AFR Exam 2
Intra-Entity Gross Profit - Year Following Transfer (Year 2)
-After Entry G, a $7,500 overstatement remains in the separate financial records of the buyer and seller -the ending inventory portion of intra-entity gross profit must be adjusted in two successive years: 1. from ending inventory in the year of transfer 2. from beginning inventory of the next period
Intra-Entity Transactions - Upstream Inventory Transfers (Entry *G) example
-As of Jan 1, 2018, $16,000 of transfers remain in parent/top's inventory, and $4,000 of gross profit is unearned. Sub/Bottom's beginning Retained Earnings are overstated by $4,000, the gross profit from 2017 intra-entity transfers -a credit to COGS increases consolidated net income to recognize the profit in 2018 from sales to outsiders as follows: Journal Entry: Debit: retained earnings (sub) ($4,000) Credit: COGS ($4,000) -to remove 2020 intra-entity gross profit in inventory from seller's beginning balance and recognize the gross profit in 2021 following sales to outsiders. Top/parent uses the equity method and intra-entity sales were upstream
Consolidated Financial Statements - Income Statement and Balance Sheet
-CNI is computed at the combined entity level and allocated to the noncontrolling and controlling interests -identifiable assets acquired and liabilities assumed are adjusted to their full individual fair values at the acquisition date
Depreciable Asset Transfers - Additional Issues
-Downstream sales are assumed to have no effect on any noncontrolling interest values. The parent rather than the sub made the sale -the impact on net income created by upstream sales must be considered in computing the balances attributed to these outside owners -many acceptable alternatives exist for assignment of income created within a consolidation pricess. The authors chose to assign all income to the original seller
Intra-Entity Beginning Inventory Profit Adjustment - Downstream Sales When Parent Uses Equity Method
-Entry TI and Entry G are standard, regardless of the circumstances -Entry *G differs IF: 1. the original transfer is downstream AND 2. the parent applies the equity method for internal accounting purposes THEN: -Investment in Sub account replaces parent's beginning Retained Earnings in consolidation entry *G
Intra-Entity Beginning Inventory Profit Adjustment - Downstream Transfers (Entry *G)
-Using the equity method for internal reporting, the parent: 1. Recognizes beginning inventory gross profits 2. Defers intra-entity ending inventory gross profits -Debiting the Investment account allows parent's net income and retained earnings to appropriately reflect consolidated balances -Journal Entry: Debit: Investment in Sub Credit: COGS (beginning inventory component) -to recognize previously deferred intra-entity downstream inventory gross profit as part of current-year net income when the parent uses the equity method
Control Achieved in Steps - Acquisition Method
-a step acquisition occurs when control is achieved in a series of equity acquisitions -the acquisition method measures the acquired firm (including the noncontrolling interest) at fair value at the date control is obtained -the parent utilizes a single uniform valuation basis for all subsidiary assets acquired and liabilities assumed - fair value at the date control is obtained
Intra-Entity Transactions
-companies that make up a business combination frequently retain their legal identities as separate operating centers and maintain their own record-keeping -inventory sales between the companies must be recorded. the seller records revenue, and the buyer enters the purchase into its accounts -for internal reporting purposes, recording an inventory transfer as a sale/purchase provides vital data to help measure the operational efficiency of each enterprise
Noncontrolling Interest and Consolidations
-consolidation is substantially unchanged with the presence of a noncontrolling interest -parent company must determine and enter each of these figures when constructing a wkst: noncontrolling interest in sub at beginning of current year, net income attributable to noncontrolling interest, sub dividends attributable to noncontrolling interest, noncontrolling interest as of the end of the year (combo of three listed before this)
Sales and Purchases - Intra-Entity Entry TI (transfer inventory)
-cost of goods sold is reduced under the assumption that the Purchases account usually is closed out prior to the consolidation process -total recorded (intra-entity) sales is deleted regardless of whether the transfer was downstream (parent to sub) or upstream (sub to parent) Debit: Sales ($80,000) Credit: COGS ($80,000)
Intra-Entity Transactions - Depreciable Asset Transfers (Entry ED)
-deferred intra-entity profits on depreciable asset transfers are achieved on the consolidated worksheet through a credit to depreciation expense -Entry ED eliminates overstatement of depreciation expense caused by the inflated price -Journal Entry: -Debit: Accumulated Depreciation -Credit: Depreciation Expense
Intra-Entity Transactions - Upstream Inventory Transfers (Entry S)
-entry S eliminates a portion of the parent's investment account and provides the initial noncontrolling interest balance -the entry removes stockholders' equity accounts of the subsidiary as of the beginning of the current year Journal Entry: -Debit: common stock - sub (150,000), Retained Earnings - sub (306,000) -Credit: Investment in Sub (364,800), Noncontrolling interest (91,200)
Intra-Entity Transactions (consolidated perspective)
-from a consolidated perspective, an intra-entity transfer is the internal movement of inventory that creates no net change in the financial position of the business combination taken as a whole -in producing consolidated financial statements, transfers are eliminated -consolidated statements reflect only transactions with outside parties -the entire impact of the intra-entity transfer must be identified and then removed
Intra-Entity Gross Profit - Entry G (when all inventory remains at year-end)
-if all transferred inventory is retained by the business combination at year-end, Entry G eliminates the effects of the seller's gross profit that is unrealized in the buyer's ending inventory in Year 1 -Journal Entry: Debit: Cost of Goods Sold ($30,000) Credit: Inventory ($30,000) -to remove gross profit in ending inventory created by intra-entity sales
Noncontrolling Interest Additional Issues
-if noncontrolling interest's share of sub's fair value exceeds its total fair value, the excess reduces goodwill recognized by the parent -if total fair value of acquired firm is less than the collective sum of its identifiable net assets: a bargain purchase occurs, parent recognizes the entire gain in current income, no gain is ever allocated to noncontrolling interest, if price per share paid by parent equals noncontrolling interest per share fair value then goodwill is recognized proportionately accross the two ownership groups
Parent Company Sales of Subsidiary Stock - Less Than Entire Investment
-if the former parent retains any of its former sub's shares, the investment should be remeasured to fair value on the date control is lost -any resulting gain or loss from the remeasurement should be recognized in the parent's net income -if it sells less than the entire investment, parent must select a cost-flow assumption if it has made more than one purchase -for securities, the use of specific identification based on serial numbers is acceptable, although averaging or FIFO assumptions are often applied
Recognizing the Effect on Noncontrolling Interest - Land Transfers
-if the original sale was a DOWNSTREAM transaction, it has no effect on the noncontrolling interest -if the transfer is made UPSTREAM, it is attributed to the sub and the noncontrolling interest -all noncontrolling interest balances are computed on the reported earnings of the sub after adjustment for any upstream transfers
Postacquisition Control Achieved in Steps
-if the parent previously held a noncontrolling interest in the acquired firm, the parent remeasures its interest to fair value and recognizes a gain or loss -if after obtaining control, the parent increases its ownership interest in the subsidiary, no further remeasurement takes place -the parent account for additional subsidiary shares acquired as an equity transaction - consistent with transactions with other owners, as opposed to outsiders
Partial Equity Method
-if the parent used the partial equity method to account for the subsidiary after acquisition, Entry *C is used to convert to the equity method -in this case, only the amortization expense for the prior years must be included -under the partial equity method, the parent accrues its share of reported subsidiary income, but it does not recognize any acquisition-date excess fair value amortization expenses
Years Following Downstream Intra-Entity Depreciable Asset Transfers
-if the transfer is downstream and the parent uses the equity method, then their RE balance has already been reduced for the gain, and we adjust the Investment account instead
Effects of Using Initial Value Method
-ignores two accrual-based adjustments: 1. Parent does not accrue the percentage of subsidiary net income earned in past years in excess of dividends 2. Parent does not record amortization expense under the initial value method - Entry *C is added to the wkst to convert the previously recorded balances to the equity method
Depreciable Asset Transfers - Year of Transfer (Entry TA)
-in the year of transfer, consolidation entries TA and ED are applicable with both upstream and downstream transfers -Entry TA removes intra-entity gain and returns equipment accounts to balances based on original historical cost -Journal Entry: -Debit: Gain on Sale of Equipment AND Equipment -Credit: Accumulated Depreciation
Consolidated Net Income
-includes 100% of both the parent and sub's net income, adjusted for excess acquisition-date fair value over book value amortizations -once CNI is determined, it is allocated to the parent company and the noncontrolling interests -noncontrolling interests' ownership pertains only to sub; its share of CNI is limited to a share of the adjusted sub's net income
Partial Ownership Consolidations-Acquisition Method
-incorporates 100% of the sub's assets and liabilities at their acquisition-date fair values in the consolidated financial statements -following acquisition, changes in current fair values for assets and liabilities are not recognized -subsidiary assets acquired and liabilities assumed are reflected in future consolidated financial statements using acquisition-date fair values net of subsequent amortizations (or reduced for impairment)
Intra-Entity Transactions - Depreciable Asset Transfers the Following Year (Entries *TA and ED)
-make table to figure out numbers -Journal Entries: *TA: -Debit: Equipment AND Retained Earnings 1/1/21 (seller) -Credit: Accumulated Depreciation -to return the Equipment account to original historical cost and adjust the 1/1/21 balance of RE and Acc Depr ED: -Debit: Accumulated Depreciation -Credit: Depreciation Expense -to remove excess depreciation expense on the intra-entity transfer price and adjust Acc Depr to its 12/31/21 consolidated balance
Noncontrolling Interest in a Subsidiary
-most parent companies have 100% ownership of their subsidiaries, some establish control with lesser amount of stock - this is called noncontrolling interest
Consolidated Financial Reporting in the Presence of a Noncontrolling Interest
-parent with controlling interest must consolidate 100 % of sub's financial information as a single economic unit -acquisition method requires that the sub be valued at the acquisition-date fair value -total acquired firm fair value in a partial acquisition is the sum of two components at acquisition date: fair value of the controlling interest and fair value of the noncontrolling interest
Consolidated Financial Statements - Statement of Changes in Owner's Equity
-provides details of ownership changes for the year for controlling and noncontrolling interest shareholders -noncontrolling interest in sub's equity is placed in the consolidated owner's equity section -if appropriate, each component of other comprehensive income is allocated to controlling and noncontrolling interests -provides an allocation of accumulated other comprehensive income elements across the controlling and noncontrolling interests
Intra-Entity Gross Profit (w/ example)
-removal of the sale/purchase is often just the first in a series of consolidation entries necessitated by inventory transfers -Example: Assume that Arlington acquired or produced this inventory at a cost of $50,000 and sold it to Zirkin at the indicated $80,000 price -From a consolidated perspective, the inventory still has a historical cost of only $50,000 -Zirkin's records reflect the inventory at the $80,000 transfer price -Because of the markup, Arlington's records show a $30,000 gross profit from the intra-entity sale -Because the transaction did not occur with an outside party, recognition of profit is not appropriate for the combinations as a whole -Despite Entry TI, ending inventory is inflated by $30,000 causing COGS to be too low and profits to be too high -For consolidation purposes, the expense is increased by this amount through a worksheet adjustment that properly removes the unrealized gross profit from consolidated net income
Intra-Entity Transactions - Land Transfers (Entry *GL)
-the effects of the original transactions remain in the financial records of the individual companies for as long as the property is held -the gain recorded by Hastings carries through to Retained Earnings while Patrick's Land account retains the inflated transfer price -for every subsequent consolidation until the land is eventually sold, the elimination process must be repeated Journal Entry: -Debit: Retained Earnings (beginning balance of seller) (40,000) -Credit: Land (40,000) -to eliminate effects of intra-entity transfer of land made in a previous year
Intra-Entity Transactions - Depreciable Asset Transfers in the Years Following the Transfer
-the intra-entity gain and excess depreciation expense remain on the separate books and are closed into RE of the respective companies at year-end -Equipment is carried on the individual books at a different amount than on the consolidated books -the amounts change each year as depreciation is computed. For every subsequent period, separately reported figures must be adjusted on the worksheet to present the consolidated totals from a single entity's perspective
Intra-Entity Gross Profit - Entry *G
-the overstatement is removed from beginning inventory in the financial statements with Entry *G. The asterisk indicated that a previous year transfer created the intra-entity gross profits -Buyer's Cost of Goods Sold and the seller's Retained Earnings accounts as of the beginning of Year 2 contain intra-entity profit and must both be reduced in Entry *G -Journal Entry: Debit: Retained Earnings (beginning balance of seller) ($7,500) Credit: COGS (beginning inventory component) ($7,500) -to remove from retained earnings the gross profit in beginning inventory and to currently recognize the profit through a reduction in cost of goods sold
Eliminating Intra-Entity Gains - Land Transfers Downstream and Upstream
-the reduction in Retained Earnings is changed to an increase in the Investment in Sub account when the original sale is downstream and the parent has applied the equity method -in that situation, equity method adjustments have already corrected the timing of the parent's intra-entity gain, which has created a reduction in the Investment account that is appropriately allocated to the sub's Land account on the wkst -Conversely, if sales were upstream, the Retained Earnings of the seller (the sub) continue to be overstated even if the parent applies the equity method
Allocating Acquired Goodwill to the Controlling and Noncontrolling Interests
-to report ownership equity in consolidated financial statements, acquisition-date goodwill is apportioned across controlling and noncontrolling interests -parent first allocates goodwill to its controlling interest for the excess of the fair value of its equity interest over its share of the fair value of net assets
Intra-Entity Gross Profit - Entry G (when portion of inventory remains at year-end)
-transferred inventory held at year-end is recorded in separate statements at more than historical cost -example: with a gross profit rate of 37.5% (30,000 gross profit / 80,000 transfer price), retained inventory is stated at $7,500 (20,000 x 37.5%) more than its original cost -ending inventory intra-entity gross profit elimination (entry G) is based on the amount of transferred merchandise retained by the business at year-end -Journal Entry: Debit: COGS ($7,500) Credit: Inventory ($7,500) -to defer the intra-entity gross profit in ending inventory in year of transfer
Intra-Entity Transactions - Upstream Inventory Transfers
-upstream gross profits are attributed to the subsidiary (bottom) not the parent (top) -because the intra-entity sales are upstream, the $4000 beginning intra-entity gross profit (Entry *G) deferral no longer involves a debit to the parent's Investment in Bottom account
Net Income Attributable to the Noncontrolling Interest
-when intra-entity transfers are downstream, deferred intra-entity gross profits relate solely to the parent company and have no effect on the subsidiary or outside ownership -the noncontrolling interest's share of consolidated net income is unaffected by the downstream intra-entity profit deferral and subsequent recognition
Eliminating Intra-Entity Gains - Land Transfers (Entry *GL Sale to Outside Party)
-when the company eventually sells the land to an outsider, it must recognize the gain deferred at the time of the original transfer -on the worksheet, the gain is removed one last time from beginning Retained Earnings (or the investment account, if applicable). In this instance, though, the worksheet entry reclassifies the amount as a recognized gain -Journal Entry: -Debit: Retained Earnings (seller) (40,000) -Credit: Gain on Sale of Land (40,000) -to remove intra-entity gain from year of transfer so that total profit can be recognized in the current period when land is sold to an outside party
Conversion to Equity Method from Initial Value (Entry *C)
is used to convert to the equity method so combine: 1. the increase (since acquisition) in the subsidiary's retained earnings during past years (net income less dividends) times the parent's ownership percentage 2. the parent's percentage of total amortization expense for these same past years -entry I removes both intra-entity dividend income and subsidiary dividends to the parent
Parent Company Sales of Subsidiary Stock - Acquisition Method
the accounting effect from selling subsidiary shares depends on whether the parent continues to maintain control after the sale -if the sale results in the loss of control, parent recognizes any resulting gain or loss in CNI -if parent maintains control, it recognizes no gains or losses - the sale is shown in the equity section -the parent records any difference between proceeds of the sale and carrying amount as additional paid-in capital
Midyear Acquisitions
when control of a subsidiary is acquired at a midyear date -new parent must compute the sub's book value as of acquisition date to determine excess total fair value over book value allocations -excess amortization expenses, any equity accrual, and dividend distributions are recognized for a period of less than a year -because only net income earned by the sub after the acquisition date accrues to the new owners, it is appropriate to include only postacquisition revenues and expenses in consolidated totals
Unrealized Gross Profit - Effect on Noncontrolling Interest
According to FASB ASC paragraph 810-10-45-6: -amount of intra-entity profit or loss to be eliminated is not affected by the existence of a noncontrolling interest -complete elimination of the intra-entity profit or loss is consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity -elimination of the intra-entity profit or loss may be allocated proportionately between the parent and noncontrolling interests
Consolidated Accounts Affected by Intra-Entity Inventory Transfers
Accounts affected by intra-entity transactions: -Revenues -Cost of Goods Sold -Net Income Attributable to the Noncontrolling Interest -Retained Earnings at the Beginning of the Year -Inventory -Noncontrolling Interest in Sub at the End of Year
Sales and Purchases - Intra-Entity Example
Arlington Company makes an $80,000 inventory sale to Zirkin Company, an affiliated party within a business combination -both parties record the transfer in their internal records as a normal sale/purchase -in the consolidated financial statements, all intra-entity inventory transfers must be eliminated -a consolidation wkst entry, TI, will remove the resulting balances from the externally reported figures -this removes the gross impact of these sales
Eliminating Intra-Entity Gains - Land Transfers (Entry TL)
Assume that on July 1, 2018, Hastings sold land that originally cost $60,000 to Patrick, a related party, at a $100,000 transfer price -the seller reports a $40,000 gain -the buyer records the land at the $100,000 acquisition price -at the end of this fiscal period, the intra-entity effect of this transaction must be eliminated for consolidation purposes -Journal Entry: Debit: Gain on Sale of Land (40,000) Credit: Land (40,000) -to eliminate effects of intra-entity transfer of land
Years Following Downstream Intra-Entity Depreciable Asset Transfers Example
Assume that: 1. Able is the parent 2. Able has applied the equity method to account for its investment in Baker Entry *TA: -Debit: Equipment (10,000) AND Investment in Baker (27,000) -Credit: Accumulated Depreciation (37,000) Entry ED: -Debit: Accumulated Depreciation (3,000) -Credit: Depreciation Expense (3,000)
Intra-Entity Transactions - Land Transfers
Consolidation procedures for intra-entity land transfers partially parallel those for the events occurring in an intra-entity inventory transfer. The worksheet process must adjust the account balance as a single economic entity. The sequence of events in an intra-entity land sale: 1. The original seller of the land reports a gain, even though the transaction occurred between related parties. The acquiring company capitalizes the inflated transfer price 2. The gain recorded by the seller is closed into retained earnings at the end of the year. As a consolidated entity, the account is artificially increased by a related party. The buyer's Land account and the seller's retained earnings account continue to contain the intra-entity gain 3. The gain on the original transfer is recognized in consolidated net income only when the land is subsequently disposed of to an outside party. Appropriate consolidation techniques must eliminate the intra-entity gain each period until the time of resale.
Deferral and Subsequent Recognition of Intra-Entity Gains - Depreciable Assets
Financial reporting objectives remain unchanged for intra-entity sales of depreciable assets: -defer intra-entity gains -re-establish historical cost balances -recognize appropriate income within the consolidated financial statements -defer gains created by intra-entity transfers until the subsequent use or resale of the asset consummates the original transaction