Intercorporate Inventory and Debt Transfers (Effective Interest Method)
Puzzle Corporation purchased 75 percent of Sunday Company’s common stock at underlying book value on January 1, 20X3. At that date, the fair value of the noncontrolling interest was equal to 25 percent of Sunday’s book value.
During 20X7, Puzzle resold inventory purchased from Sunday in 20X6. It had cost Sunday $44,000 to produce the inventory, and Puzzle had purchased it for $59,000. In 20X7, Puzzle had purchased inventory for $40,000 and sold it to Sunday for $60,000. At December 31, 20X7. Sunday continued to hold $27,000 of the inventory.
Sunday had issued $200,000 of 8 percent, 10−year bonds on January 1, 20X4, at 104. Puzzle had purchased $80,000 of the bonds from one of the original owners for $78,400 on December 31, 20X5. Interest is paid annually on December 31. Assume Puzzle uses the fully adjusted equity method.
Required
a. What amount of cost of goods sold will be reported in the 20X7 consolidated income statement?
b. What inventory balance will be reported in the December 31, 20X7, consolidated
c. Prepare the
d. Prepare the journal entry to record interest income for Puzzle for 20X7.
e. What amount will be assigned to the noncontrolling interest in the consolidated balance sheet prepared at December 31, 20X7?
f. Prepare all consolidation entries needed at December 31, 20X7, to complete a three−part consolidation worksheet.
g. Prepare a consolidation worksheet for 20X7 in good form.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 1
Amount of cost of goods sold to be reported in consolidated income statement.
Answer to Problem 8.25AP
Cost of goods sold to be reported in consolidated income statement is $794,000
Explanation of Solution
$ | $ | |
Amount of cost of goods reported by P corporation | 620,000 | |
Amount of cost of goods reported by S corporation | 240,000 | |
Adjustment of unrealized profit on inventory purchased by P from S | (15,000) | |
Adjustment of inventory purchased from subsidiary and resold 20X7 | ||
CGS intercompany sales recorded by P | 40,000 | |
CGS intercompany sales recorded by S | 33,000 | |
Total | 73,000 | |
CGS based on P’s cost 40,000 x (33,000 /60,000) | (22,000) | |
Required adjustment | (51,000) | |
Cost of goods sold | 794,000 |
b.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 2
Inventory balance to be reported in consolidated balance sheet December 31 20X7
Answer to Problem 8.25AP
Consolidated inventory balance to be reported in consolidated balance sheet is $278,000
Explanation of Solution
$ | $ | |
Amount of inventory reported by P | 167,000 | |
Amount of inventory reported by S | 120,000 | |
Total | 287,000 | |
Less: Unrealized profit in ending inventory held by S (27,000 / 60,000) x20,000 | (9,000) | |
Consolidated inventory balance | 278,000 |
b.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 3
Journal entry to record interest expenses by S
Answer to Problem 8.25AP
Debit | Credit | |
Interest expense | 15,200 | |
Bond premium | 800 | |
Cash | 16,000 |
Explanation of Solution
Computation of interest expenses
Par value of bond issued | $200,000 |
Annual Interest $200,000 x 0.8 | $16,000 |
Annual amortization of premium ($4,800 /6 years) | (800) |
Interest expenses | $15,200 |
d.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 4
Journal entry to record interest income
Answer to Problem 8.25AP
Debit | Credit | |
Cash | $6,400 | |
Investment in A company bond | 200 | |
Interest income | 6,600 |
Explanation of Solution
Computation of interest income
Annual payment received (80,000 x 0.80 | $6,400 |
Amortization of discount | 200 |
Interest income | $6,600 |
e.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 5
The income assigned to non-controlling interest in consolidated balance sheet
Answer to Problem 8.25AP
Consolidated inventory balance to be reported in consolidated balance sheet is $278,000
Explanation of Solution
$ | |
Net income reported by S | 48,000 |
Adjustment for realization of profit on inventory sold to P | 15,000 |
Adjustment of gain on bond retirement ($4,160 / 8 years) | (520) |
Realized net income | 62,480 |
Income assigned to non-controlling interest $62,480 x 0.25 | 15,620 |
Computation of gain on bond retirement
$ | $ | |
Par value of bond | 200,000 | |
Amortization per year (4,800 / 6 years ) | 800 | |
Premium maturity value Dec 31 20X5 (800 x 8 years) | 6,400 | |
Book value of bond | 206,400 | |
Book value of bond purchase 206,400 x 0.40 | 82,560 | |
Purchase price | (78,400) | |
Gain | 4,160 |
f.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 2
Preparation of consolidation entries needed at December 31 20X7 to complete consolidation worksheet.
Answer to Problem 8.25AP
Debit | Credit | |
1. To eliminate income from subsidiary | ||
Income from subsidiary | 36,000 | |
Dividends declared | 18,000 | |
Investment in S company stock | 18,000 | |
2. Assign income to non-controlling interest. | ||
Income to non-controlling interest | 15,620 | |
Dividends declared | 6,000 | |
Non-controlling interest | 9,620 | |
3. Eliminate beginning investment balance | ||
Common stock S company | 50,000 | |
Retained earnings January 1 | 170,000 | |
Investment in A’s stock | 165,000 | |
Non-controlling interest | 55,000 | |
4. Eliminating beginning inventory profit | ||
Retained earnings, January 1 | 11,250 | |
Non-controlling interest | 3,750 | |
Cost of goods sold | 15,000 | |
5. Eliminating intercompany sale of inventory by P | ||
Sales | 60,000 | |
Cost of goods sold | 51,000 | |
Inventory | 9,000 | |
6. Eliminating intercompany bond holdings | ||
Bond payable | 80,000 | |
Bond premium | 1,920 | |
Interest income | 6,600 | |
Investment on S company’s bonds | 78,800 | |
Interest expenses | 6,080 | |
Retained earnings, January 1 | 2,730 | |
Non-controlling interest | 910 |
Explanation of Solution
- Income from subsidiary is eliminated by debiting to income from subsidiary account.
- Assignment of income to non-controlling interest
- Common stock and retained earnings in the beginning of the year was $170,000 and 50,000 which is $220,000 eliminating by crediting to investment in S account and non- controlling interest account in the ratio of parental and subsidiary holdings.
- Beginning inventory profit of $15,000 is eliminated as required by debiting retained earnings at 75% and non-controlling interest by 25%.
- Intercompany sale of inventory is eliminated by posting reversal entry.
- Eliminating corporate bond holding
Realized net income by S company
Net income reported by S $48,000
Realization of profit on inventory sold to P
(59,000 − 44,000) $15,000
Adjustment of gain on bond retirement ($4,160 / 8 years) (520)
Realized net income62,480
Non-controlling interest $62,480 x 0.25 = $15,620
Bond premium:
Bond premium given $4,800
P bond discount 80,000 − 78,400 (1,600)
Net premium on bond $3,200
Elimination ($3,200 / 10 years) x 6 years = $1,920
Interest on bonds ($80,000 x 0.08) + (1,600 / 8 years) = 6,600.
Calculation of bond investment value:
Bonds purchase consideration $78,400
Amortization of discount (1,600 / 8 years) 200
$78,800
Calculation of interest expenses:
Interest payable $80,000 x0.08 $6,400
Less amortization of premium ($3,200 / 10 years) (320)
$6,080
g.
Intercompany debt transfer:when one corporation controls another, the management has the ability to transfer resources between the two legal entities as needed. A direct intercompany debt transfer involves a loan from one affiliate to another without the participation of an unrelated party including trade receivable, payables arising from intercompany sale of inventory on credit and the issuance of note payable by one affiliate to another in exchange of operating funds.
Requirement 7
Inventory balance to be reported in consolidated balance sheet December 31 20X7
Answer to Problem 8.25AP
Consolidated inventory balance to be reported in consolidated balance sheet is $278,000
Explanation of Solution
P Corporation and S Corporation
Consolidation worksheet
December 31, 20X7
Elimination | |||||
P | S | Debit | Credit | Consolidation | |
Sales | 750,000 | 320,000 | 60,000 | 1,010,000 | |
Interest and other income | 16,000 | 5,000 | 6,600 | 14,400 | |
Income from subsidiary | 36,000 | 36,000 | |||
802,000 | 325,000 | 1,024,400 | |||
Less: Cost of goods sold | (620,000) | (240,000) | 15,000 | ||
51,000 | (794,000) | ||||
Depreciation expenses | (45,000) | (15,000) | (60,000) | ||
Interest and other expenses | (35,000) | (22,000) | 6,080 | (50,920) | |
Consolidated net income | $119,480 | ||||
Income to NCI | 15,620 | (15,620) | |||
Net income | 102,000 | 48,000 | 118,220 | 72,080 | 103,860 |
Retained earnings Jan 1 | 291,700 | 170,000 | 170,000 | 2,730 | |
11,250 | 283,180 | ||||
393,700 | 218,000 | 387,040 | |||
Dividends declared | (50,000) | (24,000) | 18,000 | ||
6,000 | (50,000) | ||||
Retained earnings Dec 31 | 343,700 | 194,000 | 299,470 | 98,810 | 337,040 |
Balance sheet: | |||||
Cash | 37,900 | 48,800 | 86,700 | ||
Accounts receivable | 110,000 | 105,000 | 215,000 | ||
Other receivable | 30,000 | 15,000 | 45,000 | ||
Inventory | 167,000 | 120,000 | 9,000 | 278,000 | |
Land | 90,000 | 40,000 | 130,000 | ||
Investment in S’s bonds | 78,800 | 78,800 | |||
Investment in S’s Stock | 183,000 | 18,000 | |||
165,000 | |||||
Buildings and Equipment | 500,000 | 250,000 | 750,000 | ||
Less Accumulated Depreciation | (155,000) | (75,000) | (230,000) | ||
Total Assets | 1,041,700 | 175,000 | 1,274,700 | ||
Accounts payable | 118,000 | 35,000 | 153,000 | ||
Other payable | 40,000 | 20,000 | 60,000 | ||
Bonds payable | 250,000 | 200,000 | 80,000 | 370,000 | |
Bonds premium | 4,800 | 1,920 | 2,880 | ||
Common Stock: | |||||
P company | 250,000 | 250,000 | |||
S company | 50,000 | 50,000 | |||
Additional Paid in capital | 40,000 | 40,000 | |||
Retained earnings Dec 31 | 343,700 | 194,000 | 299,470 | 98,810 | 337,040 |
Non-controlling interest | 3,750 | 9,620 | |||
55,000 | |||||
910 | 61,780 | ||||
Liability and equity | 1,041,700 | 175,000 | 1,274,700 |
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