Chapter 5 Advanced Accounting
Chapter 5 Advanced Accounting
Chapter 5 Advanced Accounting
1 Profits and losses on intercompany sales between affiliates are realized for consolidated statement purposes when
the purchasing affiliate resells the merchandise to parties outside of the consolidated entity. If all merchandise sold
to affiliates is resold to outside parties in the same period, there will be no unrealized profit to eliminate in preparing
the consolidated financial statements.
2 Gross profit, rather than net profit, is the concept that should be used in computing unrealized inventory profits
according to GAAP.
3 The amount of unrealized profit to be eliminated in the preparation of consolidated financial statements is not
affected by the existence of a noncontrolling interest. All unrealized profit must be eliminated. In the case of
upstream sales, however, the unrealized profit should be allocated between controlling and noncontrolling interests.
4 The elimination of intercompany sales and purchases does not affect consolidated net income. This is because equal
amounts are deducted from sales and cost of sales and the net effect on consolidated net income is nil. The
importance of the elimination lies in a correct statement of consolidated sales and cost of sales.
5 Consolidated working capital is not affected by the elimination of intercompany accounts receivable and accounts
payable balances. Since equal amounts are deducted from current assets and current liabilities, the effect on the
computation "current assets less current liabilities" is nil.
6 Upstream sales are sales from subsidiary to parent. Downstream sales are sales from parent to subsidiary. The
importance of this designation lies in the fact that the profit or loss on such transactions is the selling affiliate's profit
or loss. In the case of unrealized profit or loss on downstream sales, all the profit or loss is assigned to the parent-
seller. But unrealized profit or loss on upstream sales is profit or loss of the subsidiary-seller and is assigned to the
parent and noncontrolling interest in relation to their proportionate holdings.
7 Yes. If unrealized profits are not eliminated at year end, consolidated net income will be overstated in 2016. The
ending inventory of one year becomes the beginning inventory of the next year, and unrealized profits in the
beginning inventory will understate consolidated net income in 2017. The analysis of the effect of unrealized
inventory profits on consolidated net income is basically the same as the analysis for inventory errors. Like
inventory errors, errors in eliminating unrealized profits are self-correcting over any two accounting periods.
Consolidated net income for 2018 is unaffected.
8 The noncontrolling interest share is affected by upstream sales if the merchandise has not been resold by the parent
to outside parties by the end of the accounting period. This is because the noncontrolling interest share is based on
the income of the subsidiary. If the subsidiary has unrealized profit from intercompany sales, its realized income will
be less than its reported income. The noncontrolling interest share should be based on the realized income of the
subsidiary.
9 A parent's investment income and investment accounts are adjusted for unrealized profits on intercompany sales to
subsidiaries in accordance with the one-line consolidation concept. The parent reduces its investment and investment
income accounts for the full amount of the unrealized profits in the year of intercompany sale. When the goods are
sold to outside parties by the subsidiary, the profits of the parent are realized and the parent increases its investment
and investment income accounts.
10 Combined cost of goods sold is overstated when there are unrealized profits in the beginning inventory and
understated when there are unrealized profits in the ending inventory. The elimination of unrealized profits in the
beginning inventory reduces (credits) cost of goods sold and the elimination of unrealized profits in the ending
inventory increases (debits) cost of goods sold.
11 The effect of unrealized profits on consolidated cost of goods sold is not affected either by a noncontrolling interest
or by the direction of the intercompany sales. All unrealized profit from both upstream and downstream sales is
eliminated from consolidated cost of goods sold.
12 Unrealized profit in the beginning inventory is reflected in an overstatement of cost of sales and is eliminated by
reducing (crediting) cost of sales and debiting the investment account if a correct equity method has been used and
the intercompany sales are downstream. In the case of upstream sales, cost of sales is credited and the
noncontrolling interest and the investment account are debited proportionately.
13 There are two equally good approaches for computing noncontrolling interest share when there are unrealized profits
from upstream sales in both beginning and ending inventories. One approach is to compute realized income of the
subsidiary by adding unrealized profits in the beginning inventory to reported subsidiary net income and deducting
unrealized profits in the ending inventory. The noncontrolling interest share is then equal to the realized income of
the subsidiary multiplied by the noncontrolling interest percentage.
The other approach is to compute the noncontrolling interest percentage in reported subsidiary net income,
in unrealized profits in beginning inventory, and in unrealized profits in ending inventory. Noncontrolling interest
share is then computed by adding the noncontrolling interest percentage in unrealized profits in the beginning
inventory to the noncontrolling interest share of reported income, and subtracting the noncontrolling interest
percentage relating to the unrealized profits in the ending inventory.
14 The assumption that unrealized profits in an ending inventory are realized in the succeeding period is a convenience,
but it does not result in incorrect measurements of consolidated net income as long as the unrealized profits at any
statement date are correctly determined. This is because any unrealized profits in beginning inventory that are
considered realized are credited to cost of sales. The same items will appear as unrealized profits in the ending
inventory if they remain unsold, and the elimination of these items results in debiting cost of sales for the same
amount. Thus, the workpaper effects are offsetting as illustrated in the following workpaper entries, which assume
$5,000 unrealized profits from downstream sales.
Solution E5-1
1 b 5 c
2 d 6 a
3 a 7 a
4 c 8 c
1 a
2 c
Unrealized profits from intercompany sales are eliminated from the ending
inventory: $960 combined current assets less $36 unrealized profit ($180 ´
20%).
3 c
Combined cost of sales of $2,250 less $750 intercompany sales
Solution 5-3
1 d
Pop's separate income (in thousands) $2,000
Add: Share of Son's income ($1,000 ´ 100%) 1,000
Add: Realization of profit deferred in 2016
$3,000 - ($3,000/150%) 1,000
Less: Unrealized profit in 2017 inventory
$2,400 - ($2,400/150%) (800)
Controlling share of consolidated net income $3,200
2 d
Combined sales $2,800
Less: Intercompany sales (100)
Consolidated sales $2,700
3 c
Combined cost of sales $1,360
Less: Intercompany purchases (100)
Less: Unrealized profit in beginning inventory (8)
Add: Unrealized profit in ending inventory 20
Consolidated cost of sales $1,272
1 b
Pop's share of Son's income ($120,000 ´ 80%) $ 96,000
Less: Unrealized profit in ending inventory
($40,000 ´ 50% unsold ´ 80% owned) (16,000)
Income from Son $ 80,000
2 d
Combined cost of sales $ 900,000
Less: Intercompany sales (200,000)
Add: Unrealized profit in ending inventory 20,000
Consolidated cost of sales $ 720,000
3 b
Reported income of Son $ 120,000
Unrealized profit (20,000)
Son's realized income 100,000
Noncontrolling interest percentage 20%
Noncontrolling interest share $ 20,000
Solution E5-5
1 c
Combined sales $1,800,000
Less: Intercompany sales (400,000)
Consolidated sales $1,400,000
2 c
Unrealized profit in beginning inventory
$100,000 - ($100,000/125%) $ 20,000
3 b
Combined cost of goods sold $1,440,000
Less: Intercompany sales (400,000)
Less: Unrealized profit in beginning inventory
$100,000 - ($100,000/125%) (20,000)
Add: Unrealized profit in ending inventory
$125,000 - ($125,000/125%) 25,000
Consolidated cost of goods sold $1,045,000
1 a
Pam's separate income $200,000
Add: Income from Sun (below) 144,550
Controlling share of consolidated net income $344,550
2 c
Pop's share of Son’s reported net loss
($150,000 loss ´ 60%) $(90,000)
Add: Unrealized profit in ending inventory
($200,000 ´ 1/4 unsold) (50,000)
Income from Son (140,000)
Pop's separate income 300,000
Controlling share of consolidated net income $160,000
3 b
Sun's reported net income $300,000
Add: Realized profit in beginning inventory
$150,000 - ($150,000/1.25) 30,000
Less: Deferred profit in ending inventory
$200,000 - ($200,000/1.25) (40,000)
Income from Sun $290,000
Pam’s 75% controlling share of Sun’s income $217,500
Noncontrolling interest share (25%) $ 72,500
Solution E5-7
Solution E5-9
2 Consolidated sales
Combined sales $1,250,000
Less: Intercompany sales 100,000
Consolidated sales $1,150,000
Supporting computations
Cost of investment in Son at January 1, 2017 $ 1,200
Implied fair value of Son ($1,200 / 80%) $ 1,500
Book value of Son (1,400)
Goodwill $ 100
Solution E5-11
1 b
Income as reported $ 200,000
Add: Realization of profits in beginning inventory
$120,000 - ($120,000/1.2) 20,000
Less: Unrealized profits in ending inventory
$360,000 - ($360,000/1.2) (60,000)
Realized income 160,000
Percent ownership 60%
Income from Sun $ 96,000
2 c
Sun's equity as reported ($3,400,000 + $2,100,000) $5,500,000
Less: Unrealized profit in ending inventory (60,000)
Realized equity 5,440,000
Noncontrolling share 40%
Noncontrolling interest December 31, 2016 $2,176,000
3 b
Realized equity $5,440,000
Controlling share 60%
Investment balance December 31, 2016 $3,264,000
Note: The excess fair value over book value is fully amortized. Therefore, the
investment balance of $3,264,000 plus the noncontrolling interest of
$2,176,000 is equal to the $5,440,000 realized equity at the balance sheet
date.
SOLUTIONS TO PROBLEMS
Solution P5-1
Alternatively,
Pop's separate income $ 50,000
Add: Income from Son 124,200
Controlling share of consolidated net income $ 174,200
Add: Noncontrolling interest share 13,800
Consolidated net income $188,000
Intercompany profit:
aPam:
Inventory acquired intercompany ($120,000 ´ 40%) $ 48,000
Cost of intercompany inventory ($48,000/1.2) (40,000)
Unrealized profit in Pam's inventory $ 8,000
bSun:
Inventory acquired intercompany ($77,500 ´ 100%) $ 77,500
Cost of intercompany inventory ($77,500/1.25) (62,000)
Unrealized profit in Sun's inventory $ 15,500
Intercompany profit:
cPam:
Inventory acquired intercompany ($108,000 ´ 50%) $ 54,000
Cost of intercompany inventory ($54,000/1.2) (45,000)
Unrealized profit in Pam's inventory $ 9,000
dSun:
Inventory acquired intercompany ($62,500 ´ 100%) $ 62,500
Cost of intercompany inventory ($62,500/1.25) (50,000)
Unrealized profit in Sun's inventory $ 12,500
Retained Earnings
Retained earnings — Pam $ 600 600
Retained earnings — Sun $ 380 e 380
Net income 200ü 100ü 200
Dividends 100* 50* d 50 100*
Retained earnings
December 31 $ 700 $ 430 $ 700
Balance Sheet
Cash $ 54 $ 37 $ 91
Receivables — net 90 60 g 17 133
Inventories 100 80 b 12 168
Other assets 70 90 160
Land 50 50 100
Buildings — net 200 150 350
Equipment — net 500 400 900
Investment in Sun 736 c 20 d 52
e 704
Patents ______ _____ e 24 f 6 18
$1,800 $ 867 $1,920
Sun's income of $100,000 plus $20,000 profit in beginning inventory, less $12,000 profit in
ending inventory, and less $6,000 patent amortization equals $102,000 income from Sun.
Preliminary computations
Investment cost $2,700,000
Implied fair value of Sun($2,700,000/0.9) $3,000,000
Less: Book value of Sun 2,500,000
Patents $ 500,000
Upstream sales
Unrealized profit in December 31, 2016 inventory of Pam
$280,000 - ($280,000 ¸ 1.4) = $80,000
Unrealized profit in December 31, 2017 inventory of Pam
$420,000 - ($420,000 ¸ 1.4) = $120,000
Investment balance
Initial investment cost $2,700,000
Increase in Sun's net assets from December 31, 2015
to December 31, 2017 ($700,000 ´ 90%) 630,000
Patent amortization for 2 years (90%) ( 90,000)
Unrealized profit in December 31, 2017 inventory (108,000)
Investment balance December 31, 2017 $3,132,000
Retained Earnings
Retained earnings — Pam $ 1,200 $ 1,200
Retained earnings — Sun $ 700 e 700
Controlling share of NI 2,005ü 1,000ü 2,005
Dividends 1,000* 500* d 450
h 50 1,000*
Retained earnings
December 31 $ 2,205 $1,200 $ 2,205
Balance Sheet
Cash $ 753 $ 500 $ 1,253
Inventory 420 800 b 120 1,100
Other current assets 600 200 g 100 700
Plant assets — net 3,000 3,000 6,000
Investment in Sun 3,132 c 72 d 369
e 2,835
Patents _______ ______ e 450 f 50 400
$ 7,905 $4,500 $ 9,453
Retained Earnings
Retained earnings — Pop $ 606 606
Retained earnings — Son $ 380 e 380
Net income 206ü 100ü 206
Dividends 100* 50* d 50 100*
Retained earnings
December 31 $ 712 $ 430 $ 712
Balance Sheet
Cash $ 54 $ 37 $ 91
Receivables — net 90 60 f 17 133
Inventories 100 80 b 12 168
Other assets 70 90 160
Land 50 50 100
Buildings — net 200 150 350
Equipment — net 500 400 900
Investment in Son 748 c 20 d 58
e 710
Goodwill ______ ______ e 30 30
$1,812 $ 867 $1,932
Son's income of $100,000 plus $20,000 profit in beginning inventory less $12,000
profit in ending inventory.
Preliminary computations
Investment cost $5,400
Implied fair value of Son ($5,400 / 90%) $6,000
Less: Book value of Son 5,000
Goodwill $1,000
Upstream sales
Unrealized profit in December 31, 2018 inventory of Pop
$560 - ($560 ¸ 1.4) = $160
Unrealized profit in December 31, 2019 inventory of Pop
$840 - ($840 ¸ 1.4) = $240
Investment balance
Initial investment cost $5,400
Increase in Son's net assets from December 31, 2016
to December 31, 2019 ($1,400 ´ 90%) 1,260
Unrealized profit in December 31, 2019 inventory (90%) (216)
Investment balance December 31, 2019 $6,444
Retained Earnings
Retained earnings — Pop $ 2,500 $ 2,500
Retained earnings — Son $ 1,400 e 1,400
Controlling share of NI 4,100ü 2,000ü 4,100
Dividends 2,000* 1,000* d 900 2,000*
f 100
Retained earnings
December 31 $ 4,600 $ 2,400 $ 4,600
Balance Sheet
Cash $ 1,516 $ 1,000 $ 2,516
Inventory 840 1,600 b 240 2,200
Other current assets 1,200 400 g 200 1,400
Plant assets — net 6,000 6,000 12,000
Investment in Son 6,444 c 144 d 828
e 5,760
Goodwill _______ _______ e 1,000 1,000
$16,000 $ 9,000 $19,116
Solution PR 5-2
Noncontrolling interest should clearly be classified as equity in the consolidated
balance sheet (ASC 810-10-45-16).