To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 5: Intercompany Profit Transactions – Inventories Copyright

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

to accompanyAdvanced Accounting, 11th edition

by Beams, Anthony, Bettinghaus, and Smith

Chapter 5:

Intercompany Profit Transactions –

Inventories

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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.

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Objectives (cont.)

5. Adjust the calculations of noncontrolling interest amounts in the presence of intercompany inventory profits.

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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 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:

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.

Sales (-R, -SE) 1,429 Cost of sales (-E, +SE) 1,429

Eliminate intercompany sales = $1,000 / (1-30%) = $1,429

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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 Cost of sales (-E, +SE) 1,500

Eliminate intercompany sales = $900 / (1-40%) = $1,500Cost of sales (E, -SE) 80

Inventory (-A) 80Defer profit in ending inventory = $200 x 40%

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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

Cost of sales (-E, +SE) 650Eliminate intercompany sales = $500 + 30%($500) = $650

Cost of sales (E, -SE) 60 Inventory (-A) 60

Defer profits in ending inventory = $260 x 30%/130%Investment in Subsidiary (+A) 24

Cost of sales (-E, +SE) 24Realize profits from beginning inventory = $120 x 25%/125% = $24

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2: UPSTREAM & DOWNSTREAM INVENTORY SALES


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Downstream Sales

Parent sells to subsidiary

Subsidiary sells to parent

Upstream Sales

Upstream and Downstream Sales

Parent

Subsidiary 1 Subsidiary 2 Subsidiary 3

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Intercompany Inventory Sales

The worksheet entries for eliminating intercompany profits for downstream sales

For upstream sales, the last entry would include a debit to noncontrolling interest, sharing the realized profit between controlling and noncontrolling interests.

Sales (-R, -SE) XXX Cost of sales (-E, +SE) XXX

For the intercompany sales priceCost of sales (E, -SE) XX

Inventory (-A) XXFor the profits in ending inventoryInvestment in Subsidiary (+A) XX

Cost of sales (-E, +SE) XXFor the profits in beginning inventory

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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

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CI 80% share$3,800

(60)24

$3,764

$2,400 NCI 20% share

$950

$600

Income Sharing with Downstream Sales – PARENT Makes Sale

Subsidiary net income $5,200 Current amortizations (450)Adjusted income $4,750 Defer profits in EI (60)Recognize profits in BI 24 Income recognized $4,714 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

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NCI 20% share

$950.0(12.0)4.8

$942.8

$600

CI 80% share$3,800

(48)19.2

$3,771.2

$2,400

Income Sharing with Upstream Sales – SUBSIDIARY Makes Sale

Subsidiary net income $5,200 Current amortizations (450)Adjusted income $4,750 Defer profits in EI (60)Recognize profits in BI 24 Income recognized $4,714 Subsidiary dividends $3,000

When subsidiary makes the IC sale, the impact of deferring and recognizing profits is split among controlling and noncontrolling interests.

Income from subsidiary

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3: UNREALIZED PROFITS IN ENDING 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

Inventories (-A) XXXFor the unrealized profit

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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 inventory40%(6,250) = $2,500

Pot's Income from Sot90%(10,000) – 2,500 unrealized profits = $6,500

Noncontrolling interest share10%(10,000) = $1,000

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Entries

Pot's journal entry to record income

Worksheet entries to eliminate intercompany sale and unrealized profits

Sales (-R, -SE) 15,000

Cost of goods sold (-E, +SE) 15,000Cost of goods sold (E, -SE) 2,500

Inventory (-A) 2,500

Investment in Sot (+A) 6,500

Income from Sot (R, +SE) 6,500

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Worksheet – Income Statement

Pot Sot DR CR Consol

Sales $100.0 $50.0 15.0 $135.0

Income from Sot 6.5 6.5 0.0

Cost of sales (60.0) (35.0) 2.5 15.0 (82.5)

Expenses (15.0) (5.0) (20.0)

Noncontrolling interest share 1.0 (1.0)

Controlling interest share $31.5 $7.5 $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 Sot to Pot:Unrealized profits in ending inventory

40%(6,250) = $2,500Pot's Income from Sot

90%(10,000 – 2,500) = $6,750Noncontrolling interest share

10%(10,000 – 2,500) = $750

Upstream profits impact both: Controlling interest share Noncontrolling interest share

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4: RECOGNIZING PROFITS FROM BEGINNING 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: IMPACT ON NONCONTROLLING INTEREST


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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 salesDownstream sales

Full impact on parentUpstream 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

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.

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.

2011 2012

Perry Salt Perry Salt

Separate income $1,250 $705 $1,500 $745Dividends $600 $280 $600 $300

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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 UnamortAllocated to: 1/1/11 2011 1/1/12 2012 12/31/12Inventory 50 (50) 0 0 0 Building 100 (5) 95 (5) 90 Goodwill 50 0 50 0 50 200 (55) 145 (5) 140

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NCI 30% share$195 ($12)$183

$84

CI 70% share$455 ($28)$427

$196

2011 Income Sharing (Upstream)

Income from Salt

Salt's net income $705 Current amortizations (55)Adjusted income $650 Defer profits in EI (40)Income recognized $610

Subsidiary dividends $280

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Perry's 2011 Equity Entries

Investment in Salt (+A) 420

Cash (-A) 420For acquisition of 70% of SaltCash (+A) 196

Investment in Salt (-A) 196For dividends receivedInvestment in Salt (+A) 427

Income from Salt (R, +SE) 427For share of income

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2011 Worksheet Entries (1 of 3)

1. Adjust for errors & omissions - none2. Eliminate intercompany profits and losses

3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance

Sales (-R, -SE) 700

Cost of sales (-E, +SE) 700Cost of Sales (E, -SE) 40

Inventory (-A) 40

Income from Salt (-R, -SE) 427

Dividends (+SE) 196Investment in Salt (-A) 231

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2011 Entries (2 of 3)

4. Record noncontrolling interest in sub's earnings & dividends

5. Eliminate reciprocal Investment & sub's equity balances

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

Investment in Salt (-A) 420Noncontrolling interest (+SE) 180

Noncontrolling interest share (-SE) 183 Dividends (+SE) 84Noncontrolling interest (+SE) 99

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6. Amortize fair value/book value differentials

7. Eliminate other reciprocal balances – none

Cost of sales (E, -SE) 50

Inventory (-A) 50Depreciation expense (E, -SE) 5

Building (-A) 5

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

$228

$90

CI 70% share$518 ($14)$28 $532

$210

2012 Income Sharing (Upstream)

Income from Salt

Salt's net income $745 Current amortizations (5)Adjusted income $740 Defer profits in EI (20)Realize profits from BI 40 Income recognized $760 Subsidiary dividends $300

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Perry's 2012 Equity Entries

Cash (+A) 210Investment in Salt (-A) 210

For dividends receivedInvestment in Salt (+A) 532

Income from Salt (R, +SE) 532For share of income

5-35

2012 Worksheet Entries (1 of 3)1. Adjust for errors & omissions - none2. Eliminate intercompany profits and losses

3. Eliminate income & dividends from sub. and bring Investment account to its beginning balance

Income from Salt (-R, -SE) 532 Dividends (+SE) 210Investment in Salt (-A) 322

Sales (-R, -SE) 900 Cost of sales (-E, +SE) 900

Cost of Sales (E, -SE) 20Inventory (-A) 20

Investment in Salt (+A) 28Noncontrolling interest (-SE) 12

Cost of sales (-E, +SE) 40


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4. Record noncontrolling interest in sub's earnings & dividends

5. Eliminate reciprocal Investment & sub's equity balances

Capital stock (-SE) 200 Retained earnings (-SE) 625Inventory (+A) 0Building (+A) 95Goodwill (+A) 50

Investment in Salt (-A) 679Noncontrolling interest (+SE) 291

Noncontrolling interest share (-SE) 228 Dividends (+SE) 90Noncontrolling interest (+SE) 138

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6. Amortize fair value/book value differentials

7. Eliminate other reciprocal balances – none

Depreciation expense (E, -SE) 5Building (-A) 5

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Documents

To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 5: Intercompany Profit Transactions – Inventories Copyright