Advanced accounting 10th by a beams athony ch05

Chapter 5: Intercompany Profit
Transactions – Inventories
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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Intercompany Profits –
Inventories: Objectives
1.
2.
3.

Understand the impact of intercompany profit for inventories on preparation of
consolidation working papers.
Apply the concepts of upstream versus downstream inventory transfers.
Defer unrealized inventory profits remaining in ending inventory of either the parent or
subsidiary.

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5-2


Objectives (cont.)

4.
5.

Recognize realized, previously deferred inventory profits in the beginning inventory of
either the parent or subsidiary.
Adjust the calculations of noncontrolling interest amounts in the presence of
intercompany inventory profits.

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5-3


Intercompany Profit Transactions – Inventories

1: Intercompany Inventory Profits

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5-4


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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5-5


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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5-6

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
Cost of sales
Sales = $1,000 / (1-30%) = $1,429

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1,429

1,429

5-7


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
Cost of sales
Sales = $900 / (1-40%) = $1,500
Cost of sales
Inventory
Ending inventory profit = $200 x 40%
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1,500
1,500
80
80
5-8


Intercompany Profits Beginning
and Ending Inventories

Last 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
Inventory

60
60

Ending inv. profits = $260 x 30%/130%

Investment in Subsidiary
Cost of sales
Begin. inv. profits = $120 x 25%/125% = $24

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24
24
5-9


Intercompany Profit Transactions – Inventories

2: Upstream & Downstream
Inventory Sales

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5-10


Upstream and Downstream Sales
Downstream
Sales
Parent
Subsidiary sells
to parent

Parent sells to
subsidiary
Subsidiary 1

Subsidiary 2

Subsidiary 3
Upstream Sales

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5-11


Intercompany Inventory Sales
•

The worksheet entries for eliminating intercompany profits for downstream sales

Sales
Cost of sales

XXX
XXX

For upstream sales, the last entry would also include a debit to noncontrolling interest, splitting
For
salescontrolling
price and noncontrolling interests.
the the
profitintercompany
to be realized between

Cost of sales
Inventory

XX

XX

For the profits in ending inventory

Investment in Subsidiary
Cost of sales

XX
XX

For the profits in beginning inventory

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5-12


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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5-13


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
Income from subsidiary
$3,764
 
$2,400

NCI 20% share

When parent makes the IC
sale, the impact of deferring
and recognizing profits falls all
to the parent.
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$950
 
 
 
$600
5-14


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
When subsidiary makes the IC sale,
the impact of deferring and
recognizing profits is split among
controlling and noncontrolling
interests.

CI 80% share
$3,800
(48)
19.2
Income from subsidiary
$3,771.2
 
$2,400
NCI 20% share

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$950.0
(12.0)
4.8 
 $942.8
$600

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Intercompany Profit Transactions – Inventories

3: Unrealized Profits in Ending
Inventories
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5-16


Ending Inventory on Hand
•

Intercompany profits in ending inventory

– Eliminate at year end
•

Working paper entry

Cost of sales
Inventories
For the unrealized profit

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XXX
XXX

5-17


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 inventory
40%(6,250) = $2,500
• Porter's Income from Sorter
90%(10,000) – 2,500 unreal. Profits = $6,500
• Noncontrolling interest share
10%(10,000) = $1,000
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5-18


Entries
•

Porter's journal entry to record income

Investment in Sorter

6,500

Income from Sorter

•

6,500

Worksheet entries to eliminate intercompany sale and unrealized profits

Sales

15,000

Cost of sales
Cost of sales
Inventory
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15,000
2,500
2,500
5-19


Worksheet – Income Statement
 

Porter Sorter

Sales

$100.0

Income from Sorter

6.5  

Cost of sales

(60.0)

Expenses

(15.0)

Noncontrolling interest share
Controlling interest share

$50.0

 

(35.0)
(5.0)  
 

$31.5

$7.5  

DR

CR

Consol

15.0  

$135.0

6.5  

0.0

2.5 15.0

(82.5)

 

(20.0)

1.0  

(1.0)

 

$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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5-20


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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5-21


Intercompany Profit Transactions – Inventories

4: Recognizing Profits from
Beginning Inventories
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5-22

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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5-23


Intercompany Profit Transactions – Inventories

5: Impact on Noncontrolling Interest

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5-24


Direction of Sale and NCI
The 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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5-25