Chapter 10, Problem 10.31P

a

To determine

Consolidation income tax issues: the legal structure of an acquisition can result in a taxable or non-taxable transactions. In taxable transaction, the assets acquired and liabilities assumed will have tax basis equal to the fair market values because the subsidiary is required to recognize all inherent gains and losses for tax purposes. In order to avoid this many acquisitions are structured to avoid classification as taxable transaction.

Any difference arising out of fair market value and tax basis should be recorded as deferred tax asset or liability.

When companies in the consolidated group files separate tax returns, intercompany income accruals and dividend transfers must be considered in computing income tax expense for the period. When an investor and investee files separate tax returns, the investor is taxed on the dividends received from the investee rather than on the amount of investment income reported.

Requirement 1

the preparation of consolidated entries needed as of December 31, 20X7, needed for consolidated financial statements.

Answer to Problem 10.31P

Elimination entries:

	Debit	Credit
To eliminate income from subsidiary
Income from subsidiary	25,200
Dividends declared		7,000
Investment in SC common stock		18,200
To assign income to non-controlling interest
Income to non-controlling interest	8,100
Dividends declared		3,000
Non-controlling interest		5,100
Common stock- SC	50,000
Retained earnings January 1	150,000
Investment in SC common stock		140,000
Non-controlling interest		60,000
Eliminate unrealized profit in beginning inventory
Tax expense	4,000
Retained earnings January 1	4,200
Non-controlling interest	1,800
Cost of goods sold		10,000
Eliminating unrealized profit on ending inventory
Sales	120,000
Cost of goods sold		95,000
Inventory		25,000
Eliminating tax expense on unrealized intercompany profit
Deferred tax asset	10,000
Tax expense		10,000
Eliminate unrealized profit on sale of equipment
Building and equipment	85,000
Gain on sale of equipment	15,000
Accumulated depreciation		100,000
Eliminate income tax on unrealized gain on equipment
Deferred tax asset	6,000
Tax expense		6,000

Explanation of Solution

1. Income from subsidiary is eliminated by reverse entry, debit income from subsidiary $36,000 x .70 = $25,200 and dividends 10,000 x .70
2. Income to non-controlling interest $8,100 = ($36,000 + 6,000 − 15,000) x .30
Dividends $3,000 = $10,000 x .30 non-controlling interest $5,100 = $8,100 − 3,000.
3. Elimination of beginning investment by reversal entry
4. Unrealized profit in beginning inventory $10,000
Tax expenses $4,000 = $10,000 x .40

Non-controlling interest $1,800 = $7,000 x .30

Retained earnings $4,200 = $7,000 x .70

5. Profit on sale of inventory is eliminated by reverse entry
6. Tax on unrealized intercompany profit is eliminated by reversal $10,000 = $25,000 x .40
7. Gain on sale of equipment $15,000 = $100,00 − 85,000
8. Deferred tax expenses on unrealized gain on sale of equipment $6,000 = $15,000 x .40

b

To determine

Consolidation income tax issues: the legal structure of an acquisition can result in a taxable or non-taxable transactions. In taxable transaction, the assets acquired and liabilities assumed will have tax basis equal to the fair market values because the subsidiary is required to recognize all inherent gains and losses for tax purposes. In order to avoid this many acquisitions are structured to avoid classification as taxable transaction.

Any difference arising out of fair market value and tax basis should be recorded as deferred tax asset or liability.

When companies in the consolidated group files separate tax returns, intercompany income accruals and dividend transfers must be considered in computing income tax expense for the period. When an investor and investee files separate tax returns, the investor is taxed on the dividends received from the investee rather than on the amount of investment income reported.

Requirement 2

the preparation of consolidated work sheet for 20X7

Answer to Problem 10.31P

Consolidated retained earnings December 31 $424,500 and total Assets $1,617,800

Explanation of Solution

PC and SC Corporation

Consolidation work paper

December 31, 20X7

			Eliminations
	PC Co	SC	Debit	Credit	Consolidation
Sales	580,000	300,000	120,000		760,000
Gain on sale of equipment’s	15,000		15,000
Income from subsidiary	25,200		25,200
	620,200	300,000			760,000
Less cost of sales	(435,000)	(210,000)		10,000
				95,000	(540,000)
Dep & amortization	(40,000)	(20,000)			(60,000)
Tax expense	(44,000)	(24,000)	4,000	10,000
				6,000	(56,000)
Other expenses	(11,400)	(10,000)			(21,400)
Consolidated net income					82,600
Income to NCI			8,100		(8,100)
Income	89,800	36,000	172,300	121,000	74,500
Retained earnings January 1	374,200	150,000	150,000
			4,200		370,000
Income available	464,000	186,000			444,500
Dividends declared	(20,000)	(10,000)		7,000
				3,000	(20,000)
Retained earnings December 31	444,000	176,000	326,500	131,000	424,500

			Eliminations
	PC Co	SC	Debit	Credit	Consolidation
Cash	35,800	56,000			91,800
Accounts receivable	130,000	40,000			170,000
Inventory	220,000	60,000		25,000	255,000
Land	60,000	20,000			80,000
Buildings and equipment	450,000	400,000	85,000		935,000
Patients	70,000				70,000
Investment in SC stock	158,200			18,200
				140,000
Deferred tax asset			10,000
			6,000		16,000
	1,124,000	576,000			1,617,800
Accumulated depreciation	150,000	160,000		100,000	410,000
Accounts payable	40,000	30,000			70,000
Wages payable	70,000	20,000			90,000
Bonds payable	200,000	100,000			300,000
Deferred income tax	120,000	40,000			160,000
Common stock	100,000	50,000	50,000		100,000
Retained earnings	444,000	176,000	326,500	131,000	424,500
Non-controlling interest			1,800	5,100
				60,000	63,300
	1,124,000	576,000	479,300	479,300	1,617,800