Consolidation On January 1, 20X1, Sticky Company purchases 70 percent of the common stock of Wicket Corporation for its underlying book value of $420,000. Sticky accounts for its investment in Wicket using the equity method. Information about the two companies as of the date of combination and for the years 20X1 and 20X2 is as follows: Sticky Company Wicket Corporation Common Stock, Jan 1, 20X1 $2,000,000 $350,000 Retained Earnings, Jan 1, 20X1 $750,000 $250,000 20X1: Separate operating income, Sticky: $350,000 Net income, Wicket: $200,000 Dividends: $100,000 $80,000 20X2: Separate operating income, Sticky: $400,000 Net income, Wicket: $250,000 Dividends: $100,000 $80,000 On March 1, 20X1, Sticky buys inventory for $25,000 and resells it to Wicket for $30,000 on April 1, 20X1. Both companies use perpetual inventory systems. Required a. Assume that Wicket sells the inventory to an outside party for $35,000 on November 1, 20X1. Calculate the amounts of gross profit related to the intercorporate transfer for Sticky and Wicket. b. The entry to eliminate the intercompany inventory sale for the consolidation workpaper would include? c. Assume instead that Wicket sells the inventory to an outside party for $35,000 on February 1, 20X2. What are the entries to eliminate the downstream sale of inventory on the consolidation workpaper for 20X1. d. Assuming the facts given in the previous question, in which Wicket does not sell the inventory until February 1, 20X2, what is consolidated net income for the combined entity for 20X1? e. When Wicket sells the inventory on February 1, 20X2 for $35,000 to an outside party, the entry to eliminate the beginning inventory profit on the consolidation workpaper is? f. Sticky Company’s separate realized income for the year ended 20X2 would be? g. If Wicket continues to hold the inventory throughout 20X2 and for subsequent years, the eliminating entry necessary to eliminate the beginning inventory profit each year until the inventory is sold would be?
If they own 70% of it, shouldn’t they consolidate it and not use the equity method ?
Semper: my sentiments exactly.
this reads like homework. the Level 2 material didn’t get this in-depth. urgent indeed.
You will be lucky if someone has a crack at this …
The difference between consolidating the statements and using the equity method has to do with degree of control, not necessarily amount of ownership (granted, I would assume that they have control over the entity being that they own 70%). That being said, I’m not going to give this one a shot yet.
bad question. they own 70% so they must consolidate. also a. Assume that Wicket sells the inventory to an outside party for $35,000 on November 1, 20X1. Calculate the amounts of gross profit related to the intercorporate transfer for Sticky and Wicket. – This makes no sense whatsoever, I’m assuming intercorporate really means inter-company in this case. And if they are selling to an outside party this would not be an inter-company sale.
“bad question. they own 70% so they must consolidate.” I agree that it’s a bad question, but I’m not so certain that one must consolidate with 70% ownership. Consolidation is more about control, not necessarily ownership. Temporary barriers to control may exist (bankruptcy or governmental intervention for example). That being said, I’m not so certain that the equity method is appropriate under those conditions. http://www.fasb.org/pdf/fas160.pdf The following was taken from the above link: “The usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one entity directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. However, there are exceptions to this general rule. A majority-owned entity shall not be consolidated if control does not rest with the majority owner (for instance, if the entity is in legal reorganization or in bankruptcy or operates under foreign exchange restrictions, controls, or other governmentally imposed uncertainties so severe that they cast significant doubt on the parent’s ability to control the entity).”
Even you have control over the sub, parent can still choose either equity or cost method for their own accouting entries. However, the parent must present a separated consolidated financial statement (the third set of the statements) for consolicated company. I do think this is beyond the CFA curriculum though I haven’t go through FSA competely yet.