978-0078025877 Chapter 7 Solution Manual Part 1

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

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CHAPTER 7

INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS

ANSWERS TO QUESTIONS

Q7-1 Profits on intercompany sales generally are considered to be realized when the affiliate

Q7-2 An upstream sale occurs when a subsidiary sells an item to the parent company. If the

Q7-3 If the purchaser records the services received as an expense, both revenues and

expenses will be overstated in the consolidated income statement in the period in which the

Q7-4 (a) Unrealized profit on an intercompany sale generally is included in the reported net

Q7-5 Profits on intercompany sales are included in consolidated net income in the period in

which the items are sold to a nonaffiliate. If there are unrealized profits on the books of one of

Q7-6 The profits continue to be unrealized in this case and therefore must be eliminated from

Q7-7 A downstream sale is a sale from the parent to one of its subsidiaries. If the asset is not

Q7-8 The entire balance of unrealized profits is eliminated in all cases. While the direction of

Q7-9 Consolidated net income is reduced by the amount of unrealized profits assigned to the

shareholders of the parent company. When a downstream sale occurs, all the profit is on the

Chapter 07 – Intercompany Transfers of Noncurrent Assets and Services

account for its investment in the subsidiary. If the parent uses (a) the cost method or (b) the

modified equity method, no adjustments are made on the parent company‘s books for

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on a website in whole or part.

C7-1 Correction of Consolidation Procedures

MEMO

To: Controller

Plug Corporation

From: , CPA

Re: Elimination of Intercompany Profit on Equipment

Equipment

150,000

Loss on Sale of Equipment

150,000

This entry correctly eliminates the $150,000 loss recorded by Coy January 1, 20X2, on the sale

of equipment to Plug and adds $150,000 to the equipment account. By adding back $150,000 to

equipment, the balance is adjusted to $1,000,000 ($850,000 + $150,000). This represents the

carrying value of the equipment on Coy’s books at the time of sale but does not reflect the

purchase price paid by Coy ($1,200,000) or the accumulated depreciation at the time of sale

($200,000). Moreover, the consolidation entry above understates depreciation expense for the

year. The correct consolidation entry at December 31, 20X2, is:

Equipment

350,000

Depreciation Expense

15,000

Accumulated Depreciation

215,000

Loss on Sale of Equipment

150,000

A debit of $350,000 to equipment is required to raise the balance from $850,000 recorded by

Plug to $1,200,000, the initial purchase price to the consolidated entity. Depreciation expense

must be increased by $15,000 from $85,000 ($850,000/10 years) recorded by Plug to $100,000

($1,200,000/12 years) based on the initial purchase price. Accumulated depreciation must be

credited by $215,000 to adjust from the $85,000 [($85,000/10 years) x 1 year] reported by Plug

to $300,000 [($1,200,000/12 years) x 3 years]. As previously noted, the $150,000 loss recorded

by Coy must be eliminated. If the amounts included in the second consolidation entry are

omitted, consolidated net income for 20X2 and the retained earnings balance at December 31,

20X2, will be overstated and the balances for equipment and accumulated depreciation will be

understated.

Primary citation:

ASC 810-10-S99-4

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E7-1 Multiple-Choice Questions on Intercompany Transfers

1. c – After consolidation entries are made, the consolidated balance sheet should present the

asset at Fire’s carrying amount on the date of transfer (which is equal to Water’s cost less

gain.

2. d – Business combinations always use the acquisition date fair values of assets and liabilities

that are acquired.

3. b – The gain should be recognized over the remaining useful life of the equipment, which in

this case is three years. Thus, in each year, 1/3 or 33 1/3% would be recognized.

4. a – Poe’s original cost of the machine would be the amount reported on the consolidated

balance sheet. Additionally, an extra $50,000 in depreciation would be recorded for the

5.

b –

Depreciation expense recorded by Pirn

$40,000

Depreciation expense recorded by Scroll

10,000

Total depreciation reported

$50,000

Adjustment for excess depreciation charged

by Scroll as a result of increase in

carrying value of equipment due to gain

on intercompany sale ($12,000 / 4 years)

(3,000)

Depreciation for consolidated statements

$47,000