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© Pearson Education, Inc. publishing as Prentice Hall5-1 Chapter 5: Intercompany Profit Transactions – Inventories by Jeanne M. David, Ph.D., Univ. of.

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Presentation on theme: "© Pearson Education, Inc. publishing as Prentice Hall5-1 Chapter 5: Intercompany Profit Transactions – Inventories by Jeanne M. David, Ph.D., Univ. of."— Presentation transcript:

1 © Pearson Education, Inc. publishing as Prentice Hall5-1 Chapter 5: Intercompany Profit Transactions – Inventories by Jeanne M. David, Ph.D., Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn

2 © Pearson Education, Inc. publishing as Prentice Hall5-2 Intercompany Profits – Inventories: Objectives 1.Understand the impact of intercompany profit for inventories on preparation of consolidation working papers. 2.Apply the concepts of upstream versus downstream inventory transfers. 3.Defer unrealized inventory profits remaining in ending inventory of either the parent or subsidiary.

3 © Pearson Education, Inc. publishing as Prentice Hall5-3 Objectives (cont.) 4.Recognize realized, previously deferred inventory profits in the beginning inventory of either the parent or subsidiary. 5.Adjust the calculations of noncontrolling interest amounts in the presence of intercompany inventory profits.

4 © Pearson Education, Inc. publishing as Prentice Hall5-4 1: Intercompany Inventory Profits Intercompany Profit Transactions – Inventories

5 © Pearson Education, Inc. publishing as Prentice Hall5-5 Intercompany Transactions For consolidated financial statements, ARB No. 51 (as amended by FASB Statement No. 160) states: –"intercompany balances and transactions shall be eliminated." Show income and financial position as if the intercompany transactions had never taken place.

6 © Pearson Education, Inc. publishing as Prentice Hall5-6 Intercompany Sales of Inventory Profits on intercompany sales of inventory –All 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 Consider a FIFO inventory system –Beginning inventories are sold –Ending inventories are from current period

7 © Pearson Education, Inc. publishing as Prentice Hall5-7 No Intercompany Profits in Inventories During 2009, Pretty sold goods costing $1,000 to its subsidiary, Simple, at a gross profit of 30%. Simple had none of this inventory on hand at the end of Worksheet entry for 2009: All intercompany sales of inventories have been resold to outside parties, so remove the full sales price from both sales and cost of sales. –Pretty's sales are reduced $1,429. –Simple's cost of sales are reduced $1,429. The same entry is used if Simple sells to Pretty. Sales1,429 Cost of sales1,429 Sales = $1,000 / (1-30%) = $1,429

8 © Pearson Education, Inc. publishing as Prentice Hall5-8 Intercompany Profits Only in Ending Inventories Last year, 2009, Paul 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 During 2010, Paul sold additional goods costing $900 to Sal at a gross profit of 40%. Sal has $200 of these goods on hand at 12/31/2010. Worksheet entries for 2010: Sales1,500 Cost of sales1,500 Sales = $900 / (1-40%) = $1,500 Cost of sales80 Inventory80 Ending inventory profit = $200 x 40%

9 © Pearson Education, Inc. publishing as Prentice Hall5-9 Intercompany Profits Beginning and Ending Inventories Last year, 2009, 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 During 2010, Pam sold additional goods costing $500 to Sir at a 30% mark-up. Sir has $260 of these goods on hand at 12/31/2010. Worksheet entries for 2010: Sales650 Cost of sales650 Sales = $ %($500) = $650 Cost of sales60 Inventory60 Ending inv. profits = $260 x 30%/130% Investment in Subsidiary24 Cost of sales 24 Begin. inv. profits = $120 x 25%/125% = $24

10 © Pearson Education, Inc. publishing as Prentice Hall5-10 2: Upstream & Downstream Inventory Sales Intercompany Profit Transactions – Inventories

11 © Pearson Education, Inc. publishing as Prentice Hall5-11 Downstream Sales Parent sells to subsidiary Subsidiary sells to parent Upstream Sales Upstream and Downstream Sales Parent Subsidiary 1 Subsidiary 2 Subsidiary 3

12 © Pearson Education, Inc. publishing as Prentice Hall5-12 Intercompany Inventory Sales The worksheet entries for eliminating intercompany profits for downstream sales For upstream sales, the last entry would also include a debit to noncontrolling interest, splitting the profit to be realized between controlling and noncontrolling interests. SalesXXX Cost of salesXXX For the intercompany sales price Cost of salesXX InventoryXX For the profits in ending inventory Investment in SubsidiaryXX Cost of sales XX For the profits in beginning inventory

13 © Pearson Education, Inc. publishing as Prentice Hall5-13 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 profits in ending inventory $60 –IC profit in beginning inventory $24

14 © Pearson Education, Inc. publishing as Prentice Hall5-14 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 BI24 Income recognized$4,714 Subsidiary dividends$3,000 CI 80% share $3,800 (60) 24 $3,764 $2,400 NCI 20% share $950 $600 When parent makes the IC sale, the impact of deferring and recognizing profits falls all to the parent. Income from subsidiary

15 © Pearson Education, Inc. publishing as Prentice Hall5-15 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 BI24 Income recognized$4,714 Subsidiary dividends$3,000 CI 80% share $3,800 (48) 19.2 $3,771.2 $2,400 NCI 20% share $950.0 (12.0) 4.8 $942.8 $600 When subsidiary makes the IC sale, the impact of deferring and recognizing profits is split among controlling and noncontrolling interests. Income from subsidiary

16 © Pearson Education, Inc. publishing as Prentice Hall5-16 3: Unrealized Profits in Ending Inventories Intercompany Profit Transactions – Inventories

17 © Pearson Education, Inc. publishing as Prentice Hall5-17 Ending Inventory on Hand Intercompany profits in ending inventory –Eliminate at year end Working paper entry Cost of salesXXX InventoriesXXX For the unrealized profit

18 © Pearson Education, Inc. publishing as Prentice Hall5-18 Parent Accounting Porter owns 90% of Sorter acquired at book value (no amortizations). During the current year, Sorter reported $10,000 income. Porter sold goods to Sorter during the year for $15,000 including a profit of $6,250. Sorter still holds 40% of these goods at the end of the year. Unrealized profit in ending inventory 40%(6,250) = $2,500 Porter's Income from Sorter 90%(10,000) – 2,500 unreal. Profits = $6,500 Noncontrolling interest share 10%(10,000) = $1,000

19 © Pearson Education, Inc. publishing as Prentice Hall5-19 Entries Porter's journal entry to record income Worksheet entries to eliminate intercompany sale and unrealized profits Sales15,000 Cost of sales15,000 Cost of sales2,500 Inventory2,500 Investment in Sorter6,500 Income from Sorter6,500

20 © Pearson Education, Inc. publishing as Prentice Hall5-20 Worksheet – Income Statement PorterSorterDRCRConsol Sales$100.0$ $135.0 Income from Sorter Cost of sales(60.0)(35.0) (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.

21 © Pearson Education, Inc. publishing as Prentice Hall5-21 What if? If the sales had been upstream, by Sorter to Porter: Unrealized profits in ending inventory 40%(6,250) = $2,500 Porter's Income from Sorter 90%(10,000 – 2,500) = $6,750 Noncontrolling interest share 10%(10,000 – 2,500) = $750 Upstream profits impact both –Controlling interest share –Noncontrolling interest share

22 © Pearson Education, Inc. publishing as Prentice Hall5-22 4: Recognizing Profits from Beginning Inventories Intercompany Profit Transactions – Inventories

23 © Pearson Education, Inc. publishing as Prentice Hall5-23 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!

24 © Pearson Education, Inc. publishing as Prentice Hall5-24 5: Impact on Noncontrolling Interest Intercompany Profit Transactions – Inventories

25 © Pearson Education, Inc. publishing as Prentice Hall5-25 Direction of Sale and NCI The impact of unrealized profits in ending inventory and realizing profits in beginning inventory depends on the direction Downstream sales –Full impact on parent Upstream sales –Share impact between parent and noncontrolling interest

26 © Pearson Education, Inc. publishing as Prentice Hall5-26 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)

27 © Pearson Education, Inc. publishing as Prentice Hall5-27 Upstream Example with Amortization Perry acquired 70% of Salt on 1/1/2009 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 2009, Salt sold goods costing $700 to Perry at a 20% markup. $240 of these goods were in Perry's ending inventory. In 2010, Salt sold goods costing $900 to Perry at a 25% markup and Perry still had $100 on hand at the end of the year PerrySaltPerrySalt Separate income$1,250$705$1,500$745 Dividends$600$280$600$300

28 © Pearson Education, Inc. publishing as Prentice Hall5-28 Analysis and Amortization Cost of 70% of Salt$420 Implied value of Salt 420/.70$600 Book value Excess$200 UnamortAmortUnamortAmortUnamort Allocated to:1/1/ /1/ /31/10 Inventory50(50)000 Building100(5)95(5)90 Goodwill (55)145(5)140

29 © Pearson Education, Inc. publishing as Prentice Hall 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 CI 70% share $455 ($28) $427 $196 NCI 30% share $195 ($12) $183 $84

30 © Pearson Education, Inc. publishing as Prentice Hall5-30 Perry's 2009 Equity Entries Investment in Salt420 Cash420 For acquisition of 70% of Salt Cash196 Investment in Salt196 For dividends received Investment in Salt427 Income from Salt427 For share of income

31 © Pearson Education, Inc. publishing as Prentice Hall Worksheet Entries 1.Adjust for errors & omissions - none 2.Eliminate intercompany profits and losses 3.Eliminate income & dividends from sub. and bring Investment account to its beginning balance Sales700 Cost of sales700 Cost of Sales40 Inventory40 Income from Salt427 Dividends196 Investment in Salt231

32 © Pearson Education, Inc. publishing as Prentice Hall Entries (2 of 3) 4.Record noncontrolling interest in sub's earnings & dividends 5.Eliminate reciprocal Investment & sub's equity balances Capital stock200 Retained earnings200 Inventory50 Building100 Goodwill50 Investment in Salt420 Noncontrolling interest180 Noncontrolling interest share183 Dividends84 Noncontrolling interest99

33 © Pearson Education, Inc. publishing as Prentice Hall Entries (3 of 3) 6.Amortize fair value/book value differentials 7.Eliminate other reciprocal balances – none Cost of sales50 Inventory50 Depreciation expense5 Building5

34 © Pearson Education, Inc. publishing as Prentice Hall 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 BI40 Income recognized$760 Subsidiary dividends$300 CI 70% share $518 ($14) $28 $532 $210 NCI 30% share $222 ($6) $12 $228 $90

35 © Pearson Education, Inc. publishing as Prentice Hall5-35 Perry's 2010 Equity Entries Cash210 Investment in Salt210 For dividends received Investment in Salt532 Income from Salt532 For share of income

36 © Pearson Education, Inc. publishing as Prentice Hall Worksheet Entries 1.Adjust for errors & omissions - none 2.Eliminate intercompany profits and losses 3.Eliminate income & dividends from sub. and bring Investment account to its beginning balance Sales900 Cost of sales900 Cost of Sales20 Inventory20 Investment in Salt28 Noncontrolling interest12 Cost of sales40 Income from Salt532 Dividends210 Investment in Salt322

37 © Pearson Education, Inc. publishing as Prentice Hall Entries (2 of 3) 4.Record noncontrolling interest in sub's earnings & dividends 5.Eliminate reciprocal Investment & sub's equity balances Capital stock200 Retained earnings625 Inventory0 Building95 Goodwill50 Investment in Salt679 Noncontrolling interest291 Noncontrolling interest share228 Dividends90 Noncontrolling interest138

38 © Pearson Education, Inc. publishing as Prentice Hall Entries (3 of 3) 6.Amortize fair value/book value differentials 7.Eliminate other reciprocal balances – none Depreciation expense5 Building5

39 © Pearson Education, Inc. publishing as Prentice Hall5-39 Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.


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