advanced accounting 6e by jeter chaney chapter 07

Advanced
Accounting
Jeter ● Chaney

Elimination of Unrealized
Gains or Losses on
Intercompany Sales of
Property and Equipment

1

Prepared by Sheila Ammons, Austin Community College


Learning Objectives
• Understand the financial reporting objectives in accounting for
intercompany sales of nondepreciable assets on the consolidated financial
statements.
• State the additional financial reporting objectives in accounting for
intercompany sales of depreciable assets on the consolidated financial
statements.
• Explain when gains or losses on intercompany sales of depreciable assets
should be recognized on a consolidated basis.
• Explain the term “realized through usage”.
• Describe the differences between upstream and downstream sales in
determining consolidated net income and the controlling and
noncontrolling interests in consolidated income.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Learning Objectives

• Compare the eliminating entries when the selling affiliate is a subsidiary
(less than wholly owned) versus when the selling affiliate is the parent
company.
• Compute the noncontrolling interest in consolidated net income when the
selling affiliate is a subsidiary.
• Compute consolidated net income considering the effects of intercompany
sales of depreciable assets.
• Describe the eliminating entry needed to adjust the consolidated financial
statements when the purchasing affiliate sells a depreciable asset that was
acquired from another affiliate.
• Explain the basic principles used to record or eliminate intercompany
interest, rent, and service fees.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
• When there have been intercompany sales of nondepreciable
property, workpaper entries are necessary to:
– Include gains or losses on the sale in consolidated net income
only at the time such property is sold to parties outside the
affiliated group and in an amount equal to the difference
between the cost of the property to the affiliated group and the
proceeds received from outsiders.
– Present nondepreciable property in the consolidated balance
sheet at its cost to the affiliated group.

LO 1 Financial reporting objectives – nondepreciable property.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.

Intercompany Sales of Nondepreciable
Property
Upstream Sale

• E7-4 (variation): Procter Company owns 90% of the
outstanding stock of Silex Company. On January 1,
2014, Silex Company sold land to Procter Company for
$350,000. Silex had originally purchased the land on
June 30, 2010, for $200,000.
• Procter Company plans to construct a building on the
land bought from Silex in which it will house new
production machinery. The estimated useful life of the
building and the new machinery is 15 years.
LO 1 Financial reporting objectives – nondepreciable property.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
E7-4 (variation): Entries made on the books of each affiliate to record
this intercompany sale in 2014.
Entry on Books of Silex
Cash

Entry on Books of Procter
350,000

Land

Land

Cash
350,000

350,000

200,000
Gain on
sale
Note: No further entries are recorded
150,000
on the books of Procter until the
land is
sold to outsiders.

Additional Entry for Complete Equity
Method: Proctor Only
Equity in income

135,000

Investment in Silex
135,000

To reduce its income from subsidiary by its
share of the intercompany gain ($150,000 x
LO 1 Financial
reporting objectives – nondepreciable property.
90%).

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
E7-4: B(1). Prepare the workpaper entries necessary because of the
intercompany sale of land for the year ended December 31, 2014.
Gain on Sale of Land
150,000
Land
($350,000 - $200,000)
To eliminate the $150,000 gain reported by Silex Company and to reduce the
land balance
from the $350,000 recorded on the books of Procter to its
150,000
$200,000 cost to the affiliated group.

LO 1 Financial reporting objectives – nondepreciable property
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
E7-4: B(2). Prepare the workpaper entries for the year ended December
31, 2015.
Upstream Sale
Cost Method and Partial Equity Method
Beg. Retained Earnings – Procter (90%)
Beg. Noncontrolling Interest (10%)

Land
150,000
Complete Equity Method
Investment in Silex Company (90%)
Beg/ Noncontrolling Interest (10%)
Land
150,000

135,000
15,000

135,000
15,000

LO 1 Financial reporting objectives – nondepreciable property
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
E7-4: Summary Points
– Proctor (parent) continues to report the land on their statements
at the intercompany selling price of $350,000. However, in the
consolidated balance sheet, the land is reported at its cost to the
affiliated group of $200,000.
– If the intercompany seller had been the parent (downstream
sale), the entire $150,000 would go to the controlling interest,
resulting in a $150,000 debit to the beginning retained earnings
of the parent company.

LO 1 Financial reporting objectives – nondepreciable property
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
Sales to Outsiders

Upstream Sale

E7-6: P Company owns 90% of the outstanding common
stock of S Company. On January 1, 2015, S Company sold
land to P Company for $600,000. S Company originally
purchased the land for $400,000.
– On January 1, 2016, P Company sold the land
purchased from S Company to a company outside
the affiliated group for $700,000.
LO 1 Financial reporting objectives – nondepreciable property.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
E7-6: A. Calculate the gain on the sale of the land that is recognized on the
books of P Company in 2016.
Selling price to third party
$
700,000
Cost of land to P Company
600,000

Gain recognized
by Pshould
Company
$
B. Calculate
the gain that
be recognized in the
100,000statements in 2016.
consolidated
Selling price to third party
$
700,000
Cost of land to affiliate group
400,000
Gain recognized in consolidation
$
LO 1 Financial reporting objectives – nondepreciable
property.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Nondepreciable
Property
E7-6: C. Prepare the workpaper entries for the year ended December
31, 2016.
Cost Method and Partial Equity Method
Beg. Retained Earnings – Procter (90%)
Noncontrolling Interest (10%)
Gain on Sale of Land
200,000 *

Complete Equity Method
Investment in Silex Company (90%)
Noncontrolling Interest (10%)
Gain on Sale of Land
200,000 *

180,000
20,000

180,000
20,000

* Gain recognized in consolidation less gain recognized by P Company ($300,000 $100,000 = $200,000).
LO 1 Financial reporting objectives – nondepreciable property
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
Realization through Usage
• A firm may sell property or equipment to an affiliate for a price
that differs from its book value.
• From the view of the consolidated entity, the intercompany gain
(loss) is considered to be realized from the use of the property or
equipment in the generation of revenue.
– Because such use is measured by depreciation, the recognition
of the realization of intercompany profit (loss) is accomplished
through depreciation adjustments.

LO 4 Intercompany gain realized through usage.

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
• When there have been intercompany sales of depreciable property,
workpaper entries are necessary to accomplish the following
objectives:
– To report only those gains or losses that result from the sale of
depreciable property to outside parties.
– To present property in the consolidated balance sheet at its cost to
the affiliated group.
– To present accumulated depreciation in the consolidated balance
sheet based on the cost to the affiliated group.
– To present depreciation expense in the consolidated income
statement based on the cost to the affiliated group.
LO 2 Financial reporting objectives— depreciable property.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
Workpaper Elimination Entries
• Firms using the cost or partial equity method
– An additional objective is to equate beginning consolidated retained
earnings with the amount of consolidated retained earnings reported at
the end of the prior reporting.
• Firms using the complete equity method
– This final objective is not necessary because the parent’s retained
earnings already reflects all adjustments accurately.

• For upstream sales
– The entries also serve to equate beginning NCI and prior ending NCI.

LO 2 Financial reporting objectives— depreciable property.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
Upstream Sale
P7-1 (Cost or Partial Equity): Powell Company owns 80% of the
outstanding common stock of Sullivan Company. On June 30, 2014,
Sullivan Company sold equipment to Powell Company for $500,000. The
equipment cost Sullivan Company $780,000 and had accumulated
depreciation of $400,000 on the date of the sale. The management of Powell
Company estimated that the equipment had a remaining useful life of four
years from June 30, 2014. In 2015, Powell Company reported $300,000 and
Sullivan Company reported $200,000 in net income from their independent
operations (including sales to affiliates but excluding dividend or equity
income from subsidiary).

LO 6 Subsidiary vs. parent as the seller.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
P7-1: Entries on the books of Powell and Sullivan to record the
intercompany sale are:
Powell Company

Equipment
Cash
500,000
Sullivan Company

500,000

Cash
Accumulated Depreciation
Equipment
780,000
Gain on Sale of Equipment
120,000

500,000
400,000

LO 6 Subsidiary vs. parent as the seller.

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
P7-1: A. Prepare the workpaper entries necessary because of the sale of
equipment for the year ended December 31, 2014.

2014

Equipment

280,000
Gain on Sale of Equipment
120,000
Accumulated Depreciation - Equipment
400,000
To eliminate the intercompany gain and restore equipment to its original cost to
the consolidated entity.
LO 6 Subsidiary vs. parent as the seller.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
P7-1: A. Prepare the workpaper entries necessary because of the sale of
equipment for the year ended December 31, 2014.

2014

Accumulated Depreciation - Equipment
Depreciation Expense ($30,000/2)
15,000

15,000

To adjust depreciation expense to the correct amount to the consolidated entity,
thus realizing a portion of the gain through usage.
LO 6 Subsidiary vs. parent as the seller.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.

Intercompany Sales of Depreciable
Property
P7-1: A. Prepare the workpaper entries necessary because of the sale of
equipment for the year ended December 31, 2015.

2015

Equipment (to original cost)
Beg. Retained Earnings - Powell ($120,000 x 80%)
Noncontrolling Interest ($120,000 x 20%)
Accumulated Depreciation - Equipment
400,000

280,000
96,000
24,000

To eliminate prior period intercompany gain and restore equipment to its original cost to
the consolidated entity.
LO 7 Computing the noncontrolling interest.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
P7-1: A. Prepare the workpaper entries necessary because of the sale of
equipment for the year ended December 31, 2015.

2015

Accumulated Depreciation - Equipment
Depreciation Expense ($120,000/4)
30,000
Beg. Retained Earnings – Powell ($15,000 x 80%)
12,000
Noncontrolling Interest ($15,000 x 20%)
3,000

45,000

LO 7 Computing the noncontrolling interest.

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
P7-1 (variation): For the Compete Equity Method, the 2015
workpaper entries would have changed as follows:
Equipment (to original cost)
Investment in Sullivan ($120,000 x 80%)
Noncontrolling Interest ($120,000 x 20%)
Accumulated Depreciation - Equipment
400,000

280,000
96,000
24,000

Accumulated Depreciation - Equipment

45,000
Depreciation Expense ($120,000/4)
30,000
Investment in Sullivan ($15,000 x 80%)
12,000
Noncontrolling Interest ($15,000 x 20%)
LO 7 Computing the noncontrolling interest.
3,000
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
P7-1 (variation): If this had been a Downstream sale, the 2015 entries
would have changed as follows:
Cost or Partial Equity
Noncontrolling interest of 20% would be included in Beginning
Retained Earnings of Powell Company.
Complete Equity Method
Noncontrolling interest of 20% would be included in Investment
in Sullivan.
There is no differentiation between Controlling interest and
Noncontrolling interest with Downstream Intercompany Sales.
LO 7 Computing the noncontrolling interest.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
Year Subsequent to Intercompany Sale

Upstream Sale
P7-6 (Cost Method): Pitts Company owns 80% of the common stock of
Shannon Company. The stock was purchased for $960,000 on January 1,
2012, when Shannon Company’s retained earnings were $675,000. On
January 1, 2014, Shannon Company sold fixed assets to Pitts Company for
$960,000; Shannon Company had purchased these assets for $1,350,000 on
January 1, 2004, at which time their estimated useful life was 25 years. The
estimated remaining useful life to Pitts Company on 1/1/14 is 10 years. Both
companies employ the straight-line method of depreciation.
Required: A. Prepare a consolidated statements workpaper for the year
ended December 31, 2015.

LO 6 Workpaper entries-upstream sales.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Intercompany Sales of Depreciable
Property
Upstream Sale
P7-6 (Cost Method):
(4)

(3)

(2)

(1)
(3)

(5)
(4)

NCI in Consolidated Income = 20% x ($300,000 + $15,000) = $63,000

LO 6 Workpaper entries-upstream sales.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.