© pearson education, inc. publishing as prentice hall5-1 chapter 5: intercompany profit...
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© Pearson Education, Inc. publishing as Prentice Hall 5-1
Chapter 5: Intercompany Profit Transactions – Inventories
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany
Advanced Accounting, 10th editionby Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn
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Intercompany Profits – Inventories: Objectives1. Understand the impact of intercompany profit
for inventories on preparation of consolidation working papers.
2. Apply the concepts of upstream versus downstream inventory transfers.
3. Defer unrealized inventory profits remaining in ending inventory of either the parent or subsidiary.
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Objectives (cont.)
4. Recognize realized, previously deferred inventory profits in the beginning inventory of either the parent or subsidiary.
5. Adjust the calculations of noncontrolling interest amounts in the presence of intercompany inventory profits.
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1: Intercompany Inventory Profits1: Intercompany Inventory ProfitsIntercompany Profit Transactions – Inventories
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Intercompany Transactions
• For consolidated financial statements, ARB No. 51 (as amended by FASB Statement No. 160) states:– "intercompany balances and transactions
shall be eliminated."• Show income and financial position as if the
intercompany transactions had never taken place.
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Intercompany Sales of Inventory
• Profits on intercompany sales of inventory– All 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• Consider a FIFO inventory system
– Beginning inventories are sold– Ending inventories are from current period
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No Intercompany Profits in Inventories• During 2009, Pretty sold goods costing $1,000 to its subsidiary, Simple, at a gross profit of 30%. Simple had none of
this inventory on hand at the end of 2009. Worksheet entry for 2009:
• All intercompany sales of inventories have been resold to outside parties, so remove the full sales price from both sales and cost of sales. – Pretty's sales are reduced $1,429.– Simple's cost of sales are reduced $1,429.
• The same entry is used if Simple sells to Pretty.Sales 1,429 Cost of sales 1,429
Sales = $1,000 / (1-30%) = $1,429
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Intercompany Profits Only in Ending Inventories• Last year, 2009, Paul 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 2009.
• During 2010, Paul sold additional goods costing $900 to Sal at a gross profit of 40%. Sal has $200 of these goods on hand at 12/31/2010. Worksheet entries for 2010:
Sales 1,500 Cost of sales 1,500
Sales = $900 / (1-40%) = $1,500
Cost of sales 80 Inventory 80
Ending inventory profit = $200 x 40%
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Intercompany Profits Beginning and Ending InventoriesLast year, 2009, 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 2009.
During 2010, Pam sold additional goods costing $500 to Sir at a 30% mark-up. Sir has $260 of these goods on hand at 12/31/2010. Worksheet entries for 2010:
Sales 650 Cost of sales 650
Sales = $500 + 30%($500) = $650
Cost of sales 60 Inventory 60
Ending inv. profits = $260 x 30%/130%
Investment in Subsidiary 24
Cost of sales 24Begin. inv. profits = $120 x 25%/125% = $24
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2: Upstream & Downstream 2: Upstream & Downstream Inventory SalesInventory Sales
Intercompany Profit Transactions – Inventories
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Downstream Sales
Parent sells to subsidiary
Subsidiary sells to parent
Upstream Sales
Upstream and Downstream Sales
Parent
Subsidiary 1 Subsidiary 2 Subsidiary 3
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Intercompany Inventory Sales• The worksheet entries for eliminating intercompany profits for downstream sales
For upstream sales, the last entry would also include a debit to noncontrolling interest, splitting the profit to be realized between controlling and noncontrolling interests.
Sales XXX Cost of sales XXX
For the intercompany sales price
Cost of sales XX Inventory XX
For the profits in ending inventory
Investment in Subsidiary XX
Cost of sales XXFor the profits in beginning inventory
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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 profits in ending inventory $60– IC profit in beginning inventory $24
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Income Sharing with Downstream Sales – PARENT Makes Sale
Subsidiary net income $5,200 Current amortizations (450)Adjusted income $4,750 Defer profits in EI (60)Recognize profits in BI 24
Income recognized $4,714 Subsidiary dividends $3,000
CI 80% share$3,800
(60)24
$3,764
$2,400 NCI 20% share
$950
$600
When parent makes the IC sale, the impact of deferring and recognizing profits falls all to the parent.
Income from subsidiary
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Income Sharing with Upstream Sales – SUBSIDIARY Makes Sale
Subsidiary net income $5,200 Current amortizations (450)Adjusted income $4,750 Defer profits in EI (60)Recognize profits in BI 24 Income recognized $4,714 Subsidiary dividends $3,000
CI 80% share$3,800
(48)19.2
$3,771.2
$2,400 NCI 20% share
$950.0(12.0)4.8
$942.8
$600
When subsidiary makes the IC sale, the impact of deferring and recognizing profits is split among controlling and noncontrolling interests.
Income from subsidiary
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3: Unrealized Profits in Ending 3: Unrealized Profits in Ending InventoriesInventories
Intercompany Profit Transactions – Inventories
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Ending Inventory on Hand
• Intercompany profits in ending inventory– Eliminate at year end
• Working paper entry
Cost of sales XXX
Inventories XXX
For the unrealized profit
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Parent Accounting
Porter owns 90% of Sorter acquired at book value (no amortizations). During the current year, Sorter reported $10,000 income. Porter sold goods to Sorter during the year for $15,000 including a profit of $6,250. Sorter still holds 40% of these goods at the end of the year.
• Unrealized profit in ending inventory40%(6,250) = $2,500
• Porter's Income from Sorter90%(10,000) – 2,500 unreal. Profits = $6,500
• Noncontrolling interest share10%(10,000) = $1,000
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Entries
• Porter's journal entry to record income
• Worksheet entries to eliminate intercompany sale and unrealized profits
Sales 15,000
Cost of sales 15,000
Cost of sales 2,500
Inventory 2,500
Investment in Sorter 6,500
Income from Sorter 6,500
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Worksheet – Income Statement
Porter Sorter DR CR Consol
Sales $100.0 $50.0 15.0 $135.0
Income from Sorter 6.5 6.5 0.0
Cost of sales (60.0) (35.0) 2.5 15.0 (82.5)
Expenses (15.0) (5.0) (20.0)
Noncontrolling interest share 1.0 (1.0)
Controlling interest share $31.5 $7.5 $31.5
There would be a credit adjustment to Inventory for 2.5 on the balance sheet portion of the worksheet.
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What if?If the sales had been upstream, by Sorter to
Porter:• Unrealized profits in ending inventory
40%(6,250) = $2,500• Porter's Income from Sorter
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
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4: Recognizing Profits from 4: Recognizing Profits from Beginning InventoriesBeginning Inventories
Intercompany Profit Transactions – Inventories
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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!
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5: Impact on Noncontrolling Interest5: Impact on Noncontrolling InterestIntercompany Profit Transactions – Inventories
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Direction of Sale and NCIThe impact of unrealized profits in ending
inventory and realizing profits in beginning inventory depends on the direction
• Downstream sales– Full impact on parent
• Upstream sales– Share impact between parent and
noncontrolling interest
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Calculating Income and NCI
Downstream sales:Income from sub = CI%(Sub's NI) – Profits in EI + Profits in BINoncontrolling 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)
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Upstream Example with AmortizationPerry acquired 70% of Salt on 1/1/2009 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.
During 2009, Salt sold goods costing $700 to Perry at a 20% markup. $240 of these goods were in Perry's ending inventory.
In 2010, Salt sold goods costing $900 to Perry at a 25% markup and Perry still had $100 on hand at the end of the year.
2009 2010
Perry Salt Perry SaltSeparate income $1,250 $705 $1,500 $745Dividends $600 $280 $600 $300
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Analysis and Amortization
Cost of 70% of Salt $420
Implied value of Salt 420/.70 $600
Book value 200 + 200 400
Excess $200
Unamort Amort Unamort Amort UnamortAllocated to: 1/1/09 2009 1/1/10 2010 12/31/10Inventory 50 (50) 0 0 0 Building 100 (5) 95 (5) 90 Goodwill 50 0 50 0 50 200 (55) 145 (5) 140
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2009 Income Sharing (Upstream)
Income from Salt
Salt's net income $705 Current amortizations (55)Adjusted income $650 Defer profits in EI (40)Income recognized $610
Subsidiary dividends $280
CI 70% share$455 ($28)$427
$196
NCI 30% share$195 ($12)$183
$84
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Perry's 2009 Equity Entries
Investment in Salt 420
Cash 420
For acquisition of 70% of Salt
Cash 196
Investment in Salt 196
For dividends received
Investment in Salt 427
Income from Salt 427
For share of income
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2009 Worksheet Entries1. Adjust for errors & omissions - none2. Eliminate intercompany profits and losses
3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance
Sales 700
Cost of sales 700
Cost of Sales 40
Inventory 40
Income from Salt 427
Dividends 196
Investment in Salt 231
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2009 Entries (2 of 3)4. Record noncontrolling interest in sub's earnings &
dividends
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock 200 Retained earnings 200
Inventory 50
Building 100
Goodwill 50
Investment in Salt 420
Noncontrolling interest 180
Noncontrolling interest share 183 Dividends 84
Noncontrolling interest 99
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2009 Entries (3 of 3)
6. Amortize fair value/book value differentials
7. Eliminate other reciprocal balances – none
Cost of sales 50
Inventory 50
Depreciation expense 5
Building 5
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2010 Income Sharing (Upstream)
Income from Salt
Salt's net income $745 Current amortizations (5)Adjusted income $740 Defer profits in EI (20)Realize profits from BI 40 Income recognized $760 Subsidiary dividends $300
CI 70% share$518 ($14)$28 $532
$210
NCI 30% share$222 ($6)$12
$228
$90
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Perry's 2010 Equity Entries
Cash 210
Investment in Salt 210
For dividends received
Investment in Salt 532
Income from Salt 532
For share of income
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2010 Worksheet Entries1. Adjust for errors & omissions - none2. Eliminate intercompany profits and losses
3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance
Sales 900 Cost of sales 900
Cost of Sales 20
Inventory 20
Investment in Salt 28
Noncontrolling interest 12
Cost of sales 40
Income from Salt 532 Dividends 210
Investment in Salt 322
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2010 Entries (2 of 3)4. Record noncontrolling interest in sub's earnings &
dividends
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock 200 Retained earnings 625
Inventory 0
Building 95
Goodwill 50
Investment in Salt 679
Noncontrolling interest 291
Noncontrolling interest share 228 Dividends 90
Noncontrolling interest 138
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2010 Entries (3 of 3)
6. Amortize fair value/book value differentials
7. Eliminate other reciprocal balances – none
Depreciation expense 5
Building 5
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