1. Chapter 5: Intercompany Profit Transactions – Inventories
Beams, Advanced Accounting 10e, Ch. 5
4/14/2017
Chapter 5: Intercompany Profit Transactions – Inventories
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn
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2. Intercompany Profits – Inventories: Objectives
Understand the impact of intercompany profit for inventories on preparation of consolidation working papers.
Apply the concepts of upstream versus downstream inventory transfers.
Defer unrealized inventory profits remaining in ending inventory of either the parent or subsidiary.
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3. Objectives (cont.)
Recognize realized, previously deferred inventory profits in the beginning inventory of either the parent or subsidiary.
Adjust the calculations of noncontrolling interest amounts in the presence of intercompany inventory profits.
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4. 1: Intercompany Inventory Profits
Intercompany Profit Transactions – Inventories
1: Intercompany Inventory Profits
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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.
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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
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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.
Sales
1,429
Cost of sales
Sales = $1,000 / (1-30%) = $1,429
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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 2009.
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:
Sales
1,500
Cost of sales
Sales = $900 / (1-40%) = $1,500 80
Inventory
Ending inventory profit = $200 x 40%
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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 2009.
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:
Sales
650
Cost of sales
Sales = $ %($500) = $650 60
Inventory
Ending inv. profits = $260 x 30%/130%
Investment in Subsidiary 24
Begin. inv. profits = $120 x 25%/125% = $24
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10. 2: Upstream & Downstream Inventory Sales
Intercompany Profit Transactions – Inventories
2: Upstream & Downstream Inventory Sales
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11. Upstream and Downstream Sales
Parent sells to subsidiary
Subsidiary sells to parent
Upstream Sales
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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.
Sales
XXX
Cost of sales
For the intercompany sales price XX
Inventory
For the profits in ending inventory
Investment in Subsidiary
For the profits in beginning inventory
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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
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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 BI 24
Income recognized
$4,714
Subsidiary dividends
$3,000
CI 80% share
$3,800
(60) 24
$3,764
$2,400
Income from subsidiary
NCI 20% share
$950
$600
When parent makes the IC sale, the impact of deferring and recognizing profits falls all to the parent.
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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 BI 24
Income recognized
$4,714
Subsidiary dividends
$3,000
CI 80% share
$3,800
(48)
19.2
$3,771.2
$2,400
Income from subsidiary
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.
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16. 3: Unrealized Profits in Ending Inventories
Intercompany Profit Transactions – Inventories
3: Unrealized Profits in Ending Inventories
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17. Ending Inventory on Hand
Intercompany profits in ending inventory
Eliminate at year end
Working paper entry
Cost of sales
XXX
Inventories
For the unrealized profit
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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
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19. Entries Porter's journal entry to record income
Worksheet entries to eliminate intercompany sale and unrealized profits
Investment in Sorter
6,500
Income from Sorter
Sales
15,000
Cost of sales
2,500
Inventory
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20. Worksheet – Income Statement
Porter
Sorter DR CR
Consol
Sales
$100.0
$50.0
15.0
$135.0
Income from Sorter
6.5
0.0
Cost of sales
(60.0)
(35.0)
2.5
(82.5)
Expenses
(15.0)
(5.0)
(20.0)
Noncontrolling interest share
1.0
(1.0)
Controlling interest share
$31.5
$7.5
There would be a credit adjustment to Inventory for 2.5 on the balance sheet portion of the worksheet.
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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
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22. 4: Recognizing Profits from Beginning Inventories
Intercompany Profit Transactions – Inventories
4: Recognizing Profits from Beginning Inventories
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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!
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24. 5: Impact on Noncontrolling Interest
Intercompany Profit Transactions – Inventories
5: Impact on Noncontrolling Interest
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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
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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:
= CI%(Sub's NI – Profits in EI + Profits in BI)
= NCI%(Sub's NI – Profits in EI + Profits in BI)
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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.
2009
2010
Perry
Salt
Separate income
$1,250
$705
$1,500
$745
Dividends
$600
$280
$300
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28. Analysis and Amortization
Cost of 70% of Salt
$420
Implied value of Salt 420/.70
$600
Book value
400
Excess
$200
Unamort
Amort
Allocated to:
1/1/09
2009
1/1/10
2010
12/31/10
Inventory 50
(50)
Building
100
(5) 95 90
Goodwill
200
(55)
145
140
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29. 2009 Income Sharing (Upstream)
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
Income from Salt
NCI 30% share
$195
($12)
$183
$84
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30. Perry's 2009 Equity Entries Investment in Salt 420 Cash
For acquisition of 70% of Salt
196
For dividends received
427
Income from Salt
For share of income
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31. 2009 Worksheet Entries Adjust for errors & omissions - none
Eliminate intercompany profits and losses
Eliminate income & dividends from sub. and bring Investment account to its beginning balance
Sales
700
Cost of sales
Cost of Sales 40
Inventory
Income from Salt
427
Dividends
196
Investment in Salt
231
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32. 2009 Entries (2 of 3)
Record noncontrolling interest in sub's earnings & dividends
Eliminate reciprocal Investment & sub's equity balances
Noncontrolling interest share
183
Dividends 84
Noncontrolling interest 99
Capital stock
200
Retained earnings
Inventory 50
Building
100
Goodwill
Investment in Salt
420
Noncontrolling interest
180
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33. 2009 Entries (3 of 3) Amortize fair value/book value differentials
Eliminate other reciprocal balances – none
Cost of sales 50
Inventory
Depreciation expense 5
Building
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34. 2010 Income Sharing (Upstream)
Salt's net income
$745
Current amortizations
(5)
Adjusted income
$740
Defer profits in EI
(20)
Realize profits from BI 40
Income recognized
$760
Subsidiary dividends
$300
CI 70% share
$518
($14)
$28
$532
$210
Income from Salt
NCI 30% share
$222
($6)
$12
$228
$90
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35. Perry's 2010 Equity Entries Cash 210 Investment in Salt
For dividends received
532
Income from Salt
For share of income
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36. 2010 Worksheet Entries Adjust for errors & omissions - none
Eliminate intercompany profits and losses
Eliminate income & dividends from sub. and bring Investment account to its beginning balance
Sales
900
Cost of sales
Cost of Sales 20
Inventory
Investment in Salt 28
Noncontrolling interest 12 40
Income from Salt
532
Dividends
210
Investment in Salt
322
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37. 2010 Entries (2 of 3)
Record noncontrolling interest in sub's earnings & dividends
Eliminate reciprocal Investment & sub's equity balances
Noncontrolling interest share
228
Dividends 90
Noncontrolling interest
138
Capital stock
200
Retained earnings
625
Inventory
Building 95
Goodwill 50
Investment in Salt
679
Noncontrolling interest
291
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38. 2010 Entries (3 of 3) Amortize fair value/book value differentials
Eliminate other reciprocal balances – none
Depreciation expense 5
Building
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39. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
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Copyright © 2009 Pearson Education, Inc.   Publishing as Prentice Hall
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