intercompany transaction: inventory
TRANSCRIPT
Intercompany Transaction: Inventories
ARTHIK DAVIANTI
Understand the impact of intercompany profit
in inventories
Intercompany Transaction
• Consolidated financial statements – as if two or more affiliates are one entity• Transaction between affiliates must be eliminated• The objective is to show the income and financial
position of the consolidated entity as they would have appeared if the intercompany transaction had never taken place• This situation depends on the existence of arm’s
length transaction
• Firms recognize revenue when it is realized – when it is earned.• For consolidated entity, revenue earns when there is a
sale to outside entities.• Revenue between affiliates cannot be recognized until
merchandise sold outside of the consolidated entity.• Affiliates’ sales produce reciprocal sales and cost of
good sold accounts – should be eliminated.• This elimination will not affect consolidated net
income.
Intercompany Transaction: Inventory
• Transfer at cost – sold at cost or carrying valueNo profit or loss – no adjustmentElimination to remove revenue and related cost of goods sold
• Transfer at a profit or loss – sold at a mark up (or less than cost)
Profit or loss is considered realized by the selling company, but not for consolidation – until resale to an unrelated party, referred to as unrealized intercompany profit
Intercompany Transaction: Inventory
Elimination for consolidation:Income statement: Sales and cost of goods soldThe sales revenue from the intercompany sale and the related cost of goods sold recorded by the transferring affiliate must be removed.Balance sheet: InventoryThe profit or loss on the intercompany sale must be removed so the inventory is reported at the cost to the consolidated entity.
Intercompany Transaction: Inventory
• For consolidation purposes – profits from intercompany inventory sale are recognized in the period of a resold to an unrelated party.• Downstream sale – a sale from a parent to a subsidiary,
gain or loss accrues to the parent company.• Upstream sale – a sale from a subsidiary to a parent,
gain or loss accrues to the subsidiary.• Three situations: (1) the item is resold to a nonaffiliate
during the same period, (2) the item is resold to a nonaffiliate during the next period, or (3) the item is held for two or more periods.
Intercompany Transaction: Inventory
1. Peerless Products Corp purchases 80% of Special Foods Inc.’s stock on December 31, 20X1, at the stock’s book value of $240,000. The fair value of Special Food’s non controlling interest on that date is $60,000, the book value of those shares.
2. During 20X1, Peerless reports separate income of $140,000 income from regular operation and declares dividends of $60,000. Special Foods reports net income of $50,000 and declares dividends of $30,000.
3. Peerless accounts for its investments in Special Foods using the equity method and adjusts for unrealized intercompany profits using the fully adjusted equity method.
Downstream Sale of Inventory
On March 1, 20X1, Peerless buys inventory for $7,000 and resell it to Special Foods for $10,000 on April 1. Peerless records the following entries:
Downstream Sale of Inventory: Illustration
March 1, 20X1Inventory 7,000
Cash7,000
To record inventory purchaseApril 1, 20X1Cash 10,000
Sales10,000
Cost of goods sold 7,000Inventory
7,000To record sale and cost of inventory sold to Special Foods
Special Foods entry for the purchase of the inventory from Peerless:
Downstream Sale of Inventory: Illustration
April 1, 20X1Inventory 10,000
Cash10,000
To record inventory purchase from Peerless
Inventory is resold to a nonaffiliate during the same period, November 5, 20X1, for 15,000. Special Foods’ entry:
Resale in Period of Intercompany Transaction
November 5, 20X1Cash 15,000
Sales15,000
Cost of goods sold 10,000Inventory
10,000To record sale and cost of inventory sold to Nonaffiliated
Parent Sub$7,000 For $15,000$10,000
3/120X1
4/120X1
11/520X1
A review of all entries recorded:
Resale in Period of Intercompany Transaction
Item Peerless Products
Special Foods
Unadjusted Totals
Consolidated amounts
Sales 10,000 15,000 25,000 15,000Cost of goods sold (7,000) (10,000) (17,000) (7,000)Gross profit 3,000 5,000 8,000 8,000
The amount of intercompany sale must be eliminated:Sales 10,000
Cost of goods sold10,000
Extending the previous illustration – Special Foods sells the inventory to Nonaffiliated Corporation for $15,000 on January 2, 20X2.Equity method entries to record income and dividends for 20X1:
Resale in Period following Intercompany Transaction
Parent Sub$7,000 For $15,000$10,000
3/120X1
4/120X1
1/220X2
Investment in Special Foods 40,000Income from Special Foods
40,000To record Peerless 80% share of income
Resale in Period following Intercompany Transaction
Cash 24,000Investment in Special Foods 24,000
To record Peerless 80% share of dividend
The downstream sale of inventory to Special Foods results in $3,000 of unrealized profits. Under the fully adjusted equity method, Peerless defers the entire $3,000 (assumes that the NCI shareholders do not own Peerless stock):Income from Special Foods 3,000
Investment in Special Foods 3,000To defer unrealized gross profit on inventory sales to Special Foods not yet resold
Resale in Period following Intercompany Transaction
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 60,000 240,000 200,000 100,000+ Net income 10,000 40,000 50,000- Dividend (6,000) (24,000) (30,000)
Ending book value 64,000 256,000 200,000 120,000
=
Elimination entries for consolidation worksheet:
Resale in Period following Intercompany Transaction
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 37,000NCI in NI of Special Foods 10,000
Dividends Declared30,000
Investment in Special Foods253,000NCI in NA of Special Foods
64,000
The amounts in the Income from Special Foods and Investment in Special Foods are reduced by the $3,000 deferral (worksheet, Baker p. 262).
Elimination of intercompany sale (ending inventory):Sales 10,000
Cost of goods sold7,000
Inventory3,000
• Resold by the parent to a nonaffiliate during the same period, all the parent’s equity method entries, and the elimination entries in the consolidation worksheet are identical with those in the downstream case.• When the inventory is not resold to nonaffiliated
before the end of the period – consider the apportionment of the unrealized intercompany profit to both CI and NCI.
Upstream Sale of Inventory
Cash 24,000Investment in Special Foods 24,000
To record Peerless 80% share of dividend
Upstream Sale of InventoryEquity method entries to record income and dividends for 20X1 (these entries are the same as in the illustration of the downstream sale and the difference is the unrealized gross profit is deferred only by Peerless’ ownership percentage: $3,000 X 80% = $2,400):
Investment in Special Foods 40,000Income from Special Foods
40,000To record Peerless 80% share of income
Income from Special Foods 2,400Investment in Special Foods 2,400
To defer unrealized gross profit on inventory sales to Special Foods not yet resold
Upstream Sale of Inventory
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 60,000 240,000 200,000 100,000+ Net income 10,000 40,000 50,000- Dividend (6,000) (24,000) (30,000)
Ending book value 64,000 256,000 200,000 120,000
=
Elimination entries for consolidation worksheet:
Upstream Sale of Inventory
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 37,600NCI in NI of Special Foods 9,400
Dividends Declared30,000
Investment in Special Foods253,600NCI in NA of Special Foods
63,400
The amounts in the Income from Special Foods and Investment in Special Foods are reduced by the $3,000 deferral (worksheet, Baker p. 268).
Elimination of intercompany sale (ending inventory):Sales 10,000
Cost of goods sold7,000
Inventory3,000
Source:
BAKER CHRISTENSEN COTTLRELLAdvanced Financial Accounting
Ninth Edition
McGRAW HILL INTERNATIONAL EDITION