CHAPTER SIX

ELIMINATION OF UNREALIZED PROFIT 
ON INTERCOMPANY SALES OF INVENTORY

Updates

The concepts that are introduced and detailed in this chapter are
not affected by the changes brought about by SFAS No. 141 and 142.
However, several of the homework problems are comprehensive in nature
and thus are affected by the elimination of goodwill amortization. The
revised homework problems affected are shown here. The revised
solutions are available in the solutions manual on the Website and are
labeled as 2nd edition solutions.

Problem 6-8 Upstream Eliminating Entries and Consolidated Net

Income

On January 2, 2002, Patten Company purchased a 90% interest in Sterling

Company for $1,400,000. At that time Sterling Company had capital stock
outstanding of $800,000 and retained earnings of $425,000. The
difference between cost and book value was assigned to the following
assets:

Inventory $ 37,500
Plant and equipment (net) 180,000
Excess of cost over fair value 80,000

The inventory was sold in 2002. The plant and equipment had a
remaining useful life of 12 years on January 2, 2002.
During 2002 Sterling sold merchandise with a cost of $950,000 to
Patten at a 20% markup above cost. At December 31, 2002, Patten still
had merchandise in its inventory that it purchased from Sterling for
$576,000.
In 2002, Sterling Company reported net income of $410,000 and
declared no dividends.

Required:

A. Prepare in general journal form all entries necessary on the

consolidated financial statements workpaper to eliminate the effects of
the intercompany sales, to eliminate the investment account, and to
assign the difference between cost and book value.

B. Assume that Patten Company reports net income of $2,000,000 from its
independent operations. Calculate consolidated net income.
C. Calculate noncontrolling interest in combined income.
Problem 6-9 Upstream and Downstream Worksheet

On January 1, 2002, Perry Company purchased 80% of Selby Company for

$990,000. At that time Selby had capital stock outstanding of $350,000
and retained earnings of $375,000.
The fair value of Selby Company's assets and liabilities is equal to their
book value except for the following:

Fair Value Book Value

Inventory $210,000 $160,000
Plant and equipment (10-year life) 780,000 630,000

One-half of the inventory was sold in 2002; the remainder was sold in
2003.
At the end of 2002, Perry Company had in its ending inventory
$60,000 of merchandise it had purchased from Selby Company during the
year. Selby Company sold the merchandise at 25% above cost. During
2003, Perry Company sold merchandise to Selby Company for $310,000
at a markup of 20% of the selling price. At December 31, 2003, Selby still
had merchandise that it purchased from Perry Company for $82,000 in its
inventory.
Financial data for 2003 are presented here:

Perry Selby
Company Company
Sales $1,400,000 $ 800,000
Dividend income 20,000 -------
Total revenue 1,420,000 800,000
Cost of goods sold:
Beginning inventory 230,000 145,000
Purchases 900,000 380,000
Cost of Goods Available 1,130,000 525,000
Less: Ending inventory 450,000 200,000
Cost of goods sold 680,000 325,000
Other expenses 250,000 195,000
Total cost and expense 930,000 520,000
Net Income $ 490,000 $ 280,000

1/1 Retained earnings $1,500,000 $ 480,000

Net income 490,000 280,000
Dividends declared (50,000) (25,000)
12/31 Retained earnings $1,940,000 $ 680,000

Cash $ 95,000 $ 70,000

Accounts receivable (net) 302,000 90,000
Inventory 450,000 200,000
Investment in Selby Company 990,000
Plant and equipment (net) 850,000 582,000
Other assets (net) 390,000 230,000
Total assets $3,077,000 $1,175,000

Accounts payable $ 75,000 $ 30,000

Other liabilities 102,000 60,000
Common stock 960,000 350,000
Retained earnings 1,940,000 735,000
Total liabilities and equity $3,077,000 $1,175,000

Required:

A. Prepare the consolidated statements workpaper for the year ended

December 31, 2003.

B. Calculate consolidated retained earnings on December 31, 2003, using

the analytical or T-account approach.
Problem 6-14 Omit the sentence that states that goodwill should
be amortized over 40 years.

Problem 6-18 Comprehensive Complete Equity Problem, Cost

Greater than Fair Value with Intercompany Sales of Inventory

(Note that this is the same problem as Problem 6-14, but assuming the
use of the complete equity method.) On January 1, 2003, Perry Company
purchased 80% of Selby Company for $960,000. At that time Selby had
capital stock outstanding of $400,000 and retained earnings of $400,000.
The fair value of Selby Company's assets and liabilities is equal to their
book value except for the following:

FAIR VALUE BOOK VALUE

Inventory $ 230,000 $ 155,000
Plant and equipment (10-year life) 800,000 600,000

One-half of the inventory was sold in 2003; the remainder was sold in
2004.
At the end of 2003, Perry Company had in its ending inventory $54,000
of merchandise it had purchased from Selby Company during the year.
Selby Company sold the merchandise at 20% above cost. During 2004,
Perry Company sold merchandise to Selby Company for $300,000 at a
markup of 20% of the selling price. At December 31, 2004, Selby still had
merchandise that it purchased from Perry Company for $78,000 in its
inventory.
Financial data for 2004 are presented here:

PERRY SELBY
COMPANY COMPANY
Sales $ 1,385,000 $ 720,000
Equity in subsidiary income 153,600
Total revenue 1,538,600 720,000
Cost of goods sold:
Beginning inventory 210,000 155,000
Purchases 875,000 360,000
Cost of goods available 1,085,000 515,000
Less: Ending inventory 400,000 225,000
Cost of goods sold 685,000 290,000
Other expenses 225,000 170,000
Total cost and expense 910,000 460,000
Net income $ 628,600 $ 260,000
1/1 Retained earnings 1,417,000 450,000
Net income 628,600 260,000
Dividends declared (40,000) (30,000)
12/31 Retained earnings $ 2,008,100 $ 680,000
Cash $ 90,000 $ 65,000
Accounts receivable 297,000 85,000
Inventory 400,000 225,000
Investment in Selby Company 1,076,400
Plant and equipment (net) 880,000 540,000
Other assets 384,000 230,000
Total assets $ 3,127,400 $1,145,000
Accounts payable 24,300 25,000
Other current liabilities 95,000 40,000
Common stock 1,000,000 400,000
Retained earnings 2,008,100 680,000
Total liabilities and equity $ 3,127,400 $1,145,000

Required:
A. Prepare the consolidated statements workpaper for the year ended
December 31, 2004.
B. Calculate consolidated retained earnings on December 31, 2004, using
the analytical approach or T-account approach.
C. If you completed Problem 6-14, compare the consolidated balances
obtained in part (A) with those obtained in that problem.