Chapter 4

Intercompany Sales

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Typical intercompany transactions Merchandise for resale

Land

Fixed assets

Long-term construction contracts

Notes receivable/ payable

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Merchandise sales:No inventories

Outside Co. S Co. P Outside$80 S buys

$100 P buys$125to outside

Consolidated statement for Company SP

Sales $125Cost of Goods Sold 80

The “intercompany sale” of $100 is eliminated on the worksheet.

Separate statements

Co. S Co. PSales $100 $ 125CofGS 80 100

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Intercompany price

Does the intercompany price matter?

Yes: If there is a NCI. If S was 80% owned by P, NCI gets $4 (20% x $20) and controlling interest gets $41(80% x $20 + $25)

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Merchandise sales:Unsold goods

Separate statements: S has sales of $100, C of GS of $80 P has inventory with cost of $100 Consolidated Statements: SP has inventory with a cost of $80

Outside Co. S Co. P Outside$80 $100 [in end inv]

• The “intercompany sale” of $100 is eliminated • The inventory is restated to $80• The $20 profit is not recognized until the goods are

sold by P to the outside world

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The normal merchandise procedures IS Eliminate intercompany “middle sale” - no

impact on income but overstates sales and cost of goods

BI Restore beginning inventory (included in C of GS) to cost and correct beginning Retained Earnings - this shifts profit from last year to this year

EI Restore ending inventory to cost and adjust C of GS - this defers profit to next year

IA Eliminate intercompany trade debt and interest (if any)

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Mark-up confusion

Mark-up on cost is not the sameas gross profit!

Marking a $10 cost unit up 25%$10.00 125% = $12.50

provides a gross profit of 20%$2.50 $12.50 = 20%

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Merchandise example

S (P owns 80%) buys goods for $80,000 and sells them to P for $100,000, all sales are at 20% GP

P had $10,000 of intercompany goods in beginning inventory and $15,000 of such goods in its ending inventory

P owed S $8,000 for intercompany goods at year end

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Consolidation Procedures Needed

IS - eliminate sale from subsidiary to parent

BI - reduce cost of goods sold for profit in beginning inventory and correct beginning retained earnings (allocated 20/80 because sale was by subsidiary)

EI- reduce ending inventory and increase cost of goods sold (deduct for ending inventory was too great)

IA - Eliminate intercompany trade balance

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Worksheet eliminations

Partial Worksheet Trial Balances EliminationsCo P Co S Dr Cr

Ending inventory 15,000 EI 3,000

Accounts receivable 8,000 IA 8,000

Accounts payable 8,000 IA 8,000

RE - Co. S 50,000 BI 400

RE - Co. P 120,000 BI 1,600Sales 130,000 100.000 IS 100,000

Cost of goods sold 95,000 80,000 EI 3,000 IS 100,000BI 2,000

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Adjustments on the IDSSUB

End Inv profit (EI) 3,000 Int Generated Inc 20,000

Beg Inv profit (BI) 2,000Adjusted Inc 19,000NCI % 20%NCI 3,800

PARENT

Int Generated Inc 35,000

80% of $19,000

Co. S’s adjusted inc 15,200

Controlling Interest 50,200

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Worksheet 4-3

The 4 eliminations are IS, IA, BI, EI RE split for beginning inventory because sub

sold it. If parent was seller, adjustments only to parent RE

Seller’s profit is adjusted through IDS. In this case the adjustments went to the sub (seller). They would go to Parent if parent was seller

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Worksheet 4-3 (continued)

If there is an LCM adjustment, only the remaining profit is eliminated

Phony losses (sales below market value) are also eliminated

Worksheet 4-4 shows the same adjustments for a periodic inventory

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Intercompany land sales

Year of sale: LA Gain of seller 20,000Land 20,000

Run adjustment through seller’s IDS

Gain is deferred until land is sold to outside company

Later years: LA RE (split?) 20,000Land 20,000

Adjustment is split only if seller was Sub

Year of outside sale:LA RE (split?) 20,000

Gain (loss) on land sale 20,000

Seller may finally recognize gain; credit to seller’s IDS

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Intercompany fixed asset sale: Year of saleSold 5 year machine, cost $20,000, for $30,000 on 1/1/x1

Theory - Defer gain and earn it back over period of use. The allocation method matches the depreciation method (straight-line for this example)

Year of sale:F1 Gain (seller) 10,000 defer gain on sale

Machine 10,000 return asset to costF2 Accum depr 2,000 reduce to depr. on cost

Dep Expense 2,000 recognize 1/5 profit

IDS - deduct original profit from seller and add profit equal to depreciation adjustment

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Intercompany fixed asset sale:Year subsequent to inter-company saleEnd of second year:Adjust asset at start of year

F1 RE (split?) 8,000 deferred gain on 1/1/2

Accum Depr 2,000 adjust prior year’s depr.

Machine 10,000 return asset to cost

RE adjustment is split only when sub is seller

Adjust current year depreciation

F2 Accum Depr 2,000 reduce to depr on cost Depr Expense 2,000 recognize 1/5 profit

IDS - seller gets profit equal to depreciation adjustment

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Fixed asset worksheets

WS 4-5 (year of sale) (F1) removes $10,000 profit from machinery, defers $10,000

gain (F2) adjusts depreciation and realizes $2,000 gain IDS takes away $10,000 from P [seller], gives back $2,000

WS 4-6 (end of second period after sale) (F1) removes profit from machinery, corrects last year's

depreciation and defers $8,000 profit as of 1/1/2 (F2) adjusts depreciation and realizes $2,000 gain IDS just gives back $2,000 currently realized gain to P

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Fixed asset worksheets, continued

WS 4-7 (Asset sold to outside party at end of second year) Machinery and accumulated depreciation are not there to

adjust The $6,000 remaining gain at the start of the year is now

earned - sale to outside occurred Adding the $6,000 deferred gain to the recorded $4,000

loss created a gain on the consolidated statement of $2,000. Entry is F3

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Long-term construction contracts

Completed - like any other fixed asset sale

Not Complete - Completed Contract Method:

Eliminate seller’s Billings and Cost of Construction in Progress; adjust buyer’s Asset Under Construction for unbilled costs incurred by seller

Eliminate intercompany debt balance

Not Complete - Percentage of Completion:

Key is to defer profit recorded by builder and restore asset under construction to cost

Eliminate intercompany debt balance