Chapter Five

Consolidated Financial

Statements - Intra-Entity

Asset Transactions

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Intra-entity Transactions

When companies affiliated through common control engage in intra-entity inventory transfers, consolidation procedures are required to eliminate sales and purchases balances.

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

Effects of intra-entity transactions should be eliminated from the consolidated financial statements.

Consolidated statements must reflect only transactions with outside parties.

LO 1

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The total recorded amounts are deleted.

Sales and Purchases-Intra-entity

ENTRY TI (Transferred Inventory)Eliminate all intra-entity sales/purchases of inventory by eliminating the sales price of the transfer – which one company records as sales, and the other records as cost of goods sold.

LO 2

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Note: The consolidated company has earned the profit on any portion of the intra-entity transaction that was sold to unrelated parties and does not need to make an adjustment for the sold items for consolidation purposes.

Unrealized Gross Profit – Intra-entity

ENTRY G (Gross Profit)

•Despite Entry TI, ending inventory may still be overstated due to the transfer price exceeding historical cost. Intra-entity profits that remain unrealized at year-end must be removed in arriving at consolidated figures. Unrealized gain is eliminated as follows in Year 1:

LO 3

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Unrealized Gross Profit – Intra-entity

ENTRY *GFrom a consolidated view, the buyer’s Cost of Goods Sold (the beginning inventory component) and the seller’s Retained Earnings accounts as of the beginning of Year 2 contain the unrealized profit, and must both be reduced in Entry *G in Year 2.

Entry *G removes unrealized gross profit from beginning figures so that it is recognized in the consolidated income in the period in which it is earned.

LO 4

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Unrealized Inventory Gain – Downstream Transfers

Worksheet entries to eliminate sales/purchases balances (Entry TI) and to remove unrealized gross profit from ending Inventory in Year 1 (Entry G) are standard, regardless of the circumstances of the consolidation.

BUT the procedure to eliminate intra-entity gross profit from Year 2’s beginning account balances differs from the Entry *G just presented IF:

(1) the original transfer is downstream (parent’s) and

(2) the parent applies the equity method for internal accounting purposes.

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Intra-entity Transactions – Downstream Transfers

ENTRY *GIf the transfer of inventory is downstream AND the parent uses the equity method, the following entry is used to recognize the remaining unrealized profit left at the end of the previous year.

Investment in Subsidiary account replaces the Retained Earnings account used for upstream sales.

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Unrealized Gross Profits –Effect on Noncontrolling Interest

Accounts affected by intra-entity transactions:

Revenues

Cost of Goods Sold

Expenses

Noncontrolling Interest in Subsidiary’s Net Income

Retained Earnings at the Beginning of the Year

Inventory

Land, Buildings, and Equipment

Noncontrolling Interest in Subsidiary at End of Year.

LO 5

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Intra-Entity Inventory Transfers Example

Three entries require attention in the calculation of noncontrolling interest in the sub’s net income December 31, 2013.

Entry *G removes unrealized gross profits (25% rate) carried over from the previous period intra-entity downstream sales.

Entry *G reduces Cost of Goods Sold (or beginning inventory component) which creates an increase in current year income. Gross profit is correctly recognized in 2013 when inventory is sold to an outside party.

The debit to the Investment in Bottom account brings that account to a zero balance in consolidation.

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Intra-Entity Inventory Downstream Transfer - Example

Entry TI eliminates the intra-entity sales/purchases for 2013.

Entry G defers the unrealized gross profit (30% rate) of $6,000remaining at the end of 2013.

Entry G eliminates the overstatement of Inventory as well as the ending component of Cost of Goods Sold which decreases consolidated income.

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Intra-entity Transactions – Upstream Inventory Transfer

Entry S eliminates a portion of the parent’s investment account and provides the initial noncontrolling interest balance. The entry also removes stockholders’ equity accounts of the subsidiary as of the beginning of the current year.

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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.

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

LO 6

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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.

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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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.

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

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Intra-entity Transactions -- Depreciable Asset Transfers

ENTRY TA

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

LO 7

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Intra-entity Transactions -- Depreciable Asset Transfers

ENTRY ED

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

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