[cpa1988]

Can anyone explain this to me? Is there another way to arrive at 33 1/3% other than making up a scenario? I do not understand the logic here.

Port, Inc. owns 100% of Salem Inc. On January 1, Year 1, Port sold Salem delivery equipment at a gain. Port had owned the equipment for two years and used a five-year straight-line depreciation rate with no residual value. Salem is using a three-year straight-line depreciation rate with no residual value for the equipment. In the consolidated income statement, Salem’s recorded depreciation expense on the equipment for Year 1 will be decreased by:

a. 50% of the gain on sale.

b. 100% of the gain on sale.

c. 20% of the gain on sale.

d. 33 1/3% of the gain on sale.

Explanation

Choice “d” is correct. Depreciation expense will be decreased by 33 1/3% of the gain on sale, the amount that depreciation expense has been overstated.

Example:

Original purchase price by Port: $ 100

Two years’ depreciation ($100 ÷ 5 = $20 per year × 2) (40)

Net book value at date of sale 60

Sale price to Salem 75

Gain on sale 15

Depreciation expense recorded by Salem ($75 ÷ 3-year life) 25

Consolidated depreciation expense ($100 ÷ 5-year life) 20

Elimination of excess depreciation ($15 gain × 1/3) 5

[leglock]

Port had three yrs of deprec left and salem was going to deprec the asset ovr three yrs. therefore if the equip had not been sold at a price other than book value, post and salem would have had the same deprec expense each year. However bc it was sold at a gain, salem will b depreciating a higher amount than post bc its book value of the asset is higher Hiw much higher? The amount of the gain. So bc salem is deprec ovr three years, that gain which results in higher deprec expense will need to be eliminated from the consolidated stmts otherwise u would have an intrentity transaction that causes a misrepresentstion in essence. So bc salem is deprec ovr three years, the amount of the gain which is sitting in the book value of the equip on salems books will b reduced over this same period which is 33.3 percent per year. Ultimately ur consolidated stmts need to show deprec expense as if the equip was still in the hands of post

[GiniC]

I'm (was) having trouble with the same MCQ, and the provided solution didn't make logical sense to me. I tried writing a scenario (but with different numbers than Becker used) and I can't (couldn't) get the journal entry to work. For Becker numbers:

Post recording of sale: Salem recording purchase:
DR Cash 75 DR Equipment 75
DR Accum. Depr. 40 CR Cash 75 Salem depr = 75/3=25, so the reduction in expense (increase in Accum Depr) = 5
CR Equipment 100
CR I/C Gain 15 DR Depr. Exp 25
CR Accum Depr. 25
Depr. if kept = 20 so accum depr. would be 60

Workpaper elimination entry – here's where I (was) stuck – but in the process of explaining WHY, I figured out the answer!

1. eliminate the gain DR I/C Gain 15
2. restore equip value to 100 DR Equip 25
3. restore Accum Depr. from 25 to 60 CR Accum Depr. 35
My problem was that I tried to put the change in depreciation expense/accumulated depreciation here.
I didn't look at it in consolidated T accounts, which made the answer obvious – Post's Accum Depr went to zero, and Salem's was 25.
To get total Accum. Depr. to the required 60, I had to add 60-25=35 to the Accum Depr. account.

Now, to find the percentage they asked for:
The gain on sale was 15, and the increase was 5 – so 5/15=1/3, or 33-1/3%. I will run this with a couple of other number sets to prove it to myself, but I think this is the way to do it with logic.

Hopefully this saves someone else the hour I spent figuring out my (not-so-smart) mistake.

[Author]

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