A is corrent. When computing consolidated income, the objective is to restate the accounts as if the intercompany transactions had not occurred. In year 2, the gain on the sale of the equipment ($40,000 – $30,000 = $10,000) must be eliminated, since the consolidated entity has not realized any gain. Also in year 2, some depreciation expense must be eliminated because the subsidiary computed depreciation based on a cost of $40,000 rather than on the original carrying amount of $30,000. Additional depreciation of $2,000 [($40,000 – $30,000) / 5] must be eliminated. Therefore, year 2 consolidated income must be adjusted downward by $8,000 ($10,000 – $2,000). Year 3 consolidated income must also be adjusted for the additional depreciation, so it must be adjusted upward by $2,000.
C is incorrect. When computing consolidated income, the objective is to restate the accounts as if the intercompany transactions had not occurred. In year 2, the gain on the sale of the equipment ($40,000 – $30,000 = $10,000) must be eliminated, since the consolidated entity has not realized any gain. Also in year 2, some depreciation expense must be eliminated because the subsidiary computed depreciation based on a cost of $40,000 rather than on the original carrying amount of $30,000. Additional depreciation of $2,000 [($40,000 – $30,000) / 5] must be eliminated. Therefore, year 2 consolidated income must be adjusted downward by $8,000 ($10,000 – $2,000). Year 3 consolidated income must also be adjusted for the additional depreciation, so it must be adjusted upward by $2,000.
B is incorrect. When computing consolidated income, the objective is to restate the accounts as if the intercompany transactions had not occurred. In year 2, the gain on the sale of the equipment ($40,000 – $30,000 = $10,000) must be eliminated, since the consolidated entity has not realized any gain. Also in year 2, some depreciation expense must be eliminated because the subsidiary computed depreciation based on a cost of $40,000 rather than on the original carrying amount of $30,000. Additional depreciation of $2,000 [($40,000 – $30,000) / 5] must be eliminated. Therefore, year 2 consolidated income must be adjusted downward by $8,000 ($10,000 – $2,000). Year 3 consolidated income must also be adjusted for the additional depreciation, so it must be adjusted upward by $2,000.
D is incorrect. When computing consolidated income, the objective is to restate the accounts as if the intercompany transactions had not occurred. In year 2, the gain on the sale of the equipment ($40,000 – $30,000 = $10,000) must be eliminated, since the consolidated entity has not realized any gain. Also in year 2, some depreciation expense must be eliminated because the subsidiary computed depreciation based on a cost of $40,000 rather than on the original carrying amount of $30,000. Additional depreciation of $2,000 [($40,000 – $30,000) / 5] must be eliminated. Therefore, year 2 consolidated income must be adjusted downward by $8,000 ($10,000 – $2,000). Year 3 consolidated income must also be adjusted for the additional depreciation, so it must be adjusted upward by $2,000.
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