Question

Pepper Company acquired 80 percent of Salt Company's stock at underlying book value on January 1, 2018. Pepper Company acquired 80 percent of Salt Company's stock at underlying book value on January 1, 2018. At that date, Salt reported common stock outstanding of $1,050,000 and retained earnings of $840,000; the fair value of the noncontrolling interest was equal to 20 percent of the book value of Salt Company. Salt Co. sold equipment to Pepper Co. for a $720,000 on December 31, 2018. Salt Co. had originally purchased the equipment for $800,000 on January 1, 2015, with a useful life of 10 years and no salvage value. At the time of the purchase, Pepper Co. estimated that the equipment still had the same remaining useful life. Both companies use straight-line depreciation. Pepper sold land costing $132,000 to Salt Company on June 28, 2019, for $178,000.

Textbook: Custom edition of Advanced Financial Accounting,12th Edition, Christensen, Cottrell and Budd; Mc-Graw Hill.

Required:

a.) Prepare Pepper's journal entries related to intercompany sale of land and equipment for 2019.

Answer 1

IN THE BOOKS OF PEPPER

JOURNAL ENTRIES FOR INTERCOMPANY SALE OF EQUIPMENT & LAND

Date	Particulars                                                           $               $
28.06.2019	CAsh A/c Dr.                                                   178000         To Unrealised Gain A/c                                            46000         To Land A/c                                                               132000 (Being land sold to subsidiary)
28.06.2019 (Note 1)	Income from Salt Company A/c Dr.                     46000          To Investment in Salt Company A/c    46000 (Being unrealised gain on intersale of land deferred)
31.12.2019 (Note 2)	Depreciation Expense A/c Dr.                             102857        To Accumulated Depreciation A/c                             102857 (Being depreciation charged)
31.12.2019 (Note 3)	Investment in Salt Company A/c Dr.                     22857       To Income from Salt Company A/c                            22857 (Being unrealised income deferred)

Note:- Depreciable Assets's Intercompany Sales:- Equipment

Year 2018

Particulars	Amount($)
Original Cost to Salt Company	800000
Less;-Accumulated Depreciation as on December 2018           Annual Depreciation (800000-0)/10years 80000            No. of Years                                         3years	240000
Book Value as on 31st December 2018	560000
Sale Value to Pepper Company	720000
Unrealised Gain to Salt Company	160000

                     Year 2019:-

Note 1:- Since the sale is downstream transfer (i.e. from parent to subsidiary), all unrealized profit is to be eliminated from controlling interest in consolidated statements.Since in above question, only Pepper's journal entries are asked i.e. standalone statements treatment has been asked, thus no consoldiation entries are required to be passed.

Note2:-The original owner's remaining useful life at the transfer date is not relevant. Here the relevant is acquirer's estimated remaining useful life (if it is differentfrom the original remaining life). In above case also, the company estimates the remaining useful life as same as Salt Company estimates, i.e. remaining useful life = 7 years (10-3=7years).

Depreciation on Equipment (for year 2019) = $720000/7years

                                                              = $102857.14(approx)

                                                              = $102857 (approx)

Note 3:- Pepper Company will record an "EXTRA" depreciation expense, since Pepper Company's annual depreciation is $102857 as calculated above is higher. In simple manner:-

• Step 1:- If Salt Company had kept the equipment, the depreciation would be ($560000/7years) $80000
• Step 2:- Now, Pepper Ltd. is holding the equipment, thus depreciation is ($720000/7years) $102857.
• Step 3:- Thus in year 2019, (and over next 6 years) Pepper reverse 1/7 of the gain deferral, i.e. [$102857-$80000] = $22857. Consequently, over these 7 years company will defer its unrealised gain of $160000($22857*7)