 Hello and welcome to this session. This is Professor Farnhatt and this session we would look at elimination of unrealized holding gain or loss on intercompany sales of property, plant, and equipment. This is part five of five series. In other words, I have four prior session about this topic. You can see them in the description for the link. This topic is covered in advanced accounting as well as the CPA FAR exam course. If you have not connected with me on LinkedIn, please do so. YouTube is where you would need to subscribe. I have 1500 plus accounting, auditing, finance, and tax lectures. If you like my lectures, please like them, share them, put them in the playlist. If you're benefiting, if you're listening to them, it means other people might benefit as well. So please help me spread the word. Also, I have my website. On my website, I have additional resources and exercises, multiple choice questions, true or false. You have access to the PowerPoint slides notes in over 2000 CPA questions. If you're interested, please check out my website. StudyBuddyPal.co is an artificial intelligence driven StudyBuddy platform that match with a CPA or a CFA candidate. If you'd like to study with others, they'll have users in 85 countries in 2800 cities. What is the prerequisite for this session? If you're interested, there are four prior sessions about elimination of gain and losses on intercompany sales or property. You can see the link in the description. Let's go ahead and dive into this comprehensive example and show you how do we compute that information. On January 2nd, 2013. So make sure we are aware of the dates. P company, parent company sold a piece of equipment to its 80% subsidiary S company. The equipment originally has a cost of 50,000, accumulated depreciation of 20. This means the book value equal to 30,000. That's the book value on the parent company books. 50 minus 20, 50 minus 20. They sold it for 35. But if they sold it for 35, it means they're gonna have a $5,000 gain. And it has a remaining life of five years. Limit use the cost methods. We're gonna use the cost method to record the investments in S company. Calculate the unrealized gain, which we already did from the intercompany sale. Well, the cost has this 50,000, accumulated depreciation is 20. The book value is 30,000. We sold it for 35 minus the book value gives us a gain of 5,000. Now this $5,000 gain, this is an intercompany gain, okay? So we're gonna take this gain and divide it by five and we're gonna be amortizing it over 1,000. You will see how just make a note of this. Now let me show you the journal entry because if you understand the journal entry, what happened at P company and what happened at S company, the subsequent entries will be much, much easier to understand. So first you compute the gain, the unrealized gain is 5,000, the intercompany gain. Now we debit cash of 35,000. I mean, debit cash means the parent company debit cash of 35,000 because they sold the asset for 35,000. They debit accumulated depreciation, 20,000 because they have to remove accumulated depreciation. They credit equipment. They have to remove the equipment for 50,000. So this is the equipment, the $30,000 book value. Then they credit again of 50,000. Now remember this gain is an intercompany gain that will need to be eliminated, okay? Now the S company, S company will debit equipment for the cost 35,000 and they will credit cash 35,000. So notice debit cash 35, credit cash 35, those two would cancel each other out. Now what's left is, what's left is, is the gain we'll have to eliminate. The equipment will have to be restored. So the equipment, this account, which is equipment and accumulated depreciation, we have to restore them. When we prepare the financial statements, we have to restore them as if they are still on the parent company box. So the cash basically eliminate each other. The gain, we have to eliminate the gain. So we'll have to eliminate this account as well. So how do we eliminate the gain? We're gonna debit the gain. We're gonna debit the gain. So let's see what happened to the equipment. So that's easy. We're gonna debit the gain because we credit the gain. So here's what happened to our equipment. Our equipment's supposed to be $50,000. That's the account. That's the original cost. We credited the equipment 50,000. Then we debited the equipment. No, no, no, we credited the equipment 50,000. Then we debited the equipment 35. Okay, now what happened? We need to restore it back to 50. To restore it back to 50, we have to add 15,000. See this? Now, let's talk about accumulated depreciation. Accumulated depreciation, it should be at 20,000. We started at 20,000. Then we removed it. We debited at 20,000. Well, guess what? We have to restore it. Therefore, we have to, let me change the front color. It's in orange. We have to go back and credit 20,000. So to restore everything, we're gonna have to credit accumulated depreciation. We're gonna have to debit equipment. And we're gonna have to debit gain. So let's take a look at the, to eliminate the intercompany. We're gonna have to debit the gain. I already told you this. We're gonna have to debit the equipment. I already told you this. And we're gonna have to credit accumulated depreciation. Now, we have to understand that this entry, let me change my color here. This entry here, this entry here would repeat itself every year. So every year we have to, when we prepare the consolidated financial statements, we have to go back to the original number. And every time we have to debit the equipment, credit accumulated depreciation. Now, can we keep on debiting gains? Now, gain will be closed. By the end of 2013, this account will be gone. Therefore, in future years, since we are using the cost method, we're gonna be debiting beginning, retained earnings, parent company. So this account in 2014, 2015, 2016, and 2017, it will be this entry. Okay, we'll see it in a moment once we do so. So this is to eliminate the intercompany sale and restate the equipment and accumulated depreciation the year it was sold. And in that year, you would have gain. Now, also remember, when we depreciate this asset, remember, when we depreciate this asset, we have to assume that we are still depreciating the asset based on the old value. What does that mean? Let's go back here. The old value, the old value, the old value is 50,000. 20,000 was, was depreciated already. So the book value was 30. Now, when this company transferred from, when this company transferred from the parent company that subsidiary, it was inflated by 5,000. Okay, it was inflated by 5,000. Now, when we depreciate this asset on the, on the assets company books, well, we're gonna have 5,000 in aggregate of extra depreciation. We're gonna do this over five years. Therefore, every year we're gonna have an extra $1,000 in depreciation on assets books. What does that mean? It means every year we have to reduce depreciation expense and reduce accumulated depreciation by 1,000. This way we depreciate the asset as if it was still at 30,000. So let's take a look at this entry. So, so this is the entry to basically book the proper consolidated depreciation. Once again, when the asset is being depreciated on the subsidiary's books, we're adding an extra 1,000. Why? Because we increase its cost by 10,000 and we can't do, and we can't do so. We have to assume that the asset still with the parent company. Therefore, we credit depreciation expense, debit accumulated depreciation. So basically reduce accumulated depreciation, reduce depreciation expense. And obviously this entry will appear with us every year except that accumulated depreciation will have to be added $1,000 every year because it's gonna accumulate. And we'll see that in a moment. So this is for 2013. So they want us to eliminate the unrealized gain or loss from prior year intercompany sale and to restate the equivalent accumulated depreciation between 2014 and 2017, the next four years, we're gonna have to debit equipment. Same concept, because those are intercompany transaction. Credit accumulated depreciation, okay? Now, what's gonna be different in the year other than the sale year, what's gonna be different is gain. We don't have the gain anymore. So going forward, we're gonna debit beginning retained earning parent company to reduce the gain on the consolidated by $5,000 because we don't have gain, gain gets closed. So this is what happened to eliminate the entries. Now, every year we also have to repeat, not to repeat, we have to eliminate that $1,000 of accumulated depreciation. So we did it in year one. In year two, we're gonna debit accumulated depreciation, not $1,000. We're gonna debit accumulated depreciation, $2,000. You might be saying, why? Well, because for this year, we have to remove $1,000, for this year, $1,000, and we have to remove another $1,000 from the prior year. So this $1,000, this $1,000 is basically this $1,000, oops, yeah, this $1,000, this $1,000, or, sorry, this $1,000, this $1,000, okay? The year one $1,000. Now in year 2015, which is the third year, we're gonna have to eliminate 3,000 of accumulated depreciation, 1,000 for the current year, and 2,000 from the prior year. In 2016, we're gonna have 4,000 of accumulated depreciation, 1,000 for the current year, and 3,000 from year one, year two, and year three, and year five, we're gonna have $5,000, and that's gonna be 1,000 for the current year, and 4,000 for the other four years. Okay, so this is, those are the entries. Now, assume that P limit, P bought the equipment above, from S, assume it's the opposite. If it's the opposite, I'm sure you can flip the entries, we have the gain, we have the loss, so on and so forth. But what they want us to do is prepare the elimination entry to adjust the depreciation expense for year 2017. So for year 2017, this is what they're asking, but that's assuming now, assuming the asset is on the P company, the parent company, year when they were assuming P bought the asset, not P sold the asset. Well, if P bought the asset, well, same thing, we're gonna have a gain of 5,000 and accumulated depreciation, therefore, we have to have an accumulated depreciation 5,000, of which will be 1,000 for depreciation expense, and the remaining 4,000 will be two, beginning retained earning 80% and non-controlling interest 20%. Remember, now we are looking at it as if P company bought it, P purchased. Okay, the P company purchased the asset. Therefore, the remaining 4,000 will have to be split between P retained earning, because we own, remember, we only own 80% or 20% non-controlling interest. So that's what we have to do. And obviously in the prior year in 2016, we'll have 4,000 of which 1,000, then we have to split the 3,000, the remaining 3,080%, 20%, beginning retained earning and non-controlling interest. In the prior session, I do have a complete example like that. If you're interested, you can go ahead and look at it. Now, use the information. Now, assume P uses the complete equity method and its account for its investment. Now, go back where P uses the equity method rather than for its investment. You know, we're gonna be using the only difference between this and number one, we use the cost method and we're gonna be using the equity method. Slight differences, but pararo, parado, I'm sure you can follow. So we're gonna debit equipment. Once again, we're gonna restore the equipment, 15,000. Now, we're gonna debit investment in S company, 5,000, not gain. And we're gonna credit accumulated depreciation of 20,000. Why investment in S company? Because the gain increases the investment. The gain increases the investment account. Therefore, we reduce the, we have to debit the investment account, basically. Simply put, rather than the gain, we're gonna debit the investment account. We're gonna debit the investment account. So this is the entry. Now, for the depreciation, it's practically the same year after year, except rather than beginning retained earnings, rather than beginning retained earnings, P company, we will credit investment in S and this will process repeat itself. So the first two entries are the same. You have to fix depreciation. Then the third one, since we're using the equity method, the adjustment go into the investment rather than beginning retained earnings. Same thing, same exact thing, except it goes into the investment. So this is doing the same thing as prop as the first exercise, as the first requirement, except we're using the equity, the complete equity method. Use the information, assume that S company, the subsidiary, sell the equipment for 20,000 to a third party. Now we're gonna be selling it to a third party after it has owned the equipment for three years. Now we own the equipment three years, we sold it for 20,000. When we sell an asset, the first thing we have to find out is our book value. To find the book value, we have to find out how much accumulated depreciation we have. So we have the asset on our books, it has a $35,000 cost. We're gonna depreciate the asset over five years. So we're taking 7,000 per year and we had this asset for three years because by the third year we sold it. So 21,000 of accumulated depreciation was taking. We purchased the asset for 35 minus 21. We'll give us a book value of 14. We sold the asset for 20. We have a gain S company for 6,000. This is the gain for the S company. Now we're gonna compute, this is the gain for the S company. Now they want us to compute the consolidated gain or loss, the consolidated gain or loss for everything. Well, same thing. We have to go back and say, what was the record if the asset were kept at the company? What would have been accumulated depreciation? Well, when we sold the asset from P to S, we had depreciation of 20,000. This is the original parent company depreciation. Then the subsidiary depreciated the asset for 21,000. But remember, every year we were reducing depreciation by three because we were over depreciating. Therefore, if the asset being kept on the parent books alone, they would have depreciation of 38. Now, the entity cost is 50. The total accumulated depreciation is 38. Book value is 12. We sold it for 20. Book value is 12. We have a gain of 8,000. Now notice, the consolidated has a gain of eight. The subsidiary only has a gain of six. So, remember, we are kind of in a short week, in a sense, we are short of $2,000 of gains between the two. Now, the last thing is prepare the appropriate, eliminating entry as of December 31st, 2015. So the third year, because 2013, 2014, 2015, assuming that the asset has been depreciated for the year. So we're gonna assume that the asset has been depreciated for 2013, 2014, and 2015. Remember, every year, we were taking out 3,000 of unrealized gain. Now, we sold it to a third party. So remember, we had 5,000 of gains. Every year, kind of we did not count 3,000. We backed them out from the consolidated because they were intercompany gain. But once we sold it to a third party, three minus, five minus three equal to two, we still have 2,000 of unrealized gain. Once we sell it to a third party, guess what, now we can realize the gain. So we're gonna debit credit gain and debit the beginning retained earning to the company to realize the gain that we were basically unrealized. Now, we can realize it. Why can we realize it? Because we sold the asset to a third party. We sold the asset to a third party. Now that gain is not legitimate. It's recognizable because it's not intercompany gain. It's an arm length gain. It's a gain with a third party. I hope this exercise helped you understand this topic, which is not an easy topic to tackle. Obviously, this is a CPA exam. 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