1. Consolidated Financial Statements—Intra-Entity Asset Transactions
Chapter Five
Consolidated Financial Statements—Intra-Entity Asset Transactions
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2. Intra-entity Transactions
Companies that make up a business combination frequently retain their legal identities as separate operating centers and maintain their own recordkeeping.
Inventory sales between the companies must be recorded. The seller records revenue, and the buyer enters the purchase into its accounts (Remember the parent and subsidiary continue to operate as separate legal entities).
For internal reporting purposes, recording an inventory transfer as a sale/purchase provides vital data to help measure the operational efficiency of each enterprise.
companies that make up a business combination frequently retain their legal identities as separate operating centers and maintain their own recordkeeping. Thus, inventory sales between these companies trigger the independent accounting systems of both parties. The seller duly records revenue, and the buyer simultaneously enters the purchase into its accounts. For internal reporting purposes, recording an inventory transfer as a sale/purchase provides vital data to help measure the operational
efficiency of each enterprise. 2

3. Intra-entity Transactions
From a consolidated perspective neither a sale nor a purchase has occurred. An intra-entity transfer is merely the internal movement of inventory that creates no net change in the financial position of the business combination taken as a whole.
In the consolidated financial statements, the intra-entity transfers are eliminated.
The consolidated statements reflect only transactions with outside parties.
Worksheet entries report the perspective of the consolidated enterprise.
From a consolidated perspective neither a sale nor a purchase has occurred. An intra-entity transfer is merely the internal movement of inventory, an event that creates no net change in the financial position of the business combination taken as a whole.
When producing consolidated financial statements, the recorded effects of these transfers are
eliminated so that consolidated statements reflect only transactions with outside parties.
Worksheet entries serve this purpose; they adapt the financial information reported by
the separate companies to the perspective of the consolidated enterprise. The entire impact
of the intra-entity transactions must be identified and then removed. Deleting the
effects of the actual transfer is described here first. 2

4. Sales and Purchases- Intra-entity
ENTRY TI (Transferred Inventory) In a business combination, both parties record the transfer in their internal records as a normal sale/purchase. This consolidation worksheet entry is necessary to remove the resulting balances from the externally reported figures. Cost of Goods Sold is reduced here under the assumption that the intra-entity Purchases / Sales account usually is closed out prior to the consolidation process.
Sales and Purchases-Intra-entity
ENTRY TI (Transferred Inventory)
In a business combination, both parties record the transfer in their internal records as a normal sale/purchase. This consolidation worksheet entry is necessary to remove the resulting balances from the externally reported figures. Cost of Goods Sold is reduced here under the assumption that the Purchases account usually is closed out prior to the consolidation process. 3

5. Unrealized Gross Profit – Intra-entity
Despite Entry TI, the inflated ending inventory figure causes cost of goods sold to be too low and profits to be too high . For consolidation purposes, the expense is increased by this amount through a worksheet adjustment that properly removes the unrealized gross profit from consolidated net income.
Unrealized Gross Profit – Intra-entity
ENTRY G (Gross Profit)
Despite Entry TI, the inflated ending inventory figure causes cost of goods sold to be too low and, thus, profits to be too high by $30,000. For consolidation purposes, the expense is increased by this amount through a worksheet adjustment that properly removes the unrealized gross profit from consolidated
net income.
Consequently, if all of the transferred inventory is retained by the business combination
at the end of the year, the following worksheet entry also must be included
to eliminate the effects of the seller’s gross profit that remains unrealized within the
buyer’s ending inventory in year 1.
If all of the transferred inventory is retained by the business combination at the end of the year, entry G eliminates the effects of the seller’s gross profit (100%) that remains unrealized within the buyer’s ending inventory in year 1. 4

6. Unrealized Gross Profit – Intra-entity
Consoliation ENTRY G (for gross profit) Year of Transfer (Year 1) Because the gross profit rate was 37½ percent (Pg. 206) ($30,000 gross profit/$80,000 transfer price), this retained inventory is stated at a value $7,500 more than its original cost ($20,000 X 37½%). The required reduction (Entry G ) is not the entire $30,000 but only the $7,500 unrealized gross profit that remains in ending inventory.
Because the gross profit rate was 37½ percent ($30,000 gross profit/$80,000 transfer price), this retained inventory is stated at a value $7,500 more than its original cost ($20, ½%). The required reduction (Entry G ) is not the entire $30,000 shown previously but only the $7,500 unrealized gross profit that remains in ending inventory. 4

7. Unrealized Gross Profit – Intra-entity
In year 2, the overstatement is removed within the consolidation process but this time from the beginning inventory balance (which appears in the financial statements only as a positive component of cost of goods sold). This elimination is termed Entry *G. The asterisk indicates that a previous year transfer created the intra-entity gross profits.
Unrealized Gross Profit – Intra-entity
ENTRY *G
In year 2, the overstatement is removed within the consolidation process but this time from the beginning inventory balance (which appears in the financial statements only as a positive component of cost of goods sold). This elimination is termed Entry *G. The asterisk indicates that a previous year transfer created the intra-entity gross profits.
Entry *G removes unrealized gross profit from beginning figures so that it is recognized in the consolidated income in the period in which it is earned.
Entry *G removes unrealized gross profit from beginning figures so that it is recognized in the consolidated income in the period in which it is earned. 5

8. Intra-entity Transactions – Downstream Transfers
Entry *G (Pg. 218) if the transfer of inventory is downstream AND the parent uses the equity method, the following entry is used to recognize the remaining unrealized profit left at the end of the previous year.
Intra-entity Transactions – Downstream Transfers
ENTRY *G
If the transfer of inventory is downstream AND the parent uses the equity method, the following entry is used to recognize the remaining unrealized profit left at the end of the previous year. Investment in Subsidiary account replaces the Retained Earnings account used for upstream sales.
Investment in Subsidiary account replaces the Retained Earnings account used for upstream sales. 6

9. Unrealized Inventory Gain – Downstream Transfers
Worksheet entries to eliminate sales/purchases balances (Entry TI) and to remove unrealized gross profit from ending Inventory in Year 1 (Entry G) are standard, regardless of the circumstances of the consolidation. BUT the procedure to eliminate intra-entity gross profit from Year 2’s beginning account balances differs from the Entry *G just presented IF: (1) the original transfer is downstream (parent’s) and (2) the parent applies the equity method for internal accounting purposes.
Unrealized Inventory Gain – Downstream Transfers
Worksheet entries to eliminate sales/purchases balances (Entry TI) and to remove unrealized gross profit from ending Inventory in Year 1 (Entry G) are standard, regardless of the circumstances of the consolidation.
BUT the procedure to eliminate intra-entity gross profit from Year 2’s beginning account balances differs from the Entry *G just presented IF:
(1) the original transfer is downstream (parent’s) and
(2) the parent applies the equity method for internal accounting purposes.

10. Unrealized Inventory Gain - Downstream Transfers
For intra-entity beginning inventory profits resulting from downstream transfers when the parent applies the equity method:
Parent’s retained earnings are appropriately stated due to intra-entity profit deferrals and recognition.
The subsidiary retained earnings reflect none of the intra-entity profit and require no adjustment.
The parent’s investment account at beginning of Year 2 contains a credit from the deferral of Year 1 downstream profits.
Worksheet Entry *G transfers the Year 1 Investment account credit to a Year 2 earnings credit via COGS to recognize the profit in the year of sale to outsiders.
Unrealized Inventory Gain - Downstream Transfers
For intra-entity beginning inventory profits resulting from downstream transfers when the parent applies the equity method:
Parent’s retained earnings are appropriately stated due to intra-entity profit deferrals and recognition.
The subsidiary retained earnings reflect none of the intra-entity profit and require no adjustment.
The parent’s investment account at beginning of Year 2 contains a credit from the deferral of Year 1 downstream profits.
Worksheet Entry *G transfers the Year 1 Investment account credit to a Year 2 earnings credit via COGS to recognize the profit in the year of sale to outsiders. 9

11. Unrealized Gross Profits – Effect on Noncontrolling Interest
According to FASB ASC paragraph : The amount of intra-entity profit or loss to be eliminated is not affected by the existence of a noncontrolling interest. The complete elimination of the intra-entity profit or loss is consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity. The elimination of the intra-entity profit or loss may be allocated proportionately between the parent and noncontrolling interest.
Unrealized Gross Profits – Effect on Noncontrolling Interest
According to FASB ASC paragraph :
The amount of intra-entity profit or loss to be eliminated is not affected by the existence of a noncontrolling interest.
The complete elimination of the intra-entity profit or loss is consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity.
The elimination of the intra-entity profit or loss may be allocated proportionately between the parent and noncontrolling interest.

12. Intra-Entity Inventory Downstream Transfer - Example
Top Company acquires 80 percent of the voting stock of Bottom Company on January 1, A $10,000 intra-entity receivable and payable exists as of December 31, Intra-entity inventory transfers (upstream and downstream) between the two companies: 2014 *2015 Transfer prices $80,000 $100,000 Historical cost ,000 70,000 Gross profit $20,000 $ 30,000 Year-end Inventory balance (transfer price) $16,000 $ 20,000 Gross profit percentage X 25% X30% Gross profit remaining in year-end inventory$ 4,000 $ 6,000
Intra-Entity Inventory Downstream Transfer - Example
The subsidiary reports net income of $30,000 in 2014 and $70,000 in 2015, the current year.
Dividends declared are $20,000 in the first year and $50,000 in the second.
A $10,000 intra-entity debt exists as of December 31, 2015.
Intra-entity inventory transfers between the two companies:
Transfer prices $80, $100,000
Historical cost , ,000
Gross profit $20, $ 30,000
Year-end Inventory balance (transfer price) $16, $ 20,000
Gross profit percentage X 25% X30%
Gross profit remaining in year-end inventory $ 4, $ 6,000

13. Intra-Entity Inventory Downstream Transfer - Example
Entry TI eliminates the intra-entity sales/purchases for 2015.
Entry G defers the unrealized gross profit (30% rate) of $6,000 remaining at the end of 2015.
Entry G eliminates the overstatement of Inventory as well as the ending component of Cost of Goods Sold which decreases consolidated income.
Entry TI eliminates the intra-entity sales/purchases for 2015.
Entry G defers the unrealized gross profit (30% rate) of $6,000remaining at the end of 2015.
Entry G eliminates the overstatement of Inventory as well as the ending component of Cost of Goods Sold which decreases consolidated income.

14. Intra-entity Transactions – Downstream Inventory Example
Three entries require attention in the calculation of noncontrolling interest in the sub’s net income December 31, Entry *G removes unrealized gross profits (25% rate) carried over from the previous period intra-entity downstream sales. Entry *G reduces Cost of Goods Sold (or beginning inventory component) which creates an increase in current year income. Gross profit is correctly recognized in 2015 when inventory is sold to an outside party. The debit to the Investment in Bottom account brings that account to a zero balance in consolidation.
Intra-Entity Inventory Transfers Example
Three entries require attention in the calculation of noncontrolling interest in the sub’s net income December 31, 2015.
Entry *G removes unrealized gross profits (25% rate) carried over from the previous period intra-entity downstream sales.
Entry *G reduces Cost of Goods Sold (or beginning inventory component) which creates an increase in current year income. Gross profit is correctly recognized in 2015 when inventory is sold to an outside party.
The debit to the Investment in Bottom account brings that account to a zero balance in consolidation.

15. Intra-entity Transactions – Upstream Inventory Example
As of January 1, 2015, $16,000 of transfers remain in
Top’s inventory, and $4,000 of gross profit (25%) is unearned from a consolidated perspective. Also, Bottom’s beginning Retained Earnings are overstated by $4,000, the gross profit from 2014 intra-entity transfers.
A credit to Cost of Goods Sold increases consolidated net income to recognize that the profit has been earned in 2015 by sales to outsiders.
As of January 1, 2015, $16,000 of transfers remain in
Top’s inventory, and $4,000 of gross profit (25%) is unearned from a consolidated perspective. Also, Bottom’s beginning Retained Earnings are overstated by $4,000, the gross profit from 2014 intra-entity transfers.
A credit to Cost of Goods Sold increases consolidated net income to recognize that the profit has been earned in 2015 by sales to outsiders.

16. Intra-entity Transactions – Upstream vs. Downstream transfers
Compare the Entry *G for the downstream and upstream transfers to see the difference in the transactions.
Compare the Entry *G for the downstream and upstream transfers to see the difference in the transactions.
The effect of downstream and upstream transfers when the parent uses the equity method are compared in more detail.