Chapter 5: Intercompany Profit Transactions

```Chapter 5:
Intercompany Profit
Transactions –
Inventories
to accompany
by Beams, Anthony, Bettinghaus, and Smith
Inc. Publishing as Prentice Hall
5-1
Intercompany Profits – Inventories:
Objectives
1. Understand the impact of intercompany profit in
inventories on preparing consolidation
workpapers.
2. Apply the concepts of upstream versus
downstream inventory transfers.
3. Defer unrealized inventory profits remaining in the
ending inventory.
4. Recognize realized, previously deferred, inventory
profits in the beginning inventory.
Inc. Publishing as Prentice Hall
5-2
Objectives (cont.)
5. Adjust the calculations of noncontrolling interest
amounts in the presence of intercompany
inventory profits.
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5-3
Intercompany Profit Transactions – Inventories
1: INTERCOMPANY
INVENTORY PROFITS
Inc. Publishing as Prentice Hall
5-4
Intercompany Transactions
For consolidated financial statements
 “intercompany balances and transactions shall be
eliminated.” [FASB ASC 810-10-45-1]
Show income and financial position as if the
place.
Inc. Publishing as Prentice Hall
5-5
Intercompany Sales of Inventory
Profits on intercompany sales of inventory
 Recognized if goods have been resold to outsiders
 Deferred if the goods are still held in inventory
Previously deferred profits in beginning
inventory are recognized in the period the
goods are sold. Assuming FIFO
 Beginning inventories are sold
 Ending inventories are from current purchases
Inc. Publishing as Prentice Hall
5-6
No Intercompany Profits in Inventories
During 2011, Pet sold goods costing \$1,000 to its
subsidiary, Sim, at a gross profit of 30%. Sim had
none of this inventory on hand at the end of 2011. The
worksheet entry for 2011:
Sales (-R, -SE)
1,429
Cost of sales (-E, +SE)
Eliminate intercompany sales = \$1,000 / (1-30%) = \$1,429
1,429
All intercompany sales of inventories have been resold
to outside parties, so remove the full sales price from
both sales and cost of sales.
Pet's sales are reduced \$1,429.
Sim's cost of sales are reduced \$1,429.
The same entry is used if Sim sells to Pet.
Inc. Publishing as Prentice Hall
5-7
Intercompany Profits Only in Ending
Inventories
Last year, 2011, Pal sold goods costing \$500 to its
subsidiary, Sal, at a gross profit of 25%. Sal had
none of this inventory on hand at the end of 2011.
During 2012, Pal sold additional goods costing
\$900 to Sal at a gross profit of 40%. Sal has \$200
of these goods on hand at 12/31/2012. Worksheet
entries for 2012:
Sales (-R, -SE)
1,500
Cost of sales (-E, +SE)
Eliminate intercompany sales = \$900 / (1-40%) = \$1,500
Cost of sales (E, -SE)
80
Inventory (-A)
Defer profit in ending inventory = \$200 x 40%
Inc. Publishing as Prentice Hall
1,500
80
5-8
Intercompany Profits Beginning and
Ending Inventories
Last year, 2011, Pam sold goods costing \$300 to its subsidiary, Sir, at
mark-up of 25%. Sir had \$120 of this inventory on hand at the end of
2011.
During 2012, Pam sold additional goods costing \$500 to Sir at a 30%
mark-up. Sir has \$260 of these goods on hand at 12/31/2012. Worksheet
entries for 2012:
Sales (-R, -SE)
Cost of sales (-E, +SE)
650
650
Eliminate intercompany sales = \$500 + 30%(\$500) = \$650
Cost of sales (E, -SE)
Inventory (-A)
60
60
Defer profits in ending inventory = \$260 x 30%/130%
Investment in Subsidiary (+A)
Cost of sales (-E, +SE)
24
24
Realize profits from beginning inventory = \$120 x 25%/125% = \$24
Inc. Publishing as Prentice Hall
5-9
Intercompany Profit Transactions – Inventories
2: UPSTREAM &
DOWNSTREAM INVENTORY
SALES
Inc. Publishing as Prentice Hall
5-10
Upstream and Downstream Sales
Downstream Sales
Parent sells to
subsidiary
Subsidiary
1
Parent
Subsidiary
2
Subsidiary sells to
parent
Subsidiary
3
Upstream Sales
Inc. Publishing as Prentice Hall
5-11
Intercompany Inventory Sales
The worksheet entries for eliminating intercompany
profits for downstream sales
Sales (-R, -SE)
XXX
Cost of sales (-E, +SE)
XXX
For the intercompany sales price
Cost of sales (E, -SE)
Inventory (-A)
XX
XX
For the profits in ending inventory
Investment in Subsidiary (+A)
Cost of sales (-E, +SE)
XX
XX
For the profits in beginning inventory
For upstream sales, the last entry would include a debit
to noncontrolling interest, sharing the realized profit
between controlling and noncontrolling interests.
Inc. Publishing as Prentice Hall
5-12
Data for Example
For the year ended 12/31/2011:
 Subsidiary income is \$5,200
 Subsidiary dividends are \$3,000
 Current amortization of acquisition price is \$450
Intercompany (IC) sales information:
 IC sales during 2011 were \$650
 IC profit in ending inventory \$60
 IC profit in beginning inventory \$24
Inc. Publishing as Prentice Hall
5-13
Income Sharing with Downstream Sales –
PARENT Makes Sale
Subsidiary net income
Current amortizations
\$5,200
(450)
\$4,750
Defer profits in EI
Recognize profits in BI
(60)
24
Income recognized
\$4,714
Subsidiary dividends
\$3,000
CI 80% share
\$3,800
(60)
24
Income from subsidiary
\$3,764
\$2,400
When parent makes the IC sale,
the impact of deferring and
recognizing profits falls all to the
parent.
Inc. Publishing as Prentice Hall
NCI 20% share
\$950
\$600
5-14
Income Sharing with Upstream Sales –
SUBSIDIARY Makes Sale
Subsidiary net income
Current amortizations
\$5,200
(450)
\$4,750
Defer profits in EI
Recognize profits in BI
Income recognized
(60)
24
\$4,714
Subsidiary dividends
\$3,000
CI 80% share
\$3,800
(48)
19.2
Income from subsidiary
\$3,771.2
\$2,400
When subsidiary makes the IC sale, the
impact of deferring and recognizing
profits is split among controlling and
noncontrolling interests.
Inc. Publishing as Prentice Hall
NCI 20% share
\$950.0
(12.0)
4.8
\$942.8
\$600
5-15
Intercompany Profit Transactions – Inventories
3: UNREALIZED PROFITS IN
ENDING INVENTORIES
Inc. Publishing as Prentice Hall
5-16
Ending Inventory on Hand
Intercompany profits in ending inventory
 Eliminate at year end
Working paper entry
Cost of sales (E, -SE)
Inventories (-A)
For the unrealized profit
Inc. Publishing as Prentice Hall
XXX
XXX
5-17
Parent Accounting
Pot owns 90% of Sot acquired at book value (no
amortizations). During the current year, Sot reported
\$10,000 income. Pot sold goods to Sot during the year
for \$15,000 including a profit of \$6,250. Sot still holds
40% of these goods at the end of the year.
Unrealized profit in ending inventory
40%(6,250) = \$2,500
Pot's Income from Sot
90%(10,000) – 2,500 unrealized profits = \$6,500
Noncontrolling interest share
10%(10,000) = \$1,000
Inc. Publishing as Prentice Hall
5-18
Entries
Pot's journal entry to record income
Investment in Sot (+A)
Income from Sot (R, +SE)
6,500
6,500
Worksheet entries to eliminate intercompany
sale and unrealized profits
Sales (-R, -SE)
Cost of goods sold (-E, +SE)
Cost of goods sold (E, -SE)
Inventory (-A)
15,000
15,000
2,500
2,500
Inc. Publishing as Prentice Hall
5-19
Worksheet – Income Statement
Sales
Income from Sot
Pot
Sot
DR
\$100.0
\$50.0
15.0
\$135.0
6.5
0.0
6.5
Cost of sales
(60.0)
(35.0)
Expenses
(15.0)
(5.0)
Noncontrolling interest share
Controlling interest share
2.5
CR
Consol
15.0
(20.0)
1.0
\$31.5
(82.5)
\$7.5
(1.0)
\$31.5
There would be a credit adjustment to Inventory for \$2.5 on the
balance sheet portion of the worksheet.
Inc. Publishing as Prentice Hall
5-20
What if?
If the sales had been upstream, by Sot to Pot:
Unrealized profits in ending inventory
40%(6,250) = \$2,500
Pot's Income from Sot
90%(10,000 – 2,500) = \$6,750
Noncontrolling interest share
10%(10,000 – 2,500) = \$750
Upstream profits impact both:
 Controlling interest share
 Noncontrolling interest share
Inc. Publishing as Prentice Hall
5-21
Intercompany Profit Transactions – Inventories
4: RECOGNIZING PROFITS
FROM BEGINNING
INVENTORIES
Inc. Publishing as Prentice Hall
5-22
Intercompany Profits in Beginning
Inventory
Unrealized profits in
ending inventory one year
Become
Profits to be recognized in the beginning
inventory of the next year!
Inc. Publishing as Prentice Hall
5-23
Intercompany Profit Transactions – Inventories
5: IMPACT ON
NONCONTROLLING
INTEREST
Inc. Publishing as Prentice Hall
5-24
Direction of Sale and NCI
The impact of unrealized profits in ending
inventory and realizing profits in beginning
inventory depends on the direction of the
intercompany sales
Downstream sales
 Full impact on parent
Upstream sales
 Share impact between parent and noncontrolling
interest
Inc. Publishing as Prentice Hall
5-25
Calculating Income and NCI
Downstream sales:
Income from sub
= CI%(Sub's NI) – Profits in EI + Profits in BI
Noncontrolling interest share
= NCI%(Sub's NI)
Upstream sales:
Income from sub
= CI%(Sub's NI – Profits in EI + Profits in BI)
Noncontrolling interest share
= NCI%(Sub's NI – Profits in EI + Profits in BI)
Inc. Publishing as Prentice Hall
5-26
Upstream Example with Amortization
Perry acquired 70% of Salt on 1/1/2011 for \$420 when Salt's equity
consisted of \$200 capital stock and \$200 retained earnings. Salt's
inventory was understated by \$50 and building, with a 20-year
life, was understated by \$100. Any excess is goodwill.
2011
Perry
Separate income
Dividends
\$1,250
\$600
2012
Salt
Perry
Salt
\$705 \$1,500
\$745
\$280
\$300
\$600
During 2011, Salt sold goods for \$700 to Perry at a 20% markup.
\$240 of these goods were in Perry's ending inventory.
In 2012, Salt sold goods for \$900 to Perry at a 25% markup and
Perry still had \$100 on hand at the end of the year.
Inc. Publishing as Prentice Hall
5-27
Analysis and Amortization
Cost of 70% of Salt
\$420
Implied value of Salt 420/.70
\$600
Book value 200 + 200
400
Excess
Allocated to:
Inventory
Building
Goodwill
Unamort
1/1/11
50
100
50
200
\$200
Amort
2011
(50)
(5)
0
(55)
Unamort
1/1/12
0
95
50
145
Inc. Publishing as Prentice Hall
Amort
2012
0
(5)
0
(5)
Unamort
12/31/12
0
90
50
140
5-28
2011 Income Sharing (Upstream)
Salt's net income
Current amortizations
\$705
(55)
\$650
Defer profits in EI
Income recognized
(40)
\$610
Subsidiary dividends
CI 70% share
\$455
(\$28)
Income from Salt
\$427
\$196
\$280
NCI 30% share
\$195
(\$12)
\$183
\$84
Inc. Publishing as Prentice Hall
5-29
Perry's 2011 Equity Entries
Investment in Salt (+A)
Cash (-A)
For acquisition of 70% of Salt
Cash (+A)
Investment in Salt (-A)
Investment in Salt (+A)
Income from Salt (R, +SE)
420
420
196
196
427
427
For share of income
Inc. Publishing as Prentice Hall
5-30
2011 Worksheet Entries (1 of 3)
1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)
Cost of sales (-E, +SE)
Cost of Sales (E, -SE)
700
700
40
Inventory (-A)
40
3. Eliminate income & dividends from sub. and bring
Investment account to its beginning balance
Income from Salt (-R, -SE)
427
Dividends (+SE)
Investment in Salt (-A)
Inc. Publishing as Prentice Hall
196
231
5-31
2011 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share (-SE)
Dividends (+SE)
Noncontrolling interest (+SE)
183
84
99
5. Eliminate reciprocal Investment & sub's equity
balances
Capital stock (-SE)
Retained earnings (-SE)
Inventory (+A)
Building (+A)
Goodwill (+A)
Investment in Salt (-A)
Noncontrolling interest (+SE)
Inc. Publishing as Prentice Hall
200
200
50
100
50
420
180
5-32
2011 Entries (3 of 3)
6. Amortize fair value/book value differentials
Cost of sales (E, -SE)
Inventory (-A)
Depreciation expense (E, -SE)
Building (-A)
50
50
5
5
7. Eliminate other reciprocal balances – none
Inc. Publishing as Prentice Hall
5-33
2012 Income Sharing (Upstream)
Salt's net income
Current amortizations
\$745
(5)
\$740
Defer profits in EI
Realize profits from BI
Income recognized
(20)
40
\$760
Subsidiary dividends
\$300
CI 70% share
\$518
(\$14)
\$28
Income from Salt
\$532
\$210
Inc. Publishing as Prentice Hall
NCI 30% share
\$222
(\$6)
\$12
\$228
\$90
5-34
Perry's 2012 Equity Entries
Cash (+A)
Investment in Salt (-A)
Investment in Salt (+A)
Income from Salt (R, +SE)
For share of income
Inc. Publishing as Prentice Hall
210
210
532
532
5-35
2012 Worksheet Entries (1 of 3)
1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)
900
Cost of sales (-E, +SE)
Cost of Sales (E, -SE)
20
Inventory (-A)
Investment in Salt (+A)
28
Noncontrolling interest (-SE)
12
Cost of sales (-E, +SE)
3. Eliminate income & dividends from sub. and bring
Investment account to its beginning balance
Income from Salt (-R, -SE)
532
Dividends (+SE)
Investment in Salt (-A)
Inc. Publishing as Prentice Hall
900
20
40
210
322
5-36
2012 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share (-SE)
Dividends (+SE)
Noncontrolling interest (+SE)
228
90
138
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock (-SE)
Retained earnings (-SE)
Inventory (+A)
Building (+A)
Goodwill (+A)
Investment in Salt (-A)
Noncontrolling interest (+SE)
Inc. Publishing as Prentice Hall
200
625
0
95
50
679
291
5-37
2012 Entries (3 of 3)
6. Amortize fair value/book value differentials
Depreciation expense (E, -SE)
Building (-A)
5
5
7. Eliminate other reciprocal balances – none
Inc. Publishing as Prentice Hall
5-38
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