIARY CONSOLIDATION WORKING PAPERSFOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS)


90% ConsolidatedPeak Seay Debits Credits Statements

Income StatementNet sales $1,000 $300 a 20 $1,280

Dividend Income 9 d 9

Cost of goods sold (550) (200) c 2.5 a 20b 2 (730.5)


Minority interest expense($30,000 � 10%) e 3 (3)

Net income $ 109 $ 30 $ 126.5

Retained EarningsRetained earnings—Peak $ 160 b 2 f 36 $ 194

Retained earnings—Seay $ 45 g 45

Net income 109 30 126.5

Dividends (50) (10) d 9e 1 (50)

Retained earnings—December 31 $ 219 $ 65 $ 270.5


Accounts receivable 70 20 h 10 80

Inventories 90 45 c 2.5 132.5


Plant and equipment 800 120 920

Investment in Seay 94.5 f 36 g 130.5

$1,148.5 $200 $1,241.5

Accounts payable $ 80 $ 15 h 10 $ 85

Other liabilities 49.5 20 69.5

Capital stock 800 100 g 100 800

Retained earnings 219 65 270.5

$1,148.5 $200

Minority interest January 1 g 14.5

Minority interest December 31 e 2 16.5

$1,241.5


b Retained earnings—Peak January 1 (�SE) 2,000


To adjust cost of goods sold and Peak’s beginning-of-the-periodretained earnings for unrealized profits in the beginning inventory.

c Cost of goods sold (E, �SE) 2,500

Inventories (�A) 2,500

To eliminate unrealized profits in ending inventory.

d Dividend income (�R, �SE) 9,000


To eliminate dividend income and 90% of Seay’sdividends.

e Minority interest expense (E, �SE) 3,000

Dividends—Seay (+SE) 1,000

Minority interest (+L) 2,000

To enter minority interest share of subsidiary income and dividends.

f Investment in Seay (+A) 36,000

Retained earnings—Peak January 1 (+SE) 36,000

To increase Peak’s beginning retained earnings for its shareof Seay’s retained earnings increase between the date ofacquisition and the beginning of the period.

g Capital stock—Seay (�SE) 100,000

Retained earnings—Seay (�SE) 45,000


Minority interest January 1 (+L) 14,500

To eliminate reciprocal investment and equity balances.

h Accounts payable (�L) 10,000

Accounts receivable (�A) 10,000

To eliminate reciprocal receivables and payables.

Entries a, b, and c are the same as those in Exhibit I5-7 under the incomplete equity method.Under the cost method, the balance of Peak’s investment in Seay account remains at the $94,500original cost. Peak recognizes dividend income but does not record its share of Seay’s income oreliminate intercompany profits.

Entry d eliminates dividend income and 90% of Seay’s dividends. Entry e records minorityinterest in Seay’s earnings and dividends. Entry f establishes reciprocity between the investment inSeay account balance and Seay’s equity balances at the beginning of the period ($145,000 � 90%).Entries g and h are the same as under the equity method.

CONSOLIDATION EXAMPLE—INTERCOMPANY PROFITS FROM UPSTREAM SALESSmith Corporation is an 80%-owned subsidiary of Poch Corporation, acquired for $480,000 onJanuary 2, 2003, when Smith’s stockholders’ equity consisted of $500,000 capital stock and $100,000retained earnings. The investment cost was equal to the book value and fair value of Smith’s netassets acquired, so no cost/book value differential resulted from the business combination.

Smith Corporation sells inventory items to Poch Corporation on a regular basis. The intercom-pany transaction data for 2004 are as follows:

Sales to Poch in 2004 $300,000Unrealized profits in Poch’s inventory at December 31, 2003 40,000Unrealized profits in Poch’s inventory at December 31, 2004 30,000Intercompany accounts receivable and payable at December 31, 2004 10,000


Incomplete Equity MethodAssume that Poch Corporation failed to consider its intercompany transactions in accounting forits investment in Smith for 2003 and 2004. In that case, both Poch’s investment in Smith and itsretained earnings account balances at December 31, 2003, are $32,000 greater than under theequity method. This $32,000 overstatement is the result of Poch’s failure to reduce investment andinvestment income accounts for 80% of the $40,000 unrealized inventory profit in 2003.

By December 31, 2004, the overstatement decreases to $24,000 because the $32,000 deferredfrom 2003 is not recognized in Poch’s income for 2004, and the $24,000 unrealized profit for 2004(80% of $30,000 unrealized profit at December 31, 2004) is not excluded from Poch’s 2004income. These observations are summarized by comparison with the equity method examplealready illustrated (in thousands):

Incomplete EquityEquity � Overstated � MethodMethod + Understated (see Exhibit 5-8)

Investment balance atDecember 31, 2003 $600 �$32 $568

Income from Smith in 2004 80 +32 ��24 88

Dividends received in 2004 (40) (40)Investment balance at

December 31, 2004 $640 �$24 $616

CONVERSION TO EQUITY METHOD APPROACH The errors from omitting the intercompany profits in 2003and 2004 affect the investment in Smith and retained earnings accounts of Poch by equal amounts.

A working paper entry to correct for the omissions on Poch’s books in the 2004 consolidationworking papers of Poch and Subsidiary is as follows:

a Retained earnings—Poch (�SE) 32,000

Income from Smith (R, +SE) 8,000

Investment in Smith (�A) 24,000

This working paper entry converts the separate accounts of Poch from the incomplete equity tothe equity method for working paper utilization. After entering the conversion in the workingpapers, the other working paper entries are the same as those illustrated in the consolidation work-ing papers of Exhibit 5-8. The conversion entry could also be recorded in Poch’s separate recordsbefore closing in 2004 to correct for the 2003 and 2004 errors of omission.

TRADITIONAL WORKING PAPER SOLUTION FOR INCOMPLETE EQUITY METHOD Exhibit I5-8 illustratesthe traditional approach to consolidating the financial statements of Poch and Smith under an incom-plete equity method. Beginning parent company retained earnings is overstated by Poch’s share of theunrealized profits in Poch’s December 31, 2003, inventory of goods acquired from Smith. Entry beliminates the $40,000 cost-of-goods-sold effect of the intercompany profits in Poch’s beginninginventory, and allocates it 80% to Poch’s beginning-of-the-period retained earnings and 20% tobeginning-of-the-period minority interest. Entry d eliminates income from Smith (as recorded byPoch) and 80% of Smith’s dividends, and reduces the investment account to its beginning-of-the-period balance. Other entries in Exhibit I5-8 are the same as those under the equity method.

Cost MethodIf Poch Corporation uses the cost method of accounting for its investment in Smith for 2003 and2004, its investment in Smith account remains at $480,000, the original cost of the investment.Assume the same facts for Poch and Smith as shown in Exhibit 5-8 under the equity method,except that Poch accounts for the investment in Smith by the cost method.

CONVERSION TO EQUITY METHOD APPROACH Exhibit C5-9 provides data for the working paperentry to convert Poch’s cost-based accounting records to the equity basis. We use the informationin the cost-to-equity conversion schedule to construct a consolidation working paper entry for Pochand Smith as follows:


EXHIBIT I5-8Intercompany Profitson Upstream Sales—IncompleteEquity Method

POCH CORPORATION AND SUBSIDIARY CONSOLIDATION WORKING PAPERSFOR THE YEAR ENDED DECEMBER 31, 2004 (IN THOUSANDS)


80% ConsolidatedPrep Smith Debits Credits Statements

Income StatementSales $3,000 $1,500 a 300 $4,200

Income from Smith 80 d 80

Cost of goods sold (2,000) (1,000) c 30 a 300 (2,690)b 40


Minority interest expense* e 22 (22)

Net income $ 492 $ 100 $ 500

Retained EarningsRetained earnings—Poch $1,032 b 32 $1,000

Retained earnings—Smith $ 250 f 250

Add: Net income 492 100 500

Deduct: Dividends (400) (50) d 40e 10 (400)

Retained earnings—December 31 $1,124 $ 300 $1,100


Accounts receivable 700 100 g 50 750

Inventories 1,100 200 c 30 1,270


Plant and equipment—net 2,000 500 2,500

Investment in Smith 640 d 40f 600

$5,024 $1,000 $5,304

Accounts payable $ 500 $ 150 g 50 $ 600

Other liabilities 400 50 450

Capital stock 3,000 500 f 500 3,000

Retained earnings 1,124 300 1,100

$5,024 $1,000

Minority interest January 1 b 8 f 150

Minority interest December 31 e 12 154

$5,304

*Minority interest expense ($100,000 + $40,000 � $30,000) � 20% = $22,000


Poch’sRetainedEarnings Investment Income from Dividend12/31/03 in Smith Smith Income

Prior Years’ Effect80% of increase in Smith’s

undistributed earnings fromJanuary 2, 2003, to December31, 2003 ($250,000 � $100,000)� 80% $120,000 $120,000

80% of unrealized profit in Poch’sDecember 31, 2003, inventory(40,000 � 80%) (32,000) (32,000)

Current Years’ EffectReclassify dividend income as

investment decrease($50,000 dividends � 80%) (40,000) $(40,000)

Equity in Smith’s 2004 income($100,000 � 80%) 80,000 $80,000

80% of unrealized profit in Poch’sDecember 31, 2003, inventory 32,000 32,000

80% of unrealized profit in Poch’sDecember 31, 2004, inventory($30,000 � 80%) (24,000) (24,000)

2004 working paper adjustmentsto convert from cost to equity $ 88,000 $136,000 $88,000 $(40,000)

EXHIBIT C5-9Poch and SubsidiaryCost-to-EquityConversion Schedule

a Dividend income (�R, �SE) 40,000

Investment in Smith (+A) 136,000

Income from Smith (R, +SE) 88,000

Retained earnings—Poch (+SE) 88,000

To eliminate dividend income, enter income from Smith, adjust the investment inSmith account to an equity basis, and convert Poch’s beginning retained earningsinto beginning consolidated retained earnings.

This entry is the first working paper adjustment, after which other working paper entries are thesame as those prepared when using the equity method. The cost-to-equity conversion entry may berecorded on the parent company books before closing in 2004 to convert the parent companyrecords to an equity basis.

TRADITIONAL WORKING PAPER SOLUTION FOR THE COST METHOD Exhibit T5-8 illustrates workingpaper procedures to consolidate the financial statements of Poch and Smith without convertingto the equity method. Entries a, b, and c under the cost method are identical to those under anincomplete equity method. Entry d eliminates dividend income and 80% of Smith’s dividends.Entry e records the minority interest in Smith’s earnings and dividends. Entry f takes up Poch’sshare of Smith’s retained earnings increase between the date of acquisition of the investment andthe beginning of 2004, thereby establishing reciprocity between the investment account at thebeginning of the period and 80% of Smith’s $750,000 equity at the same date. Entries d and f arereproduced for convenient reference:

d Dividend income (�R, �SE) 40,000


To eliminate dividend income and 80% of Smith’s dividends.

f Investment in Smith (+A) 120,000

Retained earnings—Poch January 1 (+SE) 120,000

To establish reciprocity between parent’s beginning-of-the-period retained earnings andthe investment account at the same date.


EXHIBIT T5-8IntercompanyProfits on UpstreamSales—Tradit ionalCost Method

POCH CORPORATION AND SUBSIDIARY CONSOLIDATION WORKING PAPERSFOR THE YEAR ENDED DECEMBER 31, 2004 (IN THOUSANDS)


80% ConsolidatedPrep Smith Debits Credits Statements

Income StatementSales $3,000 $1,500 a 300 $4,200

Income from Smith 40 d 40

Cost of goods sold (2,000) (1,000) c 30 a 300 (2,690)b 40


Minority interest expense* e 22 (22)

Net income $ 452 $ 100 $ 500

Retained EarningsRetained earnings—Poch $ 912 b 32 f 120 $1,000

Retained earnings—Smith $ 250 g 250

Add: Net income 452 100 500

Deduct: Dividends (400) (50) d 40e 10 (400)

Retained earnings—December 31 $ 964 $ 300 $1,100


Accounts receivable 700 100 h 50 750

Inventories 1,100 200 c 30 1,270


Plant and equipment—net 2,000 500 2,500

Investment in Smith 480 f 120 g 600

$4,864 $1,000 $5,304

Accounts payable $ 500 $ 150 h 50 $ 600

Other liabilities 400 50 450

Capital stock 3,000 500 g 500 3,000

Retained earnings 964 300 1,100

$4,864 $1,000

Minority interest January 1 b 8 g 150

Minority interest December 31 e 12 154

$5,304

*Minority interest expense ($100,000 + $40,000 � $30,000) � 20% = $22,000


Entry g eliminates reciprocal investment and equity balances and enters beginning minorityinterest the same as under the equity method. Entry h eliminates reciprocal accounts receivable andpayable.

A S S I G N M E N T M A T E R I A L

W 5-1 Spud Corporation is a 90%-owned subsidiary of Pear Corporation, acquired by Pear at book value,which was also equal to its fair value on January 1, 2003. Pear uses the equity method of account-ing for its investment in Spud, but does not adjust for intercompany profit transactions [an incom-plete equity method]. Separate income statements for Pear and Spud for 2003 and 2004 are asfollows (in thousands):

Pear Spud

2003 2004 2003 2004

Sales $1,000 $1,200 $500 $700Income from Spud 90 135Cost of sales (600) (720) (300) (350)Other expenses (200) (250) (100) (200)

Net income $ 290 $ 365 $100 $150

Intercompany sales from Spud to Pear were $80,000 during 2003 and $120,000 during 2004.Unrealized profits included in ending inventories from these intercompany sales amounted to$8,000 at December 31, 2003, and $24,000 at December 31, 2004.

1. Consolidated cost of sales for 2004 should be:a. $950,000b. $966,000c. $934,000d. $926,000

2. Minority interest expense for 2004 should be:a. $16,600b. $15,000c. $13,400d. $12,600

3. Consolidated net income for 2004 should be:a. $381,000b. $379,400c. $365,000d. $350,600

W 5-2 Pepper Corporation recorded $65,000 investment income from Sneeze Corporation, its 80%-ownedsubsidiary, for the year 2007, and $70,000 for the year 2008. This investment income represented80% of Sneeze’s reported income of $81,250 and $87,500 in 2007 and 2008, respectively. Pepper’snet income (including investment income) for 2007 was $240,000, and for 2008 it was $160,000.

During 2007 Pepper sold merchandise to Sneeze for $180,000. This merchandise cost Pepper$130,000 and 40% of it was inventoried by Sneeze at December 31, 2007.

Pepper sold merchandise that cost $150,000 to Sneeze for $210,000 during 2008. The December31, 2008, inventory of Sneeze included $63,000 of this merchandise.

R E Q U I R E D1. Compute the following:

a. Pepper’s income from Sneeze on a correct equity basis for 2007 and 2008b. Consolidated net income for 2007 and 2008

2. Prepare journal entries to correct Pepper’s books at December 31, 2008, assuming that closing entries atDecember 31, 2008, have not been made.

W 5-3 Speck Corporation is an 80%-owned subsidiary of Pearl Corporation, acquired at book valueon January 1, 2003, when Speck’s assets and liabilities were equal to their fair values. During 2003


Speck sold $12,000 merchandise to Pearl at a 25% gross profit (cost to Speck was $9,000). AtDecember 31, 2003, Pearl included 40% of this merchandise in its inventory at its purchase pricefrom Speck.

Income statements for Pearl and Speck Corporation for 2003 follows (in thousands):

Pearl Speck

Sales $300 $100Income from Speck 12 —Cost of sales (200) (75)Other expenses (50) (10)

Net income $ 62 $ 15

R E Q U I R E D : Prepare a consolidated statement for Pearl Corporation and Subsidiary for the year 2003.

W 5-4 Pargo Corporation acquired all the voting common stock of Silor Corporation several years ago ina pooling of interests business combination. A summary of the separate income amounts of Pargoand Silor before consideration of any intercompany transactions for the year 2003 is as follows:

Pargo Silor

Sales $1,000 $600Cost of sales 600 300

Gross profit 400 300Operating expenses 200 200

Operating income $ 200 $100

During 2003 Pargo sold merchandise that cost $140,000 to Silor for $200,000. Two-fifths of thismerchandise remains in Silor’s inventory at December 31, 2003. This is the first year in which anyintercompany transaction has occurred, and there were no other intercompany transactions duringthe year.

R E Q U I R E D1. Calculate consolidated cost of sales for 2003.

2. Prepare the consolidated income statement for Pargo Corporation and Subsidiary for the year 2003.

W 5-5 Sadly is a 75%-owned subsidiary of Proud Corporation, acquired by Proud at book value (also fairvalue) on January 2, 2004. Comparative income statements for Proud and Sadly for 2006 are as fol-lows (in thousands):

Proud Sadly

Net sales $500 $200Cost of goods sold 300 120


Operating income 140 50Income from Sadly 37.5 —

Net income $177.5 $ 50

A D D I T I O N A L I N F O R M AT I O N1. Sadly made sales to Proud of $60,000 in 2005 and $100,000 in 2006.

2. Proud’s inventories at December 31, 2005, and December 31, 2006, included merchandise on whichSadly reported profit of $15,000 and $24,000 during 2005 and 2006, respectively.

3. Proud has not eliminated the effect of intercompany profits in accounting for its investment in Sadly.

R E Q U I R E D1. Prepare any entries necessary to adjust Proud’s investment in Sadly account at December 31, 2006, and

income from Sadly for $2006.

2. Determine the following:a. Consolidated cost of goods sold for 2006


b. Minority interest expense for 2006c. Consolidated net income for 2006

W 5-6 Plum Corporation paid $2,900,000 for all the outstanding voting common stock of Star Corporationon January 2, 2001, when Star’s stockholders’ equity consisted of $1,500,000 common stock and$1,000,000 retained earnings. The excess cost over book value acquired was allocated to previouslyunrecorded patents with a 10-year amortization period.

Financial information relating to Star’s income, dividends, and retained earnings for 2007 and2008 follows (in thousands):

2007 2008

Net income as reported $ 400 $ 700Dividends 200 300Retained earnings, December 31 1,500 1,900

During 2008 Plum sold inventory items to Star for $120,000, and $20,000 intercompany profitfrom the sales was unrealized at December 31. Star’s December 31, 2007, inventory included$30,000 unrealized profit on merchandise acquired from Plum.

Plum uses the cost method of accounting for its investment in Star, and accordingly, Plum’sinvestment in Star account balance has remained at $2,900,000 since acquisition.

Plum’s retained earnings balances at year-end 2007 and 2008 are $4,700,000 and $5,300,000,respectively.

R E Q U I R E D1. Determine the correct balance of Plum’s investment in Star account at December 31, 2007, under the

equity method.

2. Determine Plum’s income from Star under the equity method for 2008.

3. Prepare a schedule to convert from the cost to the equity method in the consolidation working papers for 2008.

4. Prepare a consolidation working paper entry for 2008 to convert Plum’s accounts to an equity basis forconsolidation purposes. The entry should be based on the schedule prepared in 3.

W 5-7 Comparative income statements for Probe Corporation and its 70%-owned subsidiary, SeekCorporation, for 2003 follow (in thousands):

Probe Seek

Sales $1,000 $600Cost of sales 480 310


Separate income 220 110Income from Seek 77 —

Net income $ 297 $110

A D D I T I O N A L I N F O R M AT I O N1. Probe acquired its interest in Seek on January 1, 2002, at a price $360,000 in excess of the fair value of the

interest acquired. Probe assigns a fair value/book value differential of $100,000 (based on the interestacquired) to equipment with a 10-year life.

2. Probe sells inventory items to Seek on a regular basis, with intercompany sales data as follows:

2002 2003

Probe’s sales to Seek $300,000 $420,000Probe’s cost of sales to Seek 200,000 280,000Percent unsold at December 31 40% 25%

R E Q U I R E D1. Prepare a corrected income statement for Probe Corporation for 2003 with Seek Corporation being treated

as an equity investee.

2. Prepare a consolidated income statement for Probe Corporation and Subsidiary for 2003.


W 5-8 Comparative separate company and consolidated balance sheets for Pharm Corporation and its80%-owned subsidiary, Silky Corporation, at year-end 2004 are as follows (in thousands):

Pharm Silky Consolidated

AssetsCash $ 180 $ 40 $ 220Inventories 200 160 360Other current assets 70 150 170Plant assets—net 500 350 850Investment in Silky 630 — —Patents — — 150

$1,580 $700 $1,750

EquitiesAccounts payable $ 80 $ 50 $ 120Dividends payable 100 50 110Capital stock, $10 par 1,000 500 1,000Retained earnings 400 100 400Minority interest — — 120

$1,580 $700 $1,750

Investigation reveals that the consolidated balance sheet is in error because Pharm Corpora-tion has not amortized patents and has not eliminated unrealized inventory profits. The invest-ment in Silky was acquired on January 1, 2003, at a price $150,000 in excess of the book valueand fair value. The original plan was to amortize patents over 20 years. Unrealized profits inSilky’s December 31, 2003 and 2004, inventories of merchandise acquired from Pharm were$30,000 and $50,000, respectively. Other current assets include intercompany receivables of$10,000.

R E Q U I R E D : Prepare consolidated balance sheet working papers on December 31, 2004, for PharmCorporation and Subsidiary.

W 5-9 Panda and Soapy Corporations combined in a pooling of interests consummated on January 1,2007. Panda issued 35,000 of its previously unissued common shares for all of Soapy’s outstandingshares, and Soapy became a 100%-owned subsidiary of Panda. Adjusted trial balances for the twocompanies at December 31, 2006, immediately before the pooling and at December 31, 2007, oneyear after the pooling, follow (in thousands).

Panda Corporation and Soapy Corporation Adjusted Trial Balances

December 31, 2006 December 31, 2007Panda Soapy Panda Soapy

Cash $ 180 $ 40 $ 155 $ 120Accounts receivable 200 100 220 130Dividends receivable 20Inventories 120 70 205 80Land 100 50 100 50Building—net 500 150 700 140Equipment—net 400 160 470 200Investment in Soapy 530Cost of sales 550 200 600 240Other expenses 250 150 300 160Dividends 100 80 100 80

Total debits $2,400 $1,000 $3,400 $1,200Accounts payable $ 225 $ 40 $ 300 $ 50Dividends payable 25 20 25 20Other liabilities 150 40 165 60Capital stock, $10 par 500 200 850 200Other paid-in capital 200 80 130 80Retained earnings 300 120 590 190Sales 1,000 500 1,200 600Income from Soapy 140

Total credits $2,400 $1,000 $3,400 $1,200


During 2007 Soapy sold inventory items to Panda for $150,000, at a markup of 150% of cost toSoapy. Panda inventoried all of this merchandise on December 31, 2007.

R E Q U I R E D : Prepare a consolidated income statement, a consolidated retained earnings statement, anda consolidated balance sheet for Panda Corporation and Subsidiary at and for the year ended December 31,2007.

ELECTRONIC SUPPLEMENT TO CHAPTER 5 -...

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