BCLAA8e_ab.az.Chapter_05

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5 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Intercompany Profit

Transactions ± Inventories

Chapter 5




Learning Objective 1

Understand the impact of

intercompany profit for

inventories on preparation

of consolidation working papers.




Intercompany Inventory Transactions

Revenue on sales between affiliated companies

cannot be recognized until merchandise is sold

outside of the consolidated entity.




Intercompany Inventory Transactions

Periodicinventory

system

Sales

Purchases

Perpetualinventory

system

Sales

Cost of goods sold




Elimination of Intercompany

Purchases and Sales

Pint formed a subsidiary, Shep Corporation.

All Shep¶s purchases are made fromPint at 20% above Pint¶s cost.

Pint sold $20,000 of merchandise

to Shep for $24,000.Shep sold all the merchandise

to its customers for $30,000.





Purchases and Sales

Inventory 20,000Accounts Payable 20,000

To record purchases on account from other entities

Accounts Receivable 24,000Sales 24,000

To record intercompany sales to Shep





Purchases and Sales

Cost of Sales 20,000Inventory 20,000

To record cost of sales to Shep

Investment 6,000Income from Shep 6,000

To record related equity interest





Purchases and Sales

Inventory 24,000Accounts Payable 24,000

To record intercompany purchases from Pint

Accounts Receivable 30,000Sales 30,000

To record sales to outside customers





Purchases and Sales

Cost of Sales 24,000Inventory 24,000

To record cost of sales to customers





Purchases and Sales

100% Adjustments and Consol-Pint Shep Eliminations idated

Sales

Cost of sales

Gross profit

$24,000

20,000

$ 4,000

$30,000

24,000

$ 6,000

a 24,000

a 24,000

$30,000

20,000

$10,000




Elimination of Unrealized

Profit in Ending Inventory

During 2004, Pint sold merchandise that

cost $30,000 to Shep for $36,000.Shep sold all but $6,000 of this

merchandise to its customers for $37,500.




Shep¶s inventory $6,000Cost to Pint ±5,000

Unrealized profit in EI $1,000


Profit in Ending Inventory30,000 ÷ 36,000 = 5/6

5/6 × 30,000 = $25,000

1/6 × 36,000 = $6,000

1/6 × 30,000 = $5,000





Profit in Ending InventoryAdjustments and Consol-

Pint Shep Eliminations idated

Sales

Cost of sales

Gross profit

Inventory

$36,000

30,000

$ 6,000

$37,500

30,000

$ 7,500

$ 6,000

a 36,000

b 1,000 a 36,000

b 1,000

$37,500

25,000

$12,500

$ 5,000




Recognition of Unrealized

Profit in Beginning Inventory

During 2005 Pint sold merchandise

that cost $40,000 to Shep for $48,000.Shep sold 75% of this merchandise

to its customers for $45,000.

Shep also sold its beginning inventorywith a transfer price of $6,000 for $7,500.






25% × 48,000 = $12,000 Ending inventory

Shep¶s inventory $12,000

Cost to Pint (10,000)

Unrealized profit in EI $ 2,000

$12,000 ÷ 1.2 = $10,000 EI transfer price






$7,500 ± $5,000 BI = $2,500 from BI

75% × 48,000 = $30,000

$45,000 ± $30,000 = $15,000

$15,000 + $2,500 = $17,500






Adjustments and Consol-Pint Shep Eliminations idated

Sales

Cost of sales

Gross profit

Inventory

Investment

in Shep

$48,000

40,000

$ 8,000

XXX

$52,500

42,000

$10,500

$12,000

a 48,000

c 2,000 a 48,000

b 1,000

c 2,000

b 1,000

$52,500

35,000

$17,500

$10,000





Apply the concepts of

upstream versus downstream

inventory transfers.




Downstream and Upstream Sales

Sales from top

to bottom aredownstream.

Sales from

bottom to topare upstream.

Parent

toSubsidiary Subsidiary

to

Parent




Downstream and Upstream Sales

In downstream sales, the parent company¶s

separate income includes the full amount of

any unrealized profit, and the subsidiary¶s

income is not affected.

In upstream sales, the subsidiary company¶s

net income includes the full amount of anyunrealized profit, and the parent company¶s

separate income is not affected.




Downstream and Upstream Effects

on Income Computations

80%-owned Parent Subsidiary

Sales $600 $300Cost of sales 300 180

Gross profit $300 $120

Expenses 100 70

Parent¶s separate income $200

Subsidiary¶s net income $ 50






Intercompany sales during the year are $100,000.

The December 31 inventory includes

$20,000 unrealized profit.






The parent company¶ssales and cost of sales

accounts reflect the

$20,000 unrealized profit.

The $50,000subsidiary net

income equals its

realized income.






The subsidiary¶s sales and

cost of sales accounts reflectthe $20,000 unrealized profit.

The subsidiary¶s

realized incomeis $30,000.






C onsolidated Income (000) Downstream Upstream

Sales ($900 ± $100) $800 $800

Cost of sales ($480 + $20 ± $100) 400 400Gross profit $400 $400

Expenses ($100 + $70) 170 170

Total realized income $230 $230Less: Minority interest 10 6

Consolidated net income $220 $224






C onsolidated Income (000) Downstream Upstream

Parent¶s separate income $200 $200

Add: Income from subsidiary:Equity in subsidiary¶s income

less unrealized profit

[($50,000 × 80%) ± $20,000] 20Equity in subsidiary¶s income

[($50,000 ± $20,000) × 80%] 24

Parent and consolidated net income $220 $224





Defer unrealized inventory profits

remaining in ending inventory of

either the parent or subsidiary.




Deferral of Intercompany Profit

in Period of Sale: Downstream90%-owned

Porter Sorter

Sales $100 $50

Cost of sales 60 35Gross profit $ 40 $15

Expenses 15 5

Operating income $ 25 $10Income from Sorter 9 ±

Net income $ 34 $10





in Period of Sale: Downstream

Porter¶s sales include $15,000 to Sorter

at a profit of $6,250.

Sorter¶s December 31, 2003, inventory includes

40% of the merchandise from this transaction.






$15,000 ± $6,250 = $8,750

$8,750 × 40% = $3,500

$15,000 × 40% = $6,000

$6,000 ± $3,500 = $2,500






Investment in Sorter 9,000Income from Sorter 9,000

To record share of Sorter¶s income

Income from Sorter 2,500

Investment in Sorter 2,500

To eliminate unrealized profit on sales to Sorter




Partial Working Papers

December 31, 2003Adjustments/ Consol-

Porter Shorter Eliminations idated

I ncome Statement SalesIncome from Sorter Cost of goods soldExpensesMinority interest expense

($10,000 × 10%) Net income Balance Sheet InventoryInvestment in Sorter

$1006.5

(60)(15)

$ 31.5

XXX

$50

(35)(5)

$10

$ 7.5

Dr. Cr.a 15c 6.5 b 2.5 a 15

b 2.5c 6.5

$135

(82.5)(20)

(1)$ 31.5

$ 5





Recognize realized, previously

deferred inventory profits in

the beginning inventory of

either the parent or subsidiary.




Recognition of Intercompany Profit

upon Sale to Outside Entities

Now assume that the merchandise acquired from

Porter during 2003 is sold by Sorter during 2004.

There are no intercompany transactions between Porter and Sorter during 2004.





upon Sale to Outside Entities90%-owned

Porter Sorter

Sales $120 $60

Cost of sales 80 40Gross profit $ 40 $20

Expenses 20 5

Operating income $ 20 $15Income from Sorter 13.5 ±

Net income $ 33.5 $15This is before considering $2,500 unrealized profit in BI.





upon Sale to Outside Entities

Investment in Sorter 13,500Income from Sorter 13,500

To record investment income from Sorter

Investment in Sorter 2,500

Income from Sorter 2,500

To record realization of profit from

intercompany sales to Sorter




Partial Working Papers

December 31, 2003Adjustments/ Consol-

Porter Shorter Eliminations idated

I ncome Statement

SalesIncome from Sorter Cost of goods soldExpensesMinority interest expense

($15,000 × 10%) Net income Balance Sheet Investment in Sorter

$12016(80)(20)

$ 36

XXX

$60

(40)(5)

$15

Dr. Cr.

b 16a 2.5

a 2.5 b 16

$180

(117.5)(25)

(1.5)$ 36





Adjust the calculations of minority

interest amounts in the presence

of intercompany inventory profits.




Consolidation Example ± Intercompany

Profits: Downstream Sales

Seay Corporation is a 90%-owned

subsidiary of Peak Corporation,

acquired for $94,500 cash on July 1, 2003.Seay¶s net assets at date of acquisition

consisted of $100,000 capital stock

and $5,000 retained earnings.The cost of Peak¶s 90% interest was equal to book

value and fair value of the interest acquired.






Cost: $105,000 × 90% = $94,500

Minority interest: $105,000 × 10% = $10,500






Peak sells inventory items to Seay on a regular basis.

Sales to S in 2007 (cost $15,000), selling price $20,000

Unrealized profit in S¶s inventory at 12/31/2006 2,000

Unrealized profit in S¶s inventory at 12/31/2007 2,500Seay¶s accounts payable to Peak 12/31/2007 10,000






At 12/31/2006 Peak¶s investment in Seay

account had a balance of $128,500.

This balance consisted of Peak¶s 90%

equity in Seay¶s $145,000 net assets onthat date less $2,000 unrealized profit

in Seay¶s 12/31/2006 inventory.






$145,000 × 90% = $130,500

$130,500 ± $2,000 = $128,500






Seay¶s equity:Common stock $100,000

Retained earnings 45,000

Net assets $145,000

$45,000 ± $5,000 = $40,000 increase in RE

$40,000 ± $4,000 (minority interest) = $36,000






During 2007, Peak made the following entries

on its books for the investment in Seay:

Cash 9,000Investment in Seay 9,000

To record dividends from Seay ($10,000 × 90%)

Investment in Seay 26,500Income from Seay 26,500

To record income from Seay for 2007






Equity in Seay¶s net income: ($30,000 × 90%) $27,000

Add: Inventory profits recognized in 2007 2,000

Deduct: Inventory profits deferred at year end ± 2,500Total $26,500






Peak¶s Investment

94,500

36,000

128,500

2,000

27,000

146,000

2,000

2,5009,000 Dividends

12/31/2006

12/31/2007






Minority Interest

1,000

10,500

4,000

14,500

3,000

16,500 12/31/2007Dividends

12/31/2006





Profits: Upstream Sales

Smith Corporation is an 80%-owned subsidiary

of Poch Corporation, acquired for $480,000

cash on January 2, 2003.Smith¶s stockholders¶ equity consisted of

$500,000 capital stock and $100,000

retained earnings.The cost of Poch¶s 80% interest was equal to

book value and fair value of the interest acquired.






Smith sells inventory items to Poch on a regular basis.

Sales to P in 2004 $300,000

Unrealized profit in P¶s inventory at 12/31/2003 40,000

Unrealized profit in P¶s inventory at 12/31/2004 30,000

Intercompany A/R and A/P at 12/31/2004 50,000






At December 31, 2003, Poch¶s investment in

Smith had an account balance of $568,000.This balance consisted of $600,000 underlying

equity in Smith¶s net assets ($750,000 × 80%)

less $32,000 unrealized profit in Poch¶sDecember 31, 2003, inventory.






During 2004, Poch made the following entries

on its books for the investment in Smith.

Cash 40,000Investment in Smith 40,000

To record dividends from Smith ($50,000 × 80%)

Investment in Smith 88,000Income from Smith 88,000

To record income from Smith for 2004






Equity in Smith¶s net income ($100,000 × 80%) $80,000Add: 80% of $40,000 unrealized profit

deferred in 2003 32,000

Less: 80% of $30,000 unrealized profit

at December 31, 2004 ±24,000Total $88,000






Poch¶s Investment

480,000

I ncome

568,000

32,000

80,000616,000

32,000

40,000

24,000Dividends12/31/2003

12/31/2004



5 55©2003 P ti H ll B i P bli hi Ad d A ti 8/ B /A th /Cl t/L h

End of Chapter 5

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