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    CHAPTER 6

    INTERCORPORATE TRANSFERS: NONCURRENT ASSETS

    ANSWERS TO QUESTIONS

    Q6-1 Profits on intercorporate sales generally are considered to be realized when the affiliate that has purchased the item sells it to a nonaffiliate. For depreciable or amortizable items that are used by the affiliate in its operations, profits are considered to be realized as the purchaser depreciates or  amortizes the asset.

    Q6-2 An upstream sale occurs when a subsidiary sells an item to the parent company. If the asset is not resold before the end of the period, the parent is the company holding the asset and any

    unrealized profits are recorded on the books of the subsidiary.

    Q6-3 (a) nrealized profit on an intercorporate sale generally is included in the reported net income of the seller.

    (b) All unrealized profit on current!period intercorporate sales must be e"cluded from consolidated net income until realized through resale to a nonaffiliate.

    Q6-4 Profits on intercompany sales are included in consolidated net income in the period in which the items are sold to a nonaffiliate. If there are unrealized profits on the books of one of the companies at the start of the period and the item is sold to a nonaffiliate during the current period,

    the intercompany profit is included in the computation of consolidated net income for the current period.

    Q6-5 #he profits continue to be unrealized in this case and therefore must be eliminated from  both the beginning and ending asset and retained earnings balances when consolidated statements are prepared. #here should be no income statement effect for the current period.

    Q6-6 A downstream sale is a sale from the parent to one of its subsidiaries. If the asset is not resold before the end of the period, the subsidiary is the company holding the asset at year!end and any unrealized profits are recorded on the books of the parent company.

    Q6-7 #he entire balance of unrealized profits is eliminated in all cases. $hile the direction of the sale will affect the allocation of unrealized profits between companies, it does not change the total amount of profit eliminated.

    McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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    Q6-8 %onsolidated net income is reduced by the amount of unrealized profits assigned to the shareholders of the parent company. $hen a downstream sale occurs, all the profit is on the parent&s  books and consolidated net income is reduced by the full amount of any unrealized profit. 'n the other hand, when an upstream sale occurs all the intercorporate profit is recorded on the books of the subsidiary and the amount of income assigned to both the parent company shareholders and the

    noncontrolling shareholders is reduced by a proportionate amount of any unrealized profit.

    Q6-9 #he amount of intercorporate profit realized in the current period from prior years& sales to the parent is added to the reported net income of the subsidiary in computing income assigned to the noncontrolling interest.

    Q6-10 Income assigned to noncontrolling interest for the current period will be less than a  proportionate share of the reported net income of the subsidiary. In determining the amount of  income to be assigned to the noncontrolling interest in the consolidated income statement, the net income reported by the subsidiary must be adusted to e"clude any unrealized gain recorded during the period on the sale of depreciable assets to the parent. 'n the other hand, if an unrealized loss had

     been recorded, the basis used in assigning income to the noncontrolling interest would be greater than the reported net income of the subsidiary. uch adustments must be made to assure that the income assigned to noncontrolling interest is based on the contribution of the subsidiary to consolidated net income rather than the amount the subsidiary may ha*e reported as net income.

    Q6-11 All other factors being e+ual, the income assigned to noncontrolling interest will be larger if  the sale occurs at the start of the current period. ome part of the gain will be considered realized in the current period as the parent depreciates the asset if the sale occurs before year!end. one of the gain will be considered realized in the period of transfer if the sale occurs at year!end.

    Q6-12 As in all other cases, income from the subsidiary recorded on the parent&s books must be eliminated in preparing the consolidated income statement and an appropriate amount of subsidiary net income must be assigned to the noncontrolling interest if the parent owns less than - percent of the subsidiary&s stock. #he gain recorded on the parent&s books also must be eliminated.

    Q6-13 /epreciation e"pense recorded by the subsidiary is o*erstated from the *iewpoint of the consolidated entity when the subsidiary pays the parent more than book *alue for the asset at the start of the period. As a result, an eliminating entry is needed to reduce depreciation e"pense and accumulated depreciation by the amount of e"cess depreciation recorded during 012.

    McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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    Q6-14 Following an intercorporate sale of a depreciable asset, the eliminating entries should adust the balance in the asset account to reflect the original purchase price to the first owner and accumulated depreciation should be adusted to reflect the balance that would be reported if the asset were still held by the first owner. In the case of an intercorporate sale of an intangible asset, only the unamortized balance normally is reported and an eliminating entry is needed to adust the carrying

    *alue to that which would be reported if the asset were still held by the first owner.

    Q6-15 Profit on an intercorporate sale of land is considered realized at the time the purchaser sells the land to a nonaffiliate. Profit on e+uipment normally is considered realized as the asset is used and depreciated on the books of the purchaser. 3+uipment typically is considered to be used up in the  production process and therefore is charged to e"pense o*er its remaining economic life, while land is not.

    Q6-16 A portion of the profit is considered realized each period as the asset is depreciated by the  purchaser. #hus, the net amount considered unrealized decreases each period and a smaller debit to  beginning retained earnings is needed.

    Q6-17A #he balance in the in*estment account will depend on which method the parent uses to account for its in*estment in the subsidiary. If the parent uses (a) the cost method or (b) the basic e+uity method, no adustments are made on the parent company&s books for unrealized intercompany  profits and the balance in the in*estment account will be the same as if there were no unrealized  profits. If the parent uses (c) the fully!adusted e+uity method, the balance in the in*estment account will be reduced by the full amount of the unrealized profit when the profit is on the parent&s books and by a proportionate share of the unrealized profit when it is on the subsidiary&s books.

    McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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    SOLUTIONS TO CASES

    C6-1 His!"i#$% C!s &!'(%

    A change to replacement cost accounting could potentially simplify the elimination process when

    there ha*e been intercorporate transfers. If assets are transferred between affiliates at fair *alue, the balance sheet amount reported by the purchaser should reflect replacement cost on the date of  transfer and no adustment would be needed if consolidation were to occur at that time. In the  periods that follow, the adustment for the change in replacement cost from the beginning of the  period to the end of the period on the books of the purchaser should be the same as if there had been no intercompany transfer and no eliminating entries are needed.

    In preparing the consolidated income statement for the period of transfer, any gain or loss recorded  by the seller on the intercorporate sale must be eliminated. #he e"act nature of the adustment will depend on whether the change in replacement cost each period is considered to be a realized or an unrealized gain. If the change in replacement cost each period is considered realized, the gain or loss

    recorded on the intercorporate sale will need to be treated as an adustment to the gain or loss on thechange in replacement cost in the period of transfer. o special adustment will be needed in the years that follow. If the change in replacement cost is considered unrealized, the gain or loss recorded at the time of transfer will be treated as an adustment to the unrealized gain or loss on the change in replacement cost each time consolidated statements are prepared.

    McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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    C6-2 I)*$# !+ ,( E%i)i$i! P"!#(ss

    a. $hile items purchased from an affiliate may be physically segregated or marked, some aspect of the recordkeeping system typically is used to keep track of such items. A uni+ue series of  accounts, in*entory numbers, purchase order numbers, or other records may be used to identify

    items ac+uired from affiliates. In a *ery simple setting the *ouchers on intercompany purchases may be kept in a special folder and checked at year!end to see if those items are still on hand. 4ore formal pro