1. CHAPTER 4 4
Transactions: Merchandise, Plant Assets, and Notes Fundamentals of Advanced Accounting 1st Edition Fischer, Taylor, and Cheng

2. Intercompany Transactions
Transactions between parent and sub
Must be eliminated
Consolidated statements represent separate companies as if they were one entity
Common intercompany transactions
Merchandise for resale
Land
Fixed assets
Notes receivable/payable
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

3. Intercompany Sales Effect on Gross Profit
Parent sells inventory to Sub:
Cost = $1,000 Sell price = $1,200
Sub sells to outside party:
Cost = $1,200 Sell price = $1,500
Gross Profit is unaffected.
Gross Profit % is distorted unless intercompany transactions are eliminated.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

4. Intercompany Transactions
Intercompany receivables/payables must be eliminated!
Represent transfers of funds
Internal loans
No profit on intercompany sales can be recognized!
Unless goods are sold to an outside party
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

5. Elimination of Intercompany Inventory Sales
Discussed in four sections
No intercompany goods in beginning or ending inventory
Intercompany goods in ending inventory
Intercompany goods in both beginning and ending inventory
Intercompany goods in both beginning and ending inventory: Periodic inventory method
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

6. No Intercompany Goods – Beginning or Ending Inventory
Review worksheet 4-1
P owns 80% of S’ stock.
Purchase price = pro rata share of sub’s book value.
P uses the equity method.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

7. No Intercompany Goods – Beginning or Ending Inventory (Continued)
Sub sells inventory to parent
Cost = $80,000 Sell price = $100,000 GP% = 20%
Parent sells inventory to third party
Cost = $100,000 Sell price = $150,000
Parent owes $25,000 to sub for inventory purchases
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

8. No Intercompany Goods – Beginning or Ending Inventory (Continued)
CY1 Sub Income - Par 60,000
Invest. In Sub - Par 60,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub 80,000
Retained Earnings - Sub 56,000
Invest. In Sub - Par 136,000
(Eliminates investment account against 80% of equity)
IS Sales 100,000
Cost of goods sold** 100,000
(Eliminates intercompany merchandise sales)
IA Account payable 25,000
Accounts receivable 25,000
(Eliminates intercompany unpaid trade balances)
**Includes $80,000 C of G S from Sub to Parent and $20,000 C of G S from Parent to outside party.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

9. Intercompany Inventory Remains in Ending Inventory
Review worksheet 4-2
Assume same facts as to acquisition.
Sub sells inventory to parent
Cost = $80,000 Sell price = $100,000 GP% = 20%
Parent sells inventory to third party
Cost = $60,000 Sell price = $90,000
Intercompany inventory of $40,000 in parent’s ending inventory
Parent owes $25,000 to sub for inventory purchases
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

10. Intercompany Inventory Remains in Ending Inventory (continued)
CY1 Sub Income - Par 60,000
Invest. In Sub - Par 60,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub 80,000
Retained Earnings - Sub 56,000
Invest. In Sub - Par 136,000
(Eliminates investment account against 80% of equity)
IS Sales 100,000
Cost of goods sold 100,000
(Eliminates intercompany merchandise sales)
EI Cost of goods sold 8,000
Inventory 8,000
(Eliminates intercompany profit in ending inventory)
IA Account payable 25,000
Accounts receivable 25,000
(Eliminates intercompany unpaid trade balances)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

11. Intercompany Inventory in Beginning and Ending Inventory
Parent’s 1/1 inventory includes $40,000 of interco. goods.
Sub sold $120,000 of goods to parent.
Sub recorded 20% gross profit on interco. sales.
Parent owes $60,000 to sub for inventory at 12/31.
Parent’s 12/31 inventory includes $30,000 of interco. goods.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

12. Intercompany Inventory Remains in Ending Inventory – Journal Entries
CY1 Sub Income - Par 48,000
Invest. In Sub - Par 48,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub 80,000
Retained Earnings - Sub 116,000
Invest. In Sub - Par 196,000
(Eliminates investment account against 80% of equity)
BI Retained Earnings 1/1 - Par 6,400
Retained Earnings 1/1 - Sub 1,600
Invest. In Sub - Par 8,000
(Eliminates profit in beginning inventory and reduces current year C of G S)
IS Sales 120,000
Cost of goods sold 120,000
(Eliminates intercompany merchandise sales)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

13. EI Cost of goods sold 6,000 Inventory 6,000 IA Account payable 60,000
Intercompany Inventory Remains in Ending Inventory – Journal Entries (continued)
EI Cost of goods sold 6,000
Inventory 6,000
(Eliminates intercompany profit in ending inventory)
IA Account payable 60,000
Accounts receivable 60,000
(Eliminates intercompany unpaid trade balances)
Review worksheet 4-3
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

14. Eliminations for Periodic Inventories
Review worksheet 4-4
Beginning inventory balances appear in the trial balance
Purchases account appears in trial balance
Entry BI credits beginning inventory balance
Entry IS credits the purchases account
Ending inventory balances appear as:
A debit to inventory
A credit to cost of goods sold
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

15. Intercompany Sales of Plant Assets
Any plant asset can be sold between parent and sub
Sale of assets can result in gains/losses
Buyer records asset at purchase price (includes gain/loss)
In consolidation, sale of plant assets are considered internal transfers
Depreciable vs. non-depreciable asset transfer
Non-depreciable: defer gain until sold to outside party
Depreciable: amortize gain/loss over useful life
Adjust depreciation of transferred asset in consolidation to reflect original cost
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

16. Sale of Non-Depreciable Asset
Elimination entry “LA”
Eliminates the interco. gain in year of sale
Eliminates the interco. gain from retained earnings in years subsequent to sale
Reclassifies gain from retained earnings to current year gain/loss
Example
Sub (80% owned) sells land to Parent
Sale price: $30,000
Cost: $20,000
$10,000 gain is deferred
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 6

17. Example: Sub (80%) Sells Land to Parent
Gain is deferred until land is sold to outside party!
Year of sale: LA Gain on land sale 10,000
Land 10,000
Later years: LA RE - Sub 2,000
RE - Parent 8,000
Land 10,000
Year of sale to third party:
LA RE - Sub 2,000
RE – Parent 8,000
Gain on land sale 10,000
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 6

18. Sale of Depreciable Asset
Elimination entries “F”
F1:
Year of sale: Eliminates the interco. gain
Years subsequent to sale:
Eliminates the interco. gain from retained earnings
Corrects accumulated depreciation
F2:
Adjusts depreciation back to calculation based on historical cost
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 6

19. Sale of Depreciable Asset (Example)
Parent sells machine to Sub
Sale price: $30,000
Historical cost: $32,000
Accumulated depreciation: $12,000
$10,000 gain based on $20,000 net book value
Sub assumes 5 year remaining life
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

20. Sale of Depreciable Asset – Elimination Entries
Year of sale:
F1 Gain on sale of machine 10, Machine 10,000 (Defer gain on sale and return asset to cost)
F2 Accum. Depreciation 2, Depreciation Expense 2,000 (Reduce to depreciation based on historical cost)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 7

21. Sale of Depreciable Asset – Elimination Entries (continued)
Year after sale:
F1 Retained earnings 8,000
Accum. Depreciation 2, Machine 10,000 (Defer gain on sale and return asset to cost)
F2 Accum. Depreciation 2, Depreciation Expense 2,000 (Reduce to depreciation based on historical cost)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 7

22. 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/X2
IDS just gives back $2,000 currently realized gain to P
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 8

23. Intercompany Debt Common for parent to lend funds to sub
Parent charges sub interest
Entry LN:
LN1
Eliminates intercompany debt
Eliminates accrued interest
LN2
Eliminates intercompany interest revenue/expense
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 11

24. Intercompany Debt - Example
7/1 Sub borrows 10,000 from Parent
Maturity: 1 year
Interest rate: 8%
Interest due at maturity
Interest accrued at 12/31: $400
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 11

25. Intercompany Debt – Elimination Entries
LN1 Note payable 10, Note receivable 10,000
Interest payable 400
Interest receivable 400
(Eliminate interco. debt and accrued interest)
LN2 Interest income Interest expense (Eliminate interco. interest)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved. 7