Exercise A10-1: Comprehensive Consolidation, I-C Inventory & I-C Depreciable Assets

Picky Corp. acquired 100 percent of the stock of Scratchy, Inc. on January 1, 2015, for $450,000.  On this date, the balances of Scratchy’s stockholders' equity accounts were Common Stock, $254,800, and Retained Earnings, $195,200. On January 1, 2015, Scratchy’s recorded book values were equal to fair values and there is no Acquisition Accounting Premium. Please ignore taxes.

On January 1, 2018, Picky sold a building to Scratchy for $100,000.  On this date, the building was carried on Picky’s books (net of accumulated depreciation) at $82,000. Both companies estimated that the building has a remaining life of 6 years on the intercompany sale date, with no salvage value. (Always assume straight line in A422 unless I specify otherwise)

Each company routinely sells merchandise to the other company, with a profit margin of 25 percent of selling price (regardless of the direction of the sale).

· During 2019, intercompany sales amount to $20,000, of which $13,000 of merchandise remains in the ending inventory of Picky.  On December 31, 2019, $6,000 of these intercompany sales remained unpaid.

· Scratchy’s December 31, 2018 inventory includes $17,000 of merchandise purchased in the preceding year from Picky. During 2018, intercompany sales amount to $28,000, and on December 31, 2018, $8,200 of these intercompany sales remained unpaid.

Picky accounts for its pre-consolidation Investment in Scratchy account using the full equity method.  The consolidation worksheets for the two companies for the year ended December 31, 2019, are provided on the next page.

Required:

1. Calculate and organize the profits and losses on intercompany transactions and balances

2. Compute the pre-consolidation equity investment account beginning and ending balances starting with Scratchy’s stockholders’ equity

3. Before proposing consolidating entries, intuitively determine the following balances:

a. Sales

b. Cost of Goods Sold

c. Depreciation and Amortization Expense

d. Net Income

e. Accounts Receivable

f. Inventories

g. Buildings and Equipment, net

h. Accounts Payable

i. Retained Earnings

4. Complete the consolidating entries according to the C-E-A-D-I sequence and complete the consolidation worksheet

Exercise A10-2: Consolidate Financial Statements, Post-acquisition, AAP, p%<100%, Equity method

Piano acquired 80% of the common stock of Sitar for $140,000 cash on January 1, 2018.  At this date, Sitar reported net assets equal to $150,000.  The fair value of Sitar’s common stock not purchased by Piano (i.e., the noncontrolling interest) is $33,000.

Sitar’s net assets had historical book values that approximately equaled their fair values, except for a customer list that had a fair value equal to $15,000 but a book value of $5,000. The customer list has a 5-year remaining useful life at January 1, 2018 (both pre- and post-acquisition).

Piano uses the equity method to account for the investment in Sitar.  Sitar reported net income of $20,000 and paid dividends of $10,000 during 2018 and 2019.

Required:

1. Prepare the Sitar-related journal entries made on Piano’s books during 2018 & 2019

2. Using the consolidation worksheet, prepare the PRE-CONSOLIDATION financial statements for the year ended December 31, 2019 (i.e., fill in the missing accounts two years after acquisition).

3. Try to determine each of the “consolidated balances” without proposing eliminating journal entries!  This step may be quite challenging, but it is an important exercise if you want to get to the heart of the intuition behind this material.

4. Complete the working paper by preparing the applicable eliminating entries in journal entry form. Hopefully, these entries result in the consolidated balances that you estimated in requirement 2 of this problem.

Piano Company and Subsidiary, Sitar Corporation

Consolidated Financial Statements Working Paper

For the year ended December 31, 2019

Exercise A10-3: Determining Controlling Interest income - 100% elimination, pro-rata allocation IIP

Note: The worksheet on the next page provides a nice framework to formulate your answers to each of the following parts.  Even better, the worksheet also provides a structured way for you to simultaneously reflect on the three parts of the problem, thereby increasing the chance that you will figure out what’s really going on with Intercompany Inventory Profits (IIP)!

Part A: Easy Start!

P owns 80% of the common stock of S.  P’s own net income (before recording its Equity in S Earnings) was $100,000 for both 20X1 and 20X2.  S reported income of $20,000 for both 20X1 and 20X2. There is no AAP and no dividends.

Required:

1. For 20X1, determine (a) consolidated net income (i.e., before noncontrolling interest), (b) income attributable to noncontrolling interest and (c) income attributable to the controlling interest.

2. For 20X2, determine (a) consolidated net income (i.e., before noncontrolling interest), (b) income attributable to noncontrolling interest and (c) income attributable to the controlling interest.

3. What is the combined (a) consolidated net income (i.e., before noncontrolling interest), (b) income attributable to noncontrolling interest and (c) income attributable to the controlling interest aggregated across the two years?

Part B: Downstream IIP!

P owns 80% of the common stock of S.  P’s own net income (excluding Equity in S Earnings) was $100,000 for both 20X1 and 20X2.  S reported income of $20,000 for both 20X1 and 20X2.  (So far, Part B is identical to Part A!) Now assume that at 12/31/20X1, the ending inventory of S includes $10,000 of goods purchased from P.  At 12/31/20X2, there are no intercompany ending inventories.  P and S both have gross profit rates based on selling price of 30%.  There is no AAP and no dividends.

Required:

Please answer the three questions asked after Part A.

Part C: Upstream IIP!

P owns 80% of the common stock of S.  P’s own net income (excluding Equity in S Earnings) was $100,000 for both 20X1 and 20X2.  S reported income of $20,000 for both 20X1 and 20X2.  Now assume that at 12/31/20X1, the ending inventory of P includes $10,000 of goods purchased from S.  At 12/31/20X2, there are no intercompany ending inventories.  P and S both have gross profit rates based on selling price of 30%.  There is no AAP and no dividends.  (Note that Part C is identical to Part B except for the direction of the intercompany inventory sales.)

Required:

Again, please answer the three questions asked after Part A.