Port, Inc. owns 100% of Salem, Inc. On January 1, year 6,
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 threeyear
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 6 will be
decreased by

(b) The requirement is to determine by how much
depreciation will be reduced. Use the solutions approach and set
up a simple numerical example.
Port’s original cost = $1,000
Depreciation per yr = $200
Selling price = $810
If Port sells equipment for $810, it recognizes a $210 gain on the
sale (selling price of $810 – carrying value of the equipment
$600). Salem, Inc. will now depreciate the equipment on their
books at $810, the price that they paid. Because the gain was not
realized with an entity outside of the consolidated entity, it must
be eliminated. In the consolidated financial statements, equipment
will be reported at its original carrying value, the gain on the
sale will be removed and depreciation expense must be recorded
at Port, Inc. original amount ($200), not the amount of depreciation
that Salem, Inc. records. Salem would record depreciation of
$270 ($810/3). Therefore, depreciation must be reduced by $70
on the consolidated financial statements to reflect the original
depreciation recorded by Port. Depreciation is reduced by $70,
which as shown by the example, is 33 1/3% of the gain
($70/$210).