Elimination of Unrealized Profit on Intercompany Sales of Inventory

2

Elimination of UnrealizedElimination of UnrealizedProfit on Intercompany Profit on Intercompany Sales of InventorySales of Inventory

Advanced Accounting, Fourth Edition

6666

3

1. Describe the financial reporting objectives for intercompany sales of inventory.

2. Determine the amount of intercompany profit, if any, to be eliminated from the consolidated statements.

3. Understand the concept of eliminating 100% of intercompany profit not realized in transactions with outsiders, and know the authoritative position.

4. Distinguish between upstream and downstream sales of inventory.

5. Compute the noncontrolling interest in consolidated net income for upstream and downstream sales, when not all the inventory has been sold to outsiders.

6. Prepare consolidated workpapers for firms with upstream and downstream sales using the cost, partial equity, and complete equity methods.

7. Discuss the treatment of intercompany profit earned prior to the parent subsidiary affiliation.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

4

Upstream and Downstream Sales of Upstream and Downstream Sales of InventoryInventoryUpstream and Downstream Sales of Upstream and Downstream Sales of InventoryInventory

LO 4 Upstream and downstream sales.LO 4 Upstream and downstream sales.

Company P

Company S2

P sells inventory

Downstream

S2 sells inventory Upstream

S1 sells inventory HorizontalCompany S1

Consolidated Entity

Profit (loss) that has not been realized through subsequent sales to third parties must be eliminated in the preparation of consolidated financial statements.

5

The financial reporting objectives are:

Consolidated sales include only sales with parties

outside the affiliated group.

Consolidated cost of sales includes only the cost to

the affiliated group of goods that have been sold to

parties outside the affiliated group.

Consolidated inventory on the balance sheet is

recorded at its cost to the affiliated group.

LO 1 Financial reporting objectives for intercompany sales.LO 1 Financial reporting objectives for intercompany sales.

Effects of Intercompany Sales of Effects of Intercompany Sales of Merchandise onMerchandise onthe Determination of Consolidated the Determination of Consolidated BalancesBalances

Effects of Intercompany Sales of Effects of Intercompany Sales of Merchandise onMerchandise onthe Determination of Consolidated the Determination of Consolidated BalancesBalances

Objective is to eliminate the effects of intercompany sales as if they had never occurred.

6

E6-7: Perkins Company owns 85% of Sheraton Company.

Perkins Company sells merchandise to Sheraton Company

at 20% above cost. During 2011 and 2012, such sales

amounted to $450,000 and $486,000, respectively. At the

end of each year, Sheraton Company had sold all of

inventory purchased from Perkins to third parties.

Required: Prepare the workpaper entries necessary to

eliminate the effects of the intercompany sales for 2011.

Intercompany Sales of Merchandise Intercompany Sales of Merchandise Intercompany Sales of Merchandise Intercompany Sales of Merchandise

Determination of Consolidated Sales, Cost of Sales, and Inventory Balances Assuming Downstream Sales

LO 6 Consolidated workpapers for downstream sales.LO 6 Consolidated workpapers for downstream sales.

Downstream Sales

7



E6-7: Summary of 2011 Intercompany Sales

(COGS) (Inventory)Total Resold On Hand

Intercompany Sales 450,000$ 450,000$ -$ Intercompany COGS 375,000 375,000 - Gross profit 75,000$ 75,000$ -$

1. The “Total” column represents the Sales and COGS booked by Perkins to record the sale to Sheraton. The Sales amount also represents the cost of the inventory recorded by Sheraton.

2. The “Resold” column represents intercompany inventory that was resold to third parties. Portions resold are recorded in COGS.

3. “On Hand” represents intercompany inventory still on hand in the affiliate group.

Downstream Sales

8




Intercompany Sales 450,000$ 450,000$ -$ Intercompany COGS 375,000 375,000 - Gross profit 75,000$ 75,000$ -$

Sales 450,000

Cost of Goods Sold (Purchases)450,000

To eliminate intercompany sales of merchandise

Prepare the workpaper entry to eliminate intercompany sales for 2011.

Downstream Sales

E6-7: Summary of 2011 Intercompany Sales

9

Gross profit may be stated either as a percentage of sales or as a percentage of cost.


Determination of Amount of Intercompany Profit

LO 2 Determining the amount of intercompany profit.LO 2 Determining the amount of intercompany profit.

The amount of intercompany profit subject to elimination should be reduced to the extent that the related goods have been written down by the purchasing affiliate.

Inventory Pricing Adjustments

10

The amount of intercompany profit or loss to be eliminated . . . is not affected by the existence of a minority [noncontrolling] interest.

The complete elimination of the intercompany profit or loss is consistent with the underlying assumption that consolidated statements represent the financial position and operating results of a single business enterprise. [Accounting Research Bulletin (ARB) No. 51, paragraph 14] [ASC 810-10-45-6]


Determination of Proportion of Intercompany Profit to Be Eliminated

LO 3 Eliminating 100% of intercompany profit.LO 3 Eliminating 100% of intercompany profit.

11

Consolidated Retained EarningsConsolidated Retained EarningsConsolidated Retained EarningsConsolidated Retained Earnings Partial Equity

Paque's Retained Earnings on 12/31/13 $ 802,125

Unrealized profit on downstream sales 0

Unrealized profit on upstream sales ($15,000 x 90%)

Consolidated retained earnings on 12/31/2013 $ 788,625

(13,500)

P6-13: Calculate consolidated retained earnings on Dec. 31, 2013.

LO 6 Consolidated workpapers – partial equity method.LO 6 Consolidated workpapers – partial equity method.

12

P6-17: (Note: This is the same problem as Problem 6-7 and 6-13, but assuming the use of the complete equity method.)

Paque Corporation owns 90% of the common stock of Segal Company. The stock was purchased for $810,000 on January 1, 2009, when Segal Company’s retained earnings were $150,000.

The January 1, 2013, inventory of Paque Corporation includes $45,000 of profit recorded by Segal Company on 2012 sales. During 2013, Segal Company made intercompany sales of $300,000 with a markup of 20% of selling price. The ending inventory of Paque Corporation includes goods purchased in 2013 from Segal Company for $75,000. Paque Corporation uses the complete equity method to record its investment in Segal Company.

Complete Equity Method: WorkpaperComplete Equity Method: WorkpaperComplete Equity Method: WorkpaperComplete Equity Method: WorkpaperUpstream Sales

LO 6 Consolidated workpapers – complete equity method.LO 6 Consolidated workpapers – complete equity method.

13

Equity in Subsidiary Income 91,125

Investment in Segal Company 37,125

Dividends declared ($60,000 x 90%) 54,000

P6-17: Prepare the worksheet entries for Dec. 31, 2013.

To reverse the effect of parent company entries for subsidiary dividends and income

1.



14


Intercompany Sales 300,000$ 225,000$ 75,000$ Intercompany COGS 240,000 180,000 60,000 Gross profit 60,000$ 45,000$ 15,000$

2013 Intercompany Sales

2. Sales 300,000

Cost of Goods Sold (purchases) 300,000

3. Cost of Goods Sold (end. inventory) 15,000

Inventory 15,000To eliminate intercompany sales and defer unrealized profit




15


Intercompany SalesIntercompany COGSGross profit 45,000$

2012 Unrealized Profit in Inventory

4. Retained earnings ($45,000 x 90%) 40,500

Noncontrolling Interest ($45,000 x 10%) 4,500

Cost of Goods Sold (beg. inventory) 45,000To realize the gross profit in inventory deferred in the prior

period




16

Beg. Retained Earnings - Segal 180,000

Common Stock - Segal 750,000

Investment in Segal837,000Noncontrolling Interest 93,000To eliminate investment account and create NCI

account

5.


Complete Equity Method: WorkpaperComplete Equity Method: WorkpaperComplete Equity Method: WorkpaperComplete Equity Method: Workpaper


Upstream Sales

17

ConsolidatedIncome Statement Paque Segal Debit Credit NCI BalancesSales 1,650,000$ 795,000$ 300,000 2,145,000$ Equity in Segal income 91,125 91,125 -

Total revenue 1,741,125 795,000 2,145,000 Cost of goods sold 1,290,000 517,500 15,000 300,000 1,477,500

45,000 Other expenses 310,500 206,250 516,750

Total cost and expense 1,600,500 723,750 1,994,250 Net income 140,625 71,250 150,750 Noncontrolling interest 10,125 (10,125) Net income 140,625$ 71,250$ 406,125$ 345,000$ 10,125$ 140,625$

Retained Earnings StatementRetained earnings, 1/1

Paque 798,000 798,000 Segal 180,000 180,000 -

Net income 140,625 71,250 406,125 345,000 10,125 140,625 Dividends declared (150,000) (60,000) 54,000 (6,000) (150,000) Retained earnings, 12/31 788,625$ 191,250$ 586,125$ 399,000$ 4,125$ 788,625$

EliminationsP6-17:

(2)(1)

(4)

(2)

(5)

(1)

NCI in Consolidated Income = 10% ($71,250 + $45,000 – $15,000) = $10,125

(3)



18

ConsolidatedBalance Sheet Paque Segal Debit Credit NCI BalancesCash 93,000$ 75,000$ 168,000$ Accounts receivable 319,500 168,750 488,250 Inventory 210,000 172,500 15,000 367,500 Investment in Segal 833,625 40,500 837,000 -

37,125 Other assets 750,000 630,000 1,380,000

Total assets 2,206,125$ 1,046,250$ 2,403,750$ -

Accounts payable 105,000$ 45,000$ 150,000$ Other current liabilities 112,500 60,000 172,500 Common stock 1,200,000 750,000 750,000 1,200,000 Retained earnings 788,625 191,250 586,125 399,000 4,125 788,625 NCI in net assets 4,500 93,000 88,500

92,625 92,625 Total liab. & equity 2,206,125$ 1,046,250$ 1,381,125$ 1,381,125$ 2,403,750$

Eliminations

(3)

(5)

(5)

(5)

(4)

P6-17:

(1)



(4)

19

Under the complete equity method:

Consolidated net income equals the parent company’s recorded income.

Consolidated retained earnings equals the parent company’s recorded retained earnings.

Complete Equity Method—Analysis of Complete Equity Method—Analysis of Consolidated Net Income and Consolidated Net Income and Consolidated Retained EarningsConsolidated Retained Earnings

Complete Equity Method—Analysis of Complete Equity Method—Analysis of Consolidated Net Income and Consolidated Net Income and Consolidated Retained EarningsConsolidated Retained Earnings


20

To eliminate intercompany sales:

All Methods Sales X Cost of Sales (purchases) X

To eliminate intercompany profit in ending inventory:

All Methods Cost of Sales (ending inventory) X Inventory X

To recognize intercompany profit in beginning inventory realized during the year:

Cost or Partial Beg. Retained Earnings—Parent X Equity Methods Cost of Sales (beg. inventory) X

Complete Equity Investment in S Company XMethod Cost of Sales (beg. inventory) X

Summary of Workpaper EntriesSummary of Workpaper EntriesSummary of Workpaper EntriesSummary of Workpaper Entries

Parent Selling (Downstream)

Illustration 6-21

21

To eliminate intercompany sales:

All Methods Sales X Cost of Sales (purchases) X

To eliminate intercompany profit in ending inventory:

All Methods Cost of Sales (ending inventory) X Inventory X

To recognize intercompany profit in beginning inventory realized during the year:

Cost or Partial Beg. Retained Earnings—Parent X Equity Methods NCI in Equity X

Cost of Sales (beg. inventory) X

Complete Equity Investment in S Company XMethod NCI in Equity X

Cost of Sales (beg. inventory) X

Summary of Workpaper EntriesSummary of Workpaper EntriesSummary of Workpaper EntriesSummary of Workpaper Entries

Subsidiary Selling (Upstream)

Illustration 6-21

Elimination of Unrealized Profit on Intercompany Sales of Inventory

Documents

Transcript of Elimination of Unrealized Profit on Intercompany Sales of Inventory