Dunn Corp. owns 100% of Grey Corp's common stock. On jan 2, y3, Dunn sold to Grey for $40,000 machinery with a carrying amount of $30,000. Grey is depreciating the acquired machinery over a 5-year life by the straight-line method. The net adjustments to compute y3 and y4 consolidated income before income tax are an increase(decrease) of

  y3     y4

a (8000) 2000

b(10,000) 2000

c (10,000) 0

d(8000)   0

correct answer A.

Why I thought I had the get rid of the gain and then decrease depreciation. The gain is 10,000 and the excess depreciation is 2000

JE

dr-Gain 10000

   cr- machinery 10000

dr-accumulated depreciation 2000

    cr-depreciation expense 2000

What am I missing???

Thanks a bunch...

wannabe, take it this way :-

Year 3 :-

as per your JEs above,

Gain reversed (10,000) + Depreciation reversed 2,000 = (8,000) net adjustments in consolidated income statement.
And, in the subsequent year(s), Retained earnings is debited as the year 3 net adjustments would have been closed to RE.

Year 4:-

JE in parent's books :-

DR Depreciation 2,000

CR Accumulated depreciation 2,000

Intercompany elimination :-

DR Acc Dep 2,000

CR Dep 2,000

Net adjustment in consolidated IS = 2,000

Thus, the answer (8,000) 2,000

Remember, gain is a one time entry - Year 3 only and depreciation is a recurring entry for 5 years in parent's books. And, thus intercompany elimination would happen for both gain and depreciation in year 3; and only for depreciation from year 4 - year 7.

Hope it's clear now :)