Question

Big Co. owns 60% of Little Co common stock. On 1/1/23 Big Co sold a patent to Little Co for $32,000. The patent had a book value of $20,000 on that date, with a 4 year remaining useful life.

On 5/1/26 Little sells the patent to a third party for $20,000.

Little Co reports earnings of $50,000 each year.

Big uses the FULL equity method to account for their investment in Little.

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Question 11 pts

How much was the unrealized gain or loss on the sale? ("xx,xxx gain" or "xx,xxx loss")

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Question 21 pts

How much unrealized gain or loss is carried forward to 2024? (xx,xxx)

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Question 31 pts

What is the "income to the NC Interest" in 2023? ("trick" question, sort of. Remember, was this an upstream sale or a downstream sale?)

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Question 41 pts

In 2026 the patent is sold to some third party. In the elimination entries related to this intercompany sale, what account                            [ Select ]                       ["Gain on sale", "Retained earnings", "Non-controlling interest", "Investment in Little", "Investment income"]         would be credited, for what amount                            [ Select ]                       ["4,000", "1,000", "3,000", "2,000"]         .

Answer 1

In the given case, the patent is in Little Co's balance sheet at year end i.e.12.31.2023. Big Co (Parent entity) should eliminate 100% of the unrealised profit on consolidation.

Below are the answers for the given questions:

Question 11 - How much was the unrealized gain or loss on the sale? ("xx,xxx gain" or "xx,xxx loss")

Answer 11- Unrealised gain on the sale which needs to be eliminated fully from the consolidated income statement is ( (Sale value - Book value= $32,000-$20,000= $12,000)). Group profit to be reduced by $ 12,000.

Question 12 - How much unrealized gain or loss is carried forward to 2024? (xx,xxx)

Answer 12 - In the previous question, we computed the unrealised gain on sale to be eliminated which is $ 12,000. In addition to this difference in depreciation expenses is also to be eliminated ( to eliminate the overstatement of depreciation expense caused by inflated transfer price) which is computed below:

a) Depreciation on carrying value in the books of Big Co is = $20,000/4= $5,000

b) Depreciation on carrying value in the books of Little Co is = $32,000/4= $8,000

Net unrealised gain to be carried forward is ( Unrealised gain on sale - Difference in depreciation expenses) = $12,000-$3,000 = $9,000

Question 31 - What is the "income to the NC Interest" in 2023?

Answer 31 - In the given case, since it is parent company (Big Co.) that has made the sale (downstream sale), the reduction in unrealised gain of $8,000 is entirely allocated to the parent company. It is also given in the question that Little Co. reports the earning of $50,000 each year and 40 % of Little Co. Common Stock which represents NCI. Income to NCI in 2023 is 40% of $50,000 i.e. 20,000.

Question 41 - In 2026 the patent is sold to some third party. In the elimination entries related to this intercompany sale, what account                            [ Select ]                       ["Gain on sale", "Retained earnings", "Non-controlling interest", "Investment in Little", "Investment income"]         would be credited, for what amount                            [ Select ]                       ["4,000", "1,000", "3,000", "2,000"]

Answer 41 - Impact on retained earnings as on 12.31.2023 (a) - $9,000 (Check Answer 12)

During 2024, impact due to excess depreciation (b) - $3,000

Impact on retained earnings as on 12.31.2024 (c= a-b) - $ 6,000

During 2025, impact due to excess depreciation (d) - $3,000

Impact on retained earnings as on 12.31.2025 (e= d-c) - $ 3,000

On 5/1/2026 asset has been sold to Third party i.e.after 4 months. the impact of excess depreciation upto 5/1/2026 is ($3,000*4/12= $1,000). As the asset is sold to third party by Little Co. the debit balance in retained earnings after all adjustments (excess depreciation) will be credited as defined below.

On the basis of above computation, the elimination entry related to this intercompany sale - Account of Retained earnings will be credited with the amount of $ 2,000 ($3,000 -$1,000).