EXERCISE 5-1

It is desirable to refinance for two reasons. First, interest rates are down, and it would be wise to
lock in at the lower rate. Second, the parent firm can borrow funds at a lower interest rate. The
simplest way to accomplish the refinancing is to have the parent incur the new debt and loan the
proceeds to the subsidiary; the subsidiary would use the funds to retire its debt with a gain on
retirement being recognized that would flow to the consolidated statements. The parent would
not only enjoy a lower interest rate, but it could also structure the loan terms, including the
maturity date, to meet its needs. The parent could decide what rate to charge Mercer Industries.
The rate charged would affect the reported income of Mercer Industries and thus, impact the
distribution of income between the noncontrolling and controlling interests. The intercompany
debt would be eliminated in the preparation of consolidated statements.
Model could incur new debt and use the proceeds to purchase Mercer Industries outstanding
bonds. The bonds would remain as debt on the separate statements of Mercer Industries. The
bonds would also appear as an investment on the books of Model. The intercompany bonds,
however, would be eliminated in the consolidated statements. The consolidated income
statement would show a gain on retirement in the year of the intercompany purchase. The NCI
would share in the gain, but this would be offset by interest adjustments in future periods.
EXERCISE 5-2
(a) (1) The consolidated income statement for 2017 will include a gain on retirement of the
bonds of $25,000 ($975,000 paid for $1,000,000 debt). The interest expense of $80,000
will be eliminated as will the interest revenue of $84,000 ($80,000 nominal + $4,000
discount amortization) recorded by the parent.
(2) The subsidiary income distribution schedule will get the benefit of the retirement gain of
$25,000 in the year the bonds are purchased, but subsidiary income will be reduced
each year for the amortization of the purchase discount recorded by the parent
($3,125). The net effect for 2017 is $21,875. The NCI would receive 20% of this
increase. The balance flows to the controlling interest.
(b) (1) The consolidated income statement includes nothing relative to the bonds. From a
consolidated viewpoint, the bonds were retired in the prior period. The interest expense
recorded by the subsidiary and the interest revenue recorded by the parent are
eliminated.
(2) The income distribution of the subsidiary is reduced by $3,125 for the amortization of
the purchase discount recorded by the parent. In the end, this adjustment is shared
20% by the NCI and 80% by the controlling interest.

Ch. 5Problems
52

EXERCISE 5-7
(1) 2015 entries for Grande Machinery Company:
Machine.........................................................................................
Cash..........................................................................................

60,000
60,000

Asset Under Operating Lease........................................................

Machine.....................................................................................

60,000

Depreciation Expense....................................................................
Accumulated DepreciationAsset Under
Operating Lease ($60,000 5 years).....................................

12,000

Cash..............................................................................................
Rental Revenue.........................................................................

15,000

(2) 2015 entry for Sunshine Engineering Company:

Rent Expense................................................................................
Cash..........................................................................................
(3) 2015 consolidation worksheet eliminations and adjustments:
Machine.........................................................................................
Accumulated DepreciationAsset Under Operating Lease...........
Asset Under Operating Lease...................................................
Accumulated Depreciation.........................................................
Rent Revenue................................................................................
Rent Expense............................................................................
To eliminate the intercompany lease transactions.

60,000

12,000
15,000
15,000
15,000
60,000
12,000
60,000
12,000
15,000
15,000

EXERCISE 5-8
(1)
Lease Payment Amortization Schedule
Date

Payment

January 1, 2015
January 1, 2015
January 1, 2016
January 1, 2017
January 1, 2018
Total

$12,000
12,000
12,000
12,000
$48,000

*Adjusted for rounding.

Interest at 12% on
Previous Balance

$3,459
2,434
1,285*
$7,178

Reduction
of Principal
$12,000
8,541
9,566
10,715
$40,822

Principal
Balance
$40,822
28,822
20,281
10,715
0

Exercise 5-8, Concluded

(2) Eliminations and Adjustments at December 31, 2015:
Interest Revenue (see amortization schedule)...............................
Interest Expense........................................................................
To eliminate intercompany interest revenue and expense.

3,459
3,459

Obligations Under Capital Lease ($40,822 $12,000 first payment)

Interest Payable.............................................................................
Unearned Interest Income [($2,434 + $1,285) or ($7,178 $3,459)]
Minimum Lease Payments Receivable......................................
To eliminate intercompany debt recorded by lessee against
net intercompany receivable of lessor.

28,822
3,459
3,719

Property, Plant, and Equipment......................................................

Accumulated DepreciationAssets Under
Capital Lease ($40,822 5 years)...............................................
Assets Under Capital Lease......................................................
Accumulated DepreciationProperty, Plant, and Equipment....
To reclassify asset under capital lease and related
accumulated depreciation as a productive asset owned
by the consolidated entity.

40,822

36,000

8,164
40,822
8,164

(3) Eliminations and Adjustments at December 31, 2016:

Interest Revenue (see amortization schedule)...............................
Interest Expense........................................................................
To eliminate intercompany interest revenue and expense.

2,434

Obligations Under Capital Lease....................................................

Interest Payable.............................................................................
Unearned Interest Income..............................................................
Minimum Lease Payments Receivable......................................
To eliminate intercompany debt recorded by lessees
against net receivable of lessor.

20,281
2,434
1,285

Property, Plant, and Equipment......................................................

Accumulated DepreciationAssets Under Capital
Lease (2 $8,164).......................................................................
Assets Under Capital Lease......................................................
Accumulated DepreciationProperty, Plant, and Equipment....
To reclassify asset under capital lease and related
accumulated depreciation as a productive asset
owned by the consolidated entity.

40,822

2,434

24,000

16,328
40,822
16,328

Ch. 5Problems
54

PROBLEM 5-1
(1) Bonds Payable...............................................................................
Interest Income ($3,500 + $250 amortization)................................
Investment in Bonds ($48,000 + $250 amortization)..................
Interest Expense........................................................................
Gain on Extinguishment of Debt................................................
(2)

Jones Corporation and Subsidiary Dancer Corporation

Consolidated Income Statement
For Year Ended December 31, 2016
Sales....................................................................................................
Cost of goods sold...............................................................................
Gross profit....................................................................................
Other expenses ($720,000 + $106,000)..............................................
Gain on debt retirement.......................................................................
Consolidated net income.....................................................................

50,000
3,750
48,250
3,500
2,000

$3,040,000
1,405,000
$1,635,000
(826,000)
2,000
$ 811,000

55

Ch. 5Problems

PROBLEM 5-10
Paratec Corporation and Subsidiary Sym Corporation
Worksheet for Consolidated Financial Statements
For Year Ended December 31, 2018

Cash..................................................
Accounts Receivable (net)................
Inventory...........................................
Prepaid Rent on Equipment.............
Investment in Bonds.........................
Investment in Sym Corporation........

Trial Balance
Paratec
Sym
190,000
40,000
738,350
142,000
500,000
75,000
.............
7,000
250,000
65,000
400,000
.............
.............
.............
.............
.............
250,000
85,000
1,950,000
295,000

Eliminations and Adjustments

Dr.
Cr.
.............
.............
.............
.............
.............
.............
.............
(CL1)
7,000
.............
.............
(CV)
160,000
.............
.............
(EL)
510,000
.............
(D)
50,000
.............
.............
(CL2)
120,000
.............

Consolidated
Income
Statement
.............
.............
.............
.............
.............
.............
.............
.............
.............
.............

Land..................................................
Plant and Equipment........................
Accumulated Depreciation
Plant and Equipment.....................
(250,000)
(60,000)
.............
(CL2)
36,000
.............
Equipment Under Operating Lease. .
120,000
.............
.............
(CL2)
120,000
.............
Accumulated Depreciation
Assets Under Operating Lease.....
(36,000)
.............
(CL2)
36,000
.............
.............
Goodwill............................................
.............
.............
(D)
50,000
.............
.............
Accounts Payable.............................
(385,000)
(52,000)
.............
.............
.............
Deferred Rent Revenue....................
(7,000)
.............
(CL1)
7,000
.............
.............
Common Stock (no par)Paratec. . .
(2,000,000)
.............
.............
.............
.............
Retained Earnings, January 1, 2018
Paratec.......................................
(1,076,350)
.............
.............
(CV)
160,000
.............
Common Stock (no par)Sym.........
.............
(200,000)
(EL)
200,000
.............
.............
Retained Earnings, January 1, 2018
Sym............................................
.............
(310,000)
(EL)
310,000
.............
.............
Sales.................................................
(4,720,000)
(500,000)
.............
.............
(5,220,000)
Rental Income...................................
(12,000)
.............
(CL1)
12,000
.............
.............
Cost of Goods Sold...........................
3,068,000
300,000
.............
.............
3,368,000
Rent Expense...................................
.............
12,000
.............
(CL1)
12,000
.............
Other Expenses................................
725,000
101,000
.............
.............
826,000
Dividends Declared...........................
295,000
.............
.............
.............
.............
Total...............................................
0
0
895,000
895,000
.............
Consolidated Net Income.......................................................................................................................................
(1,026,000)
Consolidated Retained Earnings, December 31, 2018..................................................................................................................

Controlling
Retained
Earnings
.............
.............
.............
.............
.............
.............
.............
.............
.............
.............

Consolidated
Balance
Sheet
230,000
880,350
575,000
.............
315,000
.............
.............
.............
335,000
2,365,000

.............
.............

(346,000)
.............

.............
.............
.............
.............
.............

.............
50,000
(437,000)
.............
(2,000,000)

(1,236,350)
.............

.............
.............

.............
.............
.............
.............
.............
.............
295,000
.............
(1,026,000)
(1,967,350)

.............
.............
.............
.............
.............
.............
.............
.............
.............
(1,967,350)

Ch. 5Problems

56

Totals...................................................................................................................................................................................................................

57

Ch. 5Problems

Problem 5-10, Concluded

Eliminations and Adjustments:
(CV)
(EL)
(D)
(CL1)
(CL2)

Convert to equity method as of January 1, 2018, 100% ($310,000 $150,000).

Eliminate the parents investment in the subsidiary and the subsidiary equity accounts.
Establish the goodwill.
Eliminate the prepaid rent, the deferred rent revenue, and the current-year rent
expense and income.
Reclassify the equipment under operating lease and its related accumulated
depreciation to the plant and equipment account and related accumulated
depreciation.
PROBLEM 5-11

Determination and Distribution of Excess Schedule

Company
Implied
Fair Value
$562,500

Fair value of subsidiary.....................

Less book value of interest acquired:
Common stock ($1 par)...............
Paid-in capital in excess of par....
Retained earnings.......................
Total equity............................
Interest acquired.........................
Book value........................................
Excess of fair value over book
value...........................................

$ 10,000
190,000
190,000
$390,000

$172,500

Parent
Price
(80%)
$450,000

NCI
Value
(20%)
$112,500

$390,000
80%
$312,000

$390,000
20%
$ 78,000

$138,000

$ 34,500

Adjustment of identifiable accounts:

Buildings...........................................
Goodwill............................................
Total............................................
Account Adjustments
to Be Amortized
Buildings................................
Total amortizations...........

Adjustment
$100,000
72,500
$172,500

Life
20

Worksheet
Key
debit D1
debit D2

Life
20

Amortization
per Year
$5,000

Annual
Amount

Current
Year

Prior
Years

Total

$5,000
$5,000

$5,000
$5,000

$5,000
$5,000

$10,000
$10,000

Key
(A1)

Ch. 5Problems

58

Problem 5-11, Continued

Intercompany Inventory Profit Deferral
Parent
Parent
Parent
Sub
Amount
Percent
Profit
Amount
Beginning..............................
Ending...................................

0%
0

$10,000
12,000

Sub
Percent
25%
25

Sub
Profit
$2,500
3,000

Subsidiary Simon Company Income Distribution

Ending inventory profit................
Amortization................................

$3,000
5,000

Internally generated net

income.....................................
Beginning inventory profit..............

$40,804
2,500

Adjusted income............................
NCI share......................................
NCI................................................

$35,304

20%
$ 7,061

Parent Press Company Income Distribution

Internally generated net
income..................................... $174,196
80% Simon adjusted income
of $35,304................................
28,243
Controlling interest......................... $202,439

59

Ch. 5Problems

Problem 5-11, Continued

Cash.................................................
Accounts Receivable........................
Inventory...........................................
Land.................................................
Investment in Simon.........................

Minimum Lease Payments

Receivable....................................
Unearned Interest.............................
Buildings ..........................................
Accumulated Depreciation................
Equipment........................................

Press Company and Subsidiary Simon Company

Worksheet for Consolidated Financial Statements
For Year Ended December 31, 2016
Eliminations
Consolidated
Trial Balance
and Adjustments
Income
Press
Simon
Dr.
Cr.
Statement
72,363
73,637
.........
.........
.........
72,000
45,000
.........
(IA)
6,000
.........
120,000
56,000
.........
(EI)
3,000
.........
100,000
100,000
.........
.........
.........
506,643
.........
......... (CY1) 32,643
.........
.........
......... (CY2)
8,000
.........
.........
.........
.........
.........
(EL) 344,000
.........
.........
.........
.........
(D) 138,000
.........

103,452
(17,619)
800,000
(220,000)
150,000
.........
Accumulated Depreciation................ (90,000)
.........
EquipmentCapital Lease...............
.........
Accumulated Depreciation
Capital Lease................................
.........
Goodwill............................................
.........
Accounts Payable............................. (60,000)
Bonds Payable.................................
.........
Discount (Premium)..........................
.........
Obligation Under Capital Lease........
.........
Accrued InterestCapital Lease......
.........
Common Stock ($1 par)Simon......
.........
Paid-In Capital in Excess of Par
Simon........................................
.........
Retained EarningsSimon..............
.........
.........
.........
.........

.........
.........
400,000
(220,000)
100,000
.........
(50,000)
.........
100,000
(18,000)
.........
(40,000)
.........
.........
(76,637)
(9,196)
(10,000)
(190,000)
(230,000)
.........
.........
.........

.........
(CL2) 17,619
(D1) 100,000
.........
.........
(CL3) 100,000
.........
.........
.........

NCI
.........
.........
.........
.........
.........
.........
.........
.........

Controlling
Retained
Earnings
.........
.........
.........
.........
.........
.........
.........
.........

Consolidated
Balance
Sheet
146,000
111,000
173,000
200,000
.........
.........
.........
.........

(CL2) 103,452
.........
.........
(A1) 10,000
.........
.........
.........
(CL3) 18,000
(CL3) 100,000

.........
.........
.........
.........
.........
.........
.........
.........
.........

.........
.........
.........
.........
.........
.........
.........
.........
.........

.........
.........
.........
.........
.........
.........
.........
.........
.........

.........
.........
1,300,000
(450,000)
350,000
.........
.........
(158,000)
.........

18,000
72,500
6,000
.........
.........
76,637
9,196
8,000

.........
.........
.........
.........
.........
.........
.........
.........

.........
.........
.........
.........
.........
.........
.........
.........

.........
.........
.........
.........
.........
.........
.........
(2,000)

.........
.........
.........
.........
.........
.........
.........
.........

.........
72,500
(94,000)
.........
.........
.........
.........
.........

(EL) 152,000
(EL) 184,000
(BI)
500
(A1)
1,000
.........

.........
.........
34,500
.........
.........

.........
.........
.........
.........
.........

(38,000)
.........
.........
.........
(79,000)

.........
.........
.........
.........
.........

.........
.........
.........
.........
.........

(CL3)
(D2)
(IA)
(CL2)
(CL2)
(EL)

(NCI)

Ch. 5Problems

510

Problem 5-11, Continued

Press Company and Subsidiary Simon Company
Worksheet for Consolidated Financial Statements
For Year Ended December 31, 2016
(Concluded)
Eliminations
Consolidated
Controlling
Trial Balance
and Adjustments
Income
Retained
Press
Simon
Dr.
Cr.
Statement
NCI
Earnings
Common Stock ($1 par)Press....... (100,000)
.........
.........
.........
.........
.........
.........
Paid-In Capital in Excess of Par
Press......................................... (800,000)
.........
.........
.........
.........
.........
.........
Retained EarningsPress............... (450,000)
.........
(A1)
4,000
.........
.........
.........
.........
.........
.........
(BI)
2,000
.........
.........
.........
.........
.........
.........
.........
.........
.........
......... (444,000)
Sales................................................ (800,000) (400,000)
(IS)
40,000
......... (1,160,000)
.........
.........
Cost of Goods Sold.......................... 450,000
240,000
.........
(IS)
40,000
.........
.........
.........
.........
.........
(EI)
3,000
(BI)
2,500
650,500
.........
.........
Depreciation ExpenseBuildings.... 30,000
10,000
(A1)
5,000
.........
45,000
.........
.........
Depreciation ExpenseEquipment .
15,000
28,000
.........
.........
.........
.........
.........
.........
.........
.........
.........
43,000
.........
.........
Other Expenses................................ 140,000
72,000
.........
.........
212,000
.........
.........
Interest Expense...............................
.........
9,196
......... (CL1)
9,196
.........
.........
.........
Interest Revenue..............................
(9,196)
......... (CL1)
9,196
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
Subsidiary Income............................ (32,643)
......... (CY1) 32,643
.........
.........
.........
.........
Dividends DeclaredSimon.............
.........
10,000
......... (CY2)
8,000
.........
2,000
.........
Dividends DeclaredPress.............. 20,000
.........
.........
.........
.........
.........
20,000
Totals.............................................
0
0
849,291
849,291
.........
.........
.........
Consolidated Net Income..............................................................................................................
(209,500)
.........
.........
To NCI (see distribution schedule)..............................................................................................
7,061
(7,061)
.........
To Controlling Interest (see distribution schedule)......................................................................
202,439
......... (202,439)
Total NCI...........................................................................................................................................................
(124,061)
.........
Retained EarningsControlling Interest, December 31, 2016.............................................................................................
(626,439)
Totals....................................................................................................................................................................................................

Consolidated
Balance
Sheet
(100,000)
(800,000)
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
.........
(124,061)
(626,439)
0

511
Ch. 5Problems

Problem 5-11, Concluded

Eliminations and Adjustments:
(CY1)
(CY2)
(EL)
(D)/(NCI)
(A)
(IS)
(IA)
(BI)
(EI)
(CL1)
(CL2)
(CL3)

Current-year subsidiary income.

Current-year dividend.
Eliminate controlling interest in subsidiary equity.
Distribute excess.
Amortize excess.
Eliminate intercompany sales during current period.
Eliminate intercompany unpaid trade accounts.
Defer beginning inventory profit.
Defer ending inventory profit.
Intercompany interest on capital lease.
Eliminate obligation under capital lease plus accrued interest against minimum lease
payments receivable and unearned interest.
Reclassify leased asset as owned asset.