Fischer11e PPT Ch04
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Transcript of Fischer11e PPT Ch04
FISCHER | TAYLOR | CHENG
Intercompany Transactions: Merchandise, Plant Assets,
and Notes
COPYRIGHT © 2012 South-Western/Cengage Learning 2
Learning Objectives (1 of 2)
1. Explain why transactions between members of a consolidated firm should not be reflected in the consolidated financial statements.
2. Defer intercompany profits on merchandise sales when appropriate and eliminate the double counting of sales between affiliates.
3. Defer profits on intercompany sales of long-term assets and realize the profits over the period of use and/or at the time of sale to a firm outside the consolidated group.
COPYRIGHT © 2012 South-Western/Cengage Learning 3
Learning Objectives (2 of 2)
4. Demonstrate an understanding of the profit deferral issues for intercompany sales of assets under long-term construction contracts.
5. Eliminate intercompany loans and notes.
6. Discuss the complications intercompany profits create for the use of the sophisticated equity method.
7. (Appendix) Apply intercompany profit eliminations on a vertical worksheet.
COPYRIGHT © 2012 South-Western/Cengage Learning 4
Typical Intercompany Transactions
• Merchandise for resale• Land• Fixed assets• Long-term construction contracts• Notes receivable/payable
COPYRIGHT © 2012 South-Western/Cengage Learning 5
Intercompany merchandise sales
• Sales between affiliated companies are recorded in the normal manner on the books of the separate companies.
• For the consolidated financial statements– Do not involve parties outside the consolidated group– Cannot be acknowledged in consolidated statements
• Procedures for consolidating affiliated companies with intercompany merchandise sales
1. Eliminate the intercompany sale
2. Eliminate related intercompany (i.e., internal) debt/receivable
3. Profit is realized when the goods are sold to an outside party
COPYRIGHT © 2012 South-Western/Cengage Learning 6
Combined Inc Stmtwithout eliminations
Sales ($1,200 + $1,500) $2,700C of GS ($1,000 + $1,200) 2,200Gross Profit 500Gross profit pctg 18.5%
Example of an intercompany sale
Co. P Co. S Outside$1,000
sells to S $1,200sells to outside $1,500
Consolidated Inc Stmt inter-company transaction eliminatedSales $1,500Cost of Goods Sold 1,000Gross Profit 500Gross profit pctg 33.3%
The “intercompany sale” of $1,200 is eliminated on the worksheet
COPYRIGHT © 2012 South-Western/Cengage Learning 7
Intercompany Price
Does the intercompany price matter?Yes, if there is an NCI
• the reported net income of the subsidiary reflects the intercompany sales price
• the subsidiary's separate income statement becomes the base from which the noncontrolling share of income is calculated.
• if Company S is an 80%-owned subsidiary, the NCI will receive 20% of the $300 ($1,500 - $1,200) profit made on the final sale by Company S, or $60.
COPYRIGHT © 2012 South-Western/Cengage Learning 8
Mark-up Confusion
Mark-up on cost ≠ gross profit!
Marking a $10 cost unit up 25%$10.00 125% = $12.50
Provides a gross profit of 20%$2.50 $12.50 = 20%
COPYRIGHT © 2012 South-Western/Cengage Learning 9
Merchandise: Example
• S (P owns 80%) buys goods for $80,000 and sells them to P for $100,000; all sales are at 20% gross profit
• P’s inventory of intercompany goods– Beginning: $10,000– Ending: $15,000
• P owes S $8,000 for intercompany goods at year end
COPYRIGHT © 2012 South-Western/Cengage Learning 10
Consolidation Procedures Needed
IS Eliminate sale from subsidiary to parent
BI Reduce cost of goods sold for profit in beginning inventory and correct beginning retained earnings (allocated 20/80 because sale was by subsidiary)
EI Reduce ending inventory and increase cost of goods sold (ending inventory value contains intercompany profit)
IA Eliminate intercompany trade balance
COPYRIGHT © 2012 South-Western/Cengage Learning 11
Worksheet Eliminations
Partial Worksheet Trial Balances Eliminations Co. P Co. S Dr Cr
Ending inventory 15,000 EI 3,000
Accounts receivable 8,000 IA 8,000
Accounts payable 8,000 IA 8,000
RE – Co. S 50,000 BI 400
RE – Co. P 120,000 BI 1,600 Sales 130,000 100,000 IS 100,000
Cost of goods sold 95,000 80,000 EI 3,000 IS 100,000 BI 2,000
COPYRIGHT © 2012 South-Western/Cengage Learning 12
Adjustments on the IDS
End inv profit (EI) 3,000$ Int generated inc 20,000$ Beg inv profit (BI) 2,000 Adjusted inc 19,000$ NCI % 20%NCI 3,800$
Int generated inc 35,000$ 80% of Sub's adjusted income 15,200 Controlling interest 50,200$
Subsidiary
Parent
COPYRIGHT © 2012 South-Western/Cengage Learning 13
Worksheet 4-3
• The 4 eliminations are IS, IA, BI, EI
• In elimination BI, adjustment to RE is split because partially-owned sub was the seller. – If parent or wholly-owned sub is seller, adjust only to
parent’s RE
• Seller’s profit is adjusted through IDS – In this case, the adjustments went to the sub (seller) – They would go to parent if parent was seller
COPYRIGHT © 2012 South-Western/Cengage Learning 14
Worksheet 4-3 (continued)
• If there is an LCM adjustment, only the remaining profit is eliminated
• Losses (sales below market value) are also eliminated
• Worksheet 4-4 shows the same adjustments for a periodic inventory
COPYRIGHT © 2012 South-Western/Cengage Learning 15
Intercompany Sale: Nondepreciable Asset
Year of sale:LA Gain on sale 20,000Land 20,000
Run adjustment through seller’s IDS
Gain is deferred until asset (land) is sold to outside party
Later years: LA RE (split?) 20,000Land 20,000
Adjustment is split if seller was partially-owned Sub
Year of sale to outside party:LA RE (split?) 20,000
Gain on sale 20,000Seller may finally recognize gain; credit to seller’s IDS
COPYRIGHT © 2012 South-Western/Cengage Learning 16
Intercompany Depreciable Asset Sale: Year of Sale
Sell 5-year machine, NBV $20,000, for $30,000 on 1/1/2011
Theory: Defer gain and earn it back over period of use.The allocation method matches the depreciation method (straight-line for this example)
Year of sale:F1 Gain (seller) 10,000 defer gain on sale
Machine 10,000 return asset to cost
F2 Accum. Depr. 2,000 reduce to depr. on cost
Depr. Expense 2,000 recognize 1/5 profit
IDS: Deduct original profit from seller and add profit equal to depreciation adjustment
COPYRIGHT © 2012 South-Western/Cengage Learning 17
Intercompany Depreciable Asset Sale: Year Subsequent to Intercompany Sale
End of second year:
Adjust asset at start of year
F1 RE (split?) 8,000 deferred gain on 1/1/12
Accum. Depr. 2,000 adjust prior year’s depr.
Machine 10,000 return asset to cost
RE adjustment is split when partially-owned sub is seller
Adjust current year depreciation
F2 Accum. Depr. 2,000 reduce to depr on cost Depr. Expense 2,000 recognize 1/5 profit
IDS: Seller gets profit equal to depreciation adjustment
COPYRIGHT © 2012 South-Western/Cengage Learning 18
Fixed Asset Worksheets
WS 4-5 (year of sale)
• F1 eliminate $10,000 gain; reduce machine to book value
• F2 adjusts current depreciation and realizes $2,000 gain
• IDS of seller: defer $10,000 gain; realize $2,000
WS 4-6 (end of second period after sale)
• F1 removes profit from machine value; eliminates gain unrealized as of beginning of year from RE of seller; adjusts Accum Dep for profit realized in prior year(s)
• F2 adjusts current depreciation and realizes $2,000 gain
• IDS of seller: realize another $2,000 of the gain
COPYRIGHT © 2012 South-Western/Cengage Learning 19
Fixed Asset Worksheets (continued)
WS 4-7 (Asset sold to outside party at end of second year)
• Machinery and accumulated depreciation are not there to adjust
• The $6,000 remaining gain at the start of the year is now earned (sale to outside occurred)
• F3 Combining the $6,000 deferred gain ($10,000 original less $4,000 recognized - $2,000 in 2011 and 2012) and the recorded $4,000 loss on sale to outside party creates a gain on the consolidated statement of $2,000
COPYRIGHT © 2012 South-Western/Cengage Learning 20
Long-Term Construction Contracts
Completed – Like any other fixed asset sale
Not Complete using Completed Contract Method:– Eliminate seller’s Billings and Cost of Construction in
Progress; adjust buyer’s Asset Under Construction for unbilled costs incurred by seller
– Eliminate intercompany debt balance
Not Complete using Percentage of Completion:– Key is to defer profit recorded by builder and restore
asset under construction to cost– Eliminate intercompany debt balance
COPYRIGHT © 2012 South-Western/Cengage Learning 21
Intercompany Debt
• Typically Parent lends to Sub• Eliminations
– LN1 Intercompany payables and receivables– LN2 Interest expense and revenue
• Income distribution schedule– Sub’s internally generated net income is not adjusted
for incurred intercompany interest expense
COPYRIGHT © 2012 South-Western/Cengage Learning 22
Sophisticated Equity Method:Intercompany Transactions
• Sophisticated equity method records subsidiary income net of all intercompany profits
• Parent prepares an IDS-Subsidiary to determine and record its share of subsidiary income
• Unrealized profits of prior periods– Parent’s beginning RE does not include– Sub’s beginning RE does include– Adj replaces BI to remove intercompany profit from
Sub’s beginning RE and Parents’s beginning inv