Chapter 6: Intercompany Profit

Transactions – Plant Assets

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

to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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Intercompany Profit Transactions – Plant Assets
1: Transfers of Plant Assets

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 Intercompany Profits – Plant
Assets: Objectives
1. Assess the impact of intercompany profit on
transfers of plant assets in preparing
consolidations working papers.
2. Defer unrealized profits on asset transfers by
either the parent or subsidiary.
3. Recognize realized, previously deferred profits
on asset transfers by the parent or subsidiary.
4. Adjust the calculation of noncontrolling interest
amounts in the presence of intercompany profits
on asset transfers.
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 Intercompany Fixed Asset Sales
Intercompany sales of nondepreciable fixed
assets:
• In year of intercompany sale
– Defer any gain or loss
– Restate fixed asset to cost
• In years of continued ownership
– Adjust investment account to defer gain or
loss (adjust noncontrolling interest too, if
upstream sale)
– Restate fixed asset to cost
• In year of sale to outside entity
– Adjust investment account (and
noncontrolling interest if upstream sale)
– Recognize the previously deferred gain or
loss
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 Intercompany Sale of Land
• Park owns 90% of Stan, acquired at cost equal
to fair value. In 2009, Park sells (downstream)
land to Stan and records a $10 gain. In 2013,
Stan sells the land to an outside entity at a $15
gain. Stan's separate income was $70 in 2009,
$80 per year for 2010 to 2012, and $90 in 2013.

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 2009 Calculations
Defer the unrealized gain, with full effect to Park
• Park's Income from Stan
90%(70) – 10 = $53
• Noncontrolling interest share
10%(70) = $7
Elimination entry for 2009 Worksheet

Gain on sale of land 10

Land 10

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 2010 to 2012 Calculations
Continue to defer gain, with full effect to Park
• Park's Income from Stan
90%(80) = $72
• Noncontrolling interest share
10%(80) = $8
Elimination entry for Worksheets in 2010 to 2012

Investment in Stan 10
Land 10

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 2013 Calculations
Recognize the previously deferred gain, with full
effect to Park
• Park's Income from Stan
90%(90) + 10 = $91
• Noncontrolling interest share
10%(90) = $9
Elimination entry for 2013 Worksheet
Investment in Stan 10
Gain on sale of land 10

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Intercompany Profit Transactions – Plant Assets
2: Deferring Unrealized Profits

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 Unrealized Profits on Fixed Assets
Unrealized profit or loss on nondepreciable fixed
assets
– Defer in year of intercompany sale
– Continue deferring by adjusting the
investment in subsidiary (and noncontrolling
interest if upstream)
– Recognize full profit or loss upon resale to
outside entity

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 Depreciable Fixed Assets
Gains and losses on intercompany sales of
depreciable fixed assets
– Defer in period of intercompany sale
– Recognize gain or loss over remaining life of
asset
• Adjust asset and depreciation down for
gains
• Adjust asset and depreciation up for losses
– Recognize any unamortized gain or loss upon
sale to outside entity
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 Downstream Example
Perry owns 80% of Soper, acquired at cost equal
to fair value. On 1/1/09, Perry sells equipment
to Soper at a $30 profit. The equipment has a
remaining life of 5 years from 1/1/09. Soper
disposes of the equipment at book value at the
end of 5 years. Soper's income is $70 in 2009,
$80 per year for 2010 to 2012, and $90 in 2013.

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 2009 Calculations
Defer the unrealized gain and amortize it over 5
years with full effect to Perry
30 gain / 5 years = $6
• Perry's Income from Soper
80%(70) – 30 + 6 = $32
• Noncontrolling interest share
20%(70) = $14
Elimination entry for 2009 Worksheet
Gain on sale of equipment 30
Equipment 30
Accumulated depreciation 6
Depreciation expense 6
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Intercompany Profit Transactions – Plant Assets
3: Recognizing Realized, Previously
Deferred Profits

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 Previously Deferred Gains/Losses
Recognize over the life of the depreciable asset
– Downstream sales
• Adjust investment in subsidiary account
– Upstream sales
• Adjust investment in subsidiary account and
noncontrolling interest, proportionately
– Intercompany sales at a gain
• Adjust asset and depreciation down
– Intercompany sales at a loss
• Adjust asset and depreciation up
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 2010 to 2012 Calculations
Continue to recognize part of the gain, with full
effect to Perry
• Perry's Income from Soper
80%(80) + 6 = $70
• Noncontrolling interest share
20%(80) = $16
Elimination entry for Worksheets in 2010
Investment in Soper 24
Accumulated depreciation 6
Equipment 30
Accumulated depreciation 6
Depreciation expense 6
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 Entries (cont.)
Worksheet entries for 2011
Investment in Soper 18
Accumulated depreciation 12
Equipment 30
Accumulated depreciation 6
Depreciation expense 6
Worksheet entries for 2012
Investment in Soper 12
Accumulated depreciation 18
Equipment 30
Accumulated depreciation 6
Depreciation expense 6
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 2013 Calculations
Recognize the remaining deferred gain, with full
effect to Perry
• Perry's Income from Soper
80%(90) + 6 = $78
• Noncontrolling interest share
20%(90) = $18
Elimination entries for 2013 Worksheet
Investment in Soper 6
Accumulated depreciation 24
Equipment 30
Accumulated depreciation 6
Depreciation expense 6
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Intercompany Profit Transactions – Plant Assets
4: Impact on Noncontrolling Interest

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 Sharing Unrealized Gain or Loss
Upstream sales of fixed assets require:
– Deferring the gain or loss on the sale
– Recognizing a portion of the gain or loss as
the asset depreciates
– Writing off any unrecognized gain or loss
upon the sale of the asset
– Sharing the gains and losses between the
controlling and noncontrolling interests
Upstream sales impact noncontrolling interests!

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 Upstream Example
Pail owns 70% of Shovel, acquired at cost equal to
fair value. On 1/1/09, Shovel sells equipment to
Pail at a $40 profit. The equipment has a
remaining life of 5 years from 1/1/09. Pail Uses
the equipment for four years, then sells it at a
profit at the start of 2013. Shovel's income is
$70 in 2009, $80 per year for 2010 to 2012, and
$90 in 2013.

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 2009 Calculations
Defer the unrealized gain and amortize it over 5
years sharing the gain
40 gain / 5 years = $8
• Pail's Income from Shovel
70%(70 – 40 + 8) = $26.6
• Noncontrolling interest share
30%(70 – 40 + 8) = $11.4
Elimination entry for 2009 Worksheet
Gain on sale of equipment 40
Equipment 40
Accumulated depreciation 8
Depreciation expense 8
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 2010 to 2012 Calculations
Continue to recognize part of the gain, sharing its
effect between the controlling and
noncontrolling interests
• Pail's Income from Shovel
70%(80 + 8) = $61.6
• Noncontrolling interest share
30%(80 + 8) = $26.4

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 2010 Worksheet Entries
Elimination entry for Worksheets in 2010
Investment in Shovel 22.4
Noncontrolling interest 9.6
Accumulated depreciation 8.0
Equipment 40.0
Accumulated depreciation 8.0
Depreciation expense 8.0

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 2011 Worksheet Entries
Worksheet entries for 2011
Investment in Shovel 16.8
Noncontrolling interests 7.2
Accumulated depreciation 16.0
Equipment 40
Accumulated depreciation 8.0
Depreciation expense 8.0

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 2012 Worksheet Entries
Worksheet entries for 2012
Investment in Shovel 11.2
Noncontrolling interest 4.8
Accumulated depreciation 24.0
Equipment 40.0
Accumulated depreciation 8.0
Depreciation expense 8.0

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 2013 Calculations
Recognize the remaining deferred gain, sharing the impact
with controlling and noncontrolling interests
• Unamortized gain = 1 year at $8
• Pail's Income from Shovel
70%(90 + 8) = $68.6
• Noncontrolling interest share
30%(90 + 8) = $29.4
Elimination entries for 2013 Worksheet
Investment in Shovel 5.6
Noncontrolling interests 2.4
Accumulated depreciation 32.0
Equipment 40.0
Accumulated depreciation 8.0
Gain on sale of equipment 8.0
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 Sale at Other Than Fair Value
Intercompany sales of fixed assets at prices other
than fair value
– Deserve scrutiny by shareholders
– Sales above fair value move additional
cash to the seller
– Sales below fair value transfer valuable
goods to the buyer
– There is a transfer of wealth between the
affiliated companies, and between the
controlling and noncontrolling interests

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 Inventory Items  Fixed Assets
An intercompany sale of inventory which is
acquired as a fixed asset
– Unrealized profit is removed from cost of
sales in year of sale
– Profit is recognized over the fixed asset's life
Cost of sales XXX
Equipment XXX
Accumulated depreciation X
Depreciation expense X
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