9/12/2018
Advanced Accounting
Thirteenth Edition, Global Edition
Chapter 5
Intercompany Profit
Transactions –
Inventories
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Intercompany Profits – Inventories:
Objectives
5.1 Understand the impact of intercompany inventory
profit on consolidation work papers.
5.2 Apply the concepts of upstream versus downstream
inventory transfers.
5.3 Defer unrealized inventory profits remaining in the
ending inventory.
5.4 Recognize realized, previously deferred inventory
profits in the beginning inventory.
5.5 Adjust noncontrolling interest amounts in the
presence of intercompany inventory profits.
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5.1: Intercompany Inventory Profits
Intercompany Profit Transactions – Inventories
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Intercompany Transactions
For consolidated financial statements
– “intercompany balances and transactions shall
be eliminated.” [FASB ASC 810-10-45-1]
Show income and financial position as if the
intercompany transactions had never taken place.
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Intercompany Sales of Inventory
Profits on intercompany sales of inventory
– 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 in the period the goods are sold.
Assuming FIFO:
– Beginning inventories are sold
– Ending inventories are from current purchases
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No Intercompany Profits in Inventories
During 2017, Rae sold goods costing $1,000 to its
subsidiary, Sky, at a gross profit of 30%. Sky had
none of this inventory on hand at the end of 2016.
The worksheet entry for 2016:
Sales (-R, -SE) 1,429 blank
Cost of sales (-E, +SE) blank 1,429
Eliminate intercompany sales = $1,000 / (1-30%) = $1,429 blank blank
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No Intercompany Profits in Inventories
(continued)
All intercompany sales of inventories have been
resold to outside parties, so remove the full sales
price from both sales and cost of sales.
Rae's sales are reduced $1,429.
Sky's cost of sales are reduced $1,429.
The same entry is used if Sky sells to Rae.
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Intercompany Profits Only in Ending
Inventories
Last year, 2016, Kai sold goods costing $500 to its
subsidiary, Taj, at a gross profit of 25%. Taj had
none of this inventory on hand at the end of 2016.
During 2017, Kai sold additional goods costing
$900 to Taj at a gross profit of 40%. Taj has
$200 of these goods on hand at 12/31/2017.
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Intercompany Profits Only in Ending
Inventories (continued)
Worksheet entries for 2017:
Sales (-R, -SE) 1,500 Blank
Cost of sales (-E, +SE) Blank 1,500
Eliminate intercompany sales = $900 / (1-40%) = $1,500 blank Blank
Cost of sales (E, -SE) 80 Blank
Inventory (-A) Blank 80
Defer profit in ending inventory = $200 x 40% blank blank
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Intercompany Profits Beginning and
Ending Inventories
Last year, 2016, Max sold goods costing $300 to its
subsidiary, Leo, at mark-up of 25%. Leo had $120 of
this inventory on hand at the end of 2016.
During 2017, Max sold additional goods costing $500
to Leo at a 30% mark-up. Leo has $260 of these
goods on hand at 12/31/2017.
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Intercompany Profits Beginning and
Ending Inventories (continued)
Worksheet entries for 2017:
Sales (-R, -SE) 650 blank
Cost of sales (-E, +SE) blank 650
Eliminate intercompany sales = $500 + 30%($500) = $650 blank blank
Cost of sales (E, -SE) 60 blank
Inventory (-A) blank 60
Defer unrealized profit in ending inventory = $260 x 30%/130% blank blank
Investment in Subsidiary (+A) 24 blank
Cost of sales (-E, +SE) Blank 24
Realize previously deferred profit from beginning inventory
= $120 x 25%/125% = $24 blank blank
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5.2: Upstream & Downstream
Inventory Sales
Intercompany Profit Transactions – Inventories
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Upstream and Downstream Sales
Downstream
Sales
Parent sells to Parent Subsidiary sells
subsidiary to parent
Subsidiary Subsidiary Subsidiary
1 2 3
Upstream Sales
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Intercompany Inventory Sales
The worksheet entries for eliminating intercompany profits
for downstream sales
Sales (-R, -SE) XXX blank
Cost of sales (-E, +SE) blank XXX
For the intercompany sales price blank blank
Cost of sales (E, -SE) XX blank
Inventory (-A) blank XX
For the profits in ending inventory blank blank
Investment in Subsidiary (+A) XX blank
Cost of sales (-E, +SE) blank XX
For the profits in beginning inventory blank blank
For upstream sales, the last entry would include a debit to
noncontrolling interest, sharing the realized profit between
controlling and noncontrolling interests.
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Data for Example
For the year ended 12/31/2016:
– Subsidiary income is $5,200
– Subsidiary dividends are $3,000
– Current amortization of acquisition price is $450
Intercompany (IC) sales information:
– IC sales during 2016 were $650
– IC profit in ending inventory $60
– IC profit in beginning inventory $24
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Income Sharing with Downstream Sales –
PARENT Makes Sale
Subsidiary net income $5,200 CI 80% share
Current amortizations (450) $3,800
Adjusted income $4,750 (60)
blank blank 24
Defer profits in EI (60) $3,764 Income from
Recognize profits in BI 24 subsidiary
Income recognized $4,714 $2,400 NCI 20% share
blank blank
Subsidiary dividends $3,000 $950
When parent makes the IC
sale, the impact of deferring
and recognizing profits falls
all to the parent. $600
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Income Sharing with Upstream Sales –
SUBSIDIARY Makes Sale
CI 80% share
Subsidiary net income $5,200 $3,800
Current amortizations (450) (48)
Adjusted income $4,750 19.2
blank blank $3,771.2 Income from
Defer profits in EI (60) subsidiary
Recognize profits in BI 24
$2,400
Income recognized $4,714
NCI 20% share
blank blank
Subsidiary dividends $3,000 $950.0
(12.0)
When subsidiary makes the IC 4.8
sale, the impact of deferring and $942.8
recognizing profits is split among
controlling and noncontrolling
$600
interests.
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5.3: Unrealized Profits in Ending
Inventories
Intercompany Profit Transactions – Inventories
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Ending Inventory on Hand
Intercompany profits in ending inventory
– Eliminate at year end
Working paper entry
Cost of sales (E, -SE) XXX blank
Inventories (-A) blank XXX
For the unrealized profit blank blank
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Parent Accounting
Pam owns 90% of Sun acquired at book value
(no amortizations). During the current year,
Sun reported $10,000 income. Pam sold goods
to Sun during the year for $15,000 including a
profit of $6,250. Sun still holds 40% of these
goods at the end of the year.
Unrealized profit in ending inventory
40%(6,250) = $2,500
Pam's Income from Sun
90%(10,000) – 2,500 unrealized profits = $6,500
Noncontrolling interest share
10%(10,000) = $1,000
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Entries
Pam's journal entry to record income (net of
unrealized profit):
Investment in Sun (+A) 6,500 blank
Income from Sun (R, +SE) blank 6,500
Worksheet entries to eliminate intercompany sale
and unrealized profits:
Sales (-R, -SE) 15,000 blank
Cost of goods sold (-E, +SE) blank 15,000
Cost of goods sold (E, -SE) 2,500 blank
Inventory (-A) blank 2,500
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Worksheet – Income Statement
Blank Pam Sun DR CR Consol
Sales $100.0 $50.0 15.0 blank $135.0
Income from Sun 6.5 blank 6.5 blank 0.0
Cost of sales (60.0) (35.0) 2.5 15.0 (82.5)
Expenses (15.0) (5.0) blank blank (20.0)
Noncontrolling interest share blank blank 1.0 blank (1.0)
Controlling interest share $31.5 $10.0 blank blank $31.5
There would be a credit adjustment to Inventory for
$2.5 on the balance sheet portion of the worksheet.
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What if?
If the sales had been upstream, by Sun to Pam:
Unrealized profits in ending inventory
40%(6,250) = $2,500
Pam's Income from Sun
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
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5.4: Recognizing Profits from
Beginning Inventories
Intercompany Profit Transactions – Inventories
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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!
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5.5: Impact on Noncontrolling Interest
Intercompany Profit Transactions – Inventories
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Direction of Sale and NCI
The impact of unrealized profits in ending inventory
and realizing profits in beginning inventory depends
on the direction of the intercompany sales.
Downstream sales
– Full impact on parent
Upstream sales
– Share impact between parent and
noncontrolling interest
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Calculating Income and NCI
Downstream sales:
Income from sub
= CI%(Sub's NI) – Profits in EI + Profits in BI
Noncontrolling 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)
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Upstream Example with Amortization
Phebe acquired 70% of Shay on 1/1/2016 for $420
when Shay's equity consisted of $200 capital stock
and $200 retained earnings. Shay's inventory was
understated by $50, and the building, with a 20-year
life, was understated by $100. Any excess is
goodwill.
Blank 2016 blank 2017 blank
blank Phebe Shay Phebe Shay
Separate income $1,250 $705 $1,500 $745
Dividends $600 $280 $600 $300
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Upstream Example with Amortization
(continued)
In 2016, Shay sold goods for $700 to Phebe at a
20% markup, and $240 of these goods were in
Phebe's ending inventory.
In 2017, Shay sold goods for $900 to Phebe at a
25% markup, and Phebe still had $100 on hand at
the end of the year.
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Analysis and Amortization
Cost of 70% of Shay $420
Implied value of Shay 420/.70 $600
Book value 200 + 200 400
Excess $200
blank Unamort Amort Unamort Amort Unamort
Allocated to 1/1/16 2016 1/1/17 2017 12/31/12
Inventory 50 (50) 0 0 0
Building 100 (5) 95 (5) 90
Goodwill 50 0 50 0 50
blank 200 (55) 145 (5) 140
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2016 Income Sharing (Upstream)
Shay's net income $705
CI 70% share
Current
amortizations (55) $455
Adjusted income $650 ($28)
blank blank $427 Income from Shay
Defer profits in EI (40)
Income recognized $610 $196
Blank blank
NCI 30% share
Subsidiary dividends $280 $195
($12)
$183
$84
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Phebe's 2016 Equity Entries
Investment in Shay (+A) 420 blank
Cash (-A) blank 420
For acquisition of 70% of Shay blank blank
Cash (+A) 196 blank
Investment in Shay (-A) blank 196
For dividends received blank blank
Investment in Shay (+A) 427 blank
Income from Shay (R, +SE) blank 427
For share of income blank blank
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2016 Worksheet Entries (1 of 3)
1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE) 700 blank
Cost of sales (-E, +SE) blank 700
Cost of Sales (E, -SE) 40 blank
Inventory (-A) blank 40
3. Eliminate income & dividends from sub. and bring
Investment account to its beginning balance
Income from Shay (-R, -SE) 427 blank
Dividends (+SE) blank 196
Investment in Shay (-A) blank 231
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2016 Worksheet Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings & dividends
Noncontrolling interest share (-SE) 183 blank
Dividends (+SE) blank 84
Noncontrolling interest (+SE) blank 99
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock (-SE) 200 blank
Retained earnings (-SE) 200 blank
Inventory (+A) 50 blank
Building (+A) 100 blank
Goodwill (+A) 50 blank
Investment in Shay (-A) blank 420
Noncontrolling interest (+SE) blank 180
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2016 Worksheet Entries (3 of 3)
6. Amortize fair value/book value differentials
Cost of sales (E, -SE) 50 blank
Inventory (-A) blank 50
Depreciation expense (E, -SE) 5 blank
Building (-A) blank 5
7. Eliminate other reciprocal balances – none
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2017 Income Sharing (Upstream)
Shay's net income $745
CI 70% share
Current
amortizations (5) $518
Adjusted income $740 ($14)
blank blank $28
Defer profits in EI (20) $532
Income from
Realize profits from Shay
BI 40 $210
Income recognized $760
NCI 30% share
blank blank
$222
Subsidiary dividends $300
($6)
$12
$228
$90
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Phebe's 2017 Equity Entries
Cash (+A) 210 blank
Investment in Shay (-A) blank 210
For dividends received blank blank
Investment in Shay (+A) 532 blank
Income from Shay (R, +SE) blank 532
For share of income blank blank
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2017 Worksheet Entries (1 of 3)
1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE) 900 blank
Cost of sales (-E, +SE) blank 900
Cost of Sales (E, -SE) 20 blank
Inventory (-A) blank 20
Investment in Shay (+A) 28 blank
Noncontrolling interest (-SE) 12 blank
Cost of sales (-E, +SE) blank 40
3. Eliminate income & dividends from sub. and bring
Investment account to its beginning balance
Income from Shay (-R, -SE) 532 blank
Dividends (+SE) blank 210
Investment in Shay (-A) blank 322
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2017 Worksheet Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share (-SE) 228 blank
Dividends (+SE) blank 90
Noncontrolling interest (+SE) blank 138
5. Eliminate reciprocal Investment & sub's equity
balances
Capital stock (-SE) 200 blank
Retained earnings (-SE) 625 blank
Inventory (+A) 0 blank
Building (+A) 95 blank
Goodwill (+A) 50 blank
Investment in Shay (-A) blank 679
Noncontrolling interest (+SE) blank 291
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2017 Worksheet Entries (3 of 3)
6. Amortize fair value/book value differentials
Depreciation expense (E, -SE) 5 blank
Building (-A) blank 5
7. Eliminate other reciprocal balances – none
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