intercompany transaction: non-current assets (part 1)
TRANSCRIPT
Intercompany Profit Transaction:
Non-current Assets(Part 1)
ARTHIK DAVIANTI
Understand and explain concepts associated with
transfers of long-term assetsand services.
Summary of GAAP Requirements for Preparing Consolidated
StatementsAll intercompany transactions must be eliminated in consolidation.
The full amount of unrealized intercompany profit or gain must be eliminated.
The deferral is shared with NCI shareholders in upstream transactions.
Big Picture: The Consolidated
PerspectiveFrom a consolidated viewpoint, the reported amount for a fixed asset cannot change merely because the asset has been moved to a different location within the consolidated group.
Objective: Undo the transfer.
Make it appear as if we only changed the estimated useful life of asset.
P
S
Long-termAsset
Different Asset Types1. Non-depreciable Assets• The transfer of non-depreciable assets is very
similar to the transfer of inventory• Eliminate gains like unrealized gross profit
2. Depreciable Assets• Eliminate the seller’s gain• Adjust transferred asset back to old basis• Adjust depreciation back to what it would have
otherwise been if the original owner had depreciated the asset based on the revised estimate of useful life
Intercompany Transfers of Services
When one company purchases services from a related company, the purchaser typically records an expense and the seller records a revenue. • In the consolidation worksheet, an eliminating
entry would be needed to reduce both revenue (debit) and expense (credit).• Because the revenue and expense are equal and
both are eliminated, income is unaffected by the elimination.• The elimination is still important because
otherwise both revenues and expenses are overstated.
Illustration (Baker et al. 2011, p. 307-309)Intercompany sale process of land.
A series of transaction: (1) land purchased by Parent company from an unrelated party, (2) land sold to a subsidiary of Parent Company, and (3) land sold by subsidiary to an unrelated party:Details of transactions:T1 – purchase by Parent Company from an outsider for $10,000T2 – Sale from Parent Company to Subsidiary for $15,000T3 – Sale from Subsidiary to an outsider for $25,000The amount of gain reported by each company and by the consolidated entity in a periods depends on the transactions occur during a period.
Illustration (continue)Case AAll three transactions are completed in the same accounting period.
Case BOnly transaction T1 is completed during the current period.
Parent Company $ 5,000 ($15,000 - $10,000)Subsidiary Corporation 10,000 (25,000 - $15,000)Consolidated Entity 15,000 ($25,000 - $10,000)
Parent Company $ 0Subsidiary Corporation 0Consolidated Entity 0
Illustration (continue)Case CTransaction T1 and T2 are completed during the current period.
Case DOnly transaction T3 is completed during the current period, T1 and T2 occurred in a prior period.
Parent Company $ 5,000 ($15,000 - $10,000)Subsidiary Corporation 0Consolidated Entity 0
Parent Company $ 0Subsidiary Corporation 10,000 (25,000 - $15,000)Consolidated Entity 15,000 ($25,000 - $10,000)
Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following an intercompany land
transfer.
Intercompany Land Transfers
• If land is transferred between related companies at book value – no adjustment or elimination needed in consolidating financial statements.• Because there is no gain or loss, both income and
assets are stated correctly in the consolidation.• Special treatment is needed if land transfer is more or
less then book value – elimination of gain or loss.• There should be no gain or loss from related
companies reported in the consolidated financial statements – until land is sold to other party.
Illustration (p. 310 - 311)Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000
Peerless Product
SpecialFoods$20 $35
Jan 1, 20X1 Jul 1, 20X1
Purchase land
Inter-corporate transfer of
land
Consolidated Entity
Illustration (continues)Peerless records:
January 1, 20X1(1) Land 20,000
Cash 20,000Record land purchase
July 1, 20X1(2) Cash 35,000
Land 35,000Record on Sale of land to Special Food
Illustration (continues)Special Foods records
Eliminating entry
July 1, 20X1(3) Land 35,000
Cash 35,000Record land purchase
July 1, 20X1(4) Income from Special Foods 15,000
Investment in Special Food 15,000Defer gain on intercompany land sale to Special Foods
Gain on Sale of Land 15,000 Land 15,000
Assignment of Unrealized Profit
EliminationUnrealized intercompany gains and losses must be eliminated in consolidating financial statements – regardless parent’s ownership of a subsidiary. Sale EliminationDownstream (parent to subsidiary) Against controlling interestUpstream (subsidiary to parent) Wholly owned subsidiary Against controlling interest Majority-owned subsidiary Proportionately against controlling
and noncontrolling interests
Illustration
Purity Company owns 75% of the common stock of Southern Corp.Purity reports operating income (excluding any investment income from Southern) of $100,000Southern reports net income of $60,000, included the income of selling affiliate is an unrealized gain of $10,000 from the intercompany transfer of asset.
Illustration (continues)
• If the sale is a downstream transfer, all unrealized profit is to be eliminated from the controlling interest.• Consolidated net income (computed and allocated):
Purity’s separate income $100,000Less: Unrealized intercompany gain on downstream asset sale (10,000)Purity’s separate realized income $90,000Southern’s net income 60,000Consolidated net income $150,000Income to noncontrolling interest ($60,000 x 0.25) (15,000)Income to controlling interest $135,000
Illustration (continues)• In the intercompany transfer is from subsidiary to
parent, the unrealized profit on the upstream sale is eliminated proportionately from both the controlling and noncontrolling shareholders.• Consolidated net income (computed and allocated):Purity’s separate income $100,000Southern’s net income $60,000Less: Unrealized intercompany gain on downstream asset sale (10,000)Southern’s realized net income 50,000Consolidated net income $150,000Income to noncontrolling interest ($50,000 x 0.25) (12,500)Income to controlling interest $137,500
Illustration (continues)NCI’s proportionate share of the subsidiary’s income realized in transaction with parties to the consolidated entity.Income assigned to the NCI in downstream example.
Southern’s net income $60,000Less: Unrealized (10,000)Southern's realized net income $50,000Proportionate share to noncontrolling interest X 0.25Income assigned to noncontrolling interest $12,500
Income assigned to the NCI in upstream example.
Southern’s net income $60,000Proportionate share to noncontrolling interest X 0.25Southern's realized net income $15,000
Downstream Sale of Land• Peerless Products purchases 80% of the common
stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000.• During 20X1, Peerless reports separate income of
$140,000 and declares dividends of $60,000.• Special Foods reports net income of $50,000 and
declares dividend of $30,000.• July 1, 20X1, Peerless sells land to Special Foods for
$35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following
years.
P
S
NCI
20%
80%
Fully adjusted equity-method entries – 20X1
20X1 Peerless records its share of Special Foods’ income and dividend.
(5) Investment in Special Foods 40,000 Income from Special Foods 40,000Record Peerless’ 80% share of Special Foods’ 20X1 income
(6) Cash 24,000 Investment in Special Foods 24,000Record Peerless’ 80% share of Special Foods’ 20X1 dividend
Under the fully adjusted equity method, Peerless defers the entire $15,000 using the following entry:
Objectives: (1) Peerless income is overstated by $15,000, the
adjustment to Income from Special Foods offsets this overstatement – Peerless net income is now correct, and
(2) Special Foods’ land account is currently overstated by $15,000 (was recorded for $20,000 but purchased for $35,000), reduction on the investment account offsets the overstatement and defer the unrealized gain.
(7) Income from Special Foods 15,000 Investment in Special Foods 15,000Defer gain on intercompany land sale to Special Foods
Fully adjusted equity-method entries – 20X1
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:
Consolidation Worksheet – 20X1
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 25,000NCI in NI of Special Foods 10,000
Dividends Declared30,000
Investment in Special Foods241,000NCI in NA of Special Foods
64,000
The amounts in the Income from Special Foods and Investment in Special Foods are reduced by the $15,000 gain deferral (worksheet, Baker p. 316).
Consolidation Worksheet – 20X1
Eliminate gain on sale of land to special FoodGain on Sale of Land 15,000
Land15,000
Consolidation Worksheet—20X1
Adjustments
Parent Sub DR CR ConsolidatedIncome Statement Gain on Sale 15,000 15,000 0 Income from Sub 25,000 25,000
Basic 0
Balance Sheet Investment in Sub 241,000 241,000
Basic 0
Land 155,000 75,000 15,000 215,000
(worksheet, Baker p. 316).
Consolidated Net IncomeThe 20X1 consolidated net income is computed and allocated as follows:
Peerless’ separate income $155,000Less: Unrealized intercompany gain on downstream land sale (15,000)Peerless’ separate realized income $140,000Special Foods’ net income 50,000Consolidate net income, 20X1 $190,000Income to noncontrolling interest ($50,000 X 0.20) (10,000)Income to controlling interest $180,000
Noncontrolling InterestSpecial Foods’ net income for 20X1 is $50,000, and the noncontrolling stockholders’ ownership interest is 20%. The income of $10,000 ($50,000 X 0.20) is allocated to the noncontrolling interest.Noncontrolling interest on December 31, 20X1, is equal to a proportionate share of Special Foods’ book value:
Book value of Special Foods, December 31, 20X1: Common stock $200,000 Retained earnings 120,000 Total book value $230,000Noncontrolling stockholders’ proportionate share X 0.20Noncontrolling interest, December 31, 20X1 $64,000
Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary
following an upstream land transfer.
Upstream Sale of Land• Peerless Products purchases 80% of the common
stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000.• During 20X1, Peerless reports separate income of
$140,000 and declares dividends of $60,000.• Special Foods reports net income of $50,000 and
declares dividend of $30,000.• July 1, 20X1, Special Foods sells land to Peerless for
$35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following
years.
P
S
NCI
20%
80%
Requirement: Peerless’ entry on 20X1 and deferral entry for sold land.
Illustration (p. 318 - 321)Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000.
Peerless Product
SpecialFoods
Jan 1, 20X1Jul 1, 20X1
Purchase land
Inter-corporate transfer of
land
Consolidated Entity
$35 $20
In this this case, Special Foods recognizes a $15,000 gain from selling the land Peerless in addition to the $50,000 of income earned from its regular operations.Special Food’s net income for 20X1 is $65,000. Peerless’ separate income is $140,000.
(8) Investment in Special Foods 52,000 Income from Special Foods 52,000Record Peerless’ 80% share of Special Foods’ 20X1 income
(9) Cash 24,000 Investment in Special Foods 24,000Record Peerless’ 80% share of Special Foods’ 20X1 dividend
Fully adjusted equity-method entries – 20X1
Under the fully adjusted equity method, Peerless Inc. defers relative share of the unrealized gross profit is $12,000 (15,000 X 0.80)
Until resold to external party by Special Food, the carrying value of land must be reduces each time consolidated statements are prepared
(10) Income from special Foods 12,000 Investment in Special Foods 12,000Eliminate unrealized gain on the sale of land to Special Foods
Fully adjusted equity-method entries – 20X1
Partially Owned Upstream Sales Equity Method Adjustment
Similar to what we did with inventory transfers: we must share deferral with the NCI shareholdersSimply split up the adjustment for unrealized gains proportionately.
Unreal. 3,000 Gain To NCI Shareholders
P
S
NCI
20%
80%
Equity MethodAdjustments
Investment in Special Foods
12,000
Income from Special Foods
12,000Defer GainNI 52,000 52,000 NI
40,000
Book Value CalculationsInvestmentAccount Common RetainedNCI (20%) (80%) Stock Earnings
Original book value 60,000 240,000 200,000 100,000+ Net income 13,000 52,000 65,000- Dividend (6,000) (24,000) (30,000)
Ending book value 67,000 268,000 200,000 135,000
=
The amount in Peerless’ Income from Special Foods and Investment in Special Foods accounts by Peerless’ share of the deferral, $12,000 ($15,000 X 0.80).Reduce the NCI in Net Income of Special Foods and NCI in Net Assets of Special Foods by the NCI’s share of the deferral, $3,000 ($15,000 X 0.020)
Consolidation Worksheet – 20X1
Basic investment account elimination entry:Common Stock 200,000Retained Earnings 100,000Income from Special Foods 40,000NCI in NI of Special Foods 10,000
Dividends Declared30,000
Investment in Special Foods256,000NCI in NA of Special Foods
64,000
Consolidation Worksheet – 20X1
Eliminate gain on sale of land to special FoodGain on Sale of Land 15,000
Land15,000
Consolidation Worksheet—20X1
Adjustments
Parent Sub DR CR ConsolidatedIncome Statement Gain on Sale 15,000 15,000 0 Income from Sub 40,000 40,000
Basic 0
Balance Sheet Investment in Sub 241,000 256,000
Basic 0
Land 155,000 75,000 15,000 215,000
(worksheet, Baker p. 319).
Consolidated Net IncomeThe 20X1 consolidated net income is computed and allocated as follows:
Peerless’ separate income $140,000Special Foods’ net income $65,000Less: Unrealized intercompany gain on upstream land sale (15,000)Special Foods’ net income 50,000Consolidate net income, 20X1 $190,000Income to noncontrolling interest ($50,000 X 0.20) (10,000)Income to controlling interest $180,000
Noncontrolling InterestThe income assigned to the noncontrolling shareholders is computed as their proportionate share of the realized income of Special Foods, as follows:
Peerless’ separate income $140,000Less: Unrealized intercompany gain on upstream land sale (15,000)Special Foods’ net income 50,000Proportionate share to noncontrolling interest $190,000
X 0.20Income to noncontrolling interest $10,000
Noncontrolling InterestOn December 31, 20X1, the noncontrolling interest totals $64,000, computed as follows:
Book value of Special Foods, December 31, 20X1: Common stock $200,000 Retained earnings 135,000 Total book value $335,000Unrealized intercompany gain on upstream land sale (15,000)Noncontrolling stockholders’ proportionate share $320,000Noncontrolling stockholders’ proportionate share X 0.20Noncontrolling interest, December 31, 20X1 $64,000
Each period after sale while the asset is held by the purchasing affiliate are adjusted to remove the effects of the unrealized gain or loss. In the example the following eliminating entry is needed in the consolidated worksheet each time a consolidated balance sheet is prepared (downstream):
Eliminating the Unrealized Gain after the First Year
Investment in Special Foods 15,000Land
15,000In the upstream case, the subsidiary recognizes the intercompany gain. The unrealized intercompany gain is eliminated from the reported balance of the land and proportionate with ownership:
Investment in Special Foods 12,000NCI in NA of Special Foods 3,000
Land15,000
Subsequent Disposition of the Asset
PeerlessProducts
Special Foods$20 $45$35
January 1, 20X1Purchase land
for $20,000
July 1, 20X1Intercorporate transfer
of land $35,000
March 1, 20X1Sell land
for $45,000
Consolidated Entity
Investment in Special Foods 15,000Gain on sale of land
15,000
The following eliminating entry is made in the consolidation worksheet prepared at the end of 20X5
Subsequent Disposition of the Asset
In the upstream case, the worksheet treatment would be the same with the downstream transfer except – the debit would be proportionated between Investment in Special Foods ($12,000) and NCI in Net Assets of Special Foods ($3,000) based on the relative ownership interests:
Investment in Special Foods 12,000NCI in NA of Special Foods 3,000
Gain on sale of land15,000
Source:
BAKER CHRISTENSEN COTTLRELLAdvanced Financial Accounting
Ninth Edition
McGRAW HILL INTERNATIONAL EDITION