Company A holds 70 percent of the voting shares of Company B.During 2008,Company B sold land with a book value of $125,000 to Company A for $150,000.Company A continues to hold the land at the end of the year.The companies file separate tax returns and are subject to a 40 percent tax rate.Assume that Company A uses the basic equity method in accounting for its investment in Company B.
-Assume the Company A holds the land at the end of 2009.The eliminating entry relating to the intercorporate sale of land to be entered in the consolidation workpaper prepared at the end of 2009 will include a debit to Retained Earnings for:
A)$4,500.
B)$7,500.
C)$15,000.
D)$10,500.

Question

Quizplus · Accepted Answer

The elimination entry is required because Company A purchased land from Company B, which results in a transfer of income from Company B to Company A. Since Company A holds the land at the end of the year, the elimination entry should be made to remove the effects of the intercorporate sale from the consolidated financial statements.

To calculate the elimination entry, we need to determine the tax effect of the intercorporate sale on Company B. The gain on the sale for tax purposes is calculated as the selling price ($150,000) minus the tax basis ($125,000), which equals $25,000. Since Company B is subject to a 40% tax rate, the tax effect is $10,000 ($25,000 x 40%).

The elimination entry will include a debit to Retained Earnings (or Investment in Company B) for the portion of Company A's share of the intercorporate gain that is not yet realized. Since Company A owns 70% of Company B, its share of the gain is $7,000 ($10,000 x 70%). However, Company A has only realized 30% of this gain ($2,100), so the remaining $4,900 ($7,000 - $2,100) should be eliminated. This results in a debit to Retained Earnings for $10,500 ($4,900 / 0.70).

Therefore, the correct answer is D) $10,500.

Company a Holds 70 Percent of the Voting Shares of Company