Hi everyone,

I am really confused on understanding intercompany transactions (and eliminating

them).
Im not understanding the logic behind the unrealized and realized profits.
For example, Company A owns 100% of Company B. Company A sells company B
with a markup of 25% over its cost. Company A made a total of intercompany sales of
500,000. In year end, company B has 100,000 in their ending inventory from the
purchases of company A.
How would you determine the unrealized profit and realized profit?
The eliminating entry would be to first reverse the 500,000 of intercompany sales
(debit) and 500,000 intercompany COGS (500,000).
But after that, I am having trouble understanding the logic of how to calculate
realized/unrealized profit.
I like thisUnlike 0
October 9, 2013 at 6:35 pm #458342

Topsya
Member
I am actually having trouble with that topic myself.
Here is how I would solve this (I might be wrong though)

1. Reverse the sale.

Dr Sale $500,000
Cr COGS $500,000
We reversing it because this Sale should never been recorded in the first place. It is
simply a transfer of assets within a company.
2. Since you recorded a sale originally, COGS has changed (increased). When the item
was in the possession of the parent, its COGS was 100%, and now its 125%. Same
item though. So you need to bring it back to what it was originally.
Dr. COGS $80,000
Cr. EI $80,000
Do you know the answer? Please let me know.
Thanks,
October 9, 2013 at 6:35 pm #458480

Topsya
Member
I am actually having trouble with that topic myself.
Here is how I would solve this (I might be wrong though)
1. Reverse the sale.

Dr Sale $500,000
Cr COGS $500,000
We reversing it because this Sale should never been recorded in the first place. It is
simply a transfer of assets within a company.
2. Since you recorded a sale originally, COGS has changed (increased). When the item
was in the possession of the parent, its COGS was 100%, and now its 125%. Same
item though. So you need to bring it back to what it was originally.
Dr. COGS $80,000
Cr. EI $80,000
Do you know the answer? Please let me know.
Thanks,
October 9, 2013 at 6:55 pm #458344

barronn30
Participant
Hmm, I believe #1 is correct but I am not sure about #2.
Im having trouble with the logic but from my notes, it seems like Cost markup x Cost
= Sale price.
So it may be 1.25 x Cost = 500,000. Cost = 400,000.

So #2 is:
Dr COGS 100,000
Cr. Ending inv 100,000
(not sure if this is correct either), and then I have no clue on how to find the
additional entries for removing unrealized profits.
October 9, 2013 at 6:55 pm #458482

barronn30
Participant
Hmm, I believe #1 is correct but I am not sure about #2.
Im having trouble with the logic but from my notes, it seems like Cost markup x Cost
= Sale price.
So it may be 1.25 x Cost = 500,000. Cost = 400,000.
So #2 is:
Dr COGS 100,000
Cr. Ending inv 100,000
(not sure if this is correct either), and then I have no clue on how to find the
additional entries for removing unrealized profits.
October 9, 2013 at 7:05 pm #458346

lleon
Member
As I understand it (hopefully someone else can confirm):
The profit that would need to be eliminated is the profit recognized by the parent on
its sale to the subsidiary since they sold the goods at a markup. However, you only
need to eliminate the profit of the inventory still on hand.
So, on the sale of 500k, company A recorded:
Dr. Cash 500k
Cr. Sales 500k
Dr. COGS 400k
Cr. Inventory 400k
Company B recorded:
Dr. Inventory 500k
Cr. Cash 500k.
Therefore, company A has gross profit of 100k on their books. Upon consolidation,
company B has 100k in ending inventory. That represents 20% of the inventory
company B originally recorded (100/500). Therefore, as part of your eliminating
entries, you would have to eliminate 20% of the 100k profit originally recognized by
company A.

Eliminating entry to remove sale:

Dr. Sales 500k
Cr. COGS 500k
Entry to remove gross profit:
Dr. COGS 20k
Cr. Inventory 20k
Both entries can be combined into one as follows:
Dr. Sales 500k
Cr. COGS 480k
Cr. Inventory 20k
Can someone else confirm? Thanks!
October 9, 2013 at 7:05 pm #458484

lleon
Member
As I understand it (hopefully someone else can confirm):

The profit that would need to be eliminated is the profit recognized by the parent on
its sale to the subsidiary since they sold the goods at a markup. However, you only
need to eliminate the profit of the inventory still on hand.
So, on the sale of 500k, company A recorded:
Dr. Cash 500k
Cr. Sales 500k
Dr. COGS 400k
Cr. Inventory 400k
Company B recorded:
Dr. Inventory 500k
Cr. Cash 500k.
Therefore, company A has gross profit of 100k on their books. Upon consolidation,
company B has 100k in ending inventory. That represents 20% of the inventory
company B originally recorded (100/500). Therefore, as part of your eliminating
entries, you would have to eliminate 20% of the 100k profit originally recognized by
company A.
Eliminating entry to remove sale:
Dr. Sales 500k
Cr. COGS 500k
Entry to remove gross profit:

Dr. COGS 20k

Cr. Inventory 20k
Both entries can be combined into one as follows:
Dr. Sales 500k
Cr. COGS 480k
Cr. Inventory 20k
Can someone else confirm? Thanks!
October 9, 2013 at 7:11 pm #458348

lleon
Member
Per my post above and to more directly answer the original question, the profit
would be 100k (inter-company). 80k has been realized and 20k is unrealized and
must be removed, per my understanding.
I arrived at the 20% unrealized because of the ending inventory on company Bs
books, which is 100k. They recorded the inventory at 500k, so 100k/500k = 20% still
on the books, which would mean 20% of the inter-company profit is included in that
inventory. The rest of the inventory has presumably been sold, thus realizing the
profit from the inter-company sale.
October 9, 2013 at 7:11 pm #458486

lleon
Member
Per my post above and to more directly answer the original question, the profit
would be 100k (inter-company). 80k has been realized and 20k is unrealized and
must be removed, per my understanding.
I arrived at the 20% unrealized because of the ending inventory on company Bs
books, which is 100k. They recorded the inventory at 500k, so 100k/500k = 20% still
on the books, which would mean 20% of the inter-company profit is included in that
inventory. The rest of the inventory has presumably been sold, thus realizing the
profit from the inter-company sale.