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Intercompany Sale of Property and Equipment

Problem 1. Basic concept and entries. On January 1, 2016, Panty Co., acquired 80% of the outstanding capital stock
of Bra Co., for 434 000. Information resulting from intercompany sales of equipment are summarized as follows:
Date sold
Purchaser
Selling Price
Original cost
Accum. Dep. Remaining life
4/1/16
Bra
105 000
140 000
52 500
5
1/2/16
Panty
70 000
84 000
50 400
8
Requirement: Prepare necessary entries on the books of Panty and on the worksheet in 2016 and 2017 using (a)
cost and (b) equity method.
2016 on the books of Panty Company, the parent
Cost method
Equity method
Investment income
17 500
Investment in subsidiary
17 500
Investment income
Investment in subsidiary

29 120
29 120

Investment in subsidiary
Investment income

2 625

Investment in subsidiary
Investment income

3 640

2 625

3 640

Notes:
Under the cost method, intercompany sales of property and equipment are not reflected on the books of the
parent. Under the equity method, investment income is affected by such transactions. For purposes of convenience
and to facilitate in the preparation of the entries, a schedule below should be made:
Selling price
Book value Unrealized gain
Life Annual amortization For 2016 Transaction
105 000
87 500
17 500
5
3 500
2 625 Downstream (100%)
70 000
33 600
36 400
8
4 550
4 550 Upstream (80%)
Knowledge of whether the transaction is a downstream or an upstream one is crucial for intercompany sales.
First entry: This entry is to adjust investment income for the unrealized gain from downstream sale. The amount
of unrealized gain is the excess of the selling price over the book value (cost less accum. dep.) of the equipment.
Again, since it is downstream, such unrealized gain is attributed to the parent only (at 100%).
Second entry: This entry is to adjust investment income for the unrealized gain from upstream sale. Since it is
upstream, such unrealized gain is allocated to the parent and the NCI; thus amount recorded is at 80% only.
Third entry: This entry is to adjust investment income for the profit in the downstream sale realized through
depreciation. In other words, the unrealized gain on sale is amortized over the remaining life of the equipment
through an increase in investment income. Amortization is pro-rated since acquisition happened mid-year.
Fourth entry: This entry is to adjust investment income for the profit in the upstream sale realized through
depreciation. Record only the share of the parent, i.e. 80%, since it is an upstream transaction.
Concept of simply realizing the unrealized gain over the life of asset.
Based on the given above, the entry on the separate books of the parent and subsidiary, say for the downstream
sale, would be as follows:
Selling affiliate (parent)
Purchasing affiliate (subsidiary)
Cash
105 000
Equipment
105 000
Accum. Dep.
52 500
Cash
105 000
Equipment
140 000
Gain on sale
17 500

The purchasing affiliate in the above transaction would now record a depreciation of 15 750 (21 000 x 9/12),
which is based on the selling price of the equipment. Remember that in the lens of the economic entity (the parent
and the subsidiary as a whole), the transaction is merely a physical transfer of the asset. In other words, for
purposes of consolidation, the intercompany transaction should be treated as if the sale did not happen at all. This
follows that the true depreciation of the equipment should only be 13 125 (17 500 x 9/12), which is based on the
book value of the asset.
Thus, the depreciation expense of the economic entity is overstated, and consequently, net income is
understated by 2 625, which is the same amount if the unrealized gain on sale is amortized over the life of the
asset as shown by the entry above.
Whether the transaction is upstream or downstream, the theory behind the entries is the same. But take note that
while the unrealized and realized gain of downstream transaction are recorded at 100%, those of the upstream
transactions are recognized only at 80%, i.e. percentage ownership of parent.
Take note that like those of the intercompany sale of inventory, the entries involving intercompany sale of fixed
remain the same whether the partial or full goodwill approach is used.

2016 Eliminating entries on the worksheet


Cost method
Equity method
Gain on sale of equipment
17 500
Gain on sale of equipment
17 500
Equipment
35 000
Equipment
35 000
Accumulated Depreciation
52 500
Accumulated Depreciation
52 500
Gain on sale of equipment
36 400
Equipment
14 000
Accumulated Depreciation
50 400

Gain on sale of equipment


36 400
Equipment
14 000
Accumulated Depreciation
50 400

Accumulated Depreciation
Depreciation expense

2 625

Accumulated Depreciation
Depreciation expense

2 625

2 625

Accumulated Depreciation
Depreciation expense

4 550

Accumulated Depreciation
Depreciation expense

4 550

4 550

2 625

4 550

Notes: It can be observed that in the first year, the additional eliminating entries regarding the intercompany sale of
property and equipment are the same whether the method used by the parent is the cost or the equity method.
First and second entry: Eliminate the gain on sale recorded by the selling affiliate by bringing its balance to 0.
Recognize again the accumulated depreciation eliminated by the selling affiliate, as it recorded the sale. The debit to
equipment is merely a balancing figure. However, this is computed by getting the difference between the selling price
and the historical cost of the equipment (140 000 105 000, for downstream and 84 000 70 000, for upstream).
Again since the idea of intercompany transactions is to make it appear that it did not happen at all, the equipment
recorded by the purchasing affiliate at selling price, is adjusted to bring it back to its historical cost.
Third and fourth entry: Again, the depreciation expense is overstated, that is why both the depreciation expense
and accumulated depreciation is reduced by the amount of realized gain. In eliminating entries, whether downstream
or upstream, these are recorded at 100%. It is only on the books of the parent that upstream is at 80%.
2017 on the books of Panty Company, the parent
Cost method
Equity method
Investment in subsidiary
3 500
Investment income
Investment in subsidiary
Investment income

3 500

3 640
3 640

Note: In subsequent years, under the equity method, with respect to intercompany sale of fixed assets, record only
the realization of the unrealized gain on sale.
2016 Eliminating entries on the worksheet
Cost method
Equity method
Retained earnings parent
17 500
Investment in subsidiary
17 500
Equipment
35 000
Equipment
35 000
Accumulated Depreciation
52 500
Accumulated Depreciation
52 500
Retained earnings parent
29 120
NCI
7 280
Equipment
14 000
Accumulated Depreciation
50 400

Investment in subsidiary
29 120
NCI
7 280
Equipment
14 000
Accumulated Depreciation
50 400

Accumulated Depreciation
Depreciation expense
Retained earnings parent

6 125

Accumulated Depreciation
Depreciation expense
Investment in subsidiary

6 125

3 500
2 625

Accumulated Depreciation
Depreciation expense
Retained earnings parent
NCI

9 100

Accumulated Depreciation
Depreciation expense
Investment in subsidiary
NCI

9 100

4 550
3 640
910

3 500
2 625

4 550
3 640
910

Notes:
A. Under the cost method
First entry: Since gain on sale recorded by parent on this downstream sale is a nominal account, it has already
been closed to RE. The debit to gain on sale is replaced by a debit to RE, in order to eliminate unrealized gain.
Second entry: Since this is to eliminate unrealized gain on the upstream sale, the gain on sale recorded by
subsidiary is apportioned to the controlling interest, by a debit to RE, and to the NCI, by a debit to NCI.
Third entry: The debit to accum. dep. represents the excess depreciation expense for 2016 and 2017. The credit
to depreciation expense represents the current year of realized gain, while the credit to RE, the previous year.
Fourth entry: The realized gain recognized on the previous year is allocated to the parent and the NCI, since this
refers to the upstream sale in 2016.
B. Under the equity method same entries, replace debits and credits to RE, with investment in subsidiary
Problem 2. Computation of balances. Below is a summary of transactions between Pol and Karlo:

- Karlo acquired 80% of Pols capital stock on January 1, 2016 through payment of 1 116 000. Common stock of
acquiree on such date is 720 000 and RE is 360 000.
- Schedule of over- and undervaluation is summarized below:
Fair value
Book value
Inventory (FIFO)
90 000
72 000
Land
165 600
144 000
Equipment (8-year life)
540 000
540 000
Accumulated Depreciation
288 000
Buildings (4-year life)
432 000
1 080 000
Accumulated Depreciation
576 000
Bonds payable (4-year life)
345 600
360 000
- Goodwill was impaired by 11 250 in 2016.
- On March 30, 2016, Karlo sold its equipment having a cost of 360 000 and accumulated depreciation of 135 000,
with 20% mark-up based on book value. This equipment has a remaining life of 5 years.
- On January 1, 2016, Pol sold its equipment for 180 000. The equipment was purchased 12 years ago for 216 000,
and it had an original useful life of 20 years.
- Pol earned net income of 273 600 in 2016 and 270 000 in 2017, while Karlo earned separate income of 549 000
in 2016 and 576 000 in 2017. These are inclusive of any intercompany gains and losses from sale of equipment.
- Selected accounts from separate FS of Pol and Karlo in 2017 are given below:
Karlo
Pol
Equipment
720 000
540 000
Accumulated Dep,
450 000
306 000
Operating expenses
396 000
234 000
Dividends paid
216 000
144 000
RE, 1/1/17 (cost method)
1 499 400
525 600
Requirement: Compute the consolidated balances of the following under partial and full goodwill approach:
(a) Operating expenses, 2017 (b) Equipment, 2017 (c) Accumulated Depreciation, 2017 (d) NCINI, 2016 and 2017 (e)
Controlling interest in consolidated net income, 2016 and 2017 (f) NCI, 2017 (g) Retained earnings, 2017
Operating
expenses

630 900

Operating expenses Karlo


Operating expenses Pol
Unadjusted operating expenses
Add: Amortization of allocated excess
Less: Realized gain in 2017 (D-sale)
Less: Realized gain in 2017 (U-sale)
Consolidated operating expenses
For downstream sale
Cost
Less: AD
Book value
Multiply by: Mark-up
Unrealized gain
Divided by:
Realized gain in 2017

Equipmen
t

AD

1 386 000

765 450

360 000
(135 000)
225 000
20%
45 000
5
9 000

396 000
234 000
630 000
21 600
(9 000)
(11 700)
630 900
For upstream sale
Cost
Less: AD
Book value
Selling price
Unrealized gain
Divided by
Realized gain in 2017

216 000
(129 600)
86 400
180 000
93 600
8
11 700

Note: The date of acquisition of fixed assets do not anymore affect the realized
gain on subsequent years.
Equipment Karlo
720 000
Equipment Pol
540 000
Unadjusted equipment
1 260 000
Add: Adjustment downstream
90 000
Add: Adjustment upstream
36 000
Consolidated equipment
1 386 000
Note: The adjustment indicated above is the difference between the historical cost
of the fixed asset and the selling price.
Accum. Dep. Karlo
450 000
Accum. Dep. Pol
306 000
Unadjusted Accum. Dep.
756 000
Less: AD of undervalued equipment
(288 000)
Add: Amort. of undervaluation 2016 & 2017
72 000
Add: AD of equipment sold (D-sale)
135 000
Add: AD of equipment sold (U-sale)
129 600
Less: Realized gain 2016 & 2017 (D-sale)
(15 750)
Less: Realized gain 2016 & 2017 (U-sale)
(23 400)
Consolidated accumulated depreciation
765 450
Note: Remember that in order to adjust the book value of equipment to its fair
value, as provided by entries, AD of undervalued equipment is eliminated.

NCINI

2016:
partial
goodwill
30 420
full goodwill
28 170
2017:
partial and
full goodwill
52 020

CINI

2016:
623 430
2017:
793 080

NCI

302 040
(partial)
308 790
(full)

Net income of Pol


Less: Unrealized gain (U-sale)
Add: Realized gain (U-sale)
Less: Amortization of allocated excess
Adjusted net income of Pol in
Multiply by: NCI %
NCINI partial
Less: Impairment loss for NCI
NCINI full

For 2016
273 600
(93 600)
11 700
(39 600)
152 100
20%
30 420
(2 250)
28 170

For 2017
270 000
11 700
(21 600)
260 100
20%
52 020
52 020

Note: Since there is no impairment loss in 2017, NCINI under partial and full
goodwill approach is the same.
For 2016
For 2017
Adjusted net income of Pol
152 100
260 100
Multiply by: CI%
80%
80%
Net income of Pol attributed to Karlo
121 680
208 080
Add: Separate net income of Karlo
549 000
576 000
Less: Unrealized gain (D-sale)
(45 000)
Add: Realized gain (D-sale)
6 750
9 000
Less: Impairment loss for Parent
(9 000)
Consolidated net income
623 430
793 080
Note: Observe that for NCINI and CINI, the unrealized gain is no longer deducted in
subsequent years.
Since, the problem is asking for the NCI under full goodwill approach, it is best to
first determine the NCI on full goodwill. This is simply the difference between the
unimpaired goodwill under partial and unimpaired goodwill under full.
Partial goodwill (80%)
Full goodwill (100%)
Consideration
1 116 000
1 395 000
Less: Book value of SHE
864 000
1 080 000
Allocated excess
252 000
315 000
Less: Undervaluation
216 000
270 000
Goodwill
36 000
45 000
Less: Impairment
9 000
11 250
Unimpaired goodwill
27 000
33 750
Thus, the NCI on full goodwill is 6 750 (33 750 27 000).
Whether partial or full goodwill approach, the following formula can be used:
NCI, beginning balance
xx
However, for purposes of illustration,
Add: NCINI
xx
and to know other computations,
Less: Dividends (at NCI %)
(xx)
we may use an alternative
NCI, ending balance
xx
method in computing NCI for 2017.
Retained earnings, 1/1/17
Add: Net income of Pol
Less: Dividends
Retained earnings, 12/31/17
Common stock
BV of SHE
Less: Unrealized gain
Add: Realized gain in 2016 & 2017
Add: Undervaluation on acquisition date
Less: Amortization in 2016 & 2017
FV of subsidiarys SHE
Multiply by: NCI%
NCI partial
Add: NCI on full goodwill
NCI full

RE

2 064 510

525 600
270 000
(144 000)
651 600
720 000
1 371 600
(93 600)
23 400
270 000
(61 200)
1 510 200
20%
302 040
6 750
308 790

Under the equity method, it can be inferred that the consolidated retained earnings
can be computed as follows:
Retained earnings, beginning
xx
Add: CINI
xx
Less: Dividends by parent
(xx)
Consolidated retained earnings
xx
Since the given RE of the parent is in 2017, we must first convert the RE under the
cost model to the RE under the equity model (or to establish reciprocity).
RE of Karlo, 1/1/17 or 12/31/16

1 499 400

Less: Unrealized gain (D-sale)


Add: Realized gain (D-sale)
Adjusted RE of Karlo, 1/1/17

(45 000)
6 750
1 461 150

Adjustment to convert from cost to equity model is as follows:


Retained earnings of subsidiary, 1/1/17
525 600
Retained earnings of subsidiary, 1/1/16
360 000
Increase since date of acquisition
165 600
Less: Accumulated amortization of excess
(39 600)
Less: Unrealized gain on sale (U-sale)
(93 600)
Add: Accumulated realized gain (U-sale)
11 700
Adjusted increase in RE
44 100
Multiply by: CI%
80%
Increase in RE attributable to parent
35 280
Less: Impairment loss attributable to parent
(9 000)
Adjustment from cost to equity method
26 280
Adjusted RE of Karlo, 1/1/17
Add: Adjustment from cost to equity
Consolidated retained earnings, 1//17
Add: CINI
Less: Dividends paid by Karlo
Consolidated retained earnings, 12/31/17

1 461 150
26 280
1 487 430
793 080
(216 000)
2 064 510

Problem 3. Special cases. The following are intercompany sales between Pikachu Company and its subsidiaries:
- Charmander sold its equipment to Pikachu for 340 000 on January 1, 2014. On such date, on the books of
Charmander, the equipment, with a 5-year remaining life, had a book value of 140 000 and accumulated
depreciation of 110 000. On January 1, 2017, Pikachu sold this equipment to a third party for
375 000. Pikachu holds 75% of the common stock of Charmander.
- Bulbasaur sold the land it had purchased for 140 000 to Pikachu for 185 000 on March 1, 2016. Pikachu has an
80% ownership in Bulbasaur,
- Pikachu holds 90% of Squirtles voting shares. On January 1, 2010, Squirtle paid 300 000 to acquire a building
with a 15-year economic life. On January 1, 2016, Pikachu purchased it for 144 000.
Requirement: Prepare the eliminating entries in 2017 with respect to the above transactions, under cost method.
Sale of Charmander
RE parent
60 000
NCI
20 000
Gain on sale
80 000

Sale of Bulbasaur
RE parent
36 000
NCI
9 000
Land
45 000

Sale of Squirtle
Building
156 000
Accum. Dep.
120 000
RE
32 400
NCI
3 600

Dep. expense
4 000
RE
3 600
NCI
400
Accum. Dep.
8 000
Notes: If the problem asks for entries under the equity method, simply replace all retained earnings to investment in
subsidiary, only with respect intercompany sales transactions.
1. Sale of Charmander (Disposal by purchasing affiliate to third parties)
- The entry provided is an adjustment to the gain on sale recorded by Pikachu on its books. Remember that from a
consolidated point of view, the equipment is still carried over at its original cost on the books of the selling affiliate,
and not the cost paid for by the purchasing affiliate. It is treated as if no intercompany sale happened.
On Pikachus books
On Charmanders books
Cost
340 000
250 000
Less: Accum. Dep.
(204 000)
(194 000)
Book value
136 000
56 000
Selling price
375 000
375 000
Gain on sale
239 000
319 000
Accordingly, an adjustment should be made to the gain on sale, and since the transaction was originally an
upstream one, the gain is allocated to parent and to NCI. After 2016, no more book or workpaper entries relating to
this equipment will be required.
2. Sale of Bulbasaur (Sale of non-depreciable asset)
- The gain on the upstream sale of land is recognized in subsequent years, as made above. This eliminating entry
will be the same every year, until the land is disposed of. When it is disposed of, the concept above applies.
3. Sale of Squirtle (Sale of equipment at an intercompany loss)
- Since the upstream sale resulted to a loss, accordingly, the eliminating entries when sale results to a gain, are
simply reversed. The idea is since there is an unrealized loss, accordingly the depreciation expense is understated,
thus it is adjusted through a debit to DE.

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