BCLAA8e Ab - Az.chapter 05

Intercompany Profit Transactions Inventories Chapter 5
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
5-1
Learning Objective 1 Understand the impact of intercompany profit for inventories on preparation of consolidation working papers.
5-2
Intercompany Inventory Transactions
Revenue on sales between affiliated companies cannot be recognized until merchandise is sold outside of the consolidated entity.
5-3
Intercompany Inventory Transactions
Periodic inventory system Perpetual inventory system
Sales Purchases Sales Cost of goods sold

5-4
Elimination of Intercompany Purchases and Sales

Pint formed a subsidiary, Shep Corporation. All Sheps purchases are made from Pint at 20% above Pints cost. Pint sold $20,000 of merchandise to Shep for $24,000. Shep sold all the merchandise to its customers for $30,000.
5-5
Inventory 20,000 Accounts Payable 20,000 To record purchases on account from other entities Accounts Receivable 24,000 Sales 24,000 To record intercompany sales to Shep
5-6
Cost of Sales 20,000 Inventory To record cost of sales to Shep Investment 6,000 Income from Shep To record related equity interest
20,000
6,000
5-7
Inventory 24,000 Accounts Payable 24,000 To record intercompany purchases from Pint Accounts Receivable 30,000 Sales 30,000 To record sales to outside customers
5-8
Cost of Sales 24,000 Inventory 24,000 To record cost of sales to customers
5-9

Pint 100% Shep Adjustments and Eliminations Consolidated
Sales Cost of sales Gross profit
$24,000 $30,000 a 24,000 20,000 24,000
$30,000 a 24,000 20,000 $10,000
$ 4,000 $ 6,000
5 - 10
Elimination of Unrealized Profit in Ending Inventory

During 2004, Pint sold merchandise that cost $30,000 to Shep for $36,000. Shep sold all but $6,000 of this merchandise to its customers for $37,500.
5 - 11

30,000 36,000 = 5/6 5/6 30,000 = $25,000 1/6 36,000 = $6,000 1/6 30,000 = $5,000 Sheps inventory Cost to Pint Unrealized profit in EI $6,000 5,000 $1,000
5 - 12

Pint Shep Adjustments and Eliminations Consolidated
Sales Cost of sales Gross profit Inventory
$36,000 $37,500 a 36,000 30,000
$37,500
30,000 b 1,000 a 36,000 25,000 $12,500 b 1,000 $ 5,000

5 - 13
$ 6,000 $ 7,500 $ 6,000
Recognition of Unrealized Profit in Beginning Inventory

During 2005 Pint sold merchandise that cost $40,000 to Shep for $48,000. Shep sold 75% of this merchandise to its customers for $45,000. Shep also sold its beginning inventory with a transfer price of $6,000 for $7,500.
5 - 14

25% 48,000 = $12,000 Ending inventory $12,000 1.2 = $10,000 EI transfer price Sheps inventory Cost to Pint Unrealized profit in EI $12,000 (10,000) $ 2,000
5 - 15

$7,500 $5,000 BI = $2,500 from BI 75% 48,000 = $30,000 $45,000 $30,000 = $15,000 $15,000 + $2,500 = $17,500
5 - 16

Pint Shep Adjustments and Eliminations Consolidated
Sales Cost of sales Gross profit Inventory Investment in Shep
$48,000 $52,500 a 48,000 40,000
$52,500
42,000 c 2,000 a 48,000 b 1,000 35,000 $17,500 $ 8,000 $10,500 $12,000 XXX b 1,000
5 - 17
c 2,000 $10,000
Learning Objective 2 Apply the concepts of upstream versus downstream inventory transfers.
5 - 18
Downstream and Upstream Sales

Sales from top to bottom are downstream. Parent to Subsidiary Sales from bottom to top are upstream.
Subsidiary to Parent
5 - 19
Downstream and Upstream Sales

In downstream sales, the parent companys separate income includes the full amount of any unrealized profit, and the subsidiarys income is not affected. In upstream sales, the subsidiary companys net income includes the full amount of any unrealized profit, and the parent companys separate income is not affected.
5 - 20
Downstream and Upstream Effects on Income Computations

Parent 80%-owned Subsidiary
Sales Cost of sales Gross profit Expenses Parents separate income Subsidiarys net income
$600 300 $300 100 $200
$300 180 $120 70 $ 50

5 - 21

Intercompany sales during the year are $100,000.
The December 31 inventory includes $20,000 unrealized profit.
5 - 22
The parent companys sales and cost of sales accounts reflect the $20,000 unrealized profit.
The $50,000 subsidiary net income equals its realized income.
5 - 23
The subsidiarys sales and cost of sales accounts reflect the $20,000 unrealized profit.
The subsidiarys realized income is $30,000.

5 - 24

Consolidated Income (000) Downstream Upstream
Sales ($900 $100) Cost of sales ($480 + $20 $100) Gross profit Expenses ($100 + $70) Total realized income Less: Minority interest Consolidated net income
$800 400 $400 170 $230 10 $220
$800 400 $400 170 $230 6 $224

5 - 25

Consolidated Income (000) Downstream Upstream
Parents separate income $200 Add: Income from subsidiary: Equity in subsidiarys income less unrealized profit [($50,000 80%) $20,000] 20 Equity in subsidiarys income [($50,000 $20,000) 80%] Parent and consolidated net income $220
$200
24 $224
5 - 26
Learning Objective 3 Defer unrealized inventory profits remaining in ending inventory of either the parent or subsidiary.
5 - 27
Deferral of Intercompany Profit in Period of Sale: Downstream

Porter 90%-owned Sorter
Sales Cost of sales Gross profit Expenses Operating income Income from Sorter Net income
$100 60 $ 40 15 $ 25 9 $ 34
$50 35 $15 5 $10 $10

5 - 28

Porters sales include $15,000 to Sorter at a profit of $6,250. Sorters December 31, 2003, inventory includes 40% of the merchandise from this transaction.
5 - 29

$15,000 $6,250 = $8,750 $8,750 40% = $3,500 $15,000 40% = $6,000
$6,000 $3,500 = $2,500

5 - 30
Investment in Sorter 9,000 Income from Sorter 9,000 To record share of Sorters income Income from Sorter 2,500 Investment in Sorter 2,500 To eliminate unrealized profit on sales to Sorter
5 - 31
Partial Working Papers December 31, 2003

Adjustments/ ConsolPorter Shorter Eliminations idated
Income Statement Sales $100 Income from Sorter 6.5 Cost of goods sold (60) Expenses (15) Minority interest expense ($10,000 10%) Net income $ 31.5 Balance Sheet Inventory Investment in Sorter XXX
Dr. Cr. $50 a 15 $135 c 6.5 (35) b 2.5 a 15 (82.5) (5) (20) $10 $ 7.5 (1) $ 31.5 b 2.5 $ 5 c 6.5
5 - 32
Learning Objective 4 Recognize realized, previously deferred inventory profits in the beginning inventory of either the parent or subsidiary.
5 - 33
Recognition of Intercompany Profit upon Sale to Outside Entities

Now assume that the merchandise acquired from Porter during 2003 is sold by Sorter during 2004. There are no intercompany transactions between Porter and Sorter during 2004.
5 - 34

Porter 90%-owned Sorter
Sales Cost of sales Gross profit Expenses Operating income Income from Sorter Net income
$120 80 $ 40 20 $ 20 13.5 $ 33.5
$60 40 $20 5 $15 $15

5 - 35
This is before considering $2,500 unrealized profit in BI.

Investment in Sorter 13,500 Income from Sorter 13,500 To record investment income from Sorter Investment in Sorter 2,500 Income from Sorter 2,500 To record realization of profit from intercompany sales to Sorter
5 - 36
Partial Working Papers December 31, 2003

Adjustments/ ConsolPorter Shorter Eliminations idated
Income Statement Dr. Cr. Sales $120 $60 $180 Income from Sorter 16 b 16 Cost of goods sold (80) (40) a 2.5 (117.5) Expenses (20) (5) (25) Minority interest expense ($15,000 10%) (1.5) Net income $ 36 $15 $ 36 Balance Sheet XXX Investment in Sorter a 2.5 b 16
5 - 37
Learning Objective 5 Adjust the calculations of minority interest amounts in the presence of intercompany inventory profits.
5 - 38
Consolidation Example Intercompany Profits: Downstream Sales

Seay Corporation is a 90%-owned subsidiary of Peak Corporation, acquired for $94,500 cash on July 1, 2003. Seays net assets at date of acquisition consisted of $100,000 capital stock and $5,000 retained earnings. The cost of Peaks 90% interest was equal to book value and fair value of the interest acquired.
5 - 39
Cost:
$105,000 90% = $94,500
Minority interest: $105,000 10% = $10,500
5 - 40

Peak sells inventory items to Seay on a regular basis.
Sales to S in 2007 (cost $15,000), selling price Unrealized profit in Ss inventory at 12/31/2006 Unrealized profit in Ss inventory at 12/31/2007 Seays accounts payable to Peak 12/31/2007
$20,000 2,000 2,500 10,000

5 - 41

At 12/31/2006 Peaks investment in Seay account had a balance of $128,500. This balance consisted of Peaks 90% equity in Seays $145,000 net assets on that date less $2,000 unrealized profit in Seays 12/31/2006 inventory.
5 - 42
$145,000 90% = $130,500 $130,500 $2,000 = $128,500
5 - 43
Seays equity: Common stock Retained earnings Net assets $100,000 45,000 $145,000
$45,000 $5,000 = $40,000 increase in RE $40,000 $4,000 (minority interest) = $36,000

5 - 44

During 2007, Peak made the following entries on its books for the investment in Seay: Cash 9,000 Investment in Seay 9,000 To record dividends from Seay ($10,000 90%) Investment in Seay 26,500 Income from Seay 26,500 To record income from Seay for 2007
5 - 45
Equity in Seays net income: ($30,000 90%) $27,000 Add: Inventory profits recognized in 2007 2,000 Deduct: Inventory profits deferred at year end 2,500 Total $26,500
5 - 46

Peaks Investment 94,500 36,000 2,000 128,500 2,000 27,000 2,500 9,000 146,000
12/31/2006
Dividends
5 - 47
12/31/2007

Minority Interest 10,500 4,000 14,500 3,000 Dividends 1,000 16,500
12/31/2006
12/31/2007
5 - 48
Consolidation Example Intercompany Profits: Upstream Sales

Smith Corporation is an 80%-owned subsidiary of Poch Corporation, acquired for $480,000 cash on January 2, 2003. Smiths stockholders equity consisted of $500,000 capital stock and $100,000 retained earnings. The cost of Pochs 80% interest was equal to book value and fair value of the interest acquired.
5 - 49

Smith sells inventory items to Poch on a regular basis. Sales to P in 2004 Unrealized profit in Ps inventory at 12/31/2003 Unrealized profit in Ps inventory at 12/31/2004 Intercompany A/R and A/P at 12/31/2004 $300,000 40,000 30,000 50,000
5 - 50

At December 31, 2003, Pochs investment in Smith had an account balance of $568,000. This balance consisted of $600,000 underlying equity in Smiths net assets ($750,000 80%) less $32,000 unrealized profit in Pochs December 31, 2003, inventory.
5 - 51

During 2004, Poch made the following entries on its books for the investment in Smith. Cash 40,000 Investment in Smith 40,000 To record dividends from Smith ($50,000 80%) Investment in Smith 88,000 Income from Smith 88,000 To record income from Smith for 2004
5 - 52
Equity in Smiths net income ($100,000 80%) Add: 80% of $40,000 unrealized profit deferred in 2003 Less: 80% of $30,000 unrealized profit at December 31, 2004 Total
$80,000 32,000 24,000 $88,000

5 - 53

Pochs Investment 480,000 Income 32,000 568,000 40,000 32,000 24,000 80,000 616,000
12/31/2003
Dividends
12/31/2004
5 - 54
End of Chapter 5
5 - 55

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Intercompany Profit Transactions Inventories Chapter 5

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Intercompany Inventory Transactions

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Intercompany Inventory Transactions

Periodic inventory system Perpetual inventory system

Sales Purchases Sales Cost of goods sold

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Elimination of Intercompany Purchases and Sales

Elimination of Intercompany Purchases and Sales

Elimination of Intercompany Purchases and Sales

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Elimination of Intercompany Purchases and Sales

Elimination of Intercompany Purchases and Sales

Cost of Sales 24,000 Inventory 24,000 To record cost of sales to customers

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Elimination of Intercompany Purchases and Sales

Sales Cost of sales Gross profit

$24,000 $30,000 a 24,000 20,000 24,000

$30,000 a 24,000 20,000 $10,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Elimination of Unrealized Profit in Ending Inventory

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Elimination of Unrealized Profit in Ending Inventory

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Elimination of Unrealized Profit in Ending Inventory

Sales Cost of sales Gross profit Inventory

$36,000 $37,500 a 36,000 30,000

30,000 b 1,000 a 36,000 25,000 $12,500 b 1,000 $ 5,000

$ 6,000 $ 7,500 $ 6,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Recognition of Unrealized Profit in Beginning Inventory

Recognition of Unrealized Profit in Beginning Inventory

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Recognition of Unrealized Profit in Beginning Inventory

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Recognition of Unrealized Profit in Beginning Inventory

Sales Cost of sales Gross profit Inventory Investment in Shep

$48,000 $52,500 a 48,000 40,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Sales

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Sales

Downstream and Upstream Effects on Income Computations

$600 300 $300 100 $200

$300 180 $120 70 $ 50

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Effects on Income Computations

The December 31 inventory includes $20,000 unrealized profit.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Effects on Income Computations

The $50,000 subsidiary net income equals its realized income.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Effects on Income Computations

The subsidiarys realized income is $30,000.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Effects on Income Computations

$800 400 $400 170 $230 10 $220

$800 400 $400 170 $230 6 $224

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Downstream and Upstream Effects on Income Computations