Hoyle Chap 5 Yoel 12e Students

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Chapter Five

Consolidated Financial Statements–Intra-Entity

Asset Transactions

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Intra-entity Transactions

Transactions between the parent and subsidiary are considered “internal” transactions of a single economic entity.

The effects of these intra-entity transactions should be eliminated from the consolidated financial statements.

Thus, consolidated statements only reflect transactions with outside parties.

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CONSOLIDATION RECORD Page ##Date Description Debit Credit

Sales $$$ Cost of Goods Sold $$$ENTRY TI (Eliminates "transferred inventory")

Note: Assuming inventory has been re-sold to a third-party, both companies have debited COGS and credited Sales for the same inventory.

Intra-entity Transactions – Inventory Transfers

ENTRY TIEliminate all intra-entity sales/purchases of inventory, by eliminating the sales price of the transfer – which one company recorded as sales, and the other recorded as cost of goods sold.

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Cost of Goods Sold $$$ Inventory $$$ENTRY G (eliminates gain)

Note: Any inventory that was ‘marked-up’ in an I/C transfer must be returned to it’s original cost if it has not been sold to an outside party.


ENTRY GDespite Entry TI, ending inventory is still overstated by the amount of gain on any inventory that remains unsold at year end.We must eliminate the unrealized gain as follows:

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R/E (Beg. Bal. of seller) $$$ COGS (Beg. Inv. Component) $$$ENTRY *G


ENTRY *GIn the year that the inventory is subsequently sold to a third party, the I/C gain is in beginning Retained Earnings on the seller’s books, and must be moved to Consolidated Income.

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Note: The separate records of each company still contain the I/C transactions, including any gain that was recorded at the time they occurred.

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Unrealized Inventory Gain - Other issues

If it’s DOWNSTREAM, then any unrealized gain belongs to the parent.

If it’s UPSTREAM, then any unrealized gain belongs to the subsidiary. We will reduce the Sub’s net income by the unrealized gain prior to

calculating the noncontrolling interest’s share. Note: FASB does not provide clear guideline on the allocation of

the unrealized gain between the parent and non-controlling Interest (see page 209 of textbook)

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Does it matter if the sale is Upstream or Downstream?

YES!!

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Unrealized Gross Profits –Effect on Noncontrolling Interest

According to FASB ASC paragraph 810-10-45-6: The amount of intra-entity profit or loss to be eliminated is not affected

by the existence of a noncontrolling interest.

The complete elimination of the intra-entity profit or loss is consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity.

The elimination of the intra-entity profit or loss may be allocated proportionately between the parent and noncontrolling interest.

In this class, the noncontrolling interest’s share of consolidated net income is computed based on the reported income of the subsidiary after adjustment for any unrealized upstream gross profits.

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Investment in Subsidiary $$$ COGS (Beg. Inv. Component) $$$ENTRY *G


ENTRY *G If the transfer of inventory is downstream AND the parent uses the

equity method, then parent’s retained earnings are appropriately stated. The following entry is used to recognize the remaining unrealized profit

left at the end of the previous year.

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Note: Investment in Subsidiary account replaces the Retained Earnings account used for upstream sales.Note: an acceptable alternative to “Investment in Subsidiary” account is the “Equity in Subsidiary Income” (see footnote 6 in the textbook).

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Downstream Transfers When Parent Uses Equity Method

For intra-entity beginning inventory profits resulting from downstream transfers when the parent applies the equity method: Parent’s retained earnings are appropriately stated due to

intra-entity profit deferrals and recognition. The subsidiary retained earnings reflect none of the intra-

entity profit and require no adjustment. The parent’s investment account at beginning of Year 2

contains a credit from the deferral of Year 1 downstream profits.

Worksheet Entry *G transfers the Year 1 Investment account credit to a Year 2 earnings credit via COGS to recognize the profit in the year of sale to outsiders.

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Intra-entity Transactions – Upstream Inventory Transfer

Large Company owns 100% of the voting stock of Small Company.

During 2010, Large buys 800 widgets from Small for $80,000.

The widgets originally cost Small $50,000. At year-end on December 31, 2010, Large still had 200 of

the units on hand.

Prepare the consolidation entries on 12/31/10 to eliminate the unrealized gain.

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Consolidation WorksheetEntry Date Description Debit Credit

TI 31-Dec Sales 80,000 Cost of Goods Sold 80,000


First, the entire intra-entity transfer must be

eliminated.

{

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TI 31-Dec Sales 80,000 Cost of Goods Sold 80,000

G 31-Dec Cost of Goods Sold 7,500 Inventory 7,500


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Next, eliminate the unrealized gain:

Original Gain x % Unsold = Unrealized Gain $30,000 x (200/800) = $7,500

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*G 31-Dec Retained Earnings 7,500 Cost of Goods Sold 7,500


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And in a subsequent year when the inventory is sold to a third party, we will reverse Entry G to realize the gain.

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Intra-entity Transactions –Inventory Transfer

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And the exception is…

If the transfer is downstream and the parent uses the equity method, then their Retained Earnings balance has already been adjusted for the gain, and we adjust the Investment in Subsidiary account instead.

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The Effect of Land Transfers on Noncontrolling Interests

DOWNSTREAM transfers have

no effect on noncontrolling

interest.

UPSTREAM transfers have a gain on the

SUBSIDIARY books!All noncontrolling

interest balances are based on the sub’s

net income EXCLUDING the intra-entity gain

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Problem 31:

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Problem 31:

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Problem 31:

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Problem 31:

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Problem 31:

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McIlroy Stinson Adj. & Elim. NCI Consolidated

Sales (700,000) (335,000) Cost of goods sold 460,000 205,000

Operating expenses 188,000 70,000 Income of Stinson (28,000)

Separate company income (80,000) (60,000) Consolidated net income to noncontrolling interest to parent

Retained earnings, 1/1 (695,000) (280,000) Net income (above) (80,000) (60,000) Dividends paid 45,000 15,000 Retained earnings, 12/31 (730,000) (325,000)

Cash and receivables 248,000 148,000 Inventory 233,000 129,000 Investment in Stinson 411,000 -0-

Buildings (net) 308,000 202,000 Equipment (net) 220,000 86,000 Patents (net) -0- 20,000 Customer list Goodwill Total assets 1,420,000 585,000 Liabilities (390,000) (160,000) Common stock (300,000) (100,000) Noncontrolling interest 1/1

Noncontrolling interest 12/31 Retained earnings, 12/31 (730,000) (325,000) Total liabilities and equities (1,420,000) (585,000)

Problem 31:

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Gain on Sale of Land $$$ Land $$$ENTRY TL

Intra-entity Transactions – Land Transfer

ENTRY TLIf land is transferred between the parent and sub at a gain, the gain is considered unrealized and must be eliminated.

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Note: By crediting land for the same amount, this effectively returns the land to its carrying value on the date of transfer.

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R/E (Beg. Bal. of seller) $$$ Land $$$ENTRY *GL

Intra-entity Transactions -Land Transfer

ENTRY *GLAs long as the land remains on the books of the buyer, the unrealized gain must be eliminated at the end of each fiscal period.

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Note: The original gain was closed to R/E at the end of that period. When we eliminate the gain in subsequent years, it must come from R/E.

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R/E (Beg. Bal. of seller) $$$ Gain on Sale of Land $$$ENTRY *GL (Year of sale)

Intra-entity Land TransfersEliminating Unrealized Gains

ENTRY *GL (Year of sale)In the period the land is sold to a third party, the unrealized gain must be eliminated one more time, and also finally recognized as a REALIZED gain in the current period’s consolidated financial statements.

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Note: Modify the entry to credit the Gain account instead of Land.

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Intra-entity Transactions – Depreciable Asset Transfers

Example of Depreciable Asset Transfer Able Co and Baker Co are related parties. Able purchased equipment for $100,000 several years

ago, and has recorded $40,000 of depreciation since that time.

Baker buys the equipment from Able for $90,000 on 1/1/10.

The equipment has a remaining useful life of 10 years.

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On the Seller’s Books:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000

Accumulated Depreciation . . . . . . . . .40,000

Equipment . . . . . . . . . . . . . . . . . . . . . $100,000

Gain on Sale of Equipment . . . . . . . . . . 30,000

NOTE: The seller WOULD record depreciation expense at $6,000 per year if they had not sold the equipment.

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On the Buyer’s Books:

Equipment. . . . . . . . . . . . . . . . . . . . . $90,000

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000

NOTE: The buyer WILL record $9,000 per year in depreciation based on the remaining life.

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Intra-entity Transactions -- Depreciable Asset Transfers

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

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ENTRY EDIn addition, the buyer’s depreciation is based on the inflated transfer price. The excess depreciation expense must be eliminated.

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In Years Following the Year of Transfer Equipment is carried on the individual books at a

different amount than on the consolidated books.

The amounts change each year as depreciation is computed.

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To get the worksheet adjustments, compare the individual records to the consolidated records.

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On Baker’s (buyer’s) books, the annual depreciation = $90,000 ÷ 10 yrs. = $9,000 per year.

The 1/1/11 R/E effect = the original gain of $30,000 on Able’s (seller’s) books less one year of depreciation.

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For the consolidated entity, the annual depreciation = $48,000 remaining BV ÷ 8 yrs. = $6,000 per year.

The Accumulated Depreciation at 12/31/11 = $40,000 accumulated depreciation at 12/31/09 + two years of depreciation.

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The consolidation worksheet adjustments appear in the last column.

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ENTRY *TA (Subsequent Years)The adjustment to fixed assets and depreciation expense must be made in each succeeding period. The entry for the consolidation is:

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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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And the exception is…

If the transfer is downstream and the parent uses the equity method, then their Retained Earnings balance has already been reduced for the gain, and we adjust the Investment account instead.

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Summary

Transfers of assets among related parties are common.

In consolidated financial statements, the effects of these transfers must be removed.

Transfers of depreciable assets create the additional accounting issue of differing depreciation expense. This effect is eliminated on the consolidation worksheets.

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Possible Criticisms

No formal accounting pronouncements address valuation of noncontrolling interests in intra-entity gains.

Traditionally, the deferral of gains from upstream sales is presumed to affect the noncontrolling interest, whereas downstream sales do not.

WHAT DO YOU THINK???

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Hoyle Chap 5 Yoel 12e Students

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