Beams11 ppt05

Chapter 5:
Intercompany Profit
Transactions
Inventories
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education,
Inc. Publishing as Prentice Hall
5-1
Intercompany Profits Inventories:

Objectives
1. Understand the impact of intercompany profit in
inventories on preparing consolidation
workpapers.
2. Apply the concepts of upstream versus
downstream inventory transfers.
3. Defer unrealized inventory profits remaining in the
ending inventory.
4. Recognize realized, previously deferred, inventory
profits in the beginning inventory.

5-2
Objectives (cont.)
5. Adjust the calculations of noncontrolling interest
amounts in the presence of intercompany
inventory profits.

5-3
Intercompany Profit Transactions Inventories
1: INTERCOMPANY
INVENTORY PROFITS

5-4
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.

5-5
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

5-6
No Intercompany Profits in Inventories

During 2011, Pet sold goods costing $1,000 to its
subsidiary, Sim, at a gross profit of 30%. Sim had
none of this inventory on hand at the end of 2011. The
worksheet entry for 2011:
Sales (-R, -SE)
1,429
Cost of sales (-E, +SE)
Eliminate intercompany sales = $1,000 / (1-30%) = $1,429
1,429
All intercompany sales of inventories have been resold

to outside parties, so remove the full sales price from
both sales and cost of sales.
Pet's sales are reduced $1,429.
Sim's cost of sales are reduced $1,429.
The same entry is used if Sim sells to Pet.
5-7
Intercompany Profits Only in Ending

Inventories
Last year, 2011, Pal 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 2011.
During 2012, Pal sold additional goods costing
$900 to Sal at a gross profit of 40%. Sal has $200
of these goods on hand at 12/31/2012. Worksheet
entries for 2012:
Sales (-R, -SE)
1,500
Eliminate intercompany sales = $900 / (1-40%) = $1,500
Cost of sales (E, -SE)
80
Inventory (-A)
Inc. Publishing
as Prentice
Hall
Defer profit in ending inventory
= $200
x 40%
1,500
80
5-8
Intercompany Profits Beginning and

Ending Inventories
Last year, 2011, 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
2011.
During 2012, Pam sold additional goods costing $500 to Sir at a 30%
mark-up. Sir has $260 of these goods on hand at 12/31/2012. Worksheet
entries for 2012:
Sales (-R, -SE)

650
650
Eliminate intercompany sales = $500 + 30%($500) = $650

Inventory (-A)
60
60
Defer profits in ending inventory = $260 x 30%/130%
Investment in Subsidiary (+A)

24
24 5-9
2: UPSTREAM &
DOWNSTREAM INVENTORY
SALES

5-10
Upstream and Downstream Sales

Downstream Sales
Parent sells to
subsidiary
Subsidiary sells to
parent
Upstream Sales
5-11
Intercompany Inventory Sales

The worksheet entries for eliminating intercompany
profits for downstream sales
Sales (-R, -SE)
XXX
XXX
For the intercompany sales price

Inventory (-A)
XX
XX
For the profits in ending inventory
Investment in Subsidiary (+A)

XX
Cost of salessales,
(-E, +SE)
For upstream
the last entry would include a XX
For theto
profits
in beginning inventory
debit
noncontrolling
interest, sharing the realized
profit between controlling and noncontrolling interests.
5-12
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 profit in ending inventory $60
IC profit in beginning inventory $24

5-13
Income Sharing with Downstream Sales

PARENT Makes Sale
Subsidiary net income
$5,200
Current amortizations
(450)
Adjusted income
$4,750
CI 80% share
$3,800
(60)
24
Defer profits in EI
(60)
Recognize profits in BI
24
Income recognized
$4,714
$3,764
$2,400
Subsidiary
dividends
$3,000
When parent
makes the IC
sale,
the impact of deferring and
recognizing profits falls all to the
parent.
Income from subsidiary
NCI 20% share

$950
$600
5-14
Income Sharing with Upstream Sales

SUBSIDIARY Makes Sale
Subsidiary net income
$5,200
(450)
Adjusted income
$4,750
CI 80% share
$3,800
(48)
19.2
Defer profits in EI
Recognize profits in BI
Income recognized
(60)
$3,771.2
Income from subsidiary
24
$4,714
$2,400
Subsidiary
dividends makes $3,000
When subsidiary
the IC sale, the
impact of deferring and recognizing
profits is split among controlling and
noncontrolling interests.
NCI 20% share

$950.0
(12.0)
4.8
$942.8
$600
5-15
3: UNREALIZED PROFITS IN
ENDING INVENTORIES

5-16
Ending Inventory on Hand

Intercompany profits in ending inventory
Eliminate at year end
Working paper entry
Inventories (-A)
For the unrealized profit

XXX
XXX
5-17
Parent Accounting
Pot owns 90% of Sot acquired at book value (no
amortizations). During the current year, Sot reported
$10,000 income. Pot sold goods to Sot during the year
for $15,000 including a profit of $6,250. Sot still holds
40% of these goods at the end of the year.
Unrealized profit in ending inventory
40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000) 2,500 unrealized profits = $6,500
Noncontrolling interest share
10%(10,000) = $1,000
5-18
Entries
Pot's journal entry to record income
Investment in Sot (+A)
Income from Sot (R, +SE)
6,500
6,500
Worksheet entries to eliminate intercompany

sale and unrealized profits
Sales (-R, -SE)
Cost of goods sold (-E, +SE)
Cost of goods sold (E, -SE)
Inventory (-A)
15,000
15,000
2,500
2,500
5-19
Worksheet Income Statement

Sales
Income from Sot
Pot
Sot
DR
$100.0
$50.0
15.0
$135.0
6.5
0.0
6.5
Cost of sales
(60.0)
(35.0)
Expenses
(15.0)
(5.0)

Controlling interest share
2.5
CR
15.0
(82.5)
(20.0)
1.0
$31.5
Consol
$7.5
(1.0)
$31.5
There would be a credit adjustment to Inventory for $2.5 on the

balance sheet portion of the worksheet.

5-20
What if?
If the sales had been upstream, by Sot to Pot:
Unrealized profits in ending inventory
40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000 2,500) = $6,750
10%(10,000 2,500) = $750
Upstream profits impact both:
Controlling interest share
5-21
4: RECOGNIZING PROFITS
FROM BEGINNING
INVENTORIES

5-22
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!
5-23
5: IMPACT ON
NONCONTROLLING
INTEREST

5-24
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

5-25
Calculating Income and NCI

Downstream sales:
Income from sub
= CI%(Sub's NI) Profits in EI + Profits in BI

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

= NCI%(Sub's NI Profits in EI + Profits in BI)

5-26
Upstream Example with Amortization

Perry acquired 70% of Salt on 1/1/2011 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.
2011
Separate income
Dividends
Perry
$1,250
$600
2012
Salt Perry
$705 $1,500
$280
$600
Salt
$745
$300
During 2011, Salt sold goods for $700 to Perry at a 20% markup.
$240 of these goods were in Perry's ending inventory.
In 2012, Salt sold goods for $900 to Perry at a 25% markup and
Perry still had $100 on hand at the end of the year.
5-27
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
Unamort
1/1/11
2011
1/1/12
2012
12/31/12
Inventory
50
(50)
Building
100
(5)
95
(5)
90
Goodwill
50
50
50
200
(55)
145
(5)
140
Allocated to:

5-28
2011 Income Sharing (Upstream)

Salt's net income
Adjusted income
$705
CI 70% share
(55)
$455
$650
($28)
$427
Defer profits in EI
Income recognized
Income from Salt
(40)
$610
$196
NCI 30% share
$195
Subsidiary dividends
$280
($12)
$183

$84
5-29
Perry's 2011 Equity Entries

Investment in Salt (+A)
Cash (-A)
For acquisition of 70% of Salt
Cash (+A)
Investment in Salt (-A)
For dividends received
Income from Salt (R, +SE)
For share of income
420
420
196
196
427
427
5-30
2011 Worksheet Entries (1 of 3)

1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)
Cost of Sales (E, -SE)
Inventory (-A)
700
700
40
40
3. Eliminate income & dividends from sub. and bring

Investment
to its beginning balance
Income from account
Salt (-R, -SE)
427
Dividends (+SE)
196
231
5-31
2011 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share (-SE)
183
Dividends (+SE)
84
Noncontrolling interest (+SE)
99
5. Eliminate reciprocal Investment & sub's equity

balances
Capital stock (-SE)
200
Retained earnings (-SE)
200
Inventory (+A)
50
Building (+A)
100
Goodwill (+A)
50

4205-32
6. Amortize fair value/book value differentials
Inventory (-A)
Depreciation expense (E, -SE)
Building (-A)
50
50
5
5
7. Eliminate other reciprocal balances none

5-33
2012 Income Sharing (Upstream)

Salt's net income
Adjusted income
Defer profits in EI
Realize profits from BI
Income recognized
Subsidiary dividends
$745
(5)
$740
(20)
40
$760
CI 70% share
$518
($14)
$28
$532
$210
$300
Income from Salt

NCI 30% share
$222
($6)
$12
$228

$90
5-34
Perry's 2012 Equity Entries

Cash (+A)
For dividends received
Income from Salt (R, +SE)
For share of income

210
210
532
532
5-35
2012 Worksheet Entries (1 of 3)

1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)
900
Cost of Sales (E, -SE)
900
20
Inventory (-A)
20
28
Noncontrolling interest (-SE)
12

3. Eliminate income & dividends from sub. and bring
Income from Salt
(-R, -SE)
Investment
account
to its beginning balance 532
Dividends (+SE)
40
210
322
5-36
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share (-SE)
228
Dividends (+SE)
90

138
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock (-SE)
200
Retained earnings (-SE)
625
Inventory (+A)
Building (+A)
95
Goodwill (+A)
50

679
2915-37
6. Amortize fair value/book value differentials
Depreciation expense (E, -SE)
Building (-A)
5
5
7. Eliminate other reciprocal balances none

5-38
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5-39

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Chapter 5:

Intercompany Profits Inventories:

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Intercompany Profit Transactions Inventories

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Intercompany Sales of Inventory

Copyright 2012 Pearson Education,

No Intercompany Profits in Inventories

All intercompany sales of inventories have been resold

Intercompany Profits Only in Ending

Intercompany Profits Beginning and

Sales (-R, -SE)

Eliminate intercompany sales = $500 + 30%($500) = $650

Cost of sales (E, -SE)

Defer profits in ending inventory = $260 x 30%/130%

Investment in Subsidiary (+A)

Intercompany Profit Transactions Inventories

Copyright 2012 Pearson Education,

Upstream and Downstream Sales

Intercompany Inventory Sales

Cost of sales (E, -SE)

For the profits in ending inventory

Investment in Subsidiary (+A)

Data for Example

Copyright 2012 Pearson Education,

Income Sharing with Downstream Sales

Income from subsidiary

NCI 20% share

Income Sharing with Upstream Sales

Income from subsidiary

NCI 20% share

Intercompany Profit Transactions Inventories

Copyright 2012 Pearson Education,

Ending Inventory on Hand

Copyright 2012 Pearson Education,

Worksheet entries to eliminate intercompany

Worksheet Income Statement

Noncontrolling interest share

There would be a credit adjustment to Inventory for $2.5 on the

Copyright 2012 Pearson Education,

Intercompany Profit Transactions Inventories

Copyright 2012 Pearson Education,

Intercompany Profits in Beginning

Intercompany Profit Transactions Inventories

Copyright 2012 Pearson Education,

Direction of Sale and NCI

Copyright 2012 Pearson Education,

Calculating Income and NCI

Noncontrolling interest share

Noncontrolling interest share

Copyright 2012 Pearson Education,

Upstream Example with Amortization

Analysis and Amortization

Implied value of Salt 420/.70

Book value 200 + 200

Copyright 2012 Pearson Education,

2011 Income Sharing (Upstream)