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6 - 0 Advanced Accounting by Debra Jeter and Paul Chaney Chapter 6: Elimination of Unrealized Profit on Intercompany Sales of Inventory Slides Authored.

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Presentation on theme: "6 - 0 Advanced Accounting by Debra Jeter and Paul Chaney Chapter 6: Elimination of Unrealized Profit on Intercompany Sales of Inventory Slides Authored."— Presentation transcript:

1 6 - 0 Advanced Accounting by Debra Jeter and Paul Chaney Chapter 6: Elimination of Unrealized Profit on Intercompany Sales of Inventory Slides Authored by Hannah Wong, Ph.D. Rutgers University

2 6 - 1 Intercompany Sales of Inventory Parent Company Subsidiary Downstream Sale Upstream Sale Horizontal Sale

3 6 - 2 Financial Reporting Objectives lConsolidated sales = sales with parties outside the affiliated group lConsolidated COGS = cost to the affiliated group of goods that have been sold to outside parties lConsolidated inventory = inventory at its cost to the affiliated group

4 6 - 3 Financial Reporting Objectives lTo present consolidated balances of sales, cost of sales, and inventory as if the intercompany sale had never occurred.

5 6 - 4 Downstream Sales : No Unrealized Profit Parent Company Subsidiary Sold for $250,000 Sold for $270,000 Purchased for $200,000 Outsider Supplier Outside Customer

6 6 - 5 Downstream Sales No Unrealized Profit - EE Sales 250,000 Purchases250,000 To eliminate intercompany sale that the parent has recorded To eliminate intercompany purchase that the subsidiary has recorded

7 6 - 6 Downstream Sales: Unrealized Profit in Ending Inventory Parent Company Subsidiary Sold for $250,000 Sold 60% of goods Purchased for $200,000 Outsider Supplier Outside Customer Note: it is the parent who records the intercompany profit, thus the parents income needs to be adjusted in consolidation

8 6 - 7 Downstream Sales - EE Year of Intercompany Sale Sales 250,000 Purchases250,000 Ending Inventory - Inc. state. (COGS) 20,000 Inventory - balance sheet20,000 To eliminate intercompany sale and purchases To exclude the unrealized profit from ending inventory To exclude the unrealized profit from consolidated net income

9 6 - 8 Downstream Sales - EE Year after Intercompany Sale Beginning R/E - P 20,000 Beginning Inventory - Inc. State. (Cost of sales) 20,000 To include the intercompany profit in beginning inventory, which is realized in the current year The intercompany profit in beginning inventory is excluded from last years consolidated NI, hence this years 1/1 R/E Cost or Partial Equity Methods

10 6 - 9 Downstream Sales - EE Year after Intercompany Sale To include the intercompany profit in beginning inventory, which is realized in the current year The intercompany profit in beginning inventory is excluded from last years consolidated NI, hence the investment account Complete Equity Method Investment in S 20,000 Beginning Inventory - Inc. State. (Cost of sales) 20,000

11 6 - 10 Amount of Intercompany Profit Gross profit method intercompany profit that should be eliminated = ending inventory of buying affiliate x selling affiliates gross profit rate (i.e., gross profit / cost)

12 6 - 11 Elimination of Downstream Intercompany Profit l100% elimination n eliminate the parents and the noncontrolling stockholders portion of intercompany profit despite partial ownership of the parent n required by current GAAP lPartial elimination n eliminate only the parents portion of intercompany profit

13 6 - 12 Upstream Sales Subsidiary Parent Company Intercompany Sale Sell Purchase Outsider Supplier Outside Customer Note: it is the subsidiary who records the intercompany profit, thus the subsidiarys income needs to be adjusted in consolidation

14 6 - 13 Upstream Sales An Example 80% owned Subsidiary Parent Company Total sales $700,000 Profit margin = 25% x selling price $400,000 intercompany merchandise in ending inventory

15 6 - 14 Upstream Sales Cost or Partial Equity Methods Sales 700,000 Purchases700,000 Ending Inventory - Inc. state. (COGS) 100,000 Inventory - balance sheet100,000 To eliminate intercompany sale and purchases To exclude the unrealized profit from ending inventory To exclude the unrealized profit (400,000x25%) from consolidated net income Year of Intercompany Sale - EEs

16 6 - 15 Upstream Sales - EE Cost or Partial Equity Methods Beginning R/E - P($100,000x80%) 80,000 Beginning R/E - S ($100,000x20%) 20,000 Beginning Inventory - Inc. State. (Cost of sales) 100,000 To include the intercompany profit in beginning inventory, which is realized in the current year Parents share of unrealized profit in beginning inventory Year after Intercompany Sale - EEs Noncontrolling interests share of unrealized profit in beginning inventory

17 6 - 16 Noncontrolling Interest in Income Reported income of S Upstream-sale profit in beginning inventory Adjusted NI of S Noncontrolling % Noncontrolling interest in income x Cost or Partial Equity Methods Upstream-sale profit in ending inventory

18 6 - 17 Controlling Interest in Income Reported income of P (Adjusted NI of S) x (P %) Consolidated income Cost and Partial Equity Methods Downstream-sale profit in beginning inventory Downstream-sale profit in ending inventory Amortization of purchase differential

19 6 - 18 Consolidated Retained Earnings Reported R/E of P Ps share of increase in S R/E since acquisition Consolidated R/E Cost and Partial Equity Methods Downstream-sale profit in Ss ending inventory P% x (Upstream-sale profit in Ps ending inventory) Accumulative amortization of purchase differential

20 6 - 19 Upstream Sales Complete Equity Method Equity in subsidiary income 80,000 Investment in S 80,000 To exclude the unrealized profit (400,000x25%) from equity in subsidiary income Year of Intercompany Sales - Journal Entries

21 6 - 20 Upstream Sales Complete Equity Method Year after Intercompany Sales - Journal Entries To include in equity in subsidiary income the intercompany profit, which is realized in the current year Investment in S 80,000 Equity in subsidiary net income80,000

22 6 - 21 Upstream Sales Complete Equity Method Sales 700,000 Purchases700,000 Ending Inventory - Income Statement100,000 Inventory - Balance Sheet100,000 To eliminate intercompany sale and purchases To exclude the unrealized profit (400,000x25%) from equity in subsidiary income Year of Intercompany Sales - EEs

23 6 - 22 Upstream Sales Complete Equity Method Investment in S 80,000 Beginning retained earnings - S20,000 1/1 Inventory - Income Statement 100,000 To include the intercompany profit in beginning inventory, which is realized in the current year Parents share of unrealized profit in beginning inventory Year after Intercompany Sale - EE Noncontrolling interests share of unrealized profit in beginning inventory

24 6 - 23 Upstream Sales Complete Equity Method Consolidated net income = Reported net income of Parent Consolidated retained earnings = Reported retained earnings of Parent

25 6 - 24 Advanced Accounting by Debra Jeter and Paul Chaney Copyright © 2001 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.


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