Intercompany Sales of Inventories

Intercompany Sales of Inventories
The intercompany profit in inventory transfer between affiliates is computed by multiplying the
inventory held by the buying affiliate which was acquired from the selling affiliate by the gross profit
rate based on sales of the selling affiliate.
The working paper elimination entries used in preparing consolidated financial statements must
eliminate fully the effects of all transactions between related companies. When there are intercompany
inventory transactons, eliminating entries are needed to remove the revenue and expenses related to the
intercompany transfers recorded by the individual companies. The elimination ensures that only the
historical cost of the inventory still on hands is included in the consolidated Statement of Financial
Position.
Intercompany Sales at Cost

Merchandise sometimes is sold to related affiliates at the seller’s cost. When an intercompany sales
include no profit or loss, the inventory amounts at the end of the period require no adjustment for
consolidation. At the time the inventory is resold to outsiders, the amount recognized as cost of goods
sold by the affiliate is the cost to the consolidated entity.
However, even when the intercompany sales includes no profit or loss, an eliminating entry is needed to
remove the intercompany sale and the related cost of goods sold recorded by the seller. This avoids
overstating these two accounts. Consolidated comprehensive income is not affected by the eliminating
entry when the intercompany sale is made at cost because both sales revenue and cost of goods sold are
reduced by the same amount.
Intercompany Sales at a Profit or Loss

Sale of inventory to affiliates are usually marked-up by a certain percentage of cost. For example, a
company may mark-up 50% of its inventory sales to its affiliates. Hence, inventory costing P2,000 will be
sold for P3,000. The elimination process will remove the effects of such sales in the consolidated
statements.
When intercompany sales include profits or losses, the working paper eliminations needed for
consolidation have two goals:
1. Elimination of the effects in the statement of CI of the intercompany sales by removing the sales
revenue from the intercompany sale and the related costs of goods sold recorded by the selling affiliate.
2. Elimination from the inventory on the Statement of Financial Position of any profit or loss on the
intercompany sales that has not been confirmed or realized by resale of the inventory to outsiders.
Inventory reported in the consolidated statement of financial position must be reported at cost to the
consolidated entity. Any profits or losses arising from intercompany sales must be eliminated.
DOWNSTREAM SALE OF INVENTORY
Downstream intercompany sales of merchandise are those made from a parent company to its
subsidiaries. For consolodation purposes, profits recorded on an intercompany inventory sale are realized
in the period in which the inventory is resold to outsiders. Until the point of resale, all intercompany
profits must be deferred. Consolidated CI must be based on the realized income of the selling affiliate. If
the intercompany sales of merchandise are made by the parent company or by wholly owned subsidiary,
there is no effect on any NCI in IC or loss, because the selling affiliates does not have NCI.
Parent and Subsidiary Companies entries

The journal entries to record the above transactions are as follows:
Books of Pete Corporation:

2016
April 1 (1) Cash 10,000
Sales 10,000
To record sale of merchandise of Sake Co.
(2) Cost of goods sold 8,000

Inventory 8,000
To record cost of inventory sold.
Books of Sake Company
2016
April 1 (3) Inventory 10,000
Cash 10,000
To record purchase of inventory from Pete Company.
Nov. 7 (4) Cash 15,000

Sales 15,000
To record sale of inventory to outsiders.
(5) Cost of goods sold 10,000

Inventory 10,000
To record cost of inventory sold to outsiders.
Illustration 1
Item Pete Sake Unadjusted Consolidated

Corporation Company Balances Amounts
Sales P10,000 P15,000 P25,000 P15,000
Cost of good sold ( 8,000) ( 10,000) ( 18,000) ( 8,000)
Gross profit P 2,000 P 5,000 P 7,000 P 7,000
Illustration. Assume again that Pete Corporation on April 1, 2016 sold merchandise to Sake Company
costing P8,000 for P10,000 or at a gross profit of 20%, out of which P4,000 remained unsold by Sake
Company on December 31, 2016.
Parent and Subsidiary Companies Entries

The above transaction are recorded in summary form by the two companies as follows:
Books of Pete Corporation. Journal entries (1) and (2), given previously for the sale of merchandise.
Books of Pete Company. For the purchase of merchandising journal entry (3). The sales of inventory to
outsiders is recorded as follows:
(6) Cash 7,500

Sales 7,500
To record sales to outsiders
(7) Cost of good sold 6,000

Inventory 6,000
To record cost of goods sold
The intercompany gross profit in Pete Corporation’s sales to Sake Company during the year ended
December 31, 2016, is analyzed as follows:
Illustration 2
Selling Price Cost Gross profit
( 20% of Selling Price )
Beginning inventory - - -
Add: Sales P10,000 P8,000 P2,000
Totals P10,000 P8,000 P2,000
Less: Ending inventory 4,000 3,200 800
Cost of goods sold P 6,000 P4,800 P1,200
Illustration 3
Selling Price Cost Gross profit
( 20% of Selling Price )
Beginning inventory P 4,000 P 3,200 P 800
Add: Sales 25,000 20,000 5,000
Totals 29,000 23,200 5,800
Less: Ending inventory 6,000 4,800 1,200
Cost of goods sold P23,000 P18,400 P4,600
UPSTREAM SALE OF INVENTORY
Upstream intercompany sales are those sales from subsidiaries to the parent company. When an
upstream sale of inventory occurs and the inventory is resold by the parent to outsiders during the same
period, all the parent entries and the eliminating entries in the consolidated working paper are identical
to those in the downstream case.
When the inventory is not resold to outsiders before the end of the period, working paper eliminating
entries are different from the downstream case only by the apportionment of the unrealized
intercompany to both the controlling and NCI. The intercompany profit in an upstream sale is recognized
by the subsidiary and shared between the controlling interest and NCI. Therefore, the elimination of the
unrealized intercompany profit will reduce the interests of both ownership groups until the profit is
realized by resale of the inventory to outsiders.
SUMMARY COMPARISON OF WORKING PAPER ELIMINATION ENTRIES
Illustration 4 below shows the elimination entries in 2016 and 2017 for both downstream and upstream
sales under the perpetual system.
2016
Downstream Sale Upstream Sale
Sales 10,000 Sales 10,000
Cost of goods sold 10,000 Cost of goods sold 10,000
Cost of goods sold 800 Cost of goods sold 800

Inventory 800 Inventory 800
2017
Downstream Sale Upstream Sale
Sales 25,000 Sales 25,000

Inventory 1,200 Inventory 1,200
Retained earnings , 1/1- Pete Retained earnings , 1/1- Pete

Corporation 800 Corporation 640
Cost of goods sold 800 NCI 160
Cost of goods sold 800

Intercompany Sales of Inventories

Uploaded by

Copyright:

Available Formats

Intercompany Sales of Inventories

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Intercompany Sales of Inventories

Uploaded by

Copyright:

Available Formats

What is the difference between downstream and upstream intercompany sales of inventory?

How are intercompany profits eliminated in consolidated financial statements?

Intercompany Sales of Inventories

Intercompany Sales at Cost

Intercompany Sales at a Profit or Loss

DOWNSTREAM SALE OF INVENTORY

Parent and Subsidiary Companies entries

Books of Pete Corporation:

(2) Cost of goods sold 8,000

Nov. 7 (4) Cash 15,000

(5) Cost of goods sold 10,000

Item Pete Sake Unadjusted Consolidated

Parent and Subsidiary Companies Entries

(6) Cash 7,500

(7) Cost of good sold 6,000

SUMMARY COMPARISON OF WORKING PAPER ELIMINATION ENTRIES

Cost of goods sold 800 Cost of goods sold 800

Cost of goods sold 1,200 Cost of goods sold 1,200

Retained earnings , 1/1- Pete Retained earnings , 1/1- Pete

You might also like