Beams10e Ch05 Intercompany Profit Transactions Inventories

© Pearson Education, Inc. publishing as Prentice Hall 5-1

Chapter 5: Intercompany Profit Transactions – Inventories

by Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompany

Advanced Accounting, 10th editionby Floyd A. Beams, Robin P. Clement,

Joseph H. Anthony, and Suzanne Lowensohn


Intercompany Profits – Inventories: Objectives1. Understand the impact of intercompany profit

for inventories on preparation of consolidation working papers.

2. Apply the concepts of upstream versus downstream inventory transfers.

3. Defer unrealized inventory profits remaining in ending inventory of either the parent or subsidiary.


Objectives (cont.)

4. Recognize realized, previously deferred inventory profits in the beginning inventory of either the parent or subsidiary.

5. Adjust the calculations of noncontrolling interest amounts in the presence of intercompany inventory profits.


1: Intercompany Inventory Profits1: Intercompany Inventory ProfitsIntercompany Profit Transactions – Inventories


Intercompany Transactions

• For consolidated financial statements, ARB No. 51 (as amended by FASB Statement No. 160) states:– "intercompany balances and transactions

shall be eliminated."• Show income and financial position as if the

intercompany transactions had never taken place.


Intercompany Sales of Inventory

• Profits on intercompany sales of inventory– All recognized if goods have been resold to

outsiders– Deferred if the goods are still held in

inventory• Previously deferred profits in beginning

inventory are recognized• Consider a FIFO inventory system

– Beginning inventories are sold– Ending inventories are from current period


No Intercompany Profits in Inventories• During 2009, Pretty sold goods costing $1,000 to its subsidiary, Simple, at a gross profit of 30%. Simple had none of

this inventory on hand at the end of 2009. Worksheet entry for 2009:

• All intercompany sales of inventories have been resold to outside parties, so remove the full sales price from both sales and cost of sales. – Pretty's sales are reduced $1,429.– Simple's cost of sales are reduced $1,429.

• The same entry is used if Simple sells to Pretty.Sales 1,429 Cost of sales 1,429

Sales = $1,000 / (1-30%) = $1,429


Intercompany Profits Only in Ending Inventories• Last year, 2009, Paul sold goods costing $500 to

its subsidiary, Sal, at a gross profit of 25%. Sal had none of this inventory on hand at the end of 2009.

• During 2010, Paul sold additional goods costing $900 to Sal at a gross profit of 40%. Sal has $200 of these goods on hand at 12/31/2010. Worksheet entries for 2010:

Sales 1,500 Cost of sales 1,500

Sales = $900 / (1-40%) = $1,500

Cost of sales 80 Inventory 80

Ending inventory profit = $200 x 40%


Intercompany Profits Beginning and Ending InventoriesLast year, 2009, Pam sold goods costing $300 to its

subsidiary, Sir, at mark-up of 25%. Sir had $120 of this inventory on hand at the end of 2009.

During 2010, Pam sold additional goods costing $500 to Sir at a 30% mark-up. Sir has $260 of these goods on hand at 12/31/2010. Worksheet entries for 2010:

Sales 650 Cost of sales 650

Sales = $500 + 30%($500) = $650

Cost of sales 60 Inventory 60

Ending inv. profits = $260 x 30%/130%

Investment in Subsidiary 24

Cost of sales 24Begin. inv. profits = $120 x 25%/125% = $24


2: Upstream & Downstream 2: Upstream & Downstream Inventory SalesInventory Sales

Intercompany Profit Transactions – Inventories


Downstream Sales

Parent sells to subsidiary

Subsidiary sells to parent

Upstream Sales

Upstream and Downstream Sales

Parent

Subsidiary 1 Subsidiary 2 Subsidiary 3


Intercompany Inventory Sales• The worksheet entries for eliminating intercompany profits for downstream sales

For upstream sales, the last entry would also include a debit to noncontrolling interest, splitting the profit to be realized between controlling and noncontrolling interests.

Sales XXX Cost of sales XXX

For the intercompany sales price

Cost of sales XX Inventory XX

For the profits in ending inventory

Investment in Subsidiary XX

Cost of sales XXFor the profits in beginning inventory


Data for Example

• For the year ended 12/31/2011:– Subsidiary income is $5,200 – Subsidiary dividends are $3,000– Current amortization of acquisition price is

$450• Intercompany (IC) sales information:

– IC sales during 2011 were $650– IC profits in ending inventory $60– IC profit in beginning inventory $24


Income Sharing with Downstream Sales – PARENT Makes Sale

Subsidiary net income $5,200 Current amortizations (450)Adjusted income $4,750 Defer profits in EI (60)Recognize profits in BI 24

Income recognized $4,714 Subsidiary dividends $3,000

CI 80% share$3,800

(60)24

$3,764

$2,400 NCI 20% share

$950

$600

When parent makes the IC sale, the impact of deferring and recognizing profits falls all to the parent.

Income from subsidiary


Income Sharing with Upstream Sales – SUBSIDIARY Makes Sale

Subsidiary net income $5,200 Current amortizations (450)Adjusted income $4,750 Defer profits in EI (60)Recognize profits in BI 24 Income recognized $4,714 Subsidiary dividends $3,000

CI 80% share$3,800

(48)19.2

$3,771.2

$2,400 NCI 20% share

$950.0(12.0)4.8

$942.8

$600

When subsidiary makes the IC sale, the impact of deferring and recognizing profits is split among controlling and noncontrolling interests.

Income from subsidiary


3: Unrealized Profits in Ending 3: Unrealized Profits in Ending InventoriesInventories



Ending Inventory on Hand

• Intercompany profits in ending inventory– Eliminate at year end

• Working paper entry

Cost of sales XXX

Inventories XXX

For the unrealized profit


Parent Accounting

Porter owns 90% of Sorter acquired at book value (no amortizations). During the current year, Sorter reported $10,000 income. Porter sold goods to Sorter during the year for $15,000 including a profit of $6,250. Sorter still holds 40% of these goods at the end of the year.

• Unrealized profit in ending inventory40%(6,250) = $2,500

• Porter's Income from Sorter90%(10,000) – 2,500 unreal. Profits = $6,500

• Noncontrolling interest share10%(10,000) = $1,000


Entries

• Porter's journal entry to record income

• Worksheet entries to eliminate intercompany sale and unrealized profits

Sales 15,000

Cost of sales 15,000

Cost of sales 2,500

Inventory 2,500

Investment in Sorter 6,500

Income from Sorter 6,500


Worksheet – Income Statement

Porter Sorter DR CR Consol

Sales $100.0 $50.0 15.0 $135.0

Income from Sorter 6.5 6.5 0.0

Cost of sales (60.0) (35.0) 2.5 15.0 (82.5)

Expenses (15.0) (5.0) (20.0)

Noncontrolling interest share 1.0 (1.0)

Controlling interest share $31.5 $7.5 $31.5

There would be a credit adjustment to Inventory for 2.5 on the balance sheet portion of the worksheet.


What if?If the sales had been upstream, by Sorter to

Porter:• Unrealized profits in ending inventory

40%(6,250) = $2,500• Porter's Income from Sorter

90%(10,000 – 2,500) = $6,750• Noncontrolling interest share

10%(10,000 – 2,500) = $750• Upstream profits impact both

– Controlling interest share– Noncontrolling interest share


4: Recognizing Profits from 4: Recognizing Profits from Beginning InventoriesBeginning Inventories



Intercompany Profits in Beginning Inventory

Unrealized profits in ending inventory one year

Become

Profits to be recognized in the beginning inventory of the next year!


5: Impact on Noncontrolling Interest5: Impact on Noncontrolling InterestIntercompany Profit Transactions – Inventories


Direction of Sale and NCIThe impact of unrealized profits in ending

inventory and realizing profits in beginning inventory depends on the direction

• Downstream sales– Full impact on parent

• Upstream sales– Share impact between parent and

noncontrolling interest


Calculating Income and NCI

Downstream sales:Income from sub = CI%(Sub's NI) – Profits in EI + Profits in BINoncontrolling interest share= NCI%(Sub's NI)

Upstream sales:Income from sub = CI%(Sub's NI – Profits in EI + Profits in BI)Noncontrolling interest share= NCI%(Sub's NI – Profits in EI + Profits in BI)


Upstream Example with AmortizationPerry acquired 70% of Salt on 1/1/2009 for $420 when Salt's

equity consisted of $200 capital stock and $200 retained earnings. Salt's inventory was understated by $50 and building, with a 20 year life, was understated by $100. Any excess is goodwill.

During 2009, Salt sold goods costing $700 to Perry at a 20% markup. $240 of these goods were in Perry's ending inventory.

In 2010, Salt sold goods costing $900 to Perry at a 25% markup and Perry still had $100 on hand at the end of the year.

2009 2010

Perry Salt Perry SaltSeparate income $1,250 $705 $1,500 $745Dividends $600 $280 $600 $300


Analysis and Amortization

Cost of 70% of Salt $420

Implied value of Salt 420/.70 $600

Book value 200 + 200 400

Excess $200

Unamort Amort Unamort Amort UnamortAllocated to: 1/1/09 2009 1/1/10 2010 12/31/10Inventory 50 (50) 0 0 0 Building 100 (5) 95 (5) 90 Goodwill 50 0 50 0 50 200 (55) 145 (5) 140


2009 Income Sharing (Upstream)

Income from Salt

Salt's net income $705 Current amortizations (55)Adjusted income $650 Defer profits in EI (40)Income recognized $610

Subsidiary dividends $280

CI 70% share$455 ($28)$427

$196

NCI 30% share$195 ($12)$183

$84


Perry's 2009 Equity Entries

Investment in Salt 420

Cash 420

For acquisition of 70% of Salt

Cash 196


For dividends received


Income from Salt 427

For share of income


2009 Worksheet Entries1. Adjust for errors & omissions - none2. Eliminate intercompany profits and losses

3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance

Sales 700

Cost of sales 700

Cost of Sales 40

Inventory 40


Dividends 196



2009 Entries (2 of 3)4. Record noncontrolling interest in sub's earnings &

dividends

5. Eliminate reciprocal Investment & sub's equity balances

Capital stock 200 Retained earnings 200

Inventory 50

Building 100

Goodwill 50


Noncontrolling interest 180

Noncontrolling interest share 183 Dividends 84



2009 Entries (3 of 3)

6. Amortize fair value/book value differentials

7. Eliminate other reciprocal balances – none

Cost of sales 50

Inventory 50

Depreciation expense 5

Building 5


2010 Income Sharing (Upstream)

Income from Salt

Salt's net income $745 Current amortizations (5)Adjusted income $740 Defer profits in EI (20)Realize profits from BI 40 Income recognized $760 Subsidiary dividends $300

CI 70% share$518 ($14)$28 $532

$210

NCI 30% share$222 ($6)$12

$228

$90


Perry's 2010 Equity Entries

Cash 210


For dividends received



For share of income


2010 Worksheet Entries1. Adjust for errors & omissions - none2. Eliminate intercompany profits and losses

3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance

Sales 900 Cost of sales 900

Cost of Sales 20

Inventory 20



Cost of sales 40

Income from Salt 532 Dividends 210



2010 Entries (2 of 3)4. Record noncontrolling interest in sub's earnings &

dividends

5. Eliminate reciprocal Investment & sub's equity balances

Capital stock 200 Retained earnings 625

Inventory 0

Building 95

Goodwill 50



Noncontrolling interest share 228 Dividends 90



2010 Entries (3 of 3)

6. Amortize fair value/book value differentials

7. Eliminate other reciprocal balances – none

Depreciation expense 5

Building 5


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Beams10e Ch05 Intercompany Profit Transactions Inventories

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