Chapter 6

Intercompany Inventory and Land

Profits

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Solutions Manual, Chapter 6 1
SOLUTIONS TO REVIEW QUESTIONS
1. The pants are similar to a single economic entity composed of a parent company and its
three subsidiaries. The transfer of economic resources between the pockets in these pants
simply changes the location of the resources but does not represent revenue or expense,
or profit or loss, to the combined entity.

2. The types of intercompany revenue and expenses eliminated in the preparation of the
consolidated income statement include sales and purchases, rentals, interest, and
management fees. These eliminations have no effect on the amount of consolidated net
income or the net income attributable to non-controlling interest.

3. Intercompany sales when collected and paid, intercompany cash sales, and intercompany
borrowings do not alter the total cash of the consolidated entity. It is the same concept as
an individual transferring cash among his/her bank accounts, or from one pocket to
another.

4. The intercompany profit recorded in Period one is considered to be realized when the
particular asset is sold outside the consolidated entity by the purchasing affiliate.

5. Revenue should be recognized when it is earned with a transaction outside of the reporting
entity. The reporting entity for consolidated financial statements encompasses the parent
and all of its subsidiaries. Since intercompany transactions are transactions within the
reporting entity (not outside of the reporting entity), they must be eliminated when
preparing consolidated financial statements.

6. This statement is true if the selling affiliate has an income tax rate of 40%. The $1,000
reduction from ending inventory reduces the consolidated entity's net income. A
corresponding reduction of $400 in income tax expense transfers the tax from an expense
to an asset on the consolidated balance sheet. When the $1,000 profit is subsequently
realized, the $400 is transferred from the consolidated balance sheet to the consolidated
income statement in order to achieve a proper matching of expense to revenue.

7. The matching principle requires that expenses be matched to revenues. When

intercompany profits are eliminated from the consolidated financial statements, the income
 tax expense related to those profits must also be eliminated. When the previously
unrecognized intercompany profits are recognized in a later period, the income tax on
these profits must be expensed.

8. There is no adjustment to income tax expense corresponding to the elimination of

intercompany revenue and expenses because there is no change to the income before tax
for the consolidated entity; therefore, there should be no change to the tax expense for the
consolidated entity. Whatever tax was paid or saved for the two entities will not change for
the consolidated entity since the income before tax did not change. Income tax expense is
adjusted on consolidation when consolidated profits are changed due to adjustments for
unrealized profits.

9. Ideally, intercompany losses should be eliminated in the same manner as intercompany

gains. In turn, an impairment test would be carried out. If the recoverable amount were less
than the carrying amount, an impairment loss would be reported. When the impairment
loss is greater than the intercompany loss, one can get to the same result by not reversing
the intercompany loss and simply reporting an impairment loss to bring the carrying
amount down to the recoverable amount.

10. The elimination of intercompany sales and purchases reduces sales revenue and cost of
goods sold on the consolidated income statement. No other items on the consolidated
statements are affected. The elimination of intercompany profits in ending inventory affects
the following elements of the consolidated statements: cost of goods sold is increased;
income tax expense is decreased; net income is decreased; net income attributable to the
parent is decreased; net income attributable to the non-controlling interest is decreased (if
the subsidiary was the seller); the asset inventory is decreased; deferred income tax
assets are increased; non-controlling interest in net assets is decreased (if the subsidiary
was the seller); and consolidated retained earnings is decreased.

11. For a downstream transaction, the adjustment for unrealized profits is applied to the
parent’s income and is fully charged or credited to the parent. For an upstream
transaction, the adjustment for unrealized profits is applied to the subsidiary’s income
which is shared between the parent and non-controlling interest. In other words, the non-
controlling interest is affected by elimination of profit on upstream transactions but is not

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Solutions Manual, Chapter 6 3
 affected by the elimination of profit on downstream transactions.

12. At the end of Year 1, the unrealized profit is removed from ending inventory and added to
cost of goods sold which decreases income. In Year 2, the unrealized profit is removed
from beginning inventory, which decreases cost of goods sold for Year 2 and increases
income for Year 2. Although Year 1 and Year 2 income both must be adjusted, the
adjustments are offsetting. Therefore, the combined income for the two years does not
change as a result of the adjustments.

13. It will not be eliminated again on the consolidated income statement for subsequent years.
However, if the land remains within the consolidated entity, the unrealized gain will be
eliminated in the preparation of all subsequent consolidated balance sheets and
statements of retained earnings until such time as the land is sold to outside parties.

14. Adjustments are required on consolidation to bring the consolidated balances to the
amounts that would have been on the subsidiary’s books had it not sold the land to the
parent. Therefore, any gain reported on sale would have to be eliminated. The revaluation
surplus account would have to reflect the increase in fair value over the original cost of the
land when it was purchased by the subsidiary.

15. The journal entry would be as follows:

Investment income xxx
Investment in subsidiary xxx
where xxx is equal to the parent’s share of the unrealized profits.

16. Under IFRSs, only the investor’s percentage ownership in the associate times the profit in
ending inventory is considered to be unrealized; since the investor cannot control the
associate or the other shareholders of the associate, the profit in ending inventory times
the percentage ownership of the other shareholders is considered to be a transaction with
outsiders. Under ASPE, the entire profit in ending inventory is considered to be unrealized.
ASPE states that the unrealized profit is same amount that would be considered to be
unrealized for consolidated financial statements. For downstream transactions between a
parent and subsidiary, the entire amount of unrealized profit is eliminated and charged to
the parent’s shareholders.
SOLUTIONS TO CASES
Case 6-1
Using the data provided in the question, the financial statements for the parent, subsidiary and
consolidated entity would appear as follows for the 3 months:

Parent Subsidiary Consolidated

Aug Sept July Aug July Aug Sept
BALANCE SHEET
Inventory 240 200 200 200
Prepaid tax 16

INCOME STATEMENT
Sales 300 240 300
Cost of goods sold 240 200 200
Gross margin 60 40 100
Income tax expense 24 16 40
Net income 36 24 60

The following comments outline how all of the above financial statements present fairly the
financial position and financial performance of the company in accordance with GAAP:
1. The parent and subsidiary are separate legal entities. Each entity will pay income tax
based on the income earned by the separate legal entity. Therefore, the subsidiary will
pay income tax based on the profit it earned in August and the parent will pay income
tax based on the profit it earned in September.
2. The consolidated statements combine the statements of the parent and subsidiary as if
they were one entity i.e., one set of statements for the family.
3. Accounting principles should be and have been properly applied for all of the individual
financial statements. The main principles involved with these statements are the
historical cost principle, the revenue recognition principle, and the matching principle.
4. The historical cost principle requires that certain items such as inventory be reported at
historical cost. This has been done for all 3 financial statements. Note that the historical
cost for the inventory from a consolidated perspective was $200 which is the cost paid
by the subsidiary when it purchased the goods from outsiders.

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Solutions Manual, Chapter 6 5
 5. The revenue recognition principle requires that revenue be reported when it is earned
i.e., when the benefits and risks of ownership are transferred to the buyer. When the
subsidiary sold to the parent, the benefits and risks were transferred to the parent.
Accordingly, the subsidiary reported revenue. However, from the consolidated
perspective, the family retained the benefits and risks; they were not transferred to an
outside entity. Therefore, no revenue is reported on the consolidated income statement
for August.
6. When the parent sells to an outside entity in September, it reports revenue on its
separate entity income statement. Since the family has sold the inventory to an outside
entity, the family has earned the revenue. Accordingly, the revenue is reported in
September on the consolidated income statement.
7. The matching principle requires that costs be expensed in the same period as the
revenue to which it relates. This provides the best measure of performance. Since the
subsidiary reported revenue in August, it reported cost of goods sold in August in order
to match expenses to revenue in August. Similarly, the parent reported cost of goods
sold in September to match expenses to revenue in September. Since revenue was
reported in September from a consolidated viewpoint, the cost of goods sold is reported
as an expense in September as well. The cost from a consolidated viewpoint was the
amount paid by the subsidiary when it bought the inventory from outsiders.
8. Income tax must also be matched to the income to which it relates. In August, the
subsidiary reported income tax expense of $16 to match against the pre-tax income of
$40. Since no income was reported in the consolidated income statement for August, no
tax expense should be reported in income. Given that the subsidiary probably paid the
tax to the government, the tax is considered to have been prepaid from a consolidated
viewpoint because the tax was not yet due from a consolidated viewpoint.

Case 6-2
Overview

The managers of King Limited (King) are planning a share issue and do not want King's
earnings impaired by the poor performance of Queen Limited (Queen). The financial
statements of King will be widely distributed due to the share issue planned for Year 18. The
auditor must be aware of management's bias and must ensure that earnings and assets are not
overstated.

The drug industry is highly competitive. The principal assets in this industry are intangible due
to the large expenditures on research and development. The nature of these assets creates
problems. Note disclosure will be very important.

The relationship between King and Queen is uncooperative. It will, therefore, be difficult to
obtain sufficient and appropriate audit evidence to support the accounting method and values
used to record the Queen investment.

Accounting for the investment

The choice of the appropriate method to account for the Queen investment depends primarily
on whether King has significant influence over Queen. The following factors indicate that King
does have significant influence:
• King's ownership meets the 20% guideline;
• King had membership on the board of directors, and voluntarily gave it up;

The following factors indicate that King does not have significant influence:
• inter-company transactions have declined and are no longer material;
• dividends have not been paid recently, and perhaps earnings of Queen will not accrue to
King; and
• given the uncooperative nature of Queen and King's relationship, it does not appear that
King has significant influence over Queen.

(Students could have discussed other valid factors in determining whether King exerts
significant influence over Queen)

If King is able to exert significant influence over Queen, then it will continue to use the equity
method of accounting for the investment. If King no longer has significant influence, the
investment in Queen would be reported at fair value. It is difficult to determine whether
management of King manipulated the change in influence by ceasing to trade with Queen and
removing the King representative from Queen's board of directors. In any case, the change in
method would be accounted for prospectively since the change was made due to a change in
circumstance. Therefore, the prior period adjustment reported in the draft financial statements
would not be appropriate and should be reversed.

(Students should have reached a conclusion on the issue of significant influence and proceeded
with their analysis of either the fair value method or the equity method. This response discusses

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Solutions Manual, Chapter 6 7
both methods. However, students were not expected to provide an analysis of both the equity
and the fair value methods.)

Equity method

King must reflect its share of Queen's current loss. As shown in Appendix I, the investment
would be written down from $27.4 million to zero because King’s share of Queen’s losses
exceed the balance in the investment account. However, the investment would not be valued
as a negative amount because King is not legally obligated to pay any of Queen’s liabilities.

Fair value method

If King no longer has significant influence, it would adopt the fair value method starting on the
date it lost significant influence. The balance in the investment account under the equity
method would be retained as the initial balance under the fair value method. If the change in
significant influence occurred before Queen suffered the huge loss in Year 17, the balance in
the investment account would be $27.4 million. If the change in significant influence occurred
after King accrued its share of Queen’s loss for Year 17, the balance in the investment account
would be zero. King will likely argue that it had lost significant influence before Queen incurred
the loss and would thereby avoid the write down.

On the date that King lost its significant influence, it would make an irrevocable decision to
report dividend income and the fair value adjustments in net earnings or other comprehensive
income. At the end of each reporting period, the investment would be revalued to fair value.

At August 31, Year 17, Queen’s shares were trading at $13 per share. If this is a fair reflection
of the fair value of the company, then King’s investment would be revalued to $26 million and
the revaluation adjustment would be reported in net earnings. The adjustment would be a loss
of $1.4 million if the investment account had not been written down to zero or a gain of $26
million if the change in accounting method had occurred after King accrued its share of Queen’s
loss.

Given that Queen suffered huge losses and given that Queen’s shares were trading as low as
$5 per share during the year, one could argue that $13 is not a true reflection of the fair value of
Queen. The following factors should be considered in evaluating whether the market price is an
appropriate reflection of the fair value of the Queen shares:

• The fact that Queen refuses to disclose information may indicate a liquidity problem that the
company is reluctant to publicize. On the other hand, Queen may be trying to maintain
 confidentiality about its new drug breakthrough.

• Stock prices have been volatile, so the stock price cannot be relied on as an indication of
value unless the volatility can be explained by specific economic events (e.g., generic drug
competition, new viral drug).

• Queen has experienced severe losses this year; this situation may be considered unusual.

• There is no evidence to suggest that Queen will continue to incur losses unless economic
circumstances have changed. If, for example, competition has increased, recurring write-
offs of research and development expenditures can be expected.

• There is no evidence that the market value of King's share of Queen has been less than the
carrying value for a prolonged period.

These factors suggest that the decline in future cash flows is not permanent and that the market
price of $13 may be a reasonable reflection of the fair value of Queen. However, the market
price of Queen's shares after year-end may provide additional evidence supporting this
conclusion.

(Students should have reached a conclusion on the reasonability of the trading price as a
reflection of the fair value of the Queen’s shares.)

The current situation is unusual and will require detailed note disclosure to describe the change
in reporting method and the impact on the financial statements.

APPENDIX I
Valuation of Investment Account
(in thousands of dollars)

Carrying amount per draft financial statements $25,000

Reverse adjustment for prior period adjustment 2,400
Restated balance under equity method, beginning of year 27,400

Entries for year under equity method:

Realized profit in beginning inventory (22% x 5,000) 1,100
Unrealized profit in ending inventory (22% x 1,000) (220)

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Solutions Manual, Chapter 6 9
 Share of Queen’s loss (22% x 140,000 = 30,800) (Note 1) (28,280)
Balance under equity method, end of year $ -o–

Note 1: The adjustment should be the amount required to bring the investment account
to zero.

Case 6-4

Memo to: Audit Partner

From: Audit Senior
Re: D Ltd. – Consolidated Financial Statements

As requested, I have prepared the following memorandum, which outlines the important
financial accounting issues of D and N, its subsidiary, and K, its investee company.

1. The shares issued by D to purchase N and K should be measured at their fair value at the
date of acquisition. For now, I will assume that the fair value of 160,000 common shares
was $2,000,000 when D purchased its investments in N and K.

2. It appears that there has been no allocation of the $640,000 acquisition cost excess for N in
the consolidated financial statements. The excess should be first be allocated to identifiable
assets. Any remaining excess should be allocated to goodwill. The goodwill should be
checked for impairment at the end of each year and written down if there is an impairment
loss.

3. Given that N had capitalized some research and development expenditures, there may be
some value in what they were developing. The projects that met the conditions for
capitalization should be measured at fair value at the date of acquisition assuming that the
assets can be separately identified and reliably measured. In turn, these assets should be
amortized over their useful lives. Amortization should commence once the assets are being
used in operations and are generating revenue for the company.

4. D can use either the entity theory or parent company extension theory in preparing the
consolidated financial statements. Under these theories, N’s assets and liabilities would be
measured at fair value at the date of acquisition. It appears that the consolidated financial
statements were prepared using the parent company theory because non-controlling interest is
measured at $590,000, which is 20% of the carrying amount of N’s net assets at the end of Year 2
(i.e. common shares of $1,000,000 plus retained earnings of $1,950,000). I will assume that D will
 use the entity theory. Non-controlling interest at the date of acquisition should have been
$1,000,000 calculated as follows:

Acquisition cost for 80% interest in N $4,000,000

Implied value for 100% interest in N (4,000,000 / .8) 5,000,000
NCI’s share (20%) 1,000,000

This assumes that there is a linear relationship between the value of 80% and the value of 100% of
N.

5. Intercompany transactions and balances between D and K must be eliminated. Sales and
cost of sales should be reduced by the intercompany sales of $1,200,000. The unrealized
profit of $200,000 (1,200,000 – 1,000,000) should be taken out of ending inventory and
added to cost of goods sold. Since this was an upstream sale, non-controlling interest will
be affected by this adjustment.

6. The investment in K has been accounted for using the cost method. This method is not
acceptable under IFRSs. With a 40% interest in K, D would normally have significant
influence. If so, the equity method would be appropriate. For the purpose of this discussion,
I will assume that D does have significant influence and the equity method should be used.

7. Under the equity method, the acquisition cost would have to be allocated in a manner similar
to what is done for consolidation purposes. The acquisition differential would be allocated to
identifiable net assets where the fair value is different than carrying amount. This fair value
difference would have to be amortized and an adjustment made to the investment account
on an annual basis. We do not have sufficient information at this point to determine the
adjustment for Year 1.

8. Since D paid less than the fair value of K’s identifiable net assets, there is negative goodwill
in this acquisition cost. Negative goodwill is calculated to be $233,333 ($2,100,000 / .9 –
$2,100,000). If we used the same principles applied for consolidation purposes, this negative
goodwill would be reported as a gain on purchase.

9. Under the equity method, D’s share of the unrealized profit from intercompany transactions
would have to be eliminated. Since K made an after-tax profit of $120,000 ([1,200,000 –
1,000,000] x [1 – 0.4]) on sales to D, $48,000 (40% x 120,000) would have to be eliminated
from the investment account. Since D and K are related parties, the details of intercompany
transactions would need to be disclosed in the notes to the consolidated financial

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Solutions Manual, Chapter 6 11
 statements.

10.Based on the discussion above, I have recalculated the following account balances for the
consolidated financial statements in the schedules below:

Goodwill
Investment in K (under equity method)
Non-controlling interest on balance sheet
Profit

Allocation and amortization of acquisition cost for investment in N

Cost of 80% investment, September, Year 1 4,000,000
Implied value of 100% investment (4,000,000 / .8) 5,000,000
Carrying amounts of N’s net assets:
Common shares 1,000,000
Retained earnings 1,850,000
Total shareholders' equity 2,850,000
Acquisition differential 2,150,000
Allocation: FV – CA
Land 800,000
Plant and equipment 700,000
Research and development expenditures - 90,000
Existing goodwill - 60,000 1,350,000
Balance – newly calculated goodwill 800,000

Balance Amortization Balance

Sept 1 Aug. 31
Year 1 Year 2 Year 2

Land 800,000 800,000

Plant and equipment 700,000 70,000 630,000
Research and development - 90,000 - 90,000
Old goodwill - 60,000 - 60,000
New goodwill 800,000 800,000
2,150,000 70,000 2,080,000
Investment in K
Investment in K, at date of acquisition 2,100,000
Retained earnings of K, Aug. 31, Year 2 1,710,000
Retained earnings of K, at acquisition 1,760,000
Change - 50,000
Less: profit in ending inventory (200,000 x [1 - .4]) - 120,000
Adjusted increase - 170,000
D’s ownership % 40% - 68,000
Investment in K, Aug. 31, Year 2 2,032,000

Non-controlling interest on balance sheet

Common shares of N 1,000,000
Retained earnings of N 1,950,000
Less: unrealized profit in ending inventory
([850,000 – 630,000] x .6) - 132,000 1,818,000
Total shareholders' equity 2,818,000
Unamortized acquisition differential 2,080,000
4,898,000
20%
Non-controlling interest, Aug. 31, Year 2 979,600

Calculation of consolidated profit – Year 2

Profit of D 600,000
Less: Dividends from N (200,000 x 80%) 160,000
Dividends from K (150,000 x 40%) 60,000 220,000
380,000
Profit of N 300,000
Less: profit in closing inventory (220,000 x .6) - 132,000
amortization of acquisition differential - 70,000
Adjusted profit 98,000
Profit of K 100,000
Less: profit in closing inventory (200,000 x .6) - 120,000
Adjusted profit - 20,000
D’s ownership % 40% - 8,000
Consolidated profit, Year 2 470,000
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Solutions Manual, Chapter 6 13
Attributable to:
Shareholders of D 450,400
Non-controlling interests (20% x 98,000) 19,600
470,000

Case 6-5
REPORT ON ACCOUNTING POLICIES USED IN THE FINANCIAL STATEMENTS OF GOOD
QUALITY AUTO PARTS LIMITED FOR THE YEAR ENDED FEBRUARY 28, Year 11.

To the members of the union, Good Quality Auto Parts Limited:

I have been engaged to analyze the financial statements of Good Quality Auto Parts Limited
(GQ) for the year ended February 28, Year 11 and determine whether there are any
controversial accounting issues. For the purposes of this report, "controversial accounting
issues" will be defined as accounting policies that have the effect of reducing payments under
the profit-sharing plan to the union members.

The existence of the profit-sharing contract creates incentives for the management of GQ to
make accounting choices that reduce net income and thereby reduce the payments that must
be made to the union members. Accounting standards for private enterprises (ASPE) allow
considerable flexibility and judgment by the preparers of financial statements in selecting
accounting policies. Since the company is privately owned, the costs (real or perceived) of
reporting lower income may be small relative to the savings generated. For example, the effect
of lower income on new or existing lenders may be considered less important than the savings
derived from reduced profit sharing. In addition since the term of the contract is only three
years, some of the income deferral may yield permanent savings if the profit-sharing
component is not renewed in subsequent contracts.

In analyzing the accounting policies, I will be taking as strong a position as can be justified to
support the union's objective of making net income as large as possible. This is in conflict with
the objective of management, which is to reduce net income.

Inventory write-down
Accounting practice requires that inventory be measured at the lower of cost and net realizable
value. Thus, if the inventory cannot be sold, management can justify its write-off. However,
since much of the inventory has been on hand for several years, the decision to write it off this
year raises a question as to the motivation for the write-off. Management could be writing off the
inventory solely to reduce income, thereby reducing the payments required under the profit-
sharing plan. The problem must be considered from two points of view. First, is the inventory
genuinely unsaleable? If not, then the entry to write down the inventory must be reversed,
resulting in a higher net income figure. Assuming that the inventory is unsaleable, the next
question is whether the write-off legitimately belongs in the current period. If the inventory
became unsaleable in the current year, then the write belongs in the current period. If the
inventory was unsaleable in prior years, it should have been written down in prior years. In that
case, the financial statements should be retroactively restated to correct the error in the
appropriate period.

Allowance for returns

The return estimate represents a legitimate cost of doing business during the period. What is in
question is whether the more conservative estimate represents a genuine reflection of a change
in economic conditions or an opportunistic use of accounting judgment to reduce net income.
GQ's auditor would probably not object to the increased expense since conservatism is a key
accounting principle. However, the union's interests are not served by conservatism.

Use of accelerated depreciation

There is no requirement that all assets owned by a firm be depreciated in the same way. Thus,
GQ can argue that the use of an accelerated method on the new equipment better reflects the
pattern in which the asset’s future economic benefits are expected to be consumed by GC. We
can argue that the portfolio of manufacturing equipment acquired to produce similar products
should be accounted for similarly. If there is no difference between the new and old equipment
with respect to the effect of technological obsolescence, then either the new asset should be
depreciated on a straight-line basis or similar assets acquired previously should be
depreciated on the accelerated method. The financial impact of using the same depreciation
method for both cannot be determined at this point.

Write-off of goodwill
Goodwill should be written down or written off if there has been a permanent impairment of its
value i.e. if the recoverable amount of the cash generating unit in which the goodwill is located
is less than the carrying amount of the net assets, including goodwill, of the cash generating
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Solutions Manual, Chapter 6 15
unit. The fact that the auto parts industry is suffering through poor economic times does not
necessarily imply that what was purchased (the company name, its customers, etc.) no longer
has any value. The auto industry is very sensitive to economic cycles, and it is expected that
such downturns will occur. (Indeed, their occurrence should have been factored into the
acquisition cost paid by GQ).
Unless GQ can come up with strong evidence that the intangibles purchased have been
impaired, there is no justification for the write-off even though GQ's auditors supported it. It is
important to emphasize that their support may rest in conservatism: auditors are willing to
accept accounting treatments that are conservative. However, conservatism is inconsistent with
the union's objectives. The value of the asset acquired in Year 5 must still exist unless there is
specific evidence of its impairment. GQ should provide evidence of impairment.

Unrealized profits from intercompany sales

The unrealized profit from intercompany sales should be eliminated when preparing
consolidated financial statements. CG has not made any adjustments for these intercompany
transactions for Year 11. The unrealized profit in ending inventory is $28,000 (10% x 800,000 x
35%). When this profit is eliminated, CG’s net income will decrease by $28,000. The unrealized
profit in beginning inventory is $70,000 (200,000 x 35%). When adjusting for this profit, CG’s net
income will increase by $70,000. Therefore, CG’s Year 11 net income should be increased by
$42,000 (70,000 – 28,000).

Bonus to president and chairman

The compensation approach selected by the senior managers has a significant effect on the
money paid to the union members. Since bonuses are deducted from income whereas
dividends are not, the maximum effect of the change in compensation for union members is
$500,000 (an average of $2,500 per employee). If the amount of compensation has remained
more or less the same as in prior years, with only the method of payment changing, then an
argument can be made that GQ is violating the spirit of the contract by changing the method.

Change to tax allocation

Under ASPE, CG has the choice to use either the taxes-payable method or the liability method
of accounting for income taxes. Accordingly, the new method is acceptable under ASPE. We
could argue that the change is in violation of the contract, as the contract was signed on the
understanding that major accounting policies would remain the same. The arbitrator may accept
this argument. The arbitrator, however, would likely demand consistent treatment of accounting
changes.

SOLUTIONS TO PROBLEMS
Problem 6-1
(a)
Intercompany balances
Sales and purchases for Year 3 180,000 (a)
Accounts receivable and payable at end of Year 3 40,000 (b)

Intercompany inventory profits Before 40% After

tax tax tax
Opening inventory – Sub selling (60,000 x .3) 18,000 7,200 10,800 (c)
Closing inventory – Sub selling (70,000 x .3) 21,000 8,400 12,600 (d)

Consolidated account balances

Inventory (500,000 + 300,000 – (d) 21,000) 779,000
Accounts payable (600,000 + 320,000 – (b) 40,000) 880,000
Retained earnings, beginning of year
PAT 2,400,000
SAT R/E, beginning of year 1,100,000
SAT R/E, date of acquisition 900,000
Change since acquisition 200,000
Less: unrealized profit in beginning inventory (c) - 10,800
189,200
PAT’s share x 90% 170,280
Consolidated retained earnings 2,570,280
Sales (4,000,000 + 2,500,000 – (a) 180,000) 6,320,000
Cost of sales (3,100,000+1,700,000–(a)180,000+(d) 21,000–(c)18,000) 4,623,000
Income tax expense (80,000 + 50,000 – (d)8,400 + (c)7,200) 128,800

(b) Since the subsidiary was the seller of the intercompany sales, these transactions are
upstream transactions and the non-controlling interest (NCI) will absorb their share of the
adjustments to eliminate the unrealized profits. NCI on the income statement will decrease

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Solutions Manual, Chapter 6 17
 by $1,260 (10% x 12,600) for its share of unrealized after-tax profits in ending inventory and
increase by $1,080 (10% x 10,800) for its share of after-tax profits in beginning inventory.
NCI on the balance sheet will decrease by $1,260 (10% x 12,600) for its share of unrealized
after-tax profits in ending inventory.

d
Problem 6-3
Pike Spike Consolidated
December 31, Year 1
Land 100,000 115,000*
Gain on Sale
Income Tax on Gain
December 31, Year 2
Land 128,000 115,000*
Gain on Sale 28,000
Income Tax on Gain 11,200***
December 31, Year 3
Land
Gain on Sale 12,000 25,000**
Income Tax on Gain 4,800*** 10,000***
* = fair value of land at date of acquisition
** = selling price to outsiders less amount paid at acquisition = 140,000 – 115,000
*** = 40% x gain on sale of land

Problem 6-4
(a)
Acquisition differential amortization

Plant – Waste
Years 1– 5 ([15,000 / 8 years] x 5 years) 9,375 (a)

Year 6 (15,000 / 8 years) 1,875 (b)

Goodwill – Baste
Years 4 – 5 19,000 (c)
 Year 6 –0–

Intercompany Revenues and Expenses

Sales (90,000 + 170,000 + 150,000) 410,000 (d)

Rent (25,000 + 14,000) 39,000 (e)

Interest 10,000 (f)

Dividend income: All intercompany from Waste & Baste 43,750 (g)
Intercompany Profits

Before tax 40% tax After tax

Opening inventory – Waste selling
(15,000 x .30) 4,500 1,800 2,700 (h)
Ending inventory – Baste selling
(60,000 x .30) 18,000 7,200 10,800 (i)
– Paste selling
(22,000 x .30) 6,600 2,640 3,960 (j)
– Waste selling
(60,000 x .30) 18,000 7,200 10,800 (k)
42,600 17,040 25,560) (l)

Paste Company
Consolidated Income Statement
for the Year Ended December 31, Year 6

Sales (450,000 + 270,000 + 190,000 – (d)410,000) 500,000

Dividends (43,750 – (g) 43,750)
Interest (10,000 – (f) 10,000)
Rent (130,000 – (e) 39,000) 91,000
Total income 591,000
Cost of sales (300,000 + 163,000 + 145,000 – (d) 410,000
– (h) 4,500 + (l) 42,600 + (b) 1,875) 237,975
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Solutions Manual, Chapter 6 19
General & administrative (93,000 + 48,000 + 29,000 – (e) 39,000) 131,000
Interest (10,000 – (f) 10,000)
Income tax (27,000 + 75,000 + 7,000 + (h) 1,800 – (l) 17,040) 93,760
Total expenses 462,735
Profit 128,265
Attributable to:
Shareholders of Paste 109,910
Non-controlling interests (20% x 94,025* + 25% x -1,800*) 18,355
128,265

* see part (c) for calculation of 94,025 and –1,800

(b)
Calculation of consolidated retained earnings – December 31, Year 6

Retained earnings of Paste December 31, Year 6 703,750

Profit in ending inventory (j) (3,960)
Retained earnings of Waste December 31, Year 6 146,000
Retained earnings of Waste – acquisition 40,000
Increase 106,000
Less: profit in ending inventory (k) 10,800
amortization of acquisition differential (a) 9,375 + (b) 1,875 11,250
Adjusted increase 83,950
Paste's ownership % 80% 67,160

Retained earnings of Baste December 31, Year 6 79,000

Retained earnings of Baste – acquisition 80,000
Decrease (1,000)
Less: amortization of acquisition differential for Baste (c) 19,000
profit in ending inventory (i) 10,800
(30,800)
Paste's ownership % 75% (23,100)
Consolidated retained earnings December 31, Year 6 743,850

(c)
Profit of Waste 104,000
Add: profit in opening inventory (h) 2,700
106,700
Less: profit in ending inventory (k) 10,800
amortization of acquisition differential (b) 1,875
94,025
Paste’s share x 80% 75,220

Profit of Baste 9,000

Less: profit in ending inventory (i) 10,800
(1,800)
Paste’s share x 75% - 1,350
Profit in ending inventory – Paste selling (j) - 3,960
Investment income from subsidiaries 69,910

(d)
Revenue should be recognized when it is earned i.e., when the benefits and risks have been
transferred to an entity outside of the reporting entity. The reporting entity for consolidated
financial statements encompasses the parent and all of its subsidiaries. Since intercompany
transactions are transactions within the reporting entity (not outside of the reporting entity), they
must be eliminated when preparing consolidated financial statements. When the inventory is
sold outside of the consolidated entity, the difference between the selling price and the original
cost to the consolidated entity would be reported as profit of the consolidated entity.

Problem 6-5

(a) X's equity method journal entries

Year 1

Cash 18,750
Investment in Y Co. 18,750
75% x $25,000 dividends.
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Solutions Manual, Chapter 6 21
Investment in Y Co. 97,500
Investment income 97,500
75% x $130,000 net income.

Investment income 13,500

Investment in Y Co. 13,500
To hold back 75% of the $18,000 after-tax
inventory profit – Y selling
(60% x $30,000 = $18,000).

Investment income 22,200

Investment in Y Co. 22,200
To hold back the after-tax land profit –
X selling (60% x $37,000 = $22,200).

Investment income 47,250

Investment in Y Co. 47,250
Acquisition differential amortization – Year 1
Inventory 60,000
Equipment $45,000/15 = 3,000
63,000
x Co.’s share (@ 75%) 47,250
Note: Year 1 investment income is $14,550 (97,500 – 13,500 – 22,200 – 47,250)
Year 2

Cash 3,750
Investment in Y Co. 3,750
75% x 5,000 dividends.

Investment income 12,000

Investment in Y Co. 12,000
75% x 16,000 net loss.

Investment income 2,250

Investment in Y Co. 2,250
Acquisition differential (equipment) amortization. (3,000 x 75%)

Investment in Y Co. 13,500

Investment income 13,500
To realize opening inventory profit – Y selling.

Investment in Y Co. 22,200

Investment income 22,200
To realize land profit – X Selling

Investment income 7,200

Investment in Y Co. 7,200
To hold back after-tax inventory profit – X selling
(60% x $12,000)

Note: Year 2 investment income is $14,250 (–12,000 – 2,250 + 13,500 + 22,200 – 7,200)

(b) Calculation of consolidated net income – Year 1

Net income of X 400,000

Less: Land profit 22,200
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Solutions Manual, Chapter 6 23
Adjusted 377,800

Net income of Y 130,000

Less: closing inventory profit (18,000)
acquisition differential amortization (63,000)
Adjusted 49,000
Consolidated net income 426,800
Attributable to:
Shareholders of X 414,550
Non-controlling interests (25% x 49,000) 12,250
426,800

Calculation of Consolidated Net income – Year 2

Net income of X 72,000

Less: closing inventory profit 7,200
64,800
Add: land profit realized 22,200
Adjusted net income 87,000
Net income (loss) of Y (16,000)
Add: opening inventory profit realized 18,000
Less: acquisition differential amortization (3,000)
Adjusted net income (1,000)
Consolidated net income 86,000
Attributable to:
Shareholders of X 86,250
Non-controlling interests (25% x -1,000) (250)
86,000
(c)
Changes in Non-controlling Interest
Years 1 and 2

Balance Jan. 1 Year 1 [25% x (170,000 + 105,000)] 68,750

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24 Modern Advanced Accounting in Canada, Fifth Edition
Allocation of Y Co.’s adjusted net income Year 1
(25% x 49,000) 12,250
81,000
Less: dividends (25% x 25,000) 6,250
Balance Dec. 31, Year 1 74,750
Allocation of Y Co.’s adjusted net income Year 2
(25% x - 1,000) (250)
74,500
Less: dividends (25% x 5,000) 1,250
Balance Dec. 31, Year 2 73,250

Proof:

Y - Common shares 100,000

- Retained earnings (70,000 + 130,000 − 25,000 − 16,000 − 5,000) 154,000
- Shareholders' equity Dec. 31, Year 2 254,000
- Unamortized acquisition differential 39,000
293,000
25%
73,250

(d) Calculation of Investment in Y Co. (Equity Method)

As at December 31, Year 2

Shareholders' equity of Y Jan. 1, Year 1 170,000

Acquisition differential 105,000
275,000
X's ownership 75%
Cost of 75% investment in Y Jan. 1, Year 1 206,250
Investment income – Year 1 14,550
Year 2 14,250 28,800
235,050

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Solutions Manual, Chapter 6 25
Less: Dividends received
Year 1 (75% x 25,000) 18,750
Year 2 (75% x 5,000) 3,750 22,500
Investment in Y Dec. 31, Year 2 212,550

Proof:

Shareholders' equity of Y 254,000

Balance, unamortized equipment (45,000 − 6,000) 39,000
293,000
X's ownership 75%
219,750
Less: Holdback of inventory profit – X selling 7,200
Investment in Y, December 31, Year 2 212,550

Problem 6-6
Intercompany profits

Before tax 40% tax After tax

Opening inventory Q selling 80,000 32,000 48,000 (a)

L selling 52,000 20,800 31,200 (b)

Ending inventory Q selling 35,000 14,000 21,000 (c)

L selling 118,000 47,200 70,800 (d)

(a) Calculation of consolidated profit

Profit of L 580,000
Less: Dividends
From M (80% x 200,000) 160,000
From Q (70% x 150,000) 105,000
Ending inventory profit (d) 70,800 335,800
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26 Modern Advanced Accounting in Canada, Fifth Edition
 244,200
Add: opening inventory profit (b) 31,200
Adjusted profit 275,400

Profit of M 360,000

Profit of Q 240,000
Less: ending inventory profit (c) 21,000
219,000
Add: opening inventory profit (a) 48,000
267,000
Consolidated profit 902,400
Attributable to:
Shareholders of L 750,300
Non-controlling interests (20% x 360,000 + 30% x 267,000) 152,100
902,400

(b)
Calculation of consolidated retained earnings – beginning of current year

Retained earnings of L 976,000

Less: opening inventory profit (b) 31,200
Adjusted 944,800
Retained earnings of M 843,000
Acquisition retained earnings 500,000
Increase 343,000
L's ownership 80% 274,400

Retained earnings of Q 682,000

Acquisition retained earnings 50,000
Increase 632,000
Less: opening inventory profit (a) 48,000

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Solutions Manual, Chapter 6 27
Adjusted increase 584,000
L's ownership 70% 408,800
Consolidated retained earnings – beginning of year 1,628,000

Problem 6-7
Calculation, allocation, and amortization of acquisition differential

Cost of 80% investment, Jan. 1, Year 3 1,600,000

Implied value of 100% investment 2,000,000
Carrying amounts of Least's net assets:
Assets 3,000,000
Liabilities 1,500,000
Total shareholders' equity 1,500,000
Acquisition differential 500,000
Allocation: FV - CA
Accounts receivable - 20,000
Inventories - 50,000
Plant and equipment (net) 35,000
Long-term liabilities 100,000 65,000
Balance – goodwill 435,000

Balance Amortization Balance

Jan. 1 Dec. 31
Year 3 Years 3 to 8 Year 9 Year 9
Accounts receivable - 20,000 - 20,000
Inventories - 50,000 - 50,000
Plant and equipment (net) 35,000 26,250 4,375 4,375 (a)
Long-term liabilities 100,000 100,000
Goodwill 435,000 52,200 8,700 374,100 (b)
500,000 108,450 (c) 13,075 (d) 378,475

Intercompany revenues and expenses

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28 Modern Advanced Accounting in Canada, Fifth Edition
Sales and purchases (2,000,000 + 1,500,000) 3,500,000 (e)

Intercompany profits

Before tax 40% tax After tax

Loss on land, July 1, Year 7

realized in Year 9 – Most selling 50,000 20,000 30,000 (f)

Opening inventory – Most selling

(312,500 x 0.20) 62,500 25,000 37,500 (g)
– Least selling
(857,140 x 0.30) 257,142 102,857 154,285 (h)
319,642 127,857 191,785 (i)

Ending inventory – Most selling

(500,000 x 0.20) 100,000 40,000 60,000 (j)
– Least selling
(714,280 x 0.30) 214,284 85,714 128,570 (k)
314,284 (l) 125,714 188,570
Intercompany dividends declared but not paid (80% x 100,000) 80,000 (m)

Deferred income taxes – ending inventory (40,000 + 85,714) 125,714 (n)

Calculation of consolidated retained earnings – Jan. 1 Year 9

Retained earnings of Most, Jan. 1, Year 9

(10,400,000 – 1,000,000 + 350,000) 9,750,000

Less: Profit in opening inventory (g) 37,500

9,712,500
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Solutions Manual, Chapter 6 29
Add: land loss (f) 30,000
Adjusted retained earnings 9,742,500
Retained earnings of Least, Jan. 1, Year 9
(2,300,000 – 400,000 + 100,000) 2,000,000
Retained earnings of Least at acquisition 1,000,000
Increase 1,000,000
Less: profit in opening inventory (h) 154,285
amortization of acquisition differential (c) 108,450
Adjusted increase 737,265 (o)
Most's ownership % 80% 589,812
Consolidated retained earnings, Jan. 1, Year 9 10,332,312

Calculation of consolidated net income – Year 9

Net income of Most 1,000,000
Less: Dividends from Least (100,000 x 80%) 80,000
Profit in closing inventory (j) 60,000
Land loss (f) 30,000 170,000
830,000
Add: profit in opening inventory (g) 37,500
Adjusted net income 867,500
Net income of Least 400,000
Add: profit in opening inventory (h) 154,285
554,285
Less: profit in closing inventory (k) 128,570
amortization of acquisition differential (d) 13,075
Adjusted net income 412,640
Consolidated net income 1,280,140
Attributable to:
Shareholders of Most 1,197,612
Non-controlling interests (20% x 412,640) 82,528
1,280,140

Calculation of consolidated non-controlling interests – Jan. 1 Year 9 (Method 1)

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30 Modern Advanced Accounting in Canada, Fifth Edition
Least’s common shares, Jan. 1, Year 9 500,000
Retained earnings of Least, Jan. 1, Year 9 2,000,000
Less: profit in opening inventory (h) 154,285
Adjusted retained earnings 1,845,715
Unamortized acquisition differential (500,000 – 108,450) 391,550
2,737,265
NCI’s ownership % 20%
NCI, Jan. 1, Year 9 547,453

Calculation of consolidated non-controlling interests – Jan. 1 Year 9 (Method 2)

Non-controlling interests at date of acquisition (20% x [1,600,000 / .8) 400,000
Least’s adjusted increase in retained earnings (n) 737,265
NCI’s share @ 20% 147,453
NCI, Jan. 1, Year 9 547,453

(a) Most Company

Consolidated Statement of Changes in Equity
For Year Ended December 31, Year 9

Common Retained
Stock Earnings Total NCI Total
Balance, beginning of year 1,000,000 10,332,312 11,332,312 547,453 11,879,765
Add: net income 1,197,612 1,197,612 82,528 1,280,140
Less: dividends (350,000) (350,000) (20,000) (370,000)
Balance, end of year 1,000,000 11,179,924 12,179,924 609,981 12,789,905

Proof of consolidated retained earnings, end of Year 9

Retained earnings of Most, Dec. 31, Year 9 10,400,000

Less: profit in ending inventory (j) 60,000
Adjusted retained earnings 10,340,000
Retained earnings of Least, Dec. 31, Year 9 2,300,000
Retained earnings of Least at acquisition 1,000,000
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Solutions Manual, Chapter 6 31
Increase 1,300,000
Less: profit in ending inventory (k) 128,570
amortization of acquisition differential
((c) 108,450 + (d) 13,075) 121,525
Adjusted increase 1,049,905 (p)
Most's ownership % 80% 839,924
Consolidated retained earnings, Dec. 31, Year 9 11,179,924

Proof of non-controlling interest, end of Year 9 (Method 1)

Retained earnings of Least 2,300,000
Common shares of Least 500,000
Total shareholders' equity 2,800,000
Less: profit in ending inventory (k) 128,570
Adjusted shareholders' equity 2,671,430
Add: unamortized acquisition differential 378,475
3,049,905
20%
Non-controlling interest, Dec. 31, Year 9 609,981

Calculation of consolidated non-controlling interests – end of Year 9 (Method 2)

Non-controlling interests at date of acquisition (20% x [1,600,000 / .8]) 400,000
Least’s adjusted increase in retained earnings (o) 1,049,905
NCI’s share @ 20% 209,981
Non-controlling interest, Dec. 31, Year 9 609,981

(b) Most Company

Consolidated Balance Sheet
December 31, Year 9

Cash (500,000 + 40,000) 540,000

Accounts receivable (1,700,000 + 500,000 – (m) 80,000) 2,120,000
Inventories (2,300,000 + 1,200,000 – (l) 314,284) 3,185,716
Plant and equipment (net) (8,200,000 + 4,000,000 + (a) 4,375) 12,204,375
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32 Modern Advanced Accounting in Canada, Fifth Edition
Land (700,000 + 260,000) 960,000
Goodwill (b) 374,100
Deferred income taxes (n) 125,714
Total assets 19,509,905

Current liabilities (600,000 + 200,000 – (m) 80,000) 720,000

Long-term liabilities (3,000,000 + 3,000,000) 6,000,000
Common shares 1,000,000
Retained earnings 11,179,924
Non-controlling interest 609,981
Total liabilities & shareholders' equity 19,509,905

(c) The cost principle requires that certain assets such as inventory be reported at cost. When
a profit is made on an intercompany sale, the inventory cost to the purchaser is higher than
the cost incurred by the seller. An adjustment is made on consolidation to remove the profit
from the inventory of the purchaser to bring the value of the inventory down to the original
cost to the consolidated entity.

(d) The debt to equity ratio would increase because debt remains the same but the non-
controlling interest within shareholders’ equity decreases. Non-controlling interests
decreases because it does not contain the incorporate the non-controlling interests’ share
of the value of the subsidiary’s goodwill.

Problem 6-10
Intercompany revenues and expenses
Sales and purchases (90,000 + 177,000) 267,000 (a)
Rental revenue and expense (2,800 x 12) 33,600 (b)
Interest revenue and expense (360,000 x 0.05) 18,000 (c)

Intercompany profits
Before tax 40% tax After tax
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Solutions Manual, Chapter 6 33
Opening inventory – Evans selling
(21,250 – [21,250 / 1.25]) 4,250 1,700 2,550 (d)
– Falcon selling
(11,000 x 0.3) 3,300 1,320 1,980 (e)
7,550 3,020 4,530 (f)
Ending inventory – Evans selling
(28,750 – [28,750 / 1.25]) 5,750 2,300 3,450 (g)
– Falcon selling
(3,000 x 0.3) 900 360 540 (h)
6,650 2,660 3,990 (i)

Calculation of consolidated profit – current year

Profit of Evans 61,900

Less: Intercompany dividends (40,000 x 80%) 32,000
Profit in ending inventory (g) 3,450 35,450
26,450
Add: profit in opening inventory (d) 2,550
Adjusted profit 29,000
Profit of Falcon 75,500
Less: profit in ending inventory (h) 540
74,960
Add: profit in opening inventory (e) 1,980
76,940
Consolidated profit 105,940
Attributable to:
Shareholders of Evans 90,552
Non-controlling interests (20% x 76,940) 15,388
105,940

(a) Evans Company

Consolidated Income Statement
for the Current Year
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34 Modern Advanced Accounting in Canada, Fifth Edition
Sales (450,000 + 600,000 – (a)267,000) 783,000
Raw materials & finished goods purchased
(268,000 + 328,000 – (a)267,000) 329,000
Changes in inventory
(20,000 + 25,000 – (f)7,550 + (i)6,650) 44,100
Other expenses (104,000 + 146,000 – (b)33,600) 216,400
Interest expense (30,000 – (c)18,000) 12,000
Income taxes (31,700 + 43,500 + (f)3,020 – (I)2,660) 75,560
Total expenses 677,060
Profit 105,940
Attributable to:
Shareholders of Evans 90,552
Non-controlling interests (20% x 76,940) 15,388
105,940

(b)
Calculation of consolidated retained earnings – beginning of year

Retained earnings of Evans, beginning of year 632,000

Less: profit in opening inventory (d) 2,550
Adjusted retained earnings 629,450
Retained earnings of Falcon, beginning of the year 348,000
Less: profit in opening inventory (e) 1,980
Adjusted increase since acquisition 346,020
Evans' ownership % 80% 276,816
Consolidated retained earnings, beginning of year 906,266

Consolidated dividends declared 30,000

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Solutions Manual, Chapter 6 35
Problem 6-14
(a) Acquisition cost Allocation Acquisition January 1, Year 1

Cost (60,000 x $80) 4,800,000

Implied value of 100% investment (80,000 shares x $80) 6,400,000
CA: Ordinary Shares 3,500,000
Retained Earnings 2,100,000
5,600,000
Acquisition differential 800,000

Allocation: Life
Inventory 100,000 Cr 1
Land 200,000 Dr
Equipment 200,000 Cr 10
Patents 400,000 Dr 5
L.T. Liability 100,000 Cr 4
Subtotal 200,000 Dr
Balance: Goodwill 600,000 Dr
800,000 Dr
Non-controlling interest (20,000 shares @ $80) 1,600,000

Amortization Table:

Allocation Life Amortization Balance

YR 1 – YR 4 YR 5 Dec. 3, YR 5

Inventory 100,000 Cr 1 100,000Cr 0 0

Land 200,000 Dr 200,000 Dr
Equipment 200,000 Cr 10 80,000Cr 20,000 Cr 100,000 Cr
Patents 400,000 Dr 5 320,000Dr 80,000Dr 0
L.T. Liability 100,000 Cr 4 100,000Cr 0
Goodwill 600,000 Dr 600,000 Dr
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36 Modern Advanced Accounting in Canada, Fifth Edition
 800,000 Dr 40,000 Dr 60,000 Dr 700,000 Dr

Devine’s accumulated depreciation at date of acquisition 500,000

Intercompany Amounts:

Dividends: 500,000 x 75% 375,000

Sales: Vine (YR 5) 2 M + Devine (YR 5) 1.2M 3,200,000

Advances from Vine to Devine: 200,000

BT Tax AT
Land: Upstream Gain Sept 1, YR 5 400,000 160,000 240,000

Unrealized Profits: BT Tax AT

Opening Upstream 100 K @ 40% 40,000 16,000 24,000

Downstream 300 K @ 33 1/3% 100,000 40,000 60,000

Ending Upstream 500 K @ 40% 200,000 80,000 120,000

Downstream 600 K @ 33 1/3% 200,000 80,000 120,000

(b) Consolidated Income Statement for the year ending December 31, Year 5

Sales (11.6 M + 3 M – 3.2 M) 11,400,000

Dividend, Investment Income, and Gains

(400 K + 1,000 K – 375K – 400K) 625,000

12,025,000

Cost of Goods Sold

(8M + 1.5 M – 3.2 M - 40K – 100K + 200K + 200K) 6,560,000

Other Expenses (500K + 300K – 20K (Equip) + 80 K (Patent) 860,000

Taxes (500K + 200K – 160K + 16K + 40K –80K – 80K) 436,000

Total expenses 7,856,000

Profit 4,169,000
Attributable to:
Shareholders of Vine 3,768,000
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Solutions Manual, Chapter 6 37
 Non-controlling interests (2M – 240K –120K + 24K – 60K) x .25 401,000

4,169,000

Reconciliation:

Vine Profit: 3,000,000

Dividends from Devine Included (375,000)

Equity in Earnings of Devine 1,143,000

Consolidated Profit Attributable to Vine’s Shareholders 3,768,000

(c) Consolidated Retained Earnings: Proof

Parent retained earnings at December 31, Year 5 12,000,000

Sub retained earnings at December 31, Year 5 7,000,000
Retained earnings at acquisition 2,100,000
Increase since acquisition 4,900,000
Less: unrealized profits, ending inventory (120,000)
Land (240,000)
Less: cumulative amortization of acquisition differential (100,000)
Realized retained earnings since acquisition 4,440,000 (a)
Parent % 75% 3,330,000
Less: unrealized profits, ending inventory (120,000)
Consolidated retained earnings 15,210,000

(d)
Consolidated Statement of Financial Position
December 31, Year 5

Assets
Land (6M + 2.5 M + 200K – 400K) 8,300,000

Plant and Equipment (18.8M + 11.8M – 200K – 500K) 29,900,000

Accumulated depreciation (5.8M + 5.0M – 100K – 500K) (10,200,000)

Goodwill 600,000

Deferred Income Tax (160K + 80K + 80K) 320,000

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38 Modern Advanced Accounting in Canada, Fifth Edition
 Inventories (4.6 M + 2.4 M – 200K – 200K 6,600,000

Cash and Current Receivables (900K + 300K) 1,200,000

36,720,000
Equities and Liabilities

Ordinary shares 10,000,000

Retained Earnings (See part c) 15,210,000

Non-controlling interests (See Below) 2,710,000

Long Term Liabilities (6.6 M + 1.1 M) 7,700,000

Deferred Income Taxes (200K+100K) 300,000

Current Liabilities (700K + 300K – 200K advances) 800,000

36,720,000

Non-controlling Interests: (Method 1)

Devine – Carrying amount December 31, Year 5 10,500,000

Unrealized Profits – Upstream:
Land (240,000)
Inventory (120,000)
Unamortized acquisition differential 700,000
10,840,000
25%
Non-controlling interest 2,710,000

Calculation of non-controlling interests – December 31, Year 5 (Method 2)

Non-controlling interests at date of acquisition (25% x [4,800,000 / .75) 1,600,000
Devine’s adjusted increase in retained earnings (a) 4,440,000
NCI’s share @ 25% 1,110,000
Non-controlling interest, December 31, Year 5 2,710,000

(e)
Non-controlling interest – at date of acquisition
- under implied value approach (25% x 6,400,000) 1,600,000
- using market value of Devine’s shares (20,000 shares x $75) 1,500,000

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Solutions Manual, Chapter 6 39
Decrease in non-controlling interest 100,000
Non-controlling interest, December 31, Year 3
- as previously calculated 2,710,000
- as per new calculation 2,610,000

Goodwill at December 31, Year 3

- as previously calculated 600,000
- decrease due to change in non-controlling interest 100,000
- as per new calculation 500,000

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40 Modern Advanced Accounting in Canada, Seventh Edition