McKnight Inc. owns 80% of Horse Co.’s common stock. On January 2, 2011, McKnight Inc. sold
Horse Co. some equipment for $640,000. The equipment had a carrying amount of $400,000. At the
acquisition date, the equipment has a remaining useful life of 8 years. Horse Co. uses the straight-
line method. The net adjustments to calculate 2011 and 2012
consolidated net income
would be an
increase (decrease) of
In 2011, the consolidated entity has a gain of $240,000 to eliminate. In addition, while
McKnight’s depreciation expense is now $80,000 ($640,000 ÷ 8 years), it would have only
been $50,000 ($400,000 ÷ 8 years) if the transfer had not taken place. Therefore, we also have
to eliminate $30,000 in depreciation expense in 2011. If we eliminate a gain of $240,000
(Consolidation Entry TA) and we eliminate the excess depreciation (Consolidation Entry ED),
the net income effect would be to reduce consolidated net income by $210,000.
In 2012, the original gain is still on the seller’s records, but it is now in Retained Earnings.
Therefore the original gain should be removed from retained earnings, and there is no income
effect related to the original gain. In addition, last year’s excess depreciation is removed with
Consolidation Entry *TA. Finally, there is still the need to remove the excess depreciation for
this year. Consolidation Entry ED is repeated to eliminate the excess depreciation. The net
effect on income in 2012 is an increase of $30,000.