1. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-1 Intercompany Inventory Transactions 7 Electronic Presentation by Douglas Cloud Pepperdine University Baker / Lembke / King

2. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-2 Transactions of Affiliated Companies Inventory transactions are the most common form of intercorporate exchange. Significantly, the consolidation procedures relating to inventory transfers are quite similar to fixed assets. The eliminations ensure that only the historical 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.

3. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-3 Transactions of Affiliated Companies Parent Company Parent Company Subsidiary A Subsidiary A Subsidiary B Subsidiary B Consolidated Entity

4. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-4 Aspects of Workpaper Elimination When intercorporate sales include profits or losses, there are two aspects of the workpaper elimination needed in the period of transfer to prepare consolidated financial statements.

5. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-5  Elimination of the income statement effects of the intercorporate sale in the period in which the sale occurs, including the sales revenue from the intercorporate sale and the related cost of goods sold recorded by the transferring affiliate.  Elimination from the inventory on the balance sheet of any profit or loss on the intercompany sale that has not been confirmed by resale of the inventory to outsiders.  Elimination of the income statement effects of the intercorporate sale in the period in which the sale occurs, including the sales revenue from the intercorporate sale and the related cost of goods sold recorded by the transferring affiliate.  Elimination from the inventory on the balance sheet of any profit or loss on the intercompany sale that has not been confirmed by resale of the inventory to outsiders. Aspects of Workpaper Elimination

6. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-6 Downstream Sale–Perpetual System Consolidated net income must be based on the realized income of the transferring affiliate. Because intercompany profits from downstream sales are on the books of the parent, consolidated net income and the overall claim of parent company shareholders must be reduced by the full amount of the unrealized profits.

7. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-7 PT Induk Consolidated Entity March 1, 20X1 Purchased inventory for Rp7,000,000 Downstream Sale -- Perpetual Inventory PT Anak PT Induk Mar. 1 Inventory7,000,000 Cash7,000,000 Purchase of inventory. Mar. 1 Inventory7,000,000 Cash7,000,000 Purchase of inventory. Same Period

8. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-8 PT Induk PT Anak Consolidated Entity April 1, 20X1 Intercorporate transfer of inventory Rp10,000,000 Downstream Sale -- Perpetual Inventory PT Induk Apr. 1 Cash10,000,000 Sales10,000,000 Sale of inventory to PT Anak. Apr. 1 Cash10,000,000 Sales10,000,000 Sale of inventory to PT Anak. PT Induk Apr. 1 Cost of Goods Sold7,000,000 Inventory7,000,000 Cost of inventory sold to PT Anak. Apr. 1 Cost of Goods Sold7,000,000 Inventory7,000,000 Cost of inventory sold to PT Anak. PT Anak Apr. 1 Inventory10,000,000 Cash10,000,000 Purchase of inventory from PT Induk. Apr. 1 Inventory10,000,000 Cash10,000,000 Purchase of inventory from PT Induk. Same Period

9. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-9 PT Induk PT Anak Consolidated Entity Downstream Sale -- Perpetual Inventory Nov. 5, 20X1 Sell inventory for Rp15,000,000 PT Anak Nov. 5 Cash15,000,000 Sales15,000,000 Sale of inventory to Nonaffiliated. Nov. 5 Cash15,000,000 Sales15,000,000 Sale of inventory to Nonaffiliated. PT Anak Nov. 5 Cost of Goods Sold10,000,000 Inventory10,000,000 Cost of inventory sold to Nonaffiliated. Nov. 5 Cost of Goods Sold10,000,000 Inventory10,000,000 Cost of inventory sold to Nonaffiliated. Same Period

10. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-10 Downstream Sale -- Perpetual Inventory Item PT Induk PT Anak Unadjusted Consolidated Totals Amounts SalesRp10,000,000 Rp15,000,000 Rp25,000,000 Rp15,000,000 Cost of goods sold -7,000,000 -10,000,000-17,000,000 -7,000,000 Gross profitRp 3,000,000 Rp 5,000,000 Rp 8,000,000 Rp 8,000,000 20X1

11. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-11 Downstream Sale -- Perpetual Inventory Gross profit of Rp8,000,000 is correct from a consolidated viewpoint, but consolidated sales and cost of goods sold should be Rp15,000,000 and Rp7,000,000 respectively, rather than Rp25,000,000 and Rp17,000,000. In the consolidation workpaper, the intercompany sale must be eliminated. Sales10,000,000 Cost of goods sold10,000,000 Eliminate intercompany inventory sale.

12. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-12 Resale in Period Following Transfer PT Induk Consolidated Entity March 1, 20X1 Purchased inventory for Rp7,000,000 PT Anak April 1, 20X1 Inter-corporate transfer of inventory Rp10,000,000 January 2, 20X2 Sell inventory for Rp15,000,000

13. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-13 Basic Equity-Method Entries--20X1 During 20X1, PT Induk records its pro rata portion of PT Anak’ net income and dividends for 20X1: (9) Investment in PT Anak Stock40,000,000 Income from Subsidiary40,000,000 Record equity-method income. (8) Cash24,000,000 Investment in PT Anak Stock24,000,000 Record dividends from PT Anak. Rp30,000,000 x.80 Rp50,000,000

14. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-14 Income from Subsidiary40,000 Dividends Declared(60,000)(30,000) Investment in PT Anak256,000 Consolidation Workpaper--20X1 (in ‘000) Income from Subsidiary40,000 Dividends Declared(60,000)(30,000) Investment in PT Anak256,000 An entry is needed to eliminate PT Induk’s share of PT Anak’ income and dividends. This entry also eliminates the change in the investment account for the period. Income from Subsidiary40,000 (l0) 40,000 Dividends Declared(60,000)(30,000) (10) 24,000 Investment in PT Anak256,000 (10) 16,000 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

15. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-15 The noncontrolling interest is assigned a pro rata portion of the net income of PT Anak. Also, the noncontrolling stockholders’ share of PT Anak’ dividends is eliminated and the noncontrolling interest is increased to reflect the excess of PT Anak’ income over its dividends. Income to Non- controlling Interest Dividends Declared(60,000)(30,000)24,000 Noncontrolling Interest Consolidation Workpaper--20X1 (in ‘000) Income to Non- controlling Interest Dividends Declared(60,000)(30,000) (10) 24,000 Noncontrolling Interest (11) 10,000 (10,000) (11) 6,000(60,000) (11) 4,000 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

16. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-16 Retained Earnings, January 1300,000100,000 Investment in PT Anak256,000 (10) 16,000 Common Stock-- PT Anak500,000200,000 Noncontrolling Interest (11) 4,000 An entry is needed to eliminate the beginning balances of PT Anak’ stockholders’ equity accounts and PT Induk’s investment account. This entry also needs to establish the noncontrolling interest at the beginning of the period., (12) 100,000300,000 (12) 240,000 (12) 200,000500,000 (12) 60,00064,000 Consolidation Workpaper--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

17. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-17 Downstream Sale -- Inventory Not Resold Item PT Induk PT Anak Unadjusted Consolidated Totals Amounts SalesRp10,000,000 Rp -0- Rp10,000,000 Rp -0- Cost of goods sold -7,000,000 -0- -7,000,000 -0- Gross profitRp 3,000,000 Rp -0- Rp 3,000,000 Rp -0- InventoryRp -0- Rp10,000,000Rp10,000,000 Rp7,000,000 20X1

18. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-18 Sales400,000200,000 Cost of Goods Sold170,000115,000 Inventory100,00075,000 An entry is required to eliminate the effects of the intercompany sale of inventory. (13) 10,000590,000 (13) 7,000278,000 (13) 3,000172,000 Consolidation Workpaper--20X1 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

19. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-19 Consolidated Net Income--20X1 PT Induk’s separate operating incomeRp140,000,000 Less: Unrealized intercompany profit on downstream inventory sale -3,000,000 PT Induk’s separate realized incomeRp137,000,000 PT Induk’s share of PT Anak’ income: PT Anak’s net incomeRp50,000,000 PT Induk’s proportionate sharex.80 40,000,000 Consolidated net income, 20X1Rp177,000,000

20. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-20 Basic Equity-Method Entries--20X2 During 20X2, PT Induk records its pro rata portion of PT Anak’ net income and dividends for 20X2: (15) Investment in PT Anak Stock60,000,000 Income from Subsidiary60,000,000 Record equity-method income. (14) Cash32,000,000 Investment in PT Anak Stock32,000,000 Record dividends from PT Anak. Rp40,000,000 x.80 Rp75,000,000

21. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-21 Income from Subsidiary60,000 Dividends Declared(60,000(40,000) Investment in PT Anak284,000 An entry is needed to eliminate the effects of income from PT Anak and from PT Induk’s share of dividends. (16) 60,000 (16) 32,000 (16) 28,000 Consolidation Workpaper--20X2 (in ‘000) ) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

22. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-22 Income to Noncontrolling Interest Dividends Declared(60,000)(40,000) (16) 32,000 Noncontrolling Interest An entry is needed to assign the noncontrolling shareholders their share of income and establish the 20X2 increase in the claim of noncontrolling shareholders on the net assets of PT Anak. Consolidation Workspaper--20X2 (in ‘000) (17) 15,000(15,000) (17) 8,000(60,000) (17) 7,000 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

23. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-23 A workpaper entry is needed to eliminate the beginning stockholders’ equity balances of PT Anak and PT Induk’s beginning investment balance. Retained Earnings, January 1420,000120,000 Investment in PT Anak284,000 (16) 28,000 Common Stock500,000200,000 Noncontrolling Interest (17) 7,000 (18) 120,000420,000 (18) 256,000 (18) 200,000500,000 (18) 64,00071,000 Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

24. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-24 Downstream Sale -- Inventory Not Resold Item PT Induk PT Anak Unadjusted Consolidated Totals Amounts SalesRp -0- Rp 15,000,000 Rp15,000,000 Rp 15,000,000 Cost of goods sold -0- (10,000,000) (10,000,000)(7,000,000) Gross profitRp -0- Rp 5,000,000 Rp 5,000,000 Rp 8,000,000 20X2

25. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-25 An entry is required to eliminate beginning inventory profit. Cost of Goods Sold180,000160,000 Retained Earnings, January 1420,000120,000 (18) 120,000 Consolidation Workpaper--20X2 (in ‘000) (19) 3,000337,000 (19) 3,000417,000 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

26. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-26 Consolidated Net Income--20X2 PT Induk’s separate incomeRp160,000,000 Realization of deferred intercompany profit 3,000,000 PT Induk’s separate realized incomeRp163,000,000 PT Induk’s share of PT Anak’s income: PT Anak’ net incomeRp75,000,000 PT Induk’s proportionate sharex.80 60,000,000 Consolidated net income, 20X2Rp223,000,000

27. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-27 If Inventory Held > 2 periods Retained Earnings xxx Inventory xxx For Previous PT Induk Case: Retained Earnings 3,000,000 Inventory 3,000,000

28. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-28 Upstream Sale–Perpetual System When an upstream sale of inventory occurs and the inventory is resold by the parent to a nonaffiliate during the same period –All the eliminating entries in the consolidation work paper are identical to those in the downstream case. When the inventory is not resold to a nonaffiliate before the end of the period –work paper eliminating entries are different from the downstream case only by the apportionment of the unrealized intercompany profit to both the controlling and noncontrolling interests.

29. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-29 Upstream Sale--Perpetual Inventory PT Induk Consolidated Entity March 1, 20X1 Purchased inventory for Rp7,000,000 PT Anak April 1, 20X1 Inter- corporate transfer of inventory Rp10,000,000 Jan. 2 20X2 Sell inventory for Rp15,000,000

30. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-30 Basic Equity--Method Entries--20X1 (22) Investment in PT Anak Stock40,000,000 Income from Subsidiary40,000,000 Record equity-method income. (21) Cash24,000,000 Investment in PT Anak Foods Stock24,000,000 Record dividends from PT Anak. Rp50,000,000 x.80 Rp50,000,000

31. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-31 Consolidation Workpaper--20X1 (in ‘000) An entry is needed to eliminate the effects of income from PT Anak and from PT Induk’s share of dividends. Income from Subsidiary40,000 Dividends Declared(60,000(30,000) Investment in PT Anak256,000 (23) 40,000 (23) 24,000 (23) 16,000 ) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

32. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-32 The noncontrolling interest is assigned a pro rata portion of the net income of PT Anak. Also, the noncontrolling stockholders’ share of PT Anak’ dividends is eliminated and the noncontrolling interest is increased to reflect the excess of PT Anak’ income over its dividends. Income to Non- controlling Interest Dividends Declared(60,000)(30,000)24,000 Noncontrolling Interest Income to Non- controlling Interest Dividends Declared(60,000)(30,000) (23) 24,000 Noncontrolling Interest Consolidation Workpaper--20X1 (in ‘000) - (24) 9,400 (9,400) (24) 6,000(60,000) (24) 3,400 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

33. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-33 Retained Earnings, January 1300,000100,000 Investment in PT Anak256,000 (23) 16,000 Common Stock500,000200,000 Noncontrolling Interest (24) 3,400 An entry is needed to eliminate the beginning balances of PT Anak’ stockholders’ equity accounts and PT Induk’s investment account. This entry also needs to establish the noncontrolling interest at the beginning of the period. Consolidation Workpaper--20X1 (in ‘000) (25) 100,000300,000 (25) 240,000 (25) 200,000500,000 (25) 60,00063,400 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

34. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-34 An entry is required to eliminate the intercompany upstream sale of inventory. Consolidation Workpaper--20X1 (in ‘000) Sales400,000200,000 Cost of Goods Sold170,000115,000 Inventory100,00075,000 (26) 10,000590,000 (26) 7,000278,000 (26) 3,000172,000 PT Induk PT Anak Eliminations Item Debits Credits Consolidated

35. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-35 Consolidated Net Income--20X1 PT Induk’s separate operating incomeRp140,000,000 PT Induk’s share of PT Anak’ income: PT Anak’s net incomeRp50,000,000 Less: Unrealized intercompany profit on upstream inven- tory sale -3,000,000 PT Anak’ realized incomeRp47,000,000 PT Induk’s proportionate sharex.80 37,600,000 Consolidated net income, 20X1Rp177,600,000

36. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-36 Basic Equity--Method Entries--20X2 (28) Investment in PT Anak Stock60,000,000 Income from Subsidiary60,000,000 Record equity-method income. (27) Cash32,000,000 Investment in PT Anak Stock32,000,000 Record dividends from PT Anak. Rp75,000,000 x.80 Rp75,000,000

37. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-37 Consolidation Workpaper--20X2 (in ‘000) An entry is needed to eliminate the effects of income from PT Anak and from PT Induk’s share of dividends. Income from Subsidiary60,000 Dividends Declared(60,000(40,000) Investment in PT Anak284,000 (29) 60,000 (29) 32,000 (29) 28,000 ) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

38. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-38 Income to Noncontrolling Interest Dividends Declared(60,000)(40,000) (29) 32,000 Noncontrolling Interest An entry is needed to assign the noncontrolling shareholders their share of income and establish the 20X2 increase in the claim of noncontrolling shareholders on the net assets of PT Anak. (30) 15,600(15,600) (30) 8,000(60,000) (30) 7,600 Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

39. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-39 A workpaper entry is needed to eliminate the beginning stockholders’ equity balances of PT Anak and PT Induk’s beginning investment balance. Retained Earnings, January 1420,000120,000 Investment in PT Anak284,000 (29) 28,000 Common Stock500,000200,000 Noncontrolling Interest (30) 7,600 (31) 120,000420,000 (31) 256,000 (31) 200,000500,000 (31) 64,000 Consolidation Workpaper--20X2 (in ‘000) PT Induk PT Anak Eliminations Item Debits Credits Consolidated

40. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-40 PT Induk PT Anak Eliminations Item Debits Credits Consolidated A workpaper entry is needed to eliminate the beginning inventory profit: Rp3,000,000 x.80 and Rp3,000,000 x.20. Cost of Goods Sold180,000160,000 Retained Earnings, January 1420,000120,000 (31) 120,000 Noncontrolling Interest (30) 7,600 (31) 64,000 (32) 3,000337,000 (32) 2,400417,600 (32) 600 71,000 Consolidation Workpaper--20X2 (in ‘000)

41. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-41 Consolidated Net Income--20X2 PT Induk’s separate operating incomeRp160,000,000 PT Induk’s share of PT Anak’ income: PT Anak’s net incomeRp75,000,000 Realized intercompany profit on upstream inventory sale 3,000,000 PT Anak’ realized incomeRp78,000,000 PT Induk’s proportionate sharex.80 62,400,000 Consolidated net income, 20X2Rp222,400,000

42. Irwin/McGraw-Hill © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-42 Chapter Seven The End