Problem 5-8 (LO 2) CPA Objective, equipment, merchandise, bonds.

The problem below is an example of a question of the CPA Other Objective Format type as it was applied to the consolidations area. A mark-sensing answer sheet was used on the exam. You may just supply the answer, which should be accompanied by calculations where appropriate.

Presented below are selected amounts from the separate unconsolidated financial statements of Pero Corporation and its 90%-owned subsidiary Sean Company at December 31, 2016. Additional information follows:

	Pero Corporation	Sean Company
Selected income statement amounts:
Sales	$ 710,000	$ 530,000
Cost of goods sold	490,000	370,000
Gain on the sale of equipment		21,000
Earnings from investment in subsidiary (equity)	63,000
Other expenses	48,000	75,000
Interest expense		16,000
Depreciation	25,000	20,000
Selected balance sheet amounts:
Cash	30,000	18,000
Inventories	229,000	150,000
Equipment	440,000	360,000
Accumulated depreciation	(200,000)	(120,000)
Investment in Sean (equity balance)	211,000
Investment in bonds	(100,000)
Discount on bonds	(9,000)
Bonds payable		(200,000)
Discount on bonds payable		3,000
Common stock	100,000)	(10,000)
Additional paid-in capital in excess of par	(250,000)	(40,000)
Retained earnings	(402,000)	(140,000)
Selected statement of retained earnings amounts:
Beginning balance, December 31, 2015	272,000	100,000
Net income	210,000	70,000
Dividends paid	80,000	30,000

Additional information is as follows:

• 1. On January 2, 2016, Pero purchased 90% of Seans 100,000 outstanding common stock for cash of $175,000. On that date, Seans stockholders equity equaled $150,000, and the fair values of Seans assets and liabilities equaled their carrying amounts. Any remaining excess is considered to be goodwill.
• 2. On September 4, 2016, Sean paid cash dividends of $30,000.
• 3. On December 31, 2016, Pero recorded its equity in Seans earnings.

Required

• 1. Items (a) through (c) on page 311 represent transactions between Pero and Sean during 2016. Determine the dollar amount effect of the consolidating adjustment on 2016 consolidated net income. Ignore income tax considerations.

  Items to be answered:

  • a. On January 3, 2016, Sean sold equipment with an original cost of $30,000 and a carrying value of $21,000 to Pero for $36,000. The equipment had a remaining life of three years and was depreciated using the straight-line method by both companies.
  • b. During 2016, Sean sold merchandise to Pero for $60,000, which included a profit of $20,000. At December 31, 2016, half of this merchandise remained in Peros inventory.
  • c. On December 31, 2016, Pero paid $94,000 to purchase 50% of the outstanding bonds issued by Sean. The bonds mature on December 31, 2022, and were originally issued at a discount. The bonds pay interest annually on December 31, and the interest was paid to the prior investor immediately before Peros purchase of the bonds.
• 2. Items (a) through (l) below refer to accounts that may or may not be included in Peros consolidated financial statements. The list on the right refers to the various possibilities of those amounts to be reported in Peros consolidated financial statements for the year ended December 31, 2016. Consider all transactions stated above in determining your answer. Ignore income tax considerations.

Items to be answered:

Responses to be selected:

a. Cash b. Equipment c. Investment in subsidiary d. Bonds payable e. NCI f. Common stock g. Beginning retained earnings h. Dividends paid i. Gain on retirement of bonds j. Cost of goods sold k. Interest expense l. Depreciation expense

1. Sum of amounts on Peros and Seans separate unconsolidated financial statements. 2. Less than the sum of amounts on Peros and Seans separate unconsolidated financial statements, but not the same as the amount on either. 3. Same as amount for Pero only. 4. Same as amount for Sean only. 5. Eliminated entirely in consolidation. 6. Shown in consolidated financial statements but not in separate unconsolidated financial statements. 7. Neither in consolidated nor in separate unconsolidated financial statements. (AICPA adapted)