Intercompany transfers of services and noncurrent assets part 2

Intercompany Transfers
of Services and
Noncurrent Assets
(Part 2)

Chapter 07
BAKER CHRISTENSEN COTTLRELL
Advanced Financial Accounting
Ninth Edition
McGRAWHILL INTERNATIONAL EDITION

Learning Objective 4
Prepare equity-method journal
entries and elimination entries for
the consolidation of a subsidiary
following an upstream land
transfer.

Illustration (p. 318 - 321)
Peerless Products Corporation acquires land for $20,000
on January 1, 20X1, and sells the land to its subsidiary,
Special Food Incorporated, on July 1, 20X1, for $35,000
Peerless
Product
Jul 1, 20X1 Jan 1, 20X1
Special
Foods
$35 $20
Purchase
land
Inter-corporate
transfer of
land
Consolidated Entity

Upstream Sale of Land
• Peerless Products purchases 80% of the common
stock of Special Foods on Dec 31, 20X0, on its book
value of $240,000. The fair value of Special Foods
NCI is equal to its book value of $60,000.
• During 20X1, Peerless reports separate income of
$140,000 and declares dividends of $60,000.
• Special Foods reports net income of $50,000 and
declares dividend of $30,000.
• July 1, 20X1, Special Foods sells land to Peerless for
$35,000, which was purchased on Jan 1, 20X1, for
$20,000, resulting an unrealized gain of $15,000.
• Special Foods holds the land until the following
years.
P
80%
S
NCI
20%
Requirement: Peerless’ entry on 20X1 and deferral entry for sold
land.

Partially Owned Upstream Sales Equity Method
Adjustment
• Similar to what we did with inventory
transfers: we must share deferral with the
NCI shareholders
• Simply split up the adjustment for unrealized
gains proportionately.
NI 52,000 52,000 NI
Unreal. 3,000 Gain To NCI Shareholders
P
80%
S
NCI
20%
Equity Method
Adjustments
Investment in
Special Foods
12,000
Income from
Special Foods
Unreal. Gain 12,000
40,000

• 20X1 Peerless records its share of Special Foods’ income and
dividend under the fully adjusted method:
(8) Investment in Special Foods 40,000
Income from Special Foods 40,000
Record Peerless’ 80% share of Special Foods’ 20X1 income
(9) Cash 24,000
Investment in Special Foods 24,000
Record Peerless’ 80% share of Special Foods’ 20X1
dividend

Fully adjusted equity-method entries –
20X1
• Under the fully adjusted equity method, Peerless Inc. defers
relative share of the unrealized gross profit is $12,000
(15,000 X 0.80)
(10) Income from special Foods 12,000
Defer gain on intercompany land sale to Special Foods.
Until resold to external party by Special Food, the carrying
value of land must be reduces each time consolidated
statements are prepared

Basic investment account elimination entry:
Common stock 200,000
Retained earnings 100,000
Income from Special Foods 40,000
NCI in NI of Special Foods 10,000
Dividend declared 30,000
NCI in NA of Special Foods 64,000

Group Exercise 2: Partial Ownership Land Transfer
• Stubben Corporation is a 90%-owned subsidiary of Parker
Corporation, acquired for $270,000 on 1/1/X5.
• Investment cost was equal to book value and fair value.
• Stubben’s net income in 20X5 was $70,000, and Parker’s
income, excluding its income from Stubben, was $90,000.
• Stubben’s income includes a $10,000 unrealized gain on land
that cost $40,000 and was sold to Parker for $50,000.
• Assume that Parker sold the land in 20X7 for $65,000.
• Assume Parker adjusts for this transaction in the equity
accounts.
• Assume that Stubben sold the land in 20X7 for $65,000.
• Assume Parker adjusts for this transaction in the equity
accounts.
Required:
1. What entry(ies) would Parker make in 20X5 and 20X7?
2. Prepare the consolidation entries at 12/31/X5, 12/31/X6,
and 12/31/X7.
P
90%
S
NCI
10%

Partially Owned Upstream Sales Equity Method
Adjustment
• Similar to what we did with inventory
transfers: we must share deferral with the
NCI shareholders
• Simply split up the adjustment for unrealized
gains proportionately.
NI 63,000 63,000 NI
Unreal. 1,000 Gain To NCI Shareholders
P
90%
S
NCI
10%
Equity Method
Adjustments
Investment in
Stubben
9,000
Income from
Stubben
Unreal. Gain 9,000
54,000

Solution: Parker Company Equity Method Journal
Entries
Requirement 1
20X5 Equity Method Entries
20X7 Equity Method Entry (after Stubben resold the land)

Solution: Parker Company Equity Method
Journal Entries
Requirement 2
Consolidation Entry at 12/31/X5
Consolidation Entry at 12/31/X6
Requirement 3
Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)

Consolidation Worksheet—20X5
Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Gain on Sale 10,000 10,000 0
Income from Sub
54,000 54,000
Basic
0
Balance Sheet
Investment in Sub
324,000 324,000
Basic
0
Land 50,000 10,000 40,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Income from Sub Basic 0
Balance Sheet
Investment in Sub
(9,000)
Lower
9,000
Basic
0
NCI in NA
1,000 1,000
Lower
Land 50,000 10,000 40,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Gain on Sale 15,000 10,000 25,000
Income from Sub Basic 0
Balance Sheet
Investment in Sub
(9,000)
Lower
9,000
Basic
0
NCI in NA
1,000 1,000
Lower
Land 0

following a downstream
depreciable asset
transfer.

Transfers of Depreciable Assets
• What is the major difference between depreciable and non-depreciable
assets?
• Depreciation—DUH!
• Adds complexity because you have a “moving target” instead
of a stationary target. However, the concepts are the same!
• Adjust for:
• Unrealized gain (same as with land)
• Differences in depreciation expense
• The goal is to get back to the asset’s old basis “as if ” it were still
on the books of the original owner.
• One difference—depreciated going forward based on the new
estimated new life.
• Same as a change of depreciation estimates on any
company’s books

Developing Fixed Asset Elimination Entries
• Compare “Actual” with “As if ”
• “Actual” = How the transferred asset and related
accounts actually appear on the companies’ books
• “ As if ” = How the transferred asset and related
accounts would have appeared if the asset had stayed on
the original owner’s books
• The difference between the two gives the elimination entry
or entries.

Choosing the Right Depreciable Life
• What’s not relevant?
• The original owner’s remaining useful life at the transfer
date.
• What’s relevant?
• The acquirer’s estimated remaining useful life (if
different from the original remaining life).

Example 3—End of Year Transfer
Assume Padre Corp. purchased a machine on 1/1/20X1 for
$100,000 and estimated that the machine would have a useful
life of 10 years with no salvage value. After two years, on
12/31/20X2, Padre Corp. sold the machine to its 100% owned
subsidiary, Sonny Co., for $90,000. Sonny Co. estimated that the
asset had a remaining useful life of five years.
What is the amount of the gain or loss recorded by
Padre at the time of the fixed asset transfer?
Sale:
Proceeds $90,000
 Book Value 80,000
Gain $ 10,000
Machine
100,000
Accumulated
Depreciation
20,000
Book Value = 80,000

What accounts and balances actually exist after the
fixed asset transfer?
Machine
Accumulated
Depreciation Gain on Sale
“Actual” 10,000
90,000 0

What balances would have existed if the transfer had
not taken place?
Machine
Accumulated
90,000 0
“Actual” 10,000
100,000 “As if” 20,000 0

The worksheet entry on 12/31/X2 to eliminate the asset
transfer is simply the “adjustment” to change from
“actual” to “as if” the asset hadn’t been transferred.
Gain on Sale 10,000
Machine 10,000
Accumulated Depreciation 20,000
Machine
Accumulated
90,000 0
“Actual” 10,000
10,000 20,000 10,000
100,000 “As if” 20,000 0

Example 4: Beginning of Year Transfer
$100,000 and estimated that the machine would have a useful life
of 10 years with no salvage value. After two years, on 1/1/20X3,
Padre Corp. sold the machine to its 100% owned subsidiary, Sonny
Co., for $90,000. Sonny Co. estimated that the asset had a
remaining useful life of five years.
How much depreciation expense will Sonny record in 20X3?
Depreciation Expense= (C – SV) / # years
= (90,000 – 0) / 5 years = $18,000
How much depreciation expense would Padre have recorded in
20X3 if it had retained the machine and simply changed the
estimated life to five years?
Depreciation Expense= (BV – SV) / # years left
= (80,000 – 0) / 5 years = $16,000

Sonny’s 20X3 expense can be separated into two parts:
• The portion associated with the original book value from Padre’s
books.
• The portion associated with the extra amount paid above Padre’s
book value (the gain).
Gain = 10,000  5 = 2,000 Extra Depreciation
Book Value = 80,000  5 = 16,000 Padre Depreciation
18,000 Total Sonny Depreciation

Depreciation
Expense
Accumulated
Depreciation
18,000 “Actual” 18,000
2,000 2,000
16,000 “As if” 16,000
What is the first elimination entry?
Depreciation Expense 2,000

What balances would have existed if the transfer hadn’t taken
place?
Machine
90,000
100,000
“Actual”
“As if”
Accumulated
Depreciation
18,000
36,000
Gain on Sale
10,000
0

There are two worksheet entries on 12/31/X3 to compare “actual”
to “as if” to make it appear like the asset hadn’t been transferred.
What is the second elimination entry?
Gain on Sale 10,000
Equipment 10,000
Machine
90,000
10,000
100,000
“Actual”
“As if”
Accumulated
Depreciation
2,000
18,000
20,000
36,000
Gain on Sale
10,000
0
10,000

Example 5: Partial Ownership Depreciable
Asset Transfer at the End of the Year
Pericles Corporation sells machinery to its 80%-owned subsidiary,
Sophocles Corporation, on 12/31/20X4. The machinery has a
book value of $60,000 on this date (cost $120,000 and
accumulated depreciation $60,000), and it is sold to Sophocles
for $90,000. Thus, this transaction produces an unrealized gain
of $30,000. Assume that Pericles adjusts its equity method
accounts accordingly.
Note: Transfer is on last day of the year.
Required:
1. What journal entry would Pericles make on its
books to adjust for the unrealized gain from this transaction?
2. What worksheet entry would Pericles make to
consolidate on this date?
P
S
NCI
80%
20%

Sale:
Proceeds $90,000
Unrealized Gain $ 30,000
Equipment
Investment in Sub
30,000
Income from Sub
Defer Gain 30,000
Requirement 1: Equity Method for unrealized gain
Income from Sub 30,000
Investment in Sub 30,000
120,000
Accumulated
Depreciation
60,000
Book Value = 60,000

Equipment
Sub 90,000
30,000
Parent 120,000
“Actual”
Requirement 2: Worksheet Entry
Accumulated
Depreciation
Gain on Sale 30,000
Equipment 30,000
0
60,000
“As if” 60,000

Example 6: Depreciable Asset Transfer at
Beginning of Year
Given all other information from the previous example, assume
that the transfer takes place on 1/1/20X4. Also, assume that as
of the date of transfer, the machinery has a five-year remaining
useful life (with no residual value) and that Sophocles uses
straight-line depreciation. In addition to the journal entries to
record the transfer of the asset, Sophocles also records
depreciation expense of $18,000 for 20X4 ($90,000 / 5 years).
Note: Transfer is on first day of the year.
Required:
1.What journal entry(ies) would Pericles make on its books to
adjust for the unrealized gain from this transaction?
2. What worksheet entry(ies) would Pericles make to
consolidate on this date?

Beginning of Year
Book Value = 60,000  5 = 12,000 Parent Depreciation
18,000 Total Depreciation
Requirement 1:
Of the $18,000 of depreciation recorded, $12,000 is based on
the BV at the time of transfer and $6,000 is based on the
unrealized gain component. We can think of the $6,000 as the
cancelation of 1/5 of the unrealized gain.

Beginning of Year
Investment in Sub
30,000
6,000
Income from Sub
30,000
Defer Gain
Extra Depreciation 6,000

Beginning of Year
Equipment
Sub 90,000
30,000
Parent 120,000
“Actual”
6,000
“As if” 72,000
Requirement 2: Worksheet Entries
Accumulated
Depreciation
Gain on Sale 30,000
Equipment 30,000
18,000
60,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Gain on Sale 30,000 30,000 0
Depreciation Expense 18,000 6,000 12,000
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated
Depreciation
18,000 6,000 60,000 72,000

Example 6: Subsequent Years
Given all other information from the previous examples,
consider what happens in the last 5 years of the asset’s
useful life. Think about both the equity method entry
Pericles would have to make each year and what
elimination entry would be made each year.
Required:
1.What journal entry would Pericles make on its books to
adjust for the unrealized gain from this transaction on
12/31/X5?
2. What worksheet entry(ies) would Pericles make to
consolidate on this date on 12/31/X5?

Solution 6: Subsequent Years
Requirement 1:
Pericles will continue to extinguish $6,000 (1/5) of
the unrealized gain each year to its equity accounts.
Equity Method Entry for all Subsequent Years:

Solution 6: Subsequent Years
20X6 Worksheet Entries:
Equipment 30,000
Equipment 30,000
Equipment 30,000
Equipment
Sub 90,000
30,000
Parent 120,000
Parent 120,000
Sub 90,000
Parent 120,000
Accumulated
Depreciation
54,000
48,000
“Actual
” 6,000
“As if” 96,000
Equipment
Sub 90,000
30,000
Accumulated
Depreciation
72,000
42,000
“Actual
” 6,000
“As if” 108,000
Equipment
30,000
Accumulated
Depreciation
90,000
36,000
“Actual
” 6,000
“As if” 120,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated
Depreciation
54,000 6,000 48,000 96,000
Investment in Sub XXX 18,000 Basic 0

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated
Depreciation
72,000 6,000 42,000 108,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated
Depreciation
90,000 6,000 36,000 120,000

following an upstream
depreciable asset
transfer.

Example 7: Upstream with Partial Ownership
Depreciable Asset Transfer
On 1/1/X6, Snoopy (an 85%-owned subsidiary of Peanut)
sold equipment costing $150,000 to Peanut for $90,000. At the
time of the sale, the equipment had accumulated depreciation
of $110,000. Peanut continued depreciating the equipment
using the straight-line method and assigned a remaining
useful life of five years.
Required:
1. What journal entry would Peanut make on its
books each year to adjust for the unrealized
gain from this transaction?
2. What worksheet entry would Peanut make each
year to consolidate on this date?
P
85%
S
NCI
15%

Example 5 Computations
Equipment Accumulated Depreciation
150,000 110,000
Book Value = 40,000
Sale:
Proceeds $90,000

Example 7 Computations
Peanut
Snoopy
NCI
15% 85%
Sale:
Proceeds $90,000
Book Value = 40,000  5 = 8,000 Sub Depreciation
18,000 Total Depreciation

85%
Solution: Peanut Company Equity
Method Journal Entries
Investment in Snoopy Income from Snoopy
8,500
Defer Gain
8,500
42,500 42,500
Extra Depr.
Year 1 Income from Snoopy 42,500
Investment in Snoopy 42,500
Income from Snoopy 8,500

Solution: Peanut Company Equity
Method Journal Entries
Year 2 Investment in Snoopy 8,500

Worksheet Entries
Year 1
Gain on Sale 50,000
Equipment 60,000
Peanut 90,000
60,000
“Actual” 18,000
Snoopy 150,000 “As if”
10,000 110,000
118,000

Worksheet Entries
Year 2
NCI in NA of Snoopy 6,000
Equipment 60,000
Peanut 90,000
60,000
36,000
Snoopy 150,000
10,000 100,000
126,000
“Actual”
“As if”

Worksheet Entries
Year 3
Equipment 60,000
Peanut 90,000
60,000
54,000
Snoopy 150,000
10,000 90,000
134,000
“Actual”
“As if”

Worksheet Entries
Year 4
Equipment 60,000
Peanut 90,000
72,000
“Actual”
60,000 10,000 80,000
142,000

Worksheet Entries
Year 5
Equipment 60,000
Peanut 90,000
90,000
“Actual”
60,000 10,000 70,000
150,000

Consolidation Worksheet—Year 1
Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Gain on Sale 50,000 50,000 0
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated
Depreciation
18,000 10,000 110,000 118,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated
Depreciation
36,000 10,000 100,000 126,000
Investment in Snoopy XXX 34,000 Basic 0
NCI in NA of Snoopy 6,000 XXX

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated
Depreciation
54,000 10,000 90,000 134,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated
Depreciation
72,000 10,000 80,000 142,000

Adjustments
Parent Sub DR CR
Consol-idated
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated
Depreciation
90,000 10,000 70,000 150,000

Intercompany Transfers of Amortizable Assets
• Accounting for intangible assets usually differs
from accounting for tangible assets in that
amortizable intangibles normally are reported
at the remaining unamortized balance without
the use of a contra account.
• Other than netting the accumulated
amortization on an intangible asset against the
asset cost, the intercompany sale of intangibles
is treated the same in consolidation as the
intercompany sale of tangible assets.

Intercompany transfers of services and noncurrent assets part 2

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Intercompany transfers of services and noncurrent assets part 2