Chapter 8 Consolidated Finanical Statemetns

Chapter 8
Consolidated Financial
statements: Intercompany
Transactions
ACCT 501
(All examples are
from the textbook by
J. Larson)
Objectives of the Chapter
 To discuss the accounting and
working paper eliminations for related
party transactions between a parent
company and its subsidiaries for:
I. intercompany transactions not
involving profit or loss such as loans
on promissory notes, leases of
property under operating leases and
rendering of services;
Consolidated FS-Intercompany Transactions 2
Objectives of the Chapter (Contd.)
II.intercompany transactions involving
profit or loss such as intercompany
sale of merchandise, plant assets,
intangible assets and leases of
property (under capital/sales-type
leases).

Principle to follow to account for the
intercompany transactions for the
consolidated financial statements:
 The consolidated financial statements
should include only transactions
resulting from the consolidated group’s
dealings with outsiders.

Principle to follow to account for the
intercompany transactions for the
consolidated financial statements: (Contd.)
 Separate ledger accounts are
established for all intercompany assets,
liabilities, revenue and expenses.
 These separate accounts clearly
identify the intercompany items that
should be eliminated in the preparation
of consolidated financial statements.

I. Accounting for Intercompany Transactions
Not Involving Profit (Gain) or Loss
 loans on Notes or Open Accounts

The parent company may make
loans to its subsidiaries.
The interest rate charged by the
parent company usually exceeds the
parent company’s borrowing rate.

I. Accounting for Intercompany Transactions
Not Involving Profit (Gain) or Loss (Contd.)
Intercompany ledger accounts are
used by the parent and the subsidiary
to account for these intercompany
transactions in order to differentiate
intercompany loans and loans with
outsiders.

Example 8.1: Intercompany Loans from
Palm (the parent company) to Starr (the
subsidiary)
 Assume that Palm Corp. made the following
cash loans to its wholly owned subsidiary,
Starr Company, on promissory notes:
Term of Note, Interest Rates,
Date of Note Months % Amount
Feb.1, 2001 6 10 $10,00
0
Apr.1, 2001 6 10 15,000
Sept.1, 2001 6 10 21,000
Nov.1, 2001 6 10 24,000

subsidiary) (Contd.)
 Palm Corp. and Starr Company will use the
following ledger accounts to record the
foregoing transactions (assuming all notes
were paid by Starr when due):
PALM CORPORATION STARR COMPANY
Intercompany Notes Receivable Intercompany Notes Payable
2001 2001 2001 2001
02/01 10,000 10,000 08/01 08/01 10,000 10,000 02/01
04/01 15,000 15,000 10/01 10/01 15,000 15,000 04/01
09/01 21,000 21,000 09/01
11/01 24,000 24,000 11/01
Bal on
11/01
45,000 45,000 Bal on
11/01
Intercompany Interest
Receivable Intercompany Interest Payable
2001 2001
12/31 1,100 1,100 12/31
Intercompany Interest Revenue Intercompany Interest Expense

2001 2001
500 08/01 08/01 500
750 10/01 10/01 750
1,100 12/31 12/31 1,100
2,350 Bal on
12/31
Bal on
12/31
2,350
 In the working paper for consolidated
financial statements for Palm and
subsidiary for the year ended
12/31/2001, the foregoing ledger
accounts appear as shown below:

PALM CORPORATION AND SUBSIDIARY
Partial Working Paper for Consolidated Financial Statements
For Year Ended December 31, 2001
Palm Starr Eliminations Consolidated
Corporation Company Inc. (Dec.)
Income
Statement
Intercompany
rev. (exp.) 2,350 (2,350)
Balance Sheet
Intercompany
rec. (pay.) 46,100* (46,100)
*45,000 + $1,100 = $46,100
Discounting of Intercompany Notes
 If an intercompany note receivable is
discounted at a bank (by the payee,
i.e., Palm in example 8.1), the note
becomes payable to an outsider – the
bank.
 Therefore, discounted intercompany
notes are not eliminated in the working
paper.

Example 8.2: Discounting of
Intercompany Notes
 Continued with Example 8.1 and Assumed
that on 12/1/2001, Palm had discounted at a
12% discount rate the $24,000 note
receivable from Starr. Palm would record
the following entry:
Cash 23,940
Interest Expense
($1,260 discount – 1,000*) 260
Intercompany Notes Receivable 24,000
Intercompany Interest Revenue 200
($24,000 x 0.10 x 1/12)

Intercompany Notes (Contd.)
To record discounting of 10%,six-month
note receivable from Starr Company
dated Nov. 1,2001, at a discount rate of
12%. Cash proceeds are computed as
follows:
Maturity value of note
[$24,000 + ($24,000 x 0.10 x 6/12)] 25,200
Less: Discount ($25,200 x 0.12 x 5/12) 1,260
Proceeds $23,940
*Interest on note that accrues to discounting bank during discounting period.

 Palm should inform Starr of the discounting.
Starr would prepare the following journal
entry on 12/1/2001:
Intercompany Notes Payable 24,000
Intercompany Interest Expense 200
Notes Payable 24,000
Interest Payable 200
To transfer 10%, six-month note payable to
Palm Corporation dated Nov. 1, 2001, from
intercompany notes to outsider notes.
 Under the note discounting assumption,
the ledger accounts related to the
intercompany notes would appear in
the 12/31/2001 working paper for
consolidated financial statements as
follows:

Income
Statement
Intercompany
rev. (exp.) 2,150* (2,150)*
Balance Sheet
Intercompany
rec. (pay.) 21,700† (21,700) †
*$200 less than in illustration on page 348 because $24,000 discounted note
earned interest for one month rather than two months.
† $21,000 note dated Sept. 1, 2001, plus $700 accrued interest.
Leases of Property under Operating
Leases
 When both the parent and subsidiary
account the lease as an operating
lease, the lessee will record the lease
payment as intercompany rent
expense, while the lessor will record the
lease payment received as
intercompany rent revenue.

Leases of Property under Operating
Leases (Contd.)
 For an intercompany operating lease,
there is no profit or loss involved.
 The inercompany rent revenue would
be offset against intercompany rent
expense in the manner similar to the
offset of intercompany interest revenue
and expense illustrated earlier.

Rendering of Services
 One affiliate may render services to
another and result in intercompany fee
revenue and expense (i.e.,
management fee charged to
subsidiaries by a parent company).

Rendering of Services (Contd.)
 The intercompany fee revenue and
expense are offset in the working
paper.
 Both the parent company and the
subsidiary should record the fee billing
in the same accounting period.

Income Texas Applicable to
Intercompany Transactions
 No income tax effects associated with
the elimination of the intercompany
revenue or expenses since no profit or
loss involved in these intercompany
transactions.
 It does not matter whether the parent
company and its subsidiaries file
separate income tax returns or a
consolidated tax return.

II. Accounting for Intercompany
Transactions Involving Profit (Gain) or Loss
 For intercompany transactions involving
profit or loss, the unrealized profits or
losses must be eliminated in the
preparation of consolidated financial
statements until they are realized.

The Importance of Eliminating or Including
Intercompany Profits (Gains) and Losses
 Failure to eliminate unrealized profits
and losses would result in consolidated
income statements that report not only
results of transactions with outsiders
but also the results of related party
activities within the affiliated group.

The Importance of Eliminating or Including
Intercompany Profits (Gains) and Losses
(Contd.)
 Similarly, no recognition of realized
gains (losses) would misstate the
consolidated net income.
 The management can manipulate
consolidated net income if unrealized
intercompany profits and losses were
not eliminated.

Intercompany Sales of Merchandise
 Types of Sales
Downstream intercompany sales
Upstream intercompany sales
Lateral intercompany sales

(Contd.)
a. Intercompany Sales at Cost
 Example 8.3: Intercompany sale at cost
Assume that Palm sold merchandise

costing $150,000 to Starr during the year
ended 12/31/2001 at a selling price equals
to Palm’s cost.
The ending inventories of Starr on
12/31/2001 included $25,000 of
merchandise obtained form Palm.
Intercompany Sales of Merchandise (Contd.)
Example 8.3 : (Contd.)
 By 12/31/2001, Starr still owed
Palm $15,000 for merchandise
purchased during 12/31/2001.
 Assuming perpetual inventory
system for both companies, the
following aggregate entries would
be prepared by both companies for
the foregoing transactions:

 Palm Corporation Journal Entries
Intercompany Accounts
Receivable 150,000
Intercompany Sales 150,000
To record sales to Starr Company
Intercompany Cost of Goods Sold 150,000
Inventories 150,000
To record cost of goods sold to Satrr Company.
Cash 135,000
Receivable 135,000
To record payments received from Starr
Company

 Starr Company Journal Entries
Inventories 150,000
Payable 150,000
To record purchases from Palm Corporation.
Intercompany Accounts Payable 135,000
Cash 135,000
To record payments made to Palm Corporation.
Trade Accounts Receivable 160,000
Sales 160,000
To record sales.
Cost of Goods Sold 125,000
Inventories 125,000
To record cost of goods sold.
 The following is a partial working paper
for consolidated financial statements of
Palm and subsidiary (include only the
data related to this intercompany sale
of merchandise at cost):

Income
Statement
Intercompany
rev. (exp.) *
Balance Sheet
Intercompany
rec. (pay.) 15,000 (15,000)
*Palm Corporation’s $15,000 intercompany sales and intercompany cost of
goods sold are offset in Palm’s separate income statement in the working
paper.
 Note:
Starr Company’s cost of goods sold
and inventories are not affected by
working paper eliminations. Both
Starr’s cost of goods sold and
inventories are stated at cost.

(Contd.)
b.Intercompany Sales with Unrealized
Intercompany Profit in Ending
Inventories
 Without the working paper elimination,
the consolidated ending inventory and

cost of goods sold are both overstated.

(Contd.)
 The ending inventory is overstated for
the mark up of the unsold ending
inventory (the unrealized gain).
 The cost of goods sold is overstated for
the mark up of the cost of goods sold
(the realized gain).

Example 8.4:Intercompany sales at
a mark up
 During 2001, Sage company (the 95%-
owned subsidiary) sold merchandize to
Post at a gross profit margin of 20% on
sales price.
 Sales by Sage to Post totaled $120,000
in year 2001, of which $40,000
remained unsold by Post on
12/31/2001.

Example 8.4: (Contd.)
 On 12/31/2001, Post still owed
$30,000 to Sage for merchandise.
Both companies use the perpetual
inventory system.
 The foregoing transactions are
recorded in summary form by the
two companies as follows:

 Post Company Journal Entries
Inventories 120,000
Payable 120,000
To record purchases from Sage.
Intercompany Accounts Payable 90,000
Cash 90,000
To record payments made to Sage Company.
Trade Accounts Receivable 100,000
Sales 100,000
To record sales.
Cost of Goods Sold 80,000
Inventories 80,000
To record cost of goods sold.
 Sage Corporation Journal Entries
Receivable 120,000
To record sales to Post Corporation
Inventories 96,000
To record cost of goods sold to Post
Corporation.
Cash 90,000
Receivable 90,000
To record payments received from Post
Corporation.
 The intercompany gross profit in Sage’s sale
to Post in year 2001 is analyzed as follows:
Gross Profit
Selling (25% of Cost;
Price Cost 20%Of Selling
Price)
Beginning inventories
Add: Sales $120,000 $96,000 $24,000
Subtotals $120,000 $96,000 $24,000
Less: Ending
inventories 40,000 32,000 8,000
Cost of goods sold $80,000 64,000 $16,000
 The following working paper elimination is
required for Sage’s intercompany’s sales of
merchandise to Post for the year ended
12/31/2001:
(b) Intercompany Sales--Sage 120,000
Intercompany Cost of
Goods Sold—Sage 96,000
Cost of Goods Sold—Post 16,000
Inventories--Post 8,000
To eliminate intercompany sales, cost of
goods sold, and unrealized intercompany
profit in inventories. (Income tax effects are
disregarded.)
 Entering the preceding eliminations in
the working paper for consolidated
financial statements results in the
consolidated amounts shown below
(amounts for total sales to outsiders
and cost of goods sold are assumed):

POST CORPORATION AND SUBSIDIARY
Income Post Sage Eliminations Consolidated
Statement Corp. Company Inc.(Dec.)
Revenue:
Sales: 5,800,000 1,200,000 7,000,000
Intercompany
sales 120,000 (b)(120,000)
Costs and
expenses:
Cost of goods
sold 4,100,000 760,000 (b) (16,000) 4,844,000
Intercompany
cost of goods
sold 96,000 (b) (96,000)
 Contd.
Post Sage Eliminations Consolidated

Corp. Company Inc.(Dec.)
Balance Sheet
Assets
Intercompany
rec.(pay.) (30,000) 30,000
Inventories 900,000 475,000 (b) (8,000) 1,367,000

Notes to the Intercompany Sales of
Merchandise at a Mark Up by a Partially
Own Subsidiary
1.The $8,000 unrealized intercompany
profit is attributable to Sage (the seller,
a partially-owned subsidiary).
This unrealized intercompany profit
should be taken into account in the
computation of the minority interest in
Sage’s net income for year 2001 (would
be illustrated in Example 8.9).

Notes to the Intercompany Sales of
Merchandise at a Mark Up by a Partially
Own Subsidiary (Contd.)
2.Also, this $8,000 would be entered into the
Sage’s portion of consolidated retained
earnings on 12/31/2001.
3.If the intercompany sales of merchandise
are made by a parent company or by a
wholly owned subsidiary, the unrealized
intercompany profit will not have any effect
on any minority interest in net income.
This is because the selling agent does not
have minority stockholders.
Intercompany (Unrealized) Profit in
Beginning and Ending Inventories
 It is assumed that, on a FIFO basis, the
intercompany profit in the purchaser’s
beginning inventories is realized
through sales of the merchandise to
outsiders during the following
accounting period.

Beginning and Ending Inventories(contd.)
 Only the intercompany profit in ending
inventories remains unrealized at the
end of the period.
 Continuing with Example 8.4, assume
that Sage’s intercompany sales of
merchandise to Post Corporation during
the year ended 12/31/2002, are
analyzed as follows:

Analysis of Gross Profit
Gross Profit
Selling (25% of Cost;
Price Cost 20%Of Selling
Price)
Beginning inventories $40,000 $32,000 $8,000
Add: Sales 150,000 120,000 30,000
Subtotals $190,000 $152,000 $38,000
Less: Ending
inventories 60,000 48,000 12,000
Cost of goods sold $130,000 $104,000 $26,000
 Sage’s intercompany sales ($120,000)
and intercompany cost of goods sold
($96,000) for the year ended
12/31/2001 had been closed to Sage’s
retained earnings at the end of 2001.
Thus, from a consolidated point of view
Sage’s 12/31/2001 retained earnings
was overstated by $7,600 (95% *
$8,000).

 The remaining $400 unrealized profit on
12/31/2001 is attributable to the
minority interest in net assets of Sage.
 The following working paper elimination

would be prepared on 12/31/2002 to
reflect the above facts:

(b) Retained Earnings—Sage($8,000 x 0.95)* 7,600
Minority Interest in Net Assets of 400
Subsidiary($8,000 x 0.05)
Intercompany Sales--Sage 150,000
Intercompany Cost of Goods Sold-Sage 120,000
Cost of Goods Sold—Post 26,000
Inventories—Post 12,000
To eliminate intercompany sales, cost of goods sold,
and unrealized intercompany profit in inventories.
(Income tax effects are disregarded.)
* As indicated in Chapter 7 (Page 29), this elimination is posted to the beginning-of-year retained
earnings in the statement of retained earnings section of the working paper for consolidated
financial statements. Consolidated FS-Intercompany Transactions 53
Issues in Intercompany Profit in Ending
Inventories and Amount of Minority
Interest
 A general principle is that all the
unrealized intercompany profit in the
ending inventory of the buyer (i.e., a
partially owned or wholly owner
subsidiary or a parent), should be
eliminated for the consolidated financial
statement as long as the seller is either
the parent or other wholly owned
subsidiaries.

Interest (Contd.)
 On the other hand, when the seller is a
partially owned subsidiary (either to its
parent or to other subsidiaries), there is
no general agreement regarding
whether the unrealized intercompany
profit in the ending inventory of the
buyer (a parent or other subsidiaries)
should be all eliminated.

Interest (Contd.)
 The argument is :
The intercompany sale to the minority
stockholder is considered as a sale to
outsiders.
Therefore the unrealized intercompany
profit in the ending inventory attributes to
minority stockholder’s interest should be
treated as realized.
It should not to be eliminated in the
consolidated financial statements.
Interest (Contd.)
 The following table illustrates the types
of intercompany sales and the related
issues of the unrealized intercompany
profit in the ending inventory:

Interest (Contd.)
Type Seller Buyer Issue Current
Practice
A Parent or Partially- Should all All unrealized
wholly own unrealized intercompany
own subsidiary intercompany profit in the
Subsidiary profit in the ending
ending inventory inventory is
of the buyer be eliminated
eliminated?
B Partially- Parent or Should all Same as for
(as in own a subsidiary unrealized type A due to
Example subsidiary intercompany FASB’s
8.4) profit in the preference
ending inventory
of the buyer be
eliminated?
Interest (Contd.)
Note to the above table:
a.The unrealized intercompany profit is
attributable to the seller (the partially-
own sub.) and must be considered in
the computation of the minority interest
in net income of the partially own sub.
of the year (see Example 8.4 and
Example 8.9).

Intercompany Sales of Plant Assets
 Intercompany sales of plant assets
differ from intercompany sales of
merchandise in two ways:
1. Intercompany sales of plant assets
between affiliated companies are
rare transactions.

Intercompany Sales of Plant Assets
(Contd.)
2. Due to the long economic lives of
plant assets, it requires many
accounting periods before the
intercompany gains (losses) on
sales of these assets are realized in
transactions with outsiders.

Intercompany Gain on Sale of Land
 Example 8.5:
Assume that on 12/31/2001, Post (the
parent company) sold to Sage (the
partially owned subsidiary) a parcel of
land costing $125,000 for $175,000.
The two companies would record the
following entries:

Intercompany Gain on Sale of Land (Contd.)
Post Corporation Journal Entry Sage Company Journal Entry
Cash 175,000 Land 175,000
Land 125,000 Cash 175,000
Intercompany To record acquisition of
Gain on Sale land from Post
Corporation.
of Land 50,000
To record sale of land to
Sage Company

 In the consolidated financial statement,
the land should be reported at the
historical cost and the intercompany
gain should be eliminated until it is
realized (i.e., sold to an outsider by
Sage).

 The working paper elimination prepared
on 12/31/2001 for the intercompany
sale of land with gain transaction is as
follows:
(c) Intercompany Gain on Sale 50,000
of Land—Post
Land--Sage 50,000
To eliminate unrealized intercompany
gain on Sale of land. (Income Tax
effects are disregarded.)

 The above working paper elimination is
entered in the working paper for
consolidated financial statements for
the year ended 12/31/2001 as follows:

Corp. Company Inc. (Dec.)
Income
Statement
Intercompany gain
on sale of land 50,000 (c)(50,000)
Balance Sheet
Land (for building
site) 175,000 (c)(50,000) 125,000

 No journal entries affecting land would
be made by Sage in the subsequent
years due to land is not depreciable.
 In the consolidated financial statements

of subsequent years, the land should
always be reported at the historical cost
of $125,000 as long as it is not sold to
an outsider.

 Therefore, the following working paper
elimination applies to all subsequent
years as long as Sage does not sell the
land to an outsider:
(c) Retained Earnings—Post 50,000
Land—Sage 50,000
gain in land. (Income tax effects are
disregarded.)

 Note: The foregoing working paper
elimination has no effect on the minority
interest in net income or net assets of
the subsidiary, because the unrealized
gain is attributable to the seller that is
not a partially own subsidiary.

 Assume that, Sage sold the land to an
outsider for $200,000 in the year ended
12/31/2003, the following entry would
be recorded by Sage:
Cash 200,000
Land 175,000
Gain on Sale of Land 25,000
To record sale of land to an
outsider.

 A realized gain of $75,000 ($25,000 +
$50,000) should be reported on the
consolidated financial statement of
2002. Thus, the following working
paper elimination is needed:
(c) Retained Earnings—Post 50,000
Gain on Sale of Land—
Post 50,000
To recognize $50,000 gain on Post
Corporation’s sale of land to Sage
Company resulting from sale of land
by Sage to an outsiders. (Income tax
Intercompany Gain on Sale of
Depreciable Plant Asset
 Assume that Sage (the partially owned
subsidiary) sold machinery to Post (the
parent) on 12/31/2001. Details of the
sale and depreciation policy of the
machinery are as follows:

Depreciable Plant Asset (Contd.)
Selling price of machinery to Post Corp. $ 60,000
Cost of machinery to Sage Company
when acquired Jan. 2,1999 50,000
Estimated residual value:
To Sage Company, Jan.2,1999 $ 4,000
To Post Corporation, Dec. 31,2001 4,000
Economic life:
To Sage Company, Jan.2,1999 10 years
To Post Corporation, Dec. 31,2001 5 years
Annual depreciation expense (straight-
line method):
To Sage Company ($46,000 x 0.10) $ 4,600
To Post Corporation($56,000 x 0.20) 11,200
 The two companies would account for the
sale on 12/31/2001 as follows:
Post Corp. Journal Entry Sage Company Journal Entry
Machinery 60,000 Cash 60,000
Cash 60,000 Accumulated
Depreciation
($4,600 x 3) 13,800
Machinery 50,000
To record acquisition of Intercompany
machinery from Sage Gain on Sale
Company. of Machinery 23,800
To record sale of machinery
to Post Corp..
is required for the consolidated financial
statements on 12/31/2001:
(d) Intercompany Gain on Sale of 23,800
Machinery—Sage
Machinery-Post 23,800
To eliminate unrealized intercompany gain on sale
of machinery.(Income tax effects are disregarded.)

 The elimination results the machine to
be reported on the consolidated
financial statements at its carrying
amount to Sage as follows:
Cost of machinery to Post Corporation $ 60,000
Less:Amount of elimination—
intercompany gain 23,800
Difference– equal to carrying amount
$ 36,200
 Note: the elimination of the $23,800
gain should be taken into account in the
minority interest in the net income of
Sage (the seller) for year 2001. The
$23,800 is also included in the Sage’s
retained earnings, for consolidation
purposes, on 12/31/2001 I (see
textbook 376-378).

Intercompany Gain subsequent to Date of
Sale of Depreciable Plant Asset
statements of 12/31/2002:
(d) Retained Earnings—Sage 22,610
($23,800 x 0.95)
Minority Interest in Net Assets of
Subsidiary ($23,800 x 0.05) 1,190
Accumulated Depreciation—Post 4,760
Machinery—Post 23,800
Depreciation Expense-Post 4,760
To eliminate unrealized intercompany gain in
machinery and in related depreciation.(Income tax
effects are disregarded.) Gain element in straight-
line depreciation computed as $23,800 x 0.2 =
$4,760,based on five-year economic life.
Intercompany Gain subsequent to Date of
Sale of Depreciable Plant Asset (Contd.)
 The elimination of the Post’s
depreciation expense can also be
verified as follows:
Post’s annual straight-line depreciation
expense [($60,000-$4,000) x 0.2] $ 11,200
Less:Straight-line depreciation expense
for a five-year economic life, based on
Sage’s carrying amount on date of sale
[(36,200-$4,000) x 0.20] 6,440
Difference– equal to intercompany gain
element in Post’s annual depreciation
expense $ 4,760
Intercompany Gain in Depreciation
and Minority Interest
 From the consolidation view point, the
intercompany gain element of the
acquiring affiliate’s annual depreciation
expense represents a realization of a
portion of the total intercompany gain
by the selling affiliate .

Intercompany Gain in Depreciation
and Minority Interest (Contd.)
 Thus the $4,760 credit to Post’s
depreciation expense in the 12/31/2001
working paper elimination increases
Sage’s net income for consolidated
purposes.
 This increase must be considered in the
the subsidiary’s net income for the year
ended 12/31/2002.

Intercompany Gain in later Years
statements on 12/31/2003:
(d) Retained Earnings—Sage 18,088
[($23,800-$4,760) x 0.95]
Subsidiary [($23,800-$4,760) x 0.05] 952
Accumulated Depreciation—Post 9,520
($4,760 x 2)
Machinery—Post 23,800
Depreciation Expense-Post 4,760
machinery and in related depreciation.(Income tax
(Contd.)
 Note to the working paper elimination:
The sum of the debit amounts for
retained earnings and minority interest
in net assets of subsidiary is $4,760
less that that in 2002.
 This is because $4,760 intercompany
gain has been realized in 2002 through
the depreciation process in 2002.

(Contd.)
 The sum of the debit amounts for retained
earnings and minority interest in net
assets represents the unrealized portion
of the intercompany gain at the beginning
of the year.
 For each succeeding year, the unrealized
position of the intercompany gain
decreases (in the amount of $4,760), as
indicated in the following summary of the
working paper elimination debits for those
years:
(Contd.)
Partial Working Paper Eliminations-Debits Only
December 31,2004 though 2006
Year Ended Dec. 31,
2004 2005 2006
Debits
(d)Retained earnings-
Sage $13,566 $ 9,044 $ 4,522
Minority interest in
net assets of
subsidiary 714 476 238
Accumulated
depreciation-Post 14,280 19,040 23,800
(Contd.)
 Similar working paper elimination will
be prepared for year 2004,2005 and
2006. The changes are only in the debit
accounts as indicated in the above
table.

(Contd.)
 At the end of year 2006, the entire
intercompany gain of $23,800 has been
realized through Post’s annual depreciation
expense. The following working paper
elimination is required for the machine until it
is sold:
Accumulated Depreciation- 23,800
Post
Machinery-Psot 23,800
To eliminate intercompany gain in
machinery and related accumulated
depreciation.(Income tax effects are
disregarded.) Consolidated FS-Intercompany Transactions 88
Intercompany Lease of Property under
Capital/Sale-Type Lease
 Land, building, machinery, equipment
and other property may be transferred
between affiliate entities in the form of a
sales-type lease to the lessor and a
capital lease to the lessee.

Intercompany Lease of Property under
Capital/Sale-Type Lease (Contd.)
 Example 8.6 :
Assume that Palm leased equipment
to Starr (the wholly owned subsidiary)
on 1/2/2001 under a sales-type lease
requiring Starr to pay Palm $10,000
at beginning of each year starting
1/2/2001 through 2004, with a
bargain purchase option of $1,000
payable on 1/2/2005.

Intercompany Lease of Property under Capital/Sale-
Type Lease (Contd.)
Palm’s implicit interest rate, which was
known to Starr and was less than
Starr’s incremental borrowing rate, was
8%.
The economic life of the equipment to
Starr was 6 years, with no residual
value.
The cost of the leased equipment was
$30,000.
There were no initial direct costs under
the lease.
Type Lease (Contd.)
 The present value of the minimum
lease payment is computed as follows:
Present value of $10,000 each year for
four years at 8% ($10,000 x 3.577097) $ 35,711
Present value of $1,000 in four years at
8%(1,000 x 0.735030) 735
Palm Corporation’s net investment in the
lease $ 36,506

Type Lease (Contd.)
 Journal entries of Palm Corporation for Year
2001:
1/2 Intercompany Lease Receivables
[($10,000 x 4)+$1,000] 41,000
Unearned Intercompany
Interest Revenue ($41,000-$36,506) 4,494
Inventories 30,000
To record Sales-type lease with Starr
Company at inception and cost of leased
equipment.

Type Lease (Contd.)
 Contd.
1/2 Cash 10,000

Intercompany Lease Receivable 10,000
To record receipt of first payment on
intercompany lease.
12/31 Unearned Intercompany Interest 2,120
Revenue [(31,000-$4,494) x 0.08]
Intercompany Interest Revenue 2,120
To recognize interest earned for first year of
intercompany sales-type lease.

Type Lease (Contd.)
 Journal entries of Starr Company for Year 2001:
1/2 Lease Equipment-Capital Lease 36,506

Intercompany Liability under
Capital Lease (net) 36,506
To record intercompany capital lease at
inception.
1/2 Intercompany Liability under Capital
Lease(net) 10,000
Cash 10,000
To record lease payment for first year of
intercompany lease.

Type Lease (Contd.)
 Contd.
12/31 Intercompany Interest Expense
[($36,506-$10,000) x 0.08] 2,120
Intercompany Interest Payable 2,120
To record accrued interest on intercompany
lease obligation on 12/31/2001.
Depreciation Expense ($36,560/6) 6,084
12/31
Lease Equipment-Capital Lease 6,084
To record depreciation expense (straight-line method) for

first year of intercompany lease. (Six-year economic life of
leased equipment is used because lease contains a
bargain purchase option.)
Type Lease (Contd.)
The selected ledger accounts for both
companies relative to the lease are as follows:
PALM CORPORATION
Intercompany Lease Receivable
01/02/01 41,000a
10,000b 01/02/01
10,000c 01/02/02
10,000d 01/02/03
10,000e 01/02/04
1,000f 01/02/05
0 Bal on 01/02/05
Type Lease (Contd.)
a. Inception of lease
b. Receipt of first payment
c. Receipt of second payment
d. Receipt of third payment
e. Receipt of fourth payment
f. Receipt of purchase option

Type Lease (Contd.)
Unearned Intercompany Interest Revenue

4,494 a 01/02/01
12/31/01 2,120 b Bal. 2,374
12/31/02 1,490 c Bal. 884
12/31/03 809 d Bal. 75
12/31/04 75 e Bal. 0
Bal on 12/31/04 0

Type Lease (Contd.)
a. Inception of lease ($41,000 - $36,506)
b. Interest for year [($31,000 - $4,494) x 0.08)]
c. Interest for year [($21,000 - $2,374) x 0.08)]
d. Interest for year [($11,000 - $884) x 0.08)]
e. Interest for year [($1,000 - $75) x 0.08)];
Adjusted $1 for rounding.

Type Lease (Contd.)
Intercompany Interest Revenue
2,120a 12/31/01
12/31/01 2,120b
1,490c 12/31/02
12/31/02 1,490d
809e 12/31/03
12/31/03 809f
75g 12/31/04
12/31/04 75h
Bal on 12/31/04 0
Intercompany Lease of Property under Capital/Sale-Type
Lease (Contd.)
a. Interest for Year 2001
b. Closing entry
c. Interest for Year 2002
d. Closing entry
e. Interest for Year 2003
f. Closing entry
g. Interest for Year 2004;Adjusted $ 1 for
rounding.
h. Closing entry

Type Lease (Contd.)
STARR COMPANY
Leased Equipment—Capital Lease
01/02/01 36,506a
6,084b 12/31/01
6,084c 12/31/02
6,084d 12/31/03
6,084e 12/31/04
6,085 f 12/31/05
6,085g 12/31/06
0 Bal on 01/02/06
Type Lease (Contd.)
a. Capital lease at Inception
b. Depreciation for Year 2001
c. Depreciation for Year 2002
d. Depreciation for Year 2003
e. Depreciation for Year 2004
f. Depreciation for Year 2001;Adjusted $1
for rounding.
g. Depreciation for Year 2001;Adjusted $1
for rounding.
Type Lease (Contd.)
Intercompany Liability under Capital Lease

36,506 a 01/02/01
01/02/01 10,000b Bal. 26,506
01/02/02 7,880c Bal. 18,626
01/02/03 8,510d Bal. 10,116
01/02/04 9,191e Bal. 925
01/02/05 925f Bal. 0
Bal on 01/02/05 0

Type Lease (Contd.)
a. Capital lease at inception
b. First lease payment
c. ($10,000-$2,120 interest)
d. ($10,000-$1,490 interest)
e. ($10,000-$890 interest)
f. ($10,000-$75 interest)

Type Lease (Contd.)
Intercompany Interest Expense
12/31/01 2,120a
2,120b 12/31/01
12/31/02 1,490c
1,490d 12/31/02
12/31/03 809e
809f 12/31/03
12/31/04 75g
75h 12/31/04
0 Bal on 12/31/04
Lease (Contd.)
a. ($26,506 x 0.08)
b. Closing entry
c. ($18,626 x 0.08)
d. Closing entry
e. ($10,116 x 0.08)
f. Closing entry
g. ($925 x 0.08); Adjusted $ 1 for rounding.
h. Closing entry

Type Lease (Contd.)
Depreciation Expense
12/31/01 6,084a
6,084b 12/31/01
12/31/02 6,084c
6,084d 12/31/02
12/31/03 6,084e
6,084 f 12/31/03
12/31/04 6,084g
6,084h 12/31/04
12/31/05 6,085i
6,085 j 12/31/05
12/31/06 6,085k
6,085 l 12/31/06
0 Bal on 12/31/06
Lease (Contd.)
a. ($36,506/6)
b. Closing entry
c. ($36,506/6)
d. Closing entry
e. ($36,506/6)
f. Closing entry
g. ($36,506/6)
h. Closing entry
i. ($36,506/6); Adjusted $1 for rounding.
j. Closing entry
k. ($36,506/6);Adjusted $1 for rounding.
l. Closing entry
Lease (Contd.)
 Partial working paper eliminations (in
journal entry format) for the
consolidated financial statements for
year 2001 and year 2002 are as follows
(note: intercompany interest revenue
and intercompany interest expense are
self-eliminated on the same line of the
income statement section of the
working paper for consolidated financial
statements):
Lease (Contd.)
Partial Working Paper Eliminations
December 31, 2001
(b) Intercompany Liability under Capital Lease-Starr 26,506
Intercompany Interest Payable-Starr 2,120
Unearned Intercompany Interest Revenue- Palm 2,374
Intercompany Sales-Palm 36,506
Intercompany Cost of Goods Sold-Palm 30,000
Intercompany Lease Receivables-Palm 31,000
Leased Equipment-Capital Lease-Starr
($36,506-$30,000-$1,084) 5,422
Depreciation Expense-Starr
[($36,506-$30,000)/6] 1,084
To eliminate intercompany accounts assciated with
intercompany lease and to defer unrealized portion of
intercompany gross profit on sales-type lease.(Income tax
effects are disregarded.) Consolidated FS-Intercompany Transactions 112
Lease (Contd.)
December 31, 2002
(b) Intercompany Liability under Capital Lease-
Starr 18,626
Intercompany Interest Payable-Starr 1,490
Unearned Intercompany Interest Revenue-
Palm 884
Retained Earnings-Palm [($36,506-$30,000)-$1,084] 5,422
Intercompany Lease Receivables-Palm 21,000
Leased Equipment-Capital Lease-Starr
($5,422-$1,084) 4,388
Depreciation Expense-Starr 1,084
To eliminate intercompany accounts assciated with
intercompany lease and to defer unrealized portion of
intercompany gross profit on sales-type lease.(Income tax
Lease (Contd.)
 Note:
The elimination of 12/31/2001
removes the parent company’s
intercompany sale and cost of goods
sold.
The subsidiary’s depreciation
expense of $1,084 for 2001
represents the realization of a portion
of the parent’s gross profit margin on
the intercompany sale.
Lease (Contd.)
In Year 2002 elimination, the original
$6,506 unrealized gross profit
element in the subsidiary’s leased
equipment has been reduced by
$1,084 (the reduction of the
subsidiary’s year 2001 depreciation
expense).

Intercompany Sales of Intangible
Assets
 The working paper eliminations for
intercompany gains on sales of
intangible assets are similar to those for
intercompany gains in depreciable plant
assets, except that no accumulated
amortization is involved.

Intercompany Sales of Intangible Assets(Contd.)
Example 8.7:
 On 1/2/2002 Palm sold a patent to its
wholly own subsidiary,Starr, for
$40,000. The carrying amount of this
patent for Palm is $32,000.
 The patent had a remaining economic
life of 4 years on 1/2/2002 and was
amortized by the straight-line method.
 The working paper elimination for year
2002 and year 2003 related to this
intercompany transaction is as follows:
December 31, 2002
(c) Intercompany Gain on Sale of
Patent--Palm ($40,000- $32,000) 8,000
Amortization Expense—
Starr($8,000/4) 2,000
Patent-Starr ($8,000-2,000) 6,000
patent and related amortization.(Income tax

December 31, 2003
(c) Retained Earnings--Palm
($8,000-$2,000) 6,000
Amortization Expense—
Starr($8,000/4) 2,000
Patent-Starr ($6,000-$2,000) 4,000
patent and related amortization.(Income tax

Acquisition of Affiliate’s Bonds in
An Open Market
 Intercompany gains and losses may be
realized by the consolidated entity
when one affiliate acquires outstanding
bonds of another affiliate in the open
market.
 No realized or unrealized gain or loss
would result from the direct acquisition
of one affiliate’s bonds by another
affiliate.
An Open Market (Contd.)
 Example 8.8:
Assume that on 1/2/2001, Sage (the
partially owned subsidiary) issued to
the public $500,000 face account of
10% bonds due 1/1/2006.
The effective interest rate (market yield
rate) is 12%. Interest was payable
annually on 1/1.

Acquisition of Affiliate’s Bonds in An Open Market (Contd.)
 The net proceeds of the bond issue to
Sage were $463,952, computed as
follows (bond issue costs are
disregarded):
Present value of $500,000 in five years
at 12%, with interest paid annually
($500,000 x 0.567427) $ 283,713
Add: Present value of $50,000 each
year for five years at 12%
($50,000 x 3.604776) 180,239
Proceeds of bond issue $ 463,952
 The following entries were recorded
by Sage for year 2001 regarding
the issuance of the bond and the
accrued interest:

 2001 Sage Company Journal Entries
1/2 Cash 463,952
Discount on Bonds Payable 36,048
Bonds Payable 500,000
To record issuance of 10% bonds due
Jan. 1, 2006, at a discount to yield 12%.
12/31 Interest Expense ($463,952 x 0.12) 55,674
Interest Payable
($500,000 x 0.10) 50,000
Discount on Bonds
Payable 5,674
To record accrual of annual interest on
10% bonds.

 Assume that on 12/31/2001, Post (the
parent company) had cash available for
investment.
 The effective interest rate at the time is
15%. Thus, Sage’s bonds can be
purchased in the open market at a
substantial discount.
 Post acquired 60% of Sage’s bonds on
12/31/2001 at $257,175 plus $30,000
accrued interest.
 The acquisition cost of 60% of Sage’s
bonds is computed as follows:
Present value of $300,000 in four years
at 15%, with interest paid annually
($300,000 x 0.571753) $ 171,526
Add: Present value of $30,000 each
year for four years at 15%
($30,000 x 2.854978) 85,649
Cost to Post Corporation of $300,000
face amount of bonds $ 257,175

 Post prepared the following journal
entry on 12/31/2001 to record the
acquisition of Sage’s bonds:
Investment in Sage Company
Bonds 257,175
Receivable 30,000
Cash 287,175
To record acquisition of $300,000 face
amount of Sage Company’s 10% bonds
due Jan. 1, 2006, and accrued interest for
one year.
 The following entry is prepared by Sage
(the bond issuer) on 12/31/2001 when
notified by the parent company of this
acquisition:
Bonds Payable 300,000
Discount on Intercompany
Bonds Payable ($30,374 x 0.6) 18,224
Interest Payable ($50,000 x 0.6) 30,000
Intercompany Bonds Payable 300,000
To transfer to intercompany accounts all amounts
attributable to bonds acquired by parent company in open
market. Consolidated FS-Intercompany Transactions 128
 From the viewpoint of the consolidated
entity, Post’s acquisition of Sage’s bonds
is equivalent to the extinguishment of the
bonds at a realized gain of $24,601,
computed as follows:
Carrying amount of Sage Company’s
bonds acquired by Post Corporation on
Dec.31,2001 ($300,000 –18,224) $ 281,776
Less: Cost of Post Corporation’s
investment 257,175
Realized gain on extinguishment of
bonds $ 24,601
 The $24,601 realized gain is not
recorded in the accounting records of
either the parent company or the
subsidiary.
 However, it is recognized in the working

paper elimination (in journal entry
format) on 12/31/2001, shown as
follows:

Partial Working Paper Elimination
December 31,2001
(e) Intercompany Bonds Payable—
Sage 300,000
Bonds Payable-Sage 18,224
Investment in Sage
Company Bonds-Post 257,175
Gain on Extinguishment of
Bonds-Sage 24,601
To eliminate subsidiary’s bonds acquired by parent
and to recognize gain on the extinguishment of the
bonds.(Income tax effects are disregarded.)
 Notes to the partial working paper
elimination:
1. The intercompany interest receivable

-- Post ($30,000) and intercompany
interest payable-Sage ($30,000) are
offset in the working paper
elimination.

2. The gain is attributes to Sage – the
bond issuer (the subsidiary).
This treatment assumes that parent’s

open market acquisition of the
subsidiary’s bonds was, in
substance, the extinguishment of the
bonds by the subsidiary.

3. The gain is included in the
consolidated income statement of
Post and subsidiary for the year
ended 12/31/2001.
If the gain is material, it is displayed

as an extraordinary item.

Minority interest in Gain on Extinguishemtn
of Bonds
 Since the gain is attributed to the
partially owned subsidiary, the gain
should be considered in the
the subsidiary’s net income for the
year ended 12/31/2001.

Minority interest in Gain on Extinguishemtn
of Bonds(Contd.)
 This gain is also included in the
subsidiary’s retained earnings to be
included in the consolidated retained
earnings on 12/31/2001.
 See Example 8.9 for example.

Accounting for Gain (from Acquisition of
Affiliate’s Bonds) in Subsequent Years
 In the following four years, the realized
gain which is unrecorded by either
affiliate on the date of acquisition,is
reported by the consolidated entity
through the differences in the two
affiliates’ interest expense and the
interest revenue.

(Contd.)
 The accounting for the bond interest by
the two affiliates for the year ended
12/31/2002 and related ledger accounts
for four remaining years for both
companies are as follows:

(Contd.)
 2002 Post Corporation Journal Entries
1/2 Cash 30,000
Intercompany Interest 30,000
Receivable
To record receipt of accrued interest
on Sage Company’s 10% bonds.
12/31 Intercompany Interest
Receivable 30,000
Bonds 8,576
Revenue 38,576
To accrue annual interest on Sage
Company’s 10% bonds ($257,175 x
0.15 =$38,576). Consolidated FS-Intercompany Transactions 139
(Contd.)
 2002 Sage Company Journal Entries
1/2 Intercompany Interest Payable 30,000
Interest Payable 20,000
Cash 50,000
To record payment of accrued interest on 10%
bonds.
12/31 Intercompany Interest Expense 33,813
Interest Expense 22,542
Interest Payable 20,000
Discount on Intercompany Bonds
Payable 3,813
To accrue annual interest on 10% bonds.
Interest is computed as follows:
Intercompany ($300,000-$18,224) x 0.12=
$33,813
Other ($200,000- $12,150) x 0.12= $22,542
(Contd.)
POST CORPORATION
Investment in Sage Company Bonds
12/31/01 257,175 a
12/31/02 8,576 b
12/31/03 9,863 c
12/31/04 11,342 d
12/31/05 13,044 e
Bal on 12/31/05 300,000

(Contd.)
a.Acquisition of $300,000 face amount of bonds
b.Accumulation of discount ($38,576-$ 30,000)
c.Accumulation of discount ($39,863-$30,000)
d.Accumulation of discount ($41,342-$30,000)
e.Accumulation of discount ($43,044-$30,000)

(Contd.)
Intercompany Interest Revenue
38,576a 12/31/02
12/31/02 38,576b
39,863c 12/31/03
12/31/03 39,863d
41,342e 12/31/04
12/31/04 41,342f
43,044g 12/31/05
12/31/05 43,044h
Bal on 12/31/05 0
(Contd.)
a.($257,175 x 0.15)
b.Closing entry
c.($265,751 x 0.15)
d.Closing entry
e.($275,614 x 0.15)
f. Closing entry
g.($286,956 x 0.15),Adjusted $ 1 for rounding.
h. Closing entry

(Contd.)
Sage Company
Intercompany Bonds Payable
300,000a 12/31/01
300,000 Bal on 12/31/01
a. Bonds acquired by parent company

(Contd.)
Discount on Intercompany Bonds Payable
12/31/01 18,224a
3,813b 12/31/02
4,271c 12/31/03
4,783d 12/31/04
5,357e 12/31/05
0 Bal on 12/31/05

(Contd.)
a.Bonds acquired by parent company
b.Amortization ($33,813-$30,000)
c.Amortization ($34,271-$30,000)
d.Amortization ($34,783-$30,000)
e.Amortization ($35,357-$30,000)

(Contd.)
Intercompany Interest Expense
12/31/02 33,813a
33,813b 12/31/02
12/31/03 34,271c
34,271d 12/31/03
12/31/04 34,783e
34,783f 12/31/04
12/31/05 35,357g
35,357h 12/31/05
0 Bal on 12/31/05
(Contd.)
a.[($300,000-$18,224) x 0.12]
b.Closing entry
c.[($300,000-$14,411) x 0.12]
d.Closing entry
e.[($300,000-$10,140) x 0.12]
f. Closing entry
g.[($300,000-$5,357) x 0.12]
h. Closing entry

(Contd.)
 A summary of the differences
between the intercompany interest
revenue – Post and intercompany
interest expense – Sage is as
follows:

(Contd.)
Post Sage Difference-

Corporation’s Company’s Representing
Year Ended Intercompany Intercompany Recording of
Interest Interest Realized Gain
Dec. 31, Revenue Expense
2002 $ 38,576 $ 33,813 $ 4,763
2003 39,863 34,271 5,592
2004 41,342 34,783 6,559
2005 43,044 35,357 7,687
Totals $ 162,825 $138,224 $ 24,601

(Contd.)
 Notes to the above summary table:
1. Although the acquisition gain is not
recognized by either affiliate at
acquisition, the gain is recognized by
the consolidated entities in the
following four years through the
differences in the intercompany
interest revenue – Post and the
intercompany interest expense –
Sage.
(Contd.)
2. The total of differences between
parent’s intercompany interest
revenue and subsidiary
intercompany interest expense is
equal to the realized gain on parent’s
acquisition of subsidiary’s bonds.

Working Paper Elimination on 12/31/2002
(One Year Subsequently to Acquisition of
Bonds)
 The working paper elimination for the bonds
and interest on 12/31/2002 is as follows:
(e)Intercompany Interest Revenue-Post 38,576
Intercompany Bonds Payable-Sage 300,000
Discount on Intercompany Bonds Payable-
Sage 14,411
Investment in Sage Company Bonds- Post 265,751
Intercompany Interest Expense-Sage 33,813
Retained Earnings-Sage($24,601 x 0.95) 23,371
Minority Interest in Net Assets of Subsidiary
($24,601 x 0.05) 1,230
To eliminate subsidiary’s bonds owned by parent company, and
related interest revenue and expense; and to increase subsidiary’s
beginning retained earnings by amount of unamortized realized
gain on the extinguishments of the bonds.(Income tax effects are
Bonds) (Contd.)
 Note to the above working paper
elimination:
The foregoing working paper elimination
reduces the consolidated income
(before minority interest) by $4,796 (the
difference between the intercompany
interest revenue and intercompany
interest expense for year 2002).

Bonds) (Contd.)
 Note (contd.):
 This is because the entire gain of $24,601
had been recognized in the consolidated
income statement of year 2001.
 This is evident by the credit of retained
earnings and the minority interest in net
assets of subsidiary of $23,371 and
$1,230, respectively.
 If the gain of $4,796 is not eliminated, the
consolidated income of year 2002 will be
overstated by $4,796.

Working paper elimination on
12/31/2002
 Similar working paper elimination for
years 2004 and 2005 would be
prepared. Assume that Sage paid the
bonds in full on maturity 1/2/2006.
Therefore, no further working paper
eliminations for the bonds would be
required.

Working paper elimination on
12/31/2002 (Contd.)
 The working paper elimination on
12/31/2003 is as follows:
(e)Intercompany Interest Revenue-Post 39,863
Intercompany Bonds Payable-Sage 300,000
Discount on Intercompany Bonds Payable-
Sage 10,140
Investment in Sage Company Bonds- Post 275,614
Intercompany Interest Expense-Sage 34,271
Retained Earnings-Sage[($24,601-$4,763) x 0.95] 18,846
Minority Interest in Net Assets of Subsidiary
[($24,601-$4,763) x 0.05] 992
To eliminate subsidiary’s bonds owned by parent company, and
related interest revenue and expense; and to increase subsidiary’s
beginning retained earnings by amount of unamortized realized
gain on the extinguishments of the bonds.(Income tax effects are
Effect of Intercompany Profits on
Minority Interest in Net Income
 The following working paper eliminations for
Post and its 95%-owned subsidiary (Sage)
are taken from p138and p139 of chapter 7,
and from pages 42,65,76, and 131of this
chapter.
 These eliminations are followed by a revised
elimination (which differs from the one on
p150 of chapter 7) for minority interest in net
income of subsidiary.

Intercompany Profits on Minority
Interest in Net Income (contd.)
Working Paper Eliminations
December 31, 2001
(a)Common Stock –Sage 400,000
Additional Paid-in Capital-Sage 235,000
Retained Earnings-Sage($384,000-$4,750) 379,250
Retained Earnings of Subsidiary-Post 4,750
Intercompany Investment Income-Post 81,700
Plant Assets(net)-Sage($176,000-$14,000) 162,000
Leasehold(net)-Sage ($25,000-$5,000) 20,000
Goodwill (net)-Post($37,050-$950) 36,100
Cost of Goods Sold-Sage 17,000
Operating Expenses-Sage 2,000
 Contd.

Common Stock-Post 1,229,300
Dividends Declared-Sage 50,000
Subsidiary ($61,000 - $2,500) 58,500

 The above working paper elimination (a) is
to carry out the following:
(1) Eliminate intercompany investment and
equity accounts of subsidiary at the
beginning of year,and subsidiary
dividends.
(2) Provide for Year 2001 depreciation and
amortization on differences between
current fair values and carrying amounts
of Sage's identifiable net assets as
follows:
Cost of Operating
Goods Sold Expenses
Building depreciation $ 2,000 $ 2,000
Machinery depreciation 10,000
Leasehold amortization 5,000 $ 2,000
Totals $ 17,000 $ 2,000

(3) Allocate unamortized differences
between combination date current fair
values and carrying amounts to
appropriate assets.
(4) Establish minority interest in net assets of
subsidiary at beginning of year ($61,000),
less minority interest in dividends
declared by subsidiary during year
($50,000 x 0.05=$2,500).
(b)Intercompany Sales-Sage 120,000
Intercompany Cost
of Goods Sold-Sage 96,000
Cost of Goods Sold-
Post 16,000
Inventories-Post 8,000
goods sold, and unrealized profit in
inventories.(Income tax effects are
disregarded.)

(c)Intercompany Gain on Sale
of Land- Post 50,000
Land-Sage 50,000
gain on sale of land.(Income tax
(d)Intercompany Gain on Sale
of Machinery- Sage 23,800
Machinery-Post 23,800
gain on sale of machinery.(Income tax
(e)Intercompany Bonds Payable
-Sage 300,000
Discount on
Intercompany Bonds
Payable-Sage 18,224
Investment in Sage
Company Bonds-
Post 257,175
Gain on
Extinguishment of
Bonds-Sage 24,601
To eliminate subsidiary’s bonds acquired
by parent, and to recognize gain on the
extinguishments of the bonds.(Income
tax effects are disregarded.)
(f)Minority Interest in Net Income of
subsidiary 3,940
Minority Interest in Net
Assets of Subsidiary 3,940
To establish minority interest in subsidiary’s
adjusted net incomes for Year 2001 as follows:
Net income of subsidiary $ 105,000
Adjustments for working paper
eliminations:
(a) ($17,000+$2,000) (19,000)
(b) (8,000)
(d) (23,800)
(e) 24,601
Adjusted net income of subsidiary $ 78,801
Minority interest share ($78,801 x 0.05) $ 3,940
Working Paper for Consolidated
Financial Statements (for Year 2001)
 The following is a partial working
paper for Post Corporation and
subsidiary for the year ended
12/31/2001.
 The amounts for Post and Sage are
the same as those on p145,146 of
Chapter 7.

Financial Statements (contd.)
Statement of Retained Post Corp. Sage Elimination Consolidated
Earnings Company Inc. (Dec.)
Retained earnings,
beginning of year 1,348,500 384,000 (a)(379,250) 1,353,250
Net income 352,600 105,000 (161,839)* 295,761
Subtotals 1,701,000 489,000 (541,089) 1,649,011
Dividends declared 158,550 50,000 (a)(50,000)† 158,550
Retained earnings, end
of year 1,542,550 439,000 (491,089) 1,490,461

Financial Statements (contd.)
 Contd.
Balance Sheet / Liabilities & Post Corp. Sage Elimination Consolidated
Stockholders’ Equity Company Inc. (Dec.)
Minority interest in net assets of (a) 58,500 62,440
subsidiary (f) 3,940
Total liabilities x,xxx,xxx xxx,xxx 62,440 x,xxx,xxx
Common stock, $ 1 par 1,057,000 1,057,000
Common stock, $ 10 par 400,000 (a) (400,000)
Additional paid-in capital 1,560,250 235,000 (a) (235,000) 1,560,250
Retained earnings 1,542,550 439,000 (491,089) 1,490,461
Retained earnings of subsidiary 4,750 (a) (4,750)
Total stockholder’s equity 4,164,550 1,074,000 (1,130,839)
Total liabilities & stockholders
equity x,xxx,xxx x,xxx,xxx (1,068,399) x,xxx,xxx
•Net decrease in revenue ( and gains): $81,700 + $120,000 + $50,000 + $23,800 - $24,601 $250,899
•Less: Net decrease in costs and expenses: $96,000 + $16,000 -$19,000 - $3,940 89,060
•Decrease in combined net incomes to compute consolidated net income $161,839
•# A decrease in dividends and an increase in retained earnings
Financial Statements(contd.)
 The foregoing working paper
indicates that when intercompany
profits exist, consolidated net income
is not the same as the parent
company's net income
 The consolidated retained earnings
are not the same as the total of the
parent company's two retained
earnings amounts.
Financial Statements( for Year 2002)
 Continued with the example of Post and
its subsidiary (Sage), the followings are
selected Post's t-accounts(investment
in Sage, retained earnings) and Sage's
t-account of retained earnings.
 Review of these accounts will help in
understanding the working paper for
consolidated financial statements of
Year 2002.
Financial Statements( for Year 2002)(cont.)
POST CORPORATION
Investment in Sage Company Common Stock
12/31/99 1,192,250a
38,000b 11/24/00
12/31/00 85,500c 42,750d 12/31/00
950e 12/31/00
47,500f 11/22/01
12/31/01 99,750g 18,050h 12/31/01
950i 12/31/01
57,000j 11/25/02
12/31/02 109,250k 18.050l 12/31/02
950m 12/31/02
Bal on 2/31/02 1,262,550
Financial Statements( for Year 2002) (cont.)
a.Total cost of business combination
b.Dividend declared by Sage
c.Net income of Sage
d.Amortization of differences
e.Amortization of goodwill
f. Dividend declared by Sage
g.Net income of Sage
h.Amortization of differences
i.Amortization of goodwill
j. Dividend declared by Sage
k.Net income of Sage
l.Amortization of differences
m. Amortization of goodwill
Retained Earnings
1,050,000a 12/31/99
457,050b 12/31/00
12/31/00 158,550 c
318,400d 12/31/01
12/31/01 158,550 e
1,508,350 Bal on 12/31/01

a.Balance
b.Close net income available for dividends
c.Close Dividends Declared account
d. Close net income available for dividends
e.Close Dividends Declared account

Retained Earnings of Subsidiary
4,750a 12/31/00
34,200b 12/31/01
38,950 Bal on 12/31/01
a.Close net income not available for

dividends
b.Close net income not available for
dividends
SAGE COMPANY
Retained Earnings
334,000a 12/31/99
90,000b 12/31/00
12/31/00 40,000 c
105,000d 12/31/01
12/31/01 50,000 e
439,000 Bal on 12/31/01

a.Balance
b.Close net income
c.Close Dividends Declared account
d. Close net income
e.Close Dividends Declared account

The following is the working paper
for consolidated financial
statements for year 2002 of Post
and its 95%-partially owned
subsidiary:

Working paper for Consolidated Financial Statements
Income Statement Corporation Company Inc.(Dec.)
Revenue:
Net Sales 5,900,000 1,400,000 7,300,000
Intercompany sales 150,000 (b)(150,000)
Intercompany
interest revenue 38,576 (e) (38,576)
Intercompany
investment income 91,200 (a) (91,200)
Intercompany
revenue(expenses) 14,000 (14,000)
Total revenue 6,043,776 1,536,000 (279,776) 7,300,000

 Contd.
Income Statement Post Sage Eliminations Consolidated
(contd.) Corporation Company Inc.(Dec.)
Costs and expenses: (a) 17,000
(b) (26,000)
Cost of goods sold 4,300,000 950,000 (d) (4,760) 5,236,240
Intercompany cost of
goods sold 120,000 (b)(120,000)
Operating expenses 986,058 217,978 (a) 2,000 1,206,036
Intercompany interest
expense 33,813 (e) (33,813)
Interest expense 51,518 22,542 74,060
Income taxes expense 246,000 76,667 322,667
Minority interest in net
income of subsidiary (f) 4,600 4,600
Total costs and
expenses 5,583,576 1,421,000 *(160,973) 6,843,603
Net income 460,200 115,000 (118,803) 456,397
 Contd.
Statement of Post Sage Eliminations Consolidated
Retained Earnings Corporation Company Inc.(Dec.)
Retained earnings, (a) (400,050)
beginning of year (b) (7,600)
1,508,350 439,000 (c) (50,000) 1,490,461
(d) (22,610)
(e) 23,371
Net income 460,200 115,000 (118,803) 456,397
Subtotal 1,968,550 554,000 (575,692) 1,946,858
Dividends
declared 158,550 60,000 (a) (60,000)* 158,550
Retained earnings,
end of year 1,810,000 494,000 (515,692) 1,788,308
* A decrease in dividends and an increase in retained earnings.
 Contd.
Balance Sheet/Assets Post Sage Eliminations Consolidated
Corporation Company Inc.(Dec.)
Intercomapny
receivables (payables) (3,500) 3,500
Inventories 950,000 500,000 (b) (12,000) 1,438,000
Other current assets 760,000 428,992 1,188,992
Investment in Sage
Company stock 1,262,550 (a)(1,262,550)
Investment in Sage (e) (265,751)
Company bonds 265,751 (a) 148,000
Plant assets (net) 3,700,000 1,300,000 (d) (19,040) 5,128,960
Land(for building site) 175,000 (c) (50,000) 125,000
Leasehold (net) (a) 15,000 15,000
Goodwill (net) 85,000 (a) 35,150 120,150
Total assets 7,019,801 2,407,492 (1,411,191) 8,016,102
 Contd.
Balance Sheet/Assets Post Sage Eliminations Consolidated
Corporation Company Inc.(Dec.)
Intercomapny
receivables (payables) (3,500) 3,500
Inventories 950,000 500,000 (b) (12,000) 1,438,000
Other current assets 760,000 428,992 1,188,992
Investment in Sage
Company stock 1,262,550 (a)(1,262,550)
Investment in Sage (e) (265,751)
Company bonds 265,751 (a) 148,000
Plant assets (net) 3,700,000 1,300,000 (d) (19,040) 5,128,960
Land(for building site) 175,000 (c) (50,000) 125,000
Leasehold (net) (a) 15,000 15,000
Goodwill (net) 85,000 (a) 35,150 120,150
Total assets 7,019,801 2,407,492 (1,411,191) 8,016,102
Working Paper Elimination (for year
2002)
Working Paper Eliminations
December 31, 2002
(a)Common Stock-Sage 400,000
Additional Paid-in Capital-Sage 235,000
Retained Earnings-Sage($439,000-$38,950) 400,050
Retained Earnings of Subsidiary-Post 38,950
Intercompany Investment Income-Post 91,200
Plant Assets(net)-Sage($162,000-$14,000) 148,000
Leasehold(net)-Sage ($20,000-$5,000) 15,000
Goodwill (net)-Post($36,100-$950) 35,150
Cost of Goods Sold-Sage 17,000
Operating Expenses-Sage 2,000
2002) (contd.)
 Contd.

Common Stock-Post 1,262,550
Dividends Declared-Sage 60,000
Subsidiary 59,800

2002) (contd.)
 The above elimination is to carry out the
following:
(1) Eliminate intercompany investment and
equity accounts of subsidiary at
beginning of year,and subsidiary
dividends.
(2) Provide for Year 2002 depreciation and
amortization on differences between
current fair values and carrying amounts
of Sage's identifiable net assets as
follows:
2002) (contd.)
Cost of Operating
Goods Sold Expenses
Building depreciation $ 2,000 $ 2,000
Machinery depreciation 10,000
Leasehold amortization 5,000 $ 2,000
Totals $ 17,000 $ 2,000

2002) (contd.)
(3) Allocate unamortized differences
between combination date current fair
values and carrying amounts to
appropriate assets.
(4) Establish minority interest in net assets of
subsidiary at beginning of year,excluding
intercompany profits effects ($62,800), less
minority interest in dividends declared by
subsidiary during year ($60,000 x 0.05 =
$3,000).

2002) (contd.)
(b) Retained earnings-Sage 76,000
Assets of Subsidiary 400
Intercompany Sales-Sage 150,000
Intercompany Cost
of Goods Sold-Sage 120,000
Cost of Goods Sold-
Post 26,000
Inventories-Post 12,000
goods sold, and unrealized profit in
inventories.(Income tax effects are
2002) (contd.)
(c)Retained Earnings- Post 50,000
Land-Sage 50,000
To eliminate unrealized intercompany gain
in land.(Income tax effects are
disregarded.)
(d)Retained Earnings-Sage 22,610
Subsidiary 1,190
Accumulated Depreciation-Post 4,760
Machinery- Post 23,800
Depreciation Expense-
Post 4,760
To eliminate unrealized intercompany gain
in machinery and in related depreciation
2002) (contd.)
(e)Intercompany Interest Revenue- Post 38,576
Intercompany Bonds Payable- Sage 300,000
Bonds Payable-Sage 14,411
Investment in Sage
Company Bonds-Post 265,715
Expense-Sage 33,813
Retained Earnings- Sage 23,371
To eliminate subsidiary’s bonds owned by parent
company, and related interest revenue and
expense; and to increase subsidiary’s beginning
retained earnings by amount of unamortized
realized gain on the extinguishments of the
bonds.(Income tax effects are disregarded.)
2002) (contd.)
(f)Minority Interest in Net
Income of Subsidiary 4,600
To establish minority interest in subsidiary’s
adjusted net income for Year 2002 as follows:
Net income of subsidiary $ 115,000
Adjustments for working paper
eliminations:
(a) ($17,000+$2,000) (19,000)
(b) ($150,000-$120,000-$26,000) (4,000)
(d) Depreciation expense reduced 4,760
(e) ($38,576-$33,813) (4,763)
Adjusted net income of subsidiary $ 91,997
Minority interest share ($91,997 x 0.05) $ 4,600

Chapter 8 Consolidated Finanical Statemetns

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Chapter 8 Consolidated Finanical Statemetns

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Chapter 8

Consolidated FS-Intercompany Transactions 3

Consolidated FS-Intercompany Transactions 4

Consolidated FS-Intercompany Transactions 5

 loans on Notes or Open Accounts

Consolidated FS-Intercompany Transactions 6

Consolidated FS-Intercompany Transactions 7

Sept.1, 2001 6 10 21,000

Nov.1, 2001 6 10 24,000

Intercompany Interest Revenue Intercompany Interest Expense

Consolidated FS-Intercompany Transactions 11

Consolidated FS-Intercompany Transactions 13

Consolidated FS-Intercompany Transactions 14

*Interest on note that accrues to discounting bank during discounting period.

Consolidated FS-Intercompany Transactions 17

Consolidated FS-Intercompany Transactions 19

Consolidated FS-Intercompany Transactions 20

Consolidated FS-Intercompany Transactions 21

Consolidated FS-Intercompany Transactions 22

Consolidated FS-Intercompany Transactions 23

Consolidated FS-Intercompany Transactions 24

Consolidated FS-Intercompany Transactions 25

Consolidated FS-Intercompany Transactions 26

Consolidated FS-Intercompany Transactions 27

Assume that Palm sold merchandise

Consolidated FS-Intercompany Transactions 29

Consolidated FS-Intercompany Transactions 30

Consolidated FS-Intercompany Transactions 32

Consolidated FS-Intercompany Transactions 34

the consolidated ending inventory and

Consolidated FS-Intercompany Transactions 35

Consolidated FS-Intercompany Transactions 36

Consolidated FS-Intercompany Transactions 37

Consolidated FS-Intercompany Transactions 38

Consolidated FS-Intercompany Transactions 43

Post Sage Eliminations Consolidated

Consolidated FS-Intercompany Transactions 45

Consolidated FS-Intercompany Transactions 46

Consolidated FS-Intercompany Transactions 48

Consolidated FS-Intercompany Transactions 49

Consolidated FS-Intercompany Transactions 51

 The following working paper elimination

Consolidated FS-Intercompany Transactions 52

Consolidated FS-Intercompany Transactions 54

Consolidated FS-Intercompany Transactions 55

Consolidated FS-Intercompany Transactions 57

Consolidated FS-Intercompany Transactions 59

Consolidated FS-Intercompany Transactions 60

Consolidated FS-Intercompany Transactions 61

Consolidated FS-Intercompany Transactions 62

Consolidated FS-Intercompany Transactions 63

Consolidated FS-Intercompany Transactions 64

Consolidated FS-Intercompany Transactions 65

Consolidated FS-Intercompany Transactions 66

Consolidated FS-Intercompany Transactions 67

 In the consolidated financial statements

Consolidated FS-Intercompany Transactions 68

Consolidated FS-Intercompany Transactions 69

Consolidated FS-Intercompany Transactions 70

Consolidated FS-Intercompany Transactions 71

Consolidated FS-Intercompany Transactions 73

Consolidated FS-Intercompany Transactions 76

Consolidated FS-Intercompany Transactions 78