Chapter Five

1
Chapter Five
Consolidated Financial Statements Intercompany
Asset Transactions
2
Intercompany Inventory Transactions

• Transactions between the parent and subsidiary
  are viewed as internal transactions of a single
  economic entity.
• The effects of those transactions should be
  eliminated from the consolidated financial
  statements.

3
Intercompany Inventory Transactions

• ENTRY TI
• On the consolidation worksheet, eliminate ALL
  intercompany sales/purchases of inventory.
• The elimination amount is the -amount assigned
  as the sales price of the transfer.

Purchases component of COGS.
4
Unrealized Inventory GainsYear of Transfer

• ENTRY G
• Despite Entry TI, ending inventory is still
  overstated by the amount of gain on the inventory
  that is still unsold at year end.
• We must eliminate the unrealized gain as follows

Ending Inventory component of COGS.
5
Unrealized Inventory GainsYear Following Year of
Transfer

• ENTRY G
• If the inventory was sold during the year, the
  gain is now in Retained Earnings and must be
  moved back to Income.

Subsidiary (In case of an upstream)
Note this part of the entry serves to increase
the income for the current year (very important
for upstream!)
6
Unrealized Inventory GainsYear Following Year of
Transfer

• ENTRY G
• If the transfer of inventory is DOWNSTREAM if
  the parent uses the Equity Method, then the
  following entry is used to recognize the
  remaining unrealized profit left at the end of
  the previous year. (see explanation on next slide)

7
Unrealized Inventory GainsYear Following Year of
Transfer

• Recall from chapter 1, that the Equity Method,
  treats upstream sales the same way as downstream
  sales and that the following deferred (original)
  entry is made (which is reversed in the following
  year, when the inventory item is sold)
• (see page 18)

8
Unrealized Inventory GainsYear Following Year of
Transfer

• A C Conversion entry may be required if a
  method other than the equity method were being
  used.
• In such a case, the deferral of unrealised gains
  impact on the subsidiarys net income (and
  ultimately, the parent companys income accrual)
  are ignored for downstream sales, but are
  adjusted for on upstream sales (because they
  affect the subsidiarys net income)

9
Inventory TransfersExample

• On April 5, 2005 World Co (parent) buys 1,000
  widgets from Sub, Inc. for 500,000. The widgets
  originally cost Sub, Inc. 400,000.
• At year-end on December 31, 2005, World Co. still
  had 250 of the units on hand.
• Record the consolidation entries on 12/31/05 to
  eliminate the unrealized gain.

10
Inventory TransfersExample

First, the entire intercompany transfer must be
eliminated.
11
Inventory TransfersExample
12
Unrealized Inventory GainsEffect on
Noncontrolling Interest

• If the transfer is DOWNSTREAM, then any resulting
  unrealized gain belongs to the parent.
• No effect on Noncontrolling Interest i.e.
• NCIs share of income NCI x Sub Net Income
• If the transfer is UPSTREAM, then any resulting
  unrealized gain belongs to the subsidiary.
• Noncontrolling Interest must be adjusted for the
  unrealized gain. (see next slide)

13
Unrealized Inventory GainsEffect on
Noncontrolling Interest
Noncontrolling Interest in Sub Net Income the
noncontrolling of the subs net income, AFTER
eliminating both UPSTREAM unrealized intercompany
profits (i.e. those reversed from prior year and
those deferred from current year
14
Intercompany Land TransfersEliminating
Unrealized Gains

• ENTRY TL
• If land is transferred between the parent and sub
  at a gain, the gain is considered unrealized and
  must be eliminated.
• By crediting land for the same amount, this
  effectively returns the land to its carrying
  value on the date of transfer.

15
Intercompany Land TransfersEliminating
Unrealized Gains

• ENTRY GL
• As long as the land remains on the books of the
  buyer, the unrealized gain must be eliminated at
  the end of each fiscal period.
• The original gain appeared on last periods
  income statement. Now, the gain resides in R/E.
  Therefore, when we eliminate the gain, it must
  come from R/E.

If it were a downstream sale and the equity
method were being used by the parent, the
Investment account would have been debited. (See
page 227)
16
Intercompany Land TransfersEliminating
Unrealized Gains

• ENTRY GL (Year of sale)
• In the year of disposal, modify the entry GL, so
  that the unrealized gain must be eliminated one
  more time, and also recognized as a REALIZED gain
  in the current periods consolidated financial
  statements.

17
Land TransfersExample

• On June 25, 2004 World Co. (parent) sells a 30
  acre tract of land originally costing 600,000 to
  Sub, Inc. for 750,000.
• At year-end on December 31, 2006 Sub Inc. still
  owns the land.
• Record the appropriate consolidation entry on
  12/31/06.

18
Land TransfersExample
This entry must be made at the end of each year
as long as the land is still on the books.
19
The Effect of Land Transfers on Noncontrolling
Interests
If the transfer is DOWNSTREAM, there is no effect
on noncontrolling interest.
20
The Effect of Land Transfers on Noncontrolling
Interests
If the transfer is DOWNSTREAM, there is no effect
on noncontrolling interest.
21
Intercompany Transfer of Depreciable Assets

• ENTRY TA
• In the year of transfer, the unrealized gain must
  be eliminated and the assets restated to original
  historical cost.

22
Intercompany Transfer of Depreciable Assets

• ENTRY ED
• In addition, the buyers depreciation is based on
  the inflated transfer price. The excess
  depreciation expense must be eliminated.

23
Intercompany Transfer of Depreciable Assets

• In Years Following the Year of Transfer
• The equipment is carried on the individual books
  at a different amount than on the consolidated
  books.
• These amounts change each year as depreciation is
  computed.
• To get the worksheet adjustments, compare the
  individual records to the consolidated records.

24
Intercompany Transfer of Depreciable Assets

• Big Wheel Trucking (BWT) owns 80 of Quick
  Delivery, Inc. On 1/1/04, Quick Delivery has a
  truck on the books with an original cost of
  100,000, and accumulated depreciation of 60,000
  (4 year remaining useful life, 0 salvage value,
  straight-line).
• Quick Delivery sells the truck to BWT for
  80,000.
• Analyze the information in preparation for making
  entries on 12/31/05.

25
Intercompany Transfer of Depreciable Assets

• On BWTs books, the annual depreciation 80,000
  4 yrs. 20,000 per year.
• The 1/1/05 R/E effect the original gain of
  40,000 on Quick Deliverys books less 1 year of
  depreciation.

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Intercompany Transfer of Depreciable Assets

• For the consolidated entity, the annual
  depreciation 40,000 remaining BV 4 yrs.
  10,000 per year.
• The Acc. Depr. At 12/31/05 60,000 accumulated
  depreciation at 1/1/04 2 years of depreciation.

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Intercompany Transfer of Depreciable Assets

• The consolidation worksheet adjustments appear in
  the last column.

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Intercompany Transfer of Depreciable Assets

• ENTRY TA (Subsequent Years)
• The adjustment to fixed assets and depreciation
  expense must be made in each succeeding period.
  The entry for the BWT/Quick Delivery
  Consolidation is

As with land, if it were a downstream sale and
the equity method were being used by the parent,
the Investment account would have been debited.
(See page 231)
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Intercompany Transfer of Depreciable Assets

• ENTRY ED (Subsequent Years)
• In addition, we must adjust for the difference in
  Depreciation Expense on the two income
  statements. The entry for our example is

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End of Chapter 5
Hey, Chester, ol buddy! Im thinkin we need
to switch desks in a little intercompany
transfer.