Intercompany Profit Transactions, Study notes of Accounting

Download Intercompany Profit Transactions and more Study notes Accounting in PDF only on Docsity! Intercompany Profit Transactions - Inventories Patriani Wahyu Dewanti, S.E., M.Acc. Accounting Department Faculty of Economics Yogyakarta State University GENERAL OVERVIEW • When there have been intercompany inventory transactions, eliminating entries are needed to remove the revenue and expenses related to the intercompany transfers recorded by the individual companies • The eliminations ensure that only the cost of the inventory to the consolidated entity is included in the consolidated balance sheet when the inventory is still on hand and is charged to cost of goods sold in the period the inventory is resold to nonaffiliates Transfers at a profit or loss • Companies use different approaches in setting intercorporate transfer prices • The elimination process must remove the effects of such sales from the consolidated statements Transfers at a profit or loss • The workpaper eliminations needed for consolidation in the period of transfer must adjust accounts in: • Consolidated income statement: Sales and cost of goods sold • Consolidated balance sheet: Inventory • The resulting financial statements appear as if the intercompany transfer had not occurred Effect of type of inventory system •Most companies use either a perpetual or a periodic inventory control system to keep track of inventory and cost of goods sold • The choice between these inventory systems results in different entries on the books of the individual companies and, therefore, slightly different workpaper eliminating entries in preparing consolidated financial statements Downstream Sale of Inventory - Illustration • Resale in period of intercorporate transfer Downstream Sale of Inventory - Illustration • This entry does not affect consolidated net income • No elimination of intercompany profit is needed because all the intercompany profit has been realized through resale of the inventory to the external party during the current period Special Foods records the sale: November 5, 20X1 Cash 15,000 Sales 15,000 Sale of inventory to Nonaffiliated. Cost of Goods Sold 10,000 Inventory 10,000 Cost of inventory sold to Nonaffiliated. Eliminating Entry: Sales 10,000 Cost of Goods Sold 10,000 Eliminate intercompany inventory sale. Downstream Sale of Inventory - Illustration • Resale in period following intercorporate transfer Downstream Sale of Inventory - Illustration • Consolidated Net Income—20X1 Cash 32,000 Investment in Special Foods Stock 32,000 Record dividends from Special Foods: $40,000 x .80 Investment in Special Foods Stock 60,000 Income from Subsidiary 60,000 Record equity-method income: $75,000 x .80 During 20X2, Special Foods receives $15,000 when it sells to Nonaffiliated Corporation the inventory that it had purchased for $10,000 from Peerless in 20X1. Also, Peerless records its pro rata portion of Special Foods’ net income and dividends for 20X2 with the normal basic equity-method entries: The consolidation workpaper prepared at the end of 20X2 is shown in Figure 7–2 in the text. Four elimination entries are needed: Downstream Sale of Inventory - Illustration Investment in Special Foods Stock Original cost 240,000 (9) 20X1 Equity accrual (8) 20X1 Dividends ($50,000 x .80) 40,000 ($30,000 * .80) 24,000 Balance, 12/31/X1 256,000 20X2 Equity accrual (14) 20X2 Dividends ($75,000 .80) 60,000 ($40,000 x .80) 32,000 Balance, 12/31/X2 284,000 • Inventory held two or more periods • Prior to liquidation, an eliminating entry is needed in the consolidation workpaper each time consolidated statements are prepared to restate the inventory to its cost to the consolidated entity E(20) Retained Earnings, January 1 3,000 Inventory 3,000 Eliminate beginning inventory profit. For example, if Special Foods continues to hold the inventory purchased the following eliminating entry is needed in the consolidation workpaper each time a consolidated balance sheet is prepared for years following the year of intercompany sale, for as long as the inventory is held: UPSTREAM SALE OF INVENTORY When an upstream sale of inventory occurs and the inventory is resold by the parent to a nonaffiliate during the same period, all the parent’s equity-method entries and the eliminating entries in the consolidation workpaper are identical to those in the downstream case Upstream Sale of Inventory When the inventory is not resold to a nonaffiliate before the end of the period, workpaper eliminating entries are different from the downstream case only by the apportionment of the unrealized intercompany profit to both the controlling and noncontrolling interests © Consolidated Net Income—20X1 Peerless's separate income Special Foods’ net income Less: Unrealized intercompany profit on upstream inventory sale Special Foods’ realized net income Consolidated net income, 20X1 Income to noncontrolling interest ($47,000 x .20) Income to controlling interest $50,000 $140,000 47,000 $187,000 (9,400) $177,600 Basic Equity-Method Entries—20X2 Cash 32,000 Investment in Special Foods Stock 32,000 Record dividends from Special Foods: $40,000 x .80 Investment in Special Foods Stock 60,000 Income from Subsidiary 60,000 Record equity-method income: $75,000 x .80 As in the downstream illustration, the investment account balance at the end of 20X2 is $284,000. The consolidation workpaper used to prepare consolidated financial statements at the end of 20X2 appears in Figure 7–4 in the text. Eliminating Entries: E(29) Income from Subsidiary 60,000 Dividends Declared 32,000 Investment in Special Foods Stock 28,000 Eliminate income from subsidiary. (E30) Income to Noncontrolling Interest 15,600 Dividends Declared 8,000 Noncontrolling Interest 7,600 Assign income to noncontrolling interest: $15,600 = ($75,000 - $3,000) x .20 E(31) Common Stock—Special Foods 200,000 Retained Earnings, January 1 120,000 Investment in Special Foods Stock 256,000 Noncontrolling Interest 64,000 Eliminate beginning investment balance. E(32) Retained Earnings, January 1 2,400 Noncontrolling Interest 600 Cost of Goods Sold 3,000 Eliminate beginning inventory profit: $2,400 = $3,000 x .80 $600 = $3,000 x .20 Workpaper entry E(32) deals explicitly with the elimination of the inventory profit on the upstream sale. Costs associated with transfers • When one affiliate transfers inventory to another, some additional cost is often incurred • Such costs should be treated in the same way as if the affiliates were operating divisions of a single company Lower of cost or market • A company might write down inventory purchased from an affiliate under this rule if the market value at the end of the period is less than the intercompany transfer price The following eliminating entry is needed in the consolidation workpaper: E(34) Sales 35,000 Cost of Goods Sold 20,000 Inventory 5,000 Loss on Decline in Value of Inventory 10,000 Eliminate intercompany sale of inventory. Loss on Decline in Value of Inventory 10,000 Inventory 10,000 Write down inventory to market value. Assume that a parent company purchases inventory for $20,000 and sells it to its subsidiary for $35,000. The subsidiary still holds the inventory at year-end and determines that its market value (replacement cost) is $25,000 at that time. The subsidiary writes the inventory down from $35,000 to its lower market value of $25,000 at the end of the year and records the following entry: