Intercompany Profit Transactions, Study notes of Accounting

Download Intercompany Profit Transactions and more Study notes Accounting in PDF only on Docsity!

Intercompany Profit Transactions -

Inventories

Patriani Wahyu Dewanti, S.E., M.Acc.

Accounting Department

Faculty of Economics

Yogyakarta State University

GENERAL OVERVIEW

• When there have been intercompany inventory transactions, eliminating entries are needed to remove the revenue and expenses related to the intercompany transfers recorded by the individual companies
• The eliminations ensure that only the 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

Transfers at cost

• An eliminating entry is needed to remove both the revenue from the intercorporate sale and the related cost of goods sold recorded by the seller
• Consolidated net income is not affected by the eliminating entry

Transfers at a profit or loss

• Companies use different approaches in setting intercorporate transfer prices
• The elimination process must remove the effects of such sales from the consolidated statements

Effect of type of inventory system

• Most companies use either a perpetual or a periodic inventory control system to keep track of inventory and cost of goods sold
• The choice between these inventory systems results in different entries on the books of the individual companies and, therefore, slightly different workpaper eliminating entries in preparing consolidated financial statements

DOWNSTREAM SALE OF INVENTORY

• For consolidation purposes, profits recorded on an intercorporate inventory sale are recognized in the period in which the inventory is resold to an unrelated party
• Until the point of resale, all intercorporate profits must be deferred
• When a company sells an inventory item to an affiliate, one of three situations results:

1. The item is resold to a nonaffiliate during the same period
2. The item is resold to a nonaffiliate during the next period
3. The item is held for two or more periods by the purchasing affiliate

Downstream Sale of Inventory - Illustration

• Resale in period of intercorporate transfer

Downstream Sale of Inventory - Illustration

• This entry does not affect consolidated net income
• No elimination of intercompany profit is needed because all the

intercompany profit has been realized through resale of the inventory to

the external party during the current period

Special Foods records the sale: November 5, 20X Cash 15, Sales 15, Sale of inventory to Nonaffiliated. Cost of Goods Sold 10, Inventory 10, Cost of inventory sold to Nonaffiliated. Eliminating Entry: Sales 10, Cost of Goods Sold 10, Eliminate intercompany inventory sale.

Cash 24, Investment in Special Foods Stock 24, Record dividends from Special Foods: $30,000 x. Investment in Special Foods Stock 40, Income from Subsidiary 40, Record equity-method income: $50,000 x. Using the basic equity method, Peerless records its share of Special Foods’ income and dividends for 20X1 in the normal manner: As a result of these entries, the ending balance of the investment account is $256,000 ($240,000 + $40,000 - $24,000). The consolidation workpaper prepared at the end of 20X1 appears in Figure 7–1 of the text.

Eliminating Entries: E(10) Income from Subsidiary 40, Dividends Declared 24, Investment in Special Foods Stock 16, Eliminate income from subsidiary. E(11) Income to Noncontrolling Interest 10, Dividends Declared 6, Noncontrolling Interest 4, Assign income to noncontrolling interest. $10,000 = $50,000 x. E(12) Common Stock—Special Foods 200, Retained Earnings, January 1 100, Investment in Special Foods Stock 240, Noncontrolling Interest 60, Eliminate beginning investment balance. E(13) Sales 10, Cost of Goods Sold 7, Inventory 3, Eliminate intercompany downstream sale of inventory. Only entry E(13) relates to the elimination of unrealized inventory profits

Cash 32, Investment in Special Foods Stock 32, Record dividends from Special Foods: $40,000 x. Investment in Special Foods Stock 60, Income from Subsidiary 60, Record equity-method income: $75,000 x. During 20X2, Special Foods receives $15,000 when it sells to Nonaffiliated Corporation the inventory that it had purchased for $10,000 from Peerless in 20X1. Also, Peerless records its pro rata portion of Special Foods’ net income and dividends for 20X2 with the normal basic equity-method entries: The consolidation workpaper prepared at the end of 20X2 is shown in Figure 7–2 in the text. Four elimination entries are needed:

Downstream Sale of Inventory - Illustration

Downstream Sale of Inventory - Illustration

• Consolidated Net Income—20X

• Inventory held two or more periods
  • Prior to liquidation, an eliminating entry is needed in the consolidation workpaper each time consolidated statements are prepared to restate the inventory to its cost to the consolidated entity E(20) Retained Earnings, January 1 3, Inventory 3, Eliminate beginning inventory profit. For example, if Special Foods continues to hold the inventory purchased the following eliminating entry is needed in the consolidation workpaper each time a consolidated balance sheet is prepared for years following the year of intercompany sale, for as long as the inventory is held: