Chapter 8, Problem 8.25P

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. Trial balances for Puzzle and Sunday on December 31, 20X7, are as follows:
  
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 balance sheet?
c. Prepare the journal entry to record interest expense for Sunday for 20X7.
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.

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

Amount of cost of goods sold to be reported in consolidated income statement.

Answer to Problem 8.25P

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

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

Inventory balance to be reported in consolidated balance sheet December 31 20X7

Answer to Problem 8.25P

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 $\left(27,000/60,000\right)\times 20,000$	(9,000)
Consolidated inventory balance	278,000

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

Journal entry to record interest expenses by S

Explanation of Solution

Particulars	Debit $	Credit $
Interest expense	15,200
Bond premium	800
Cash		16,000
(Paid cash on account of interest expense)

Computation of interest expenses

Par value of bond issued	$200,000
Annual Interest $\$200,000\times 0.08$	$16,000
Annual amortization of premium ($4,800 /6 years)	(800)
Interest expenses	$15,200

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

Journal entry to record interest income for S

Explanation of Solution

Particulars	Debit $	Credit $
Cash	$6,400
Investment in A company bond	200
Interest income		6,600
(Received cash on account of interest income and premium on bond amortized)

Computation of interest income

Annual payment received $\left(80,000\times 0.08\right)$	$6,400
Amortization of discount	200
Interest income	$6,600

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

The income assigned to non-controlling interest in consolidated balance sheet

Answer to Problem 8.25P

Amount of income assigned to non-controlling interest $15,620

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 $\left(\$4,160÷8years\right)$	(520)
Realized net income	62,480
Income assigned to non-controlling interest $\$62,480\times 0.25$	15,620

Computation of gain on bond retirement

	$	$
Par value of bond		200,000
Amortization per year $\left(\$4,800÷6years\right)$	800
Premium maturity value Dec 31 20X5 $\left(\$800\times 8years\right)$		6,400
Book value of bond		206,400
Book value of bond purchase $\$206,400\times 0.40$		82,560
Purchase price		(78,400)
Gain		4,160

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

Preparation of consolidation entries needed at December 31 20X7 to complete consolidation worksheet.

Explanation of Solution

Particulars	Debit $	Credit $
To eliminate income from subsidiary
Income from subsidiary	36,000
Dividends declared		18,000
Investment in S company stock		18,000
(Income from subsidiary eliminated by reversal)
Assign income to non-controlling interest.
Income to non-controlling interest	15,620
Dividends declared		6,000
Non-controlling interest		9,620
(Income assigned to non-controlling interest)
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
(Beginning investment in S stock eliminated by reversal)
Eliminating beginning inventory profit
Retained earnings, January 1	11,250
Non-controlling interest	3,750
Cost of goods sold		15,000
(Unrealized profit on beginning inventory eliminated)
Eliminating intercompany sale of inventory by P
Sales	60,000
Cost of goods sold		51,000
Inventory		9,000
(Intercompany profit on sale of inventory eliminated)
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
(Intercompany bond holdings eliminated by reversal)

1. Income from subsidiary is eliminated by debiting to income from subsidiary account.
2. Assignment of income to non-controlling interest

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 income	62,480

  $\text{Non-controlling interest \$62,480 }\times \text{ 0}\text{.25 = \$15,620}$

1. 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.
2. Beginning inventory profit of $15,000 is eliminated as required by debiting retained earnings at 75% and non-controlling interest by 25%.
3. Intercompany sale of inventory is eliminated by posting reversal entry.
4. Eliminating corporate bond holding

Bond premium:

Bond premium given	$4,800
P bond discount 80,000 − 78,400	(1,600)
Net premium on bond	$3,200

$\text{Elimination }\left(\text{\$3,200 / 10 years}\right)\times \text{6 years}\text{=}\text{1,920}$

$\text{Interest on bonds}\left(\text{\$80,000}\times \text{0}\text{.08}\right)\text{+}\left(\text{1,600/8 years}\right)=6,600$

Calculation of bond investment value:

Bonds purchase consideration	$78,400
Amortization of discount (1,600 / 8 years)	200
Bond investment value	$78,800

Calculation of interest expenses:

$\text{Interest payable \$80,000}\times \text{0}\text{.08}$	$6,400
Less amortization of premium ($3,200 / 10 years)	(320)
Interest expenses	$6,080

To determine

Introduction: When one business organization holds majority shareholdings in another company, the management can transfer resources between these two businesses. One way of resource transfer is debt transfer from one affiliate to another without third party involvement. Debt transfer may also include setoff of trade receivable, payables arising from the intercompany sale of inventory on credit and the issue of notes payable to each other in exchange for operating funds.

The preparation of consolidation worksheet for 20X7

Answer to Problem 8.25P

The following are the balances reported in consolidation work sheet for 20X7:

• Retained earnings $337,040
• Total Assets $1,274,700

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
Total Liability and Equity	1,041,700	175,000			1,274,700