Petunia Corporation owns 100% of Stone Company's common stock. On January 1, 2017, Petunia sold equipment with a book value of $210,000 to Stone for $300,000. Stone is depreciating the equipment over a ten-year life by the straight-line method. The net adjustments to compute 2017 and 2018 consolidated income would be an increase (decrease) of:

Question

Quizplus · Accepted Answer

The correct answer is D because when Petunia sold the equipment to Stone, it recognized a gain of $90,000 ($300,000 - $210,000). For consolidation purposes, this intra-group gain must be eliminated in 2017, resulting in a decrease of $90,000. However, since Stone is depreciating the equipment over ten years, the excess depreciation due to the markup ($90,000 / 10 years = $9,000 per year) must be added back in subsequent years, including 2018, to correct the overstated depreciation expense. Thus, the net adjustments are a decrease of $81,000 in 2017 (after considering the excess depreciation of $9,000) and an increase of $9,000 in 2018.

Petunia Corporation Owns 100% of Stone Company's Common Stock