©Cambridge Business Publishing, 2010 Single Economic Entity  Consolidated statements present financial performance and status of consolidated companies as a single economic entity  Intercompany transactions must be removed  Two types of intercompany sales/transfers  Downstream sale/transfer  Occurs when the parent sells to a subsidiary  Upstream sale/transfer  Occurs when a subsidiary sells to a parent 1 Often used to enhance supply chain efficiencies

©Cambridge Business Publishing, 2010 Eliminating Intercompany Transactions  Why eliminate intercompany revenues and expenses?  Do not arise out of transactions with outside parties  Must avoid overstatement of consolidated revenues and expenses  Also eliminate related intercompany receivables and payables  Eliminate gains and losses on intercompany asset transfers  Since gains and losses are not ‘confirmed’ by outside party transactions, assets held at end of period must be adjusted 2

©Cambridge Business Publishing, 2010 Eliminating Entries 3 Eliminate current year’s equity method entries Eliminate subsidiary’s beginning-of-year stockholders’ equity account balances Revalue the subsidiary’s assets and liabilities as of the beginning of the year Recognize current year write-offs of the subsidiary’s asset and liability revaluations Recognize the noncontrolling interest in net income Eliminate the effects of upstream and downstream intercompany transactions

©Cambridge Business Publishing, 2010 Intercompany Service & Financing Transactions  Providing services such as design, maintenance, accounting, payroll, etc.  Eliminate revenue on the provider’s books  Eliminate expense on the recipient’s books  Loans between parent and subsidiary  Eliminate loan receivable on lender’s books  Eliminate loan payable on borrower’s books  Eliminate interest revenue on lender’s books  Eliminate interest expense on borrower’s books 4

©Cambridge Business Publishing, 2010 Eliminating Intercompany Service Transactions Example Parrish Shoe Factory is a subsidiary of Jordan Athleticwear. In 2010, Jordan provides design services costing $650,000 to Parrish and bills Parrish $900,000. At year-end, Parrish still owes Jordan $100, Balances at December 31, 2010: JordanParrish Balance Sheet:Accounts receivable$100,000- Accounts payable-$100,000 Income Statement:Design revenue900,000- Design expense650,000900,000 To eliminate the intercompany receivable/payable: (I) Accounts payable100,000 Accounts receivable100,000 To eliminate the intercompany service revenue/expense: (I) Design revenue900,000 Design expense 900,000

©Cambridge Business Publishing, 2010 Eliminating Intercompany Loan Transactions Example Parrish Shoe Factory is a subsidiary of Jordan Athleticwear. In 2010, Jordan loans $1,000,000 to Parrish. Interest on the loan totals $50,000, and is accrued and paid. 6 Balances at December 31, 2010: To eliminate the intercompany loan principal: To eliminate the intercompany interest revenue/expense: JordanParrish Balance Sheet:Loan receivable$1,000,000$ - Loan payable-1,000,000 Income Statement:Interest revenue 50,000- Interest expense- 50,000 (I) Loan payable1,000,000 Loan receivable 1,000,000 (I) Interest revenue50,000 Interest expense 50,000

©Cambridge Business Publishing, 2010 Intercompany Profits  Result from transferred assets from one affiliate to the other  Per ARB 51, profits not yet confirmed by further sale to outside parties must be eliminated  Both upstream and downstream transactions  i.e., not considered to be arm’s-length transactions  Confirmed profits require no elimination 7

©Cambridge Business Publishing, 2010 Eliminating Intercompany Profits Example Parrish Shoe Factory is a subsidiary of Jordan Athleticwear. In 2010, Jordan sells land to Parrish for $1,400,000 that had an original cost of $1,000,000. Prior to consolidation, Jordan shows a gain of $400,000 on its books while Parrish carries the land at $1,400, To eliminate the unconfirmed intercompany profit and reduce the land to original acquisition cost: (I) Gain on sale of land400,000 Land 400,000 Land in consolidated balance sheet will be $1,000,000 Gain of $400,000 remains in Jordan’s retained earnings Land remains at $1,400,000 on Parrish’s books

©Cambridge Business Publishing, 2010 If Subsidiary Has Noncontrolling Interest  Elimination of intercompany profits arising in downstream sales must be made  Affects only the controlling interest in consolidated income  No effect on subsidiary’s income  No effect on any noncontrolling interest in income  Elimination of intercompany profits arising in upstream sales must be made  Affects both controlling and noncontrolling interests in consolidated net income  Elimination of profit shared between controlling and noncontrolling interests 9

©Cambridge Business Publishing, 2010 Equity Method Income Effects  Affects equity method income accrual  Due to unconfirmed intercompany gains and losses on upstream and downstream sales  Parent’s share of unconfirmed intercompany gains (losses) is deducted (added) to its share of subsidiary’s reported net income  Because unconfirmed profits are eliminated in consolidation 10

©Cambridge Business Publishing, 2010 Equity Method Effects of Unconfirmed Intercompany Profits 11 Effects of Unconfirmed Intercompany Profits Equity in Net Income Noncontrolling Interest in Net Income Downstream transactions Remove all unconfirmed profit No effect Upstream transactions Remove parent's share of unconfirmed profit Remove noncontrolling interest's share of unconfirmed profit

©Cambridge Business Publishing, 2010 Equity Method Example Jordan Athleticwear acquires 80% of Parrish Shoe Factory on January 1, During 2010, Jordan sells merchandise costing $380,000 to Parrish for $400,000, which Parrish still holds at year- end. 12 $20,000 profit unconfirmed until Parrish sells to an outside customer Equity in Income of Parrish Deduct $20,000 to remove downstream intercompany profit Equity in Income of Parrish Deduct $20,000 to remove downstream intercompany profit Suppose Parrish sells the merchandise to Jordan, and Jordan holds the merchandise at year-end. $20,000 profit unconfirmed until Jordan sells to an outside customer Jordan’s Equity in Income Deduct Jordan’s 80% share of unconfirmed profit ($16,000 )to remove upstream intercompany profit Jordan’s Equity in Income Deduct Jordan’s 80% share of unconfirmed profit ($16,000 )to remove upstream intercompany profit Noncontrolling Interest in Net Income Deduct noncontrolling interest’s 20% share of unconfirmed profit ($4,000) Noncontrolling Interest in Net Income Deduct noncontrolling interest’s 20% share of unconfirmed profit ($4,000)

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land Eliminations in Year of Transfer 13 If sale is downstream  Unconfirmed gains are deducted from the equity accrual  Creates an offset of the gain in the parent’s separate income statement If sale is upstream  Parent’s share of the subsidiary’s unconfirmed gain is deducted from the equity accrual  Offsets the parent’s share of the gain in the subsidiary’s separate income statement

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land – Year of Transfer Example 14 In 2010, one affiliate sells land costing $2,000,000 to the other affiliate for $2,300,000. The buying affiliate holds the land at year-end. Consolidation eliminating entry, year of transfer To eliminate the unconfirmed intercompany profit and reduce the land to original acquisition cost (same entry, downstream or upstream): (I) Gain on sale of land300,000 Land 300,000 Effects of $300,000 Unconfirmed Intercompany Profit in Year of Transfer Equity in Net Income 20% Noncontrolling Interest in Net Income Downstream transfer Subtract $300,000No effect Upstream transfer Subtract $240,000Subtract $60,000

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land – Subsequent Years Sold Upstream in a Prior Period 15  Must eliminate the unconfirmed gain from subsidiary’s beginning retained earnings  Facilitates elimination of the investment account against the parent’s share of the subsidiary’s stockholders’ equity Sold Downstream  In subsequent years, must add back the unconfirmed gain to the investment account  No adjustment to retained earnings because downstream transfers have no effect on subsidiary’s income

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land – Subsequent Year Upstream Example Parrish Shoe is a subsidiary of Jordan Athleticwear. In 2010, Parrish sells land costing $2,000,000 to Jordan for $2,300,000. Jordan still holds the land at the end of To eliminate the unconfirmed upstream intercompany profit from a previous year and reduce the land to the original acquisition cost: December 31, 2011 Consolidation eliminating entry: (I) Retained earnings, beginning-Parrish300,000 Land 300,000 The gain was originally included in Parrish’s 2010 net income.

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land – Subsequent Year Downstream Example Parrish Shoe is a subsidiary of Jordan Athleticwear. In 2010, Jordan sells land costing $2,000,000 to Parrish for $2,300,000. Parrish still holds the land at the end of To eliminate the unconfirmed downstream intercompany profit from a previous year and reduce the land to the original acquisition cost: December 31, 2011 Consolidation eliminating entry: (I) Investment in Parrish300,000 Land 300,000 The gain was originally subtracted from the investment account.

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land – Year of Sale to Outside Party  Requires that the original intercompany gain be recognized in consolidated net income in the year of sale to outside party  Upstream  Entry transfers the original gain out of the subsidiary’s retained earnings and into current income  Downstream  Entry adds the gain back to the investment account from which it was previously deducted via the equity method income accrual and recognizes it as current income 18

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land –Year of Sale to Outside Party Example Assume the land was sold in 2012 for $3 million. The original cost to the consolidated entity was $2 million, requiring a consolidated gain of $1 million to be reported. The selling entity carries the land at $2,300,000, and reports a gain of $700, Upstream - To include in current consolidated net income the previously recorded upstream gain now confirmed through external sale: (I) Retained earnings, beginning-Parrish300,000 Gain on sale of land 300,000 Downstream - To include in current consolidated net income the previously recorded downstream gain now confirmed through external sale: (I) Investment in Parrish300,000 Gain on sale of land 300,000

©Cambridge Business Publishing, 2010 Intercompany Transfers of Land –Year of Sale to Outside Party Example Assume the land was sold in 2012 for $3 million. The original cost to the consolidated entity was $2 million, requiring a consolidated gain of $1 million to be reported. The selling entity carries the land at $2,300,000, and reports a gain of $700, Effects of $300,000 Unconfirmed Intercompany Profit in Year of Sale to Outside Party Equity in Net Income 20% Noncontrolling Interest in Net Income Downstream transfer Add $300,000No effect Upstream transfer Add $240,000Add $60,000

©Cambridge Business Publishing, 2010 Intercompany Transfers of Inventory  Elimination of intercompany revenues and expenses required  Unconfirmed gains or losses may exist  If intercompany transfer price differs from cost, and  Goods remain in the affiliated entity at year-end  Unconfirmed gain is part of ending or beginning inventory balance  Eliminated by adjusting cost of goods sold 21 Eliminating intercompany profit in ending inventory Eliminating intercompany profit in beginning inventory Decreases cost of goods soldIncreases cost of goods sold

©Cambridge Business Publishing, 2010 Intercompany Transfers of Inventory Example During 2010, Jordan sells merchandise costing $1 million to Parrish for $1.5 million. Parrish holds all the inventory in its year-end inventory at December 31, JordanParrish Balance Sheet:Inventory-$1,500,000 Income Statement:Sales revenue$1,500,000- Cost of goods sold 1,000,000- Balances at December 31, 2010: To eliminate intercompany merchandise sales and purchases: To eliminate unconfirmed profit from Parrish's ending inventory: (I-1) Sales1,500,000 Cost of goods sold1,500,000 (I-2) Cost of goods sold500,000 Inventory 500,000

©Cambridge Business Publishing, 2010 Intercompany Transfers of Inventory Example During 2010, Jordan sells merchandise costing $1 million to Parrish for $1.5 million. Parrish sells all the inventory for $1.8 million during JordanParrish Balance Sheet:Inventory- - Income Statement:Sales revenue$1,500,000$1,800,000 Cost of goods sold 1,000,000 1,500,000 Balances at December 31, 2010: To eliminate intercompany merchandise sales and purchases: The profit is confirmed, so no other elimination is needed. (I) Sales1,500,000 Cost of goods sold1,500,000

©Cambridge Business Publishing, 2010 Unconfirmed Profit in Ending Inventory  Same whether upstream or downstream  i.e., whether the parent or subsidiary holds the inventory  Adjustments required for parent’s equity income accrual and noncontrolling interest in net income 24 Eliminating intercompany profit in ending inventory Increases cost of goods sold

©Cambridge Business Publishing, 2010 Unconfirmed Profit in Ending Inventory Example Assume merchandise priced at $5 million is sold to an affiliate during The buyer’s ending inventory includes $840,000 purchased from the seller. The seller’s markup is 20% of cost. 25 To eliminate intercompany merchandise sales and purchases. To eliminate unconfirmed profit from the buyer’s ending inventory: $840,000 – ($840,000 ÷ 1.2) = $140,000 (I-1) Sales5,000,000 Cost of goods sold 5,000,000 (I-2) Cost of goods sold140,000 Inventory 140,000 Eliminations are the same whether upstream or downstream.

©Cambridge Business Publishing, 2010 Unconfirmed Profit in Ending Inventory Example Assume merchandise priced at $5 million is sold to an affiliate during The buyer’s ending inventory includes $840,000 purchased from the seller. The seller’s markup is 20% of cost. 26 Effect of $140,000 unconfirmed profit in ending inventory: Equity in Net Income 20% Noncontrolling Interest in Net Income Downstream transfer Subtract $140,000No effect Upstream transfer Subtract $112,000Subtract $28,000 20% × $140,000 = $28,000

©Cambridge Business Publishing, 2010 Unconfirmed Profit in Beginning Inventory  Consolidated cost of goods sold is overstated by the previous year’s unconfirmed profits  Must eliminate these gains by transferring into current year income and reduce cost of goods sold  Adjustments required for parent’s equity income accrual and noncontrolling interest in net income 27 Eliminating intercompany profit in beginning inventory Decreases cost of goods sold

©Cambridge Business Publishing, 2010 Unconfirmed Profit in Beginning Inventory Example Assume merchandise priced at $5 million is sold to an affiliate during The buyer’s ending inventory includes $840,000 purchased from the seller. The seller’s markup is 20% of cost. 28 Downstream: Parrish’s beginning inventory includes $840,000 purchased from Jordan. To eliminate intercompany merchandise sales and purchases: Upstream: Jordan’s beginning inventory includes $840,000 purchased from Parrish. To eliminate unconfirmed profit from beginning inventory: (I) Investment in Parrish140,000 Cost of goods sold 140,000 (I) Retained earnings, beginning - Parrish140,000 Cost of goods sold 140,000

©Cambridge Business Publishing, 2010 Unconfirmed Profit in Beginning Inventory Example Assume merchandise priced at $5 million is sold to an affiliate during The buyer’s ending inventory includes $840,000 purchased from the seller. The seller’s markup is 20% of cost. 29 Effect of $140,000 unconfirmed profit in ending inventory: Equity in Net Income 20% Noncontrolling Interest in Net Income Downstream transfer Add $140,000No effect Upstream transfer Add $112,000Add $28,000 20% × $140,000 = $28,000

©Cambridge Business Publishing, 2010 Intercompany Profits and Inventory Cost Flow Assumptions  Eliminating entries apply to any cost flow assumption  Elimination of profit from beginning inventory assumes beginning inventory is sold and profit confirmed  But if beginning inventory is not sold, it appears in ending inventory and elimination of profit from ending inventory corrects that assumption 30

©Cambridge Business Publishing, 2010 Intercompany Transfers of Depreciable Assets  Intercompany gains and losses are confirmed when  Asset is sold to an outside party or  Asset depreciates  Portion of gain equal to excess depreciation is ‘confirmed’  Objectives of eliminations  Eliminate the unconfirmed intercompany gain or loss  Eliminate the difference between depreciation expense recorded by purchasing entity and the amount based on original acquisition cost, i.e. excess depreciation  Restate the asset and accumulated depreciation accounts so that they are based on cost 31

©Cambridge Business Publishing, 2010 Eliminations in Year of Transfer for Depreciable Assets Example On January 2, 2010, Jordan sells equipment with a 10-year remaining life and an original cost of $5 million to Parrish for $4,500,000. Accumulated depreciation on the transfer date was $2 million. 32 Jordan’s gain = $4,500,000 – ($5,000,000 – $2,000,000) = $1,500,000 Parrish’s depreciation = $4,500,000/10 = $450,000 Balances on 2010 statements: JordanParrish Balance Sheet, December 31, 2010 Equipment (remaining on Parrish's books) $ -$4,500,000 Accumulated depreciation-450, Income Statement Depreciation expense 450,000 Gain on sale of equipment1,500,000-

©Cambridge Business Publishing, 2010 Eliminations in Year of Transfer for Depreciable Assets Example continued 33 December 31, 2010 consolidation eliminating entries: To eliminate unconfirmed gain on intercompany transfer of equipment: (I-1) Gain on sale of equipment1,500,000 Equipment 1,500,000 (I-2) Accumulated depreciation150,000 Depreciation expense 150,000 (I-3) Equipment2,000,000 Accumulated depreciation 2,000,000 To eliminate the excess annual depreciation expense recorded by the purchasing affiliate: $1,500,000 ÷ 10 = $150,000 To restate the assets and accumulated depreciation accounts to their original acquisition cost basis. The amount of adjustment is equal to the accumulated depreciation at the date of transfer:

©Cambridge Business Publishing, 2010 Effects in Year of Transfer for Depreciable Assets Effect of $1,500,000 unconfirmed gain on intercompany transfer of depreciable assets in year of transfer: 34 Equity in Net Income 20% Noncontrolling Interest in Net Income Downstream transfer Subtract $1,500,000 Add $150,000 No effect Upstream transfer Subtract $1,200,000 Add $120,000 Subtract $300,000 Add $30,000 The $1,500,000 unconfirmed gain as of the date of transfer is confirmed by reducing depreciation expense by $150,000 in each of the asset’s 10 years of remaining life.

©Cambridge Business Publishing, 2010 Eliminations in Subsequent Years for Depreciable Assets Downstream Example 35 December 31, 2011 downstream consolidation eliminating entries: To eliminate unconfirmed gain on intercompany transfer of equipment: (I-1) Investment in Parrish1,350,000 Accumulated depreciation150,000 Equipment 1,500,000 (I-2) Accumulated depreciation150,000 Depreciation expense 150,000 (I-3) Equipment2,000,000 Accumulated depreciation 2,000,000 To eliminate the excess annual depreciation expense recorded by the purchasing affiliate: $1,500,000 ÷ 10 = $150,000 To restate the assets and accumulated depreciation accounts to their original acquisition cost basis.

©Cambridge Business Publishing, 2010 Eliminations in Subsequent Years for Depreciable Assets Upstream Example 36 December 31, 2011 upstream consolidation eliminating entries: To eliminate unconfirmed gain on intercompany transfer of equipment: (I-1) Retained earnings, beg.- Parrish1,350,000 Accumulated depreciation150,000 Equipment 1,500,000 (I-2) Accumulated depreciation150,000 Depreciation expense 150,000 (I-3) Equipment2,000,000 Accumulated depreciation 2,000,000 To eliminate the excess annual depreciation expense recorded by the purchasing affiliate: $1,500,000 ÷ 10 = $150,000 To restate the assets and accumulated depreciation accounts to their original acquisition cost basis.

©Cambridge Business Publishing, 2010 Effects in Subsequent Years for Depreciable Assets Effect of $1,500,000 unconfirmed gain on intercompany transfer of depreciable assets during the subsequent year, 2011: 37 Equity in Net Income 20% Noncontrolling Interest in Net Income Downstream transferAdd $150,000No effect Upstream transferAdd $120,000Add $30,000 The $1,500,000 unconfirmed gain as of the date of transfer is confirmed by reducing depreciation expense by $150,000 in each of the asset’s 10 years of remaining life.

©Cambridge Business Publishing, 2010 Comprehensive Illustration Adonis Corp. acquired 90% of the voting stock of Reelok Company, on January 2, 2007 at a cost of $27,830,000. Other data: 38 Reelock’s book value at date of acquisition$2,000,000 Estimated fair value of noncontrolling interest2,170,000 Plant and equipment with 10-year remaining life undervalued by7,000,000 Long-term debt with a 4-year remaining term overvalued by400,000 Previously unreported identifiable intangibles: Order backlog with a 2-year life1,000,000 Favorable leaseholds with a 5-year life3,000,000 Calculation of goodwill:

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adonis Corp. acquired 90% of the voting stock of Reelok Company, on January 2, 2007 at a cost of $27,830,000. Total calculated goodwill is $16,600,000. The total fair value of Reelok’s identifiable net assets is $13,400, Goodwill to controlling interest: Goodwill to noncontrolling interest:

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued 40 Adonis Corp.’s intercompany transactions during 2010:  Sale of land in 2008 costing $5 million by Reelock to Adonis for $5.5 million; Sale in 2010 by Adonis to outside firm for $6.5 million  Reelock sells merchandise to Adonis at a 20% markup on sales. Adonis’ January 1, 2010 inventory balance includes $400,000 of merchandise purchased from Reelock, and its December 31, 2010 inventory includes $450,000 purchased from Reelock. Equity in net income $450,000 $72,000 ($81,000) Noncontrolling interest in net income $50,000 $8,000 ($9,000) Upstream

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued 41 Adonis Corp.’s intercompany transactions during 2010:  Adonis sells merchandise to Reelock at a 20% markup on cost. Reelock’s January 1, 2010 inventory balance includes $300,000 of merchandise purchased from Adonis, and its December 31, 2010 inventory includes $240,000 purchased from Adonis.  On January 2, 2007, Adonis sold equipment costing $5 million with $3 million of accumulated depreciation and a 10-year remaining life to Reelock for $3.5 million. Reelock holds the equipment at year-end. Equity in net income $50,000 $(40,000) $150,000 Noncontrolling interest in net income $0 Downstream

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adonis Corp. acquired 90% of the voting stock of Reelok Company, on January 2, 2007 at a cost of $27,830,000. Total calculated goodwill is $16,600,000. Reelock’s reported income for 2010 is $2,000, Equity in net income and noncontrolling interest in income:

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Elimination C The equity in net income of Reelock, reported on Adonis’ books, totals $951,000. Reelock declared and paid no dividends in To eliminate equity in net income on the parent's books and restore the investment account to its beginning-of-year value: (C) Equity in income of Reelock951,000 Investment in Reelock951,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adjustments for Intercompany Transactions 44 To recognize the confirmed gain on the upstream land sales. (I-1) Retained earnings, January 1500,000 Gain on sale of land 500,000 In 2008, Reelock sold land costing $5 million to Adonis for $5.5 million. In 2010, Adonis sold the land to a real estate investment firm for $6.5 million.

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adjustments for Intercompany Transactions Total 2010 retail sales by Reelock to Adonis were $3 million. Adonis’ January 1, 2010 inventory balance includes $400,000 in merchandise purchased from Reelock. Total 2010 retail sales by Adonis to Reelock were $2 million. Reelock sells to Adonis at a 20% markup on sales. 45 To eliminate intercompany sales and purchases: $3,000,000 + $2,000,000 = $5,000,000 (I-2) Sales revenue5,000,000 Cost of goods sold 5,000,000 To recognize the confirmed upstream profit in beginning inventory: $400,000 × 20% = $80,000 (I-3) Retained Earnings, January 180,000 Cost of goods sold 80,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adjustments for Intercompany Transactions Adonis sells to Reelock at a 20% markup on cost. Reelock’s January 1, 2010 inventory includes $300,000 in merchandise purchased from Adonis. 46 To recognize the confirmed downstream profit in beginning inventory: $300,000 – ($300,000 ÷ 1.2) = $50,000 (I-4) Investment in Reelock50,000 Cost of goods sold 50,000 (I-5) Cost of goods sold130,000 Current assets 130,000 To eliminate the unconfirmed upstream and downstream profit in ending inventory: ($450,000 × 20%) + ($240,000 – ($240,000/1.2)) = $130,000 Reelock’s December 31, 2010 inventory includes $240,000 purchased from Adonis (20% markup on cost). Adonis’ December 31, 2010 inventory includes $450,000 purchased from Reelock (20% markup on sales).

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adjustments for Intercompany Transactions On January 2, 2007, Adonis sold equipment costing $5 million with $3 million accumulated depreciation, and a 10-year remaining life, straight-line, to Reelock for $3.5 million. Reelock still holds the equipment at year-end. 47 (I-6) Investment in Reelock1,050,000 Accumulated depreciation450,000 Plant and equipment 1,500,000 To remove the unconfirmed beginning-of-year profit on downstream sale of equipment: Total gain = $3,500,000 – ($5,000,000 - $3,000,000) = $1,500,000 Unconfirmed gain = $1,500,000 – [($1,500,000 ÷ 10) × 3 years] = $1,050,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adjustments for Intercompany Transactions On January 2, 2007, Adonis sold equipment costing $5 million with $3 million accumulated depreciation, and a 10-year remaining life, straight-line, to Reelock for $3.5 million. Reelock still holds the equipment at year-end. 48 (I-7) Accumulated depreciation150,000 Operating expenses 150,000 To recognize the confirmed profit (excess depreciation) on downstream sale of equipment: $1,500,000 ÷ 10 = $150,000 (I-8) Plant and equipment3,000,000 Accumulated depreciation 3,000,000 To restate the asset and accumulated depreciation accounts to their original acquisition cost basis:

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Adjustments for Intercompany Transactions In 2010, Adonis charged Reelock $500,000 for marketing services costing $400,000. At year-end, Reelock owes Adonis $25,000 related to marketing services. At year-end, Adonis owes Reelock $100,000 related to merchandise sales, and Reelock owes Adonis $85,000 related to merchandise sales. 49 To eliminate the intercompany sale of marketing services: (I-9) Sales revenue500,000 Operating expenses 500,000 (I-10) Current liabilities210,000 Current assets 210,000 To eliminate intercompany receivables/payables: $100,000 + $85,000 + $25,000 = $210,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Elimination E Reelock’s January 1, 2010 capital stock balance was $1,400,000 and its retained earnings was $8,600,000. Entry I-1 reduced Reelock’s retained earnings by $500,000 and entry I-3 reduced it by $80, To eliminate the subsidiary's beginning-of-year capital stock account and the remainder of its beginning retained earnings account against the beginning-of-year book value portion of the investment account, and recognize the beginning-of-year book value of the noncontrolling interest: $8,600,000 – $500,000 – $80,000 = $8,020,000 (E) Capital stock1,400,000 Retained earnings, January 18,020,000 Investment in Reelock (90%) 8,478,000 Noncontrolling interest in Reelock (10%) 942,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Elimination R Reelock’s assets and liabilities were fairly reported except for plant and equipment undervalued by $7 million; long-term debt overvalued by $400,000; and previously unreported identifiable intangibles: order backlog for $1 million and favorable leaseholds for $3 million. Accumulated goodwill impairment for was $1 million. 51 To revalue Reelock's net assets as of the beginning of the year and allocate the revaluations to the controlling interest: ($7,000,000 + $1,200,000 + $100,000 – $2,100,000) = $6,200,000 (90% × $6,200,000) + (95% × $15,600,000) = $20,400,000 (10% × $6,200,000) + (5% × $15,600,000) = $1,400,000 (R) Plant and equipment7,000,000 Identifiable intangibles1,200,000 Long-term debt100,000 Goodwill15,600,000 Accumulated depreciation 2,100,000 Investment in Reelock 20,400,000 Noncontrolling interest in Reelock 1,400,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Elimination O Reelock’s assets and liabilities were fairly reported except for plant and equipment undervalued by $7 million; long-term debt overvalued by $400,000; and previously unreported identifiable intangibles: order backlog for $1 million and favorable leaseholds for $3 million. Goodwill impairment is $200,000 for To write off the revaluations for the current year: $7,000,000 ÷ 10 = $700,000 $3,000,000 ÷ 5 = $600,000 $400,000 ÷ 4 = $100,000 (O) Operating expenses1,600,000 Accumulated depreciation 700,000 Identifiable intangibles 600,000 Long-term debt 100,000 Goodwill 200,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Elimination N The noncontrolling interest in Reelock’s net income for 2010 is $99,000. Reelock declared and paid no dividends in To recognize the noncontrolling interest in the subsidiary's income: (N) Noncontrolling interest in net income99,000 Noncontrolling interest in Reelock 99,000

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Consolidation Working Paper, December 31, Exhibit 6.1

©Cambridge Business Publishing, 2010 Comprehensive Illustration continued Consolidated Balance Sheet, Dec. 31,