Ch 4: Consolidated Financial Statements and Intercompany Transactions
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17 Terms
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
Intercompany Sales of Assets
these sales frequently occur btwn the parent and one or more subsidiaries
can result in misstatements in the IS and BS if not handled correctly
Sale of Inventories: one of the most common intercompany transactions
can be raw material or partially completed goods, which are ultimately completed by the purchaser and sold to an outside party
ex. Inventory costing $140 is sold to subsidiary for $200
Seller: DR Cash 200 CR Sales 200 and DR COGS 140 Inventory 140
Parent recognizes $60 gross profit
Sub: DR Inventory 200 CR Cash
inventory is recorded at purchase price
inventory has been WRITTEN UP by $60, from 140 to 200, and that write up has resulted in the recognition of gross profit of 60
if we do not make any adjustments during consolidation process, consolidated pre-tax income will be OVERSTATED by the gross profit. And the Inventory account will be OVERSTATED by the writeup of inventory during the sale from 140 to 200
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
Intercompany Sales of Assets: how to AVOID the OVERSTATEMENTS
the sale can still occur (and is recognized in the separate, preconsolidation accounting records of the affiliated companies)
we just cant recognize intercompany transactions in the CONSOLIDATED fin st
the intercompany sales transaction must be ELIMINATED from the consolidated IS
The resulting profit is deferred until the asset is ultimately sold to unaffiliated partied
We report the asset on the consolidated BS at the pre-intercompany transaction carrying value
we accomplish the DEFERRAL OF PROFIT with the consolidation JE labeled [ I ] in the CEADI entries
our objective is to eliminate the effects of the intercompany sale of that inventory while it is being held in the consolidated group of companies
we need to back out the revenue, exp, and profit on the intercompany sale, as well as any intercompany payables and receivables
and we need to return the assets to the balances they would’ve shown had the intercompany asset sale had not taken place
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
Computation of COGS
inventory transactions and balances always affect COGS
Beg Inv + Purch - End Inv = COGS
inv transactions always affect both inventory and cogs
if we eliminate intercompany profits in End Inv then COGS is also affected by that elimination process
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
CEADI Entries Ex. Parent sells inv that originally cost $100 to its Sub for $130 cash
[C] DR Equity Inv 30 CR Income (loss) from Sub 30
Consolidation entries to eliminate changes in Equity In account during the year
Consolidation Entries to eliminate intercompany transactions and balances
[ I (sales) ] DR Sales 130 CR COGS (purchase) 130
to reverse the intercompany sale amnt and reduce cogs (related purchase)
the purchase and sale of the inventory has now been reversed
[ I (cogs) ] DR COGS (eoy inventory) 30 CR Inventories 30
to reverse the inventory write-up and deter the gross profit on the intercompany sale
reduces the carrying amnt of ending inv back to the level that they were prior to the sale (130→100)
increases cogs which decreases GP and therby deferring that profit recognition until the inventories are ultimately sold to an unaffiliated party
The two entries are req to reverse the intercompany sale and to restate the inventories to their presale balance
the net affect of these two I entries may be difficult to see. But if we combine the two [ I ] components, the two JE reverse the effects of the intercompany sale as though it had not occurred:
DR Sales 130 CR GOCS 100 CR Inventories 30
the intercomp sale is removed from consolidated sales, cogs is reduced by the cogs on the intercomp inv sale, and the carrying value of our inventories is reduced to their original cost as though the sale had not occurred
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
When Inventories are SOLD to Independent (Unaffiliated) Company: NEXT PERIOD; Sub SELLS inv to outside party for $180
when the inv are sold to an unaffiliated party, we can finally recognize the total profit on the inventory sale
[C] DR Income (loss) from Sub 80 CR Equity Investment 80
Consolidation entries to eliminate changes in Equity Investment account during the year
[ I (sales) ] DR boy Equity Investment 30 CR COGS (boy inventory) 30
Intercompany elimination entry to recognize deferred gross profit on the intercomp sale in the period the inventories are resold outside of the consolidated group
to inc the Equity inv account and recognize the deferred profit on the prior yrs sale
recognizes the $30 of profit on the intercomp inv sale that has been deferred until the inventories were sold to an unaffiliated party
the CR to COGS reduces the cogs and inc gross profit by the deferred profit that we can now recognize since the inv have bee sold to an unaffiliated party
the DR to the equity inv recognizes that profit
our consolidated IS then reports sales of 180, cogs of 100, and the og cost of the inv that the parent originally purchased, and our consolidated gp of $80 is equal to the $50 of gp recognized by the sub, the sale price of $180 less its cogs of $130, plus the recognition of the $30 of gp that was deferred in the previous period and is now recognized since the inv have been sold to an unaffiliated party
NOTE: for wholly-owned subsidiaries, it makes no difference whether the sale is from the parent to the sub or the sub to the parent,
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
Continuous Sale of Inventories
For continuous sales of inventory (more common than what we did with the two years), each year we,
Recognize the profit from LAST YEAR’S inventory sales that were deferred (assuming the inventories have now been sold to an unaffiliated party
Defer the profit from the current year’s sales (assuming these inventories won’t be sold to an unaffiliated party until NEXT YEAR)
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
Continuous Sale of Inventories: How Much Gross Profit do we Defer Each Year?
amnt of profit to defer each year= the Total Amnt of Deferred Profit x the Percent of Inventories that Remain Unsold Each Year
LO1 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the equity method of preconsolidation investment bookkeeping.
Continuous Sale of Inventories: Required [I] Entries
2018 | 2019 | |
Transfer price for upstream inventory sale | $300,000 | |
Transfer price for downstream inventory sale | $400,000 | |
Cost of goods sold | 230,000 | 320,000 |
Gross profit | $ 70,000 | $ 80,000 |
Percentage remaining in parent's inventory at 12/31/2018 | 25% | n/a |
Percentage remaining in subsidiary's inventory at 12/31/2019 | n/a | 35% |
(Upstream) gross profit deferred at 12/31/2018 | $ 17,500 | n/a |
(Downstream) gross profit deferred at 12/31/2019 | n/a | $ 28,000 |
Intercompany receivable/payable at 12/31/2018 | $ 90,000 | $ 0 |
Intercompany receivable/payable at 12/31/2019 | $ 0 | $100,000 |
Note: upstream vs downstream sales do not affect our consolidation entries at this point since sub is wholly owned (ch 5 is a diff story)
[I_cogs] DR Equity investment @ BOY 17,500 CR Cost of goods sold 17,500
Increases Equity Investment account and recognizes prior period deferred profit from inventories in current period
recognizes in 2019 the $17500 of profit that we deferred in 2018
the parent is using the full equity method and in 2018 it reduced equity income by the deferred profit w a DR and the equity inv account was reduced w a CR
the DR in this entry restores the boy eq inv acct to the bal it would have had had the sale not occurred
the Cr recognizes that deferred profit in the current yr as a reduction of COGS under the assumption that the inventories have now been sold
[I_sales] DR Sales 400,000 CR Cost of goods sold 400,000
Eliminates current period intercompany sales and cost of goods sold
[I_cogs] DR Cost of goods sold 28,000 CR Inventory 28,000
Defer current period deferred profit on intercompany sale of inventories
increasing cogs and reducing the profit by the deferral and cr to inv acct reduces that balance to its historical cost by elimination of the inventory write up on the intercomp inv sale
[I_pay] DR Accounts payable 100,000 CR Accounts receivable 100,000
Eliminates current period intercompany receivable and payable to avoid overstatement of these accounts
LO2 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the cost method of preconsolidation investment bookkeeping.
Review of Post-Acquisition Consolidation: Parent Uses the Cost Method
the consolidated fin st will look the same , regardless of the preconsolidation method of Equity Inv bookkeeping applied by the parent comp
Bc the parent comp’s pre-consolidation fin st wll be diff under the cost method vs the equity method, the consolidation entries will (out of necessity) be slightly different
W/ respect to intercomp profits, the EM reflects the elimination in the preconsol books, but CM ignores the elimination in the pre-consol books
Under the CM, our [ADJ] entry will need to include adjustments for beg of yr pre consol intercomp profits that were not removed
so now our adj entry will need to include adj for the deferral and recognition of gp on the intercomp inv sales in addition to the adj in the inc in the sub’s RE and our adj for the depr and amort of the aap assets
LO2 Describe the accounting for intercompany sales of inventory between the parent and the subsidiary when the parent uses the cost method of preconsolidation investment bookkeeping.
[ADJ] Entry - Cost Method Example
Original cost of Equity investment: $550,000
Stockholders' equity of subsidiary at acquisition date: 450,000
Increase in subsidiary retained earnings January 1, 2016, through December 31, 2018: 200,000
Original AAP (building): 100,000
Unamortized AAP balance on January 1, 2019 (building): 40,000
Annual depreciation/amortization of the AAP: 20,000
bc the sun was acquired 3 yrs ago, the accumulated amort as of the beg of the yr is 60,000
also told that the sub regularly sells inv to the parent and that the amnt of the deferred gp at the beg of the yr is 12000
Regular upstream sales of inventory
Year Ending Summary
Year Ending
Dec. 31, 2018
Dec. 31, 2019
Transfer price for inventory sale
$150,000
$200,000
Cost of goods sold
102,000
150,000
Gross profit
$48,000
$50,000
Percentage of inventory remaining
25%
30%
Deferred intercompany profit (deferred profit) in ending inventory
$12,000
$15,000
Intercompany receivable/payable at end of period*
$25,000
$30,000
Cumulative Understatement of Equity Investment Account @ BOY
Component
Amount
Increase in subsidiary retained earnings through BOY
$200,000
Cumulative depreciation of [A] assets through BOY
(60,000)
Deferred profit @ BOY
(12,000)
Cumulative understatement of Equity investment account @ BOY
$128,000
The req adjusting entry
[ADJ] DR Eq Inv boy 128000 CR RE (P) 128000
restate the eq inv account from cost to equity method
128000= 200000 cumulative inc int he subs RE and three yrs or AAP amort of 60000
reduce the equity inv account by the 12,000 of deferred gross profit on the intercomp sales as of the beg of the yr
after this adj entry, both the eq inv and boy re now reflect the balances that would have been reported had the parent used the equity method all along and we can proceed withthe remainder of our consolidation entries
after adj entry, only the c entry differs to eliminate the dividends received from the sub by the parent
LO3 Describe the accounting for intercompany sales of non-depreciable noncurrent assets between the parent and the subsidiary when the parent uses the equity method of pre-consolidation investment bookkeeping.
Intercomp Sales of Noncurrent Assets and Req Consolidated JE
intercomp sale of land that cost $80 for sales price of $100
Seller JE: DR Cash 100 CR Land 80 CR Gain on Sale 20
Buyers JE: DR Land 100 CR Cash 100
if we make no adj. consolidated NI is overstated by the gain and the land account is overstated by the write up of the land during the sale (from 80 to 100)
Req Consolidated JE:
[C] DR Equity investment 20 CR Income (loss) from subsidiary 20
Consolidation entry to eliminate changes in eq inv account caused by equity method accounting
[I_gain] DR Gain on sale 20 CR Land 20
To defer the gain on sale and to restate the Land account to its pre-sale reported amount
eliminates the gain on sale that the parent recognizes and reduces the book value of the land form the 100 purch price to its og cost of 80
books of parent and sub are not affected by consolidation process, so the land account is still reported on the buyers BS at its purch cost of 100, not at its og cost of 80
2017: Deferred profit removed from Land and income in year of I-C transfer
2018 (Holding Period): (Represented by the downward arrow and holding period entry to reduce the land account)
2019: Deferred profit is recognized as part of consolidated income in 2019
So, each yr during the holding period (2018) and until the sale of the land to an unaffiliated party, we need to reduce the land account from 100 to 80
[I_gain] DR Equity investment 20 CR Land 20
Intercompany elimination entry in the years after intercompany sale
to defer the gain on sale and to restate the Land account to its pre-sale reported amount
this is the same DR that we made in the yr of sale and it must be made each year thereafter to restore the boy bal to the amount that would have been reflected had the sale not occurred and the gain been reported
Year of Sale to Unaffiliated Party:
If and when the land is sold to unaffiliated party:
[I_gain] DR Equity investment 20 CR Gain on sale of land 20
Intercompany elimination entry in the year of sale to unaffiliated party
to recognize deferred gain in year of sale to unaffiliated party
LO4 Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and the subsidiary when the parent uses the equity method of pre-consolidation investment bookkeeping.
Intercomp Sale of Depr Assets
our goal: to adj the consolidated fin st as tho the sale has not occured (this has been our goal this whole time)
Jan 1, 2014, parent sells equip to the sub: og cost is 150 (60 of accum depr) Cash Sale Price is 135; Depr is 10 yr, SL, w no SV
Seller (P): DR Cash 135 DR AD 60 CR Eqip 150 CR Gain on sale of equip 45
parent recognizes gain on sale and removes AD of assets sold
Buyer (S): DR Equip 135 CR Cash 135
equip account is written up to sale price on subs BS
the equip cost has been written down from 150 to 135 and AD for the equip has been eliminated
[I] consolidation entry on the date of the intercomp transaction (2014)
[I_gain] DR Gain on sale of land 45 DR Equipment 15 CR AD 60
Intercompany elimination entry in the year of sale
to reverse the gain on sale recognized by the parent and adjust AD and gross equip to their pre sale amounts
gain on sale is eliminated, equip account is increased to 150 and AD balance of 50 is restored to presale balance
[I_dep] Entry
in the years following the intercomp sale of depr assets, depr exp is overstated in the buyer’s (subs) IS since it is based on the higher purch cost and not the og cost
("As If" No Intercompany Sale)Parent
(Actual)Subsidiary
Difference
Net book value
$90.0
$135.0
$45.0
Useful life
6
6
—
Depreciation expense
$15.0
$ 22.5
$ 7.5
15<22.5; higher than the depr the parent would have reported had the sale not occurred; and hte excess of 7.50 a yr will be realized for the remainder of the UL of the asset
in addition to the [I_gain] consol entries and for each yr of the remaining UL of the equip, we must adj for the inc in depr exp w our [I_depr] entry
[I_dep] DR Accumulated depreciation 7.5 CR Depreciation expense 7.5
To eliminate the excess depreciation expense recorded by the subsidiary, and to adjust accumulated depreciation from the BOY amount to the EOY amount
reduces consol depr exp to its presale amnt and this entry will need to be made every yr during remaining UL of equip
LO4 Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and the subsidiary when the parent uses the equity method of pre-consolidation investment bookkeeping.
Year After Sale
in the yr of sale, the parent recognized a gain of 45, which we deferred with our original [I_gain] entry
then in each yr for the remaining UL of the equip, the sub will report $7.50 of excess depr based on the higher stepped up BV of the equip
the remaining portion of the deferred profit is slowly reduced during the life of the depr asset by 7.50 each yr
Entries for the Year Ended Dec 31, 2015 (Yr after Sale)
Year of Sale:
[I_gain] DR Gain on sale of equipment 45, DR Equipment 15 CR AD 60
Intercompany elimination entry in the year of sale
to reverse the gain on sale recognized by the parent and adjust Accumulated Depreciation and gross Equipment to their pre-sale amounts
Year AFTER Sale
[I_gain] DR Equity investment 37.5, DR Equipment 15.0, CR AD 52.5
Intercompany elimination entry in the first year following the sale
To adjust BOY Equity Investment and Accumulated Depreciation for the consolidation adjustments made through the end of the prior year (i.e., December 31, 2014) and to restore the original (gross) cost of the Equipment
DR is 37.5 bc the gain of 45 has been reduced by 7.50 of excess depr
in each yr then, the remaining deferred gain will reduce by 7.50 as excess depr is recognized until the end of the UL of the asset
this is also why the [I_gain] entry for the yr after sale has a beg of the yr adj of only 52.50 to accumulated depr
this boy adj is comprised of the 60 CR to AD less the 7.50 of excess depr
the 15 DR to equip is necessary to inc its gross bal to 150 in the consolidated fin st
[I_dep] DR AD 7.5, CR Depreciation expense 7.5
To eliminate the excess depreciation expense recorded by the subsidiary, and to adjust accumulated depreciation from the BOY amount to the EOY amount
LO4 Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and the subsidiary when the parent uses the equity method of pre-consolidation investment bookkeeping.
When the Buyer Sells the Depr Asset
if the sub sells the equip to an unaffiliated party before its fully depr, we can then recognize the remaining amnt of the deferred profit
Assume the sub sells the equip to an unaffiliated comp for a cash sale price of 140 on jan 1, 2016
DR Cash 140 DR AD 45 945 is 2 yrs of depr exp of 22.5 per yr) CR Equip 135 CR Gain on sale of equip 50
From a consolidated perspective, the gain on sale of equip at jan 1, 2016, is 80, which is equal to the 50 recognized on the books of the sub plus the 30 of unamortized deferred profit thru jan 1, 2016
LO4 Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and the subsidiary when the parent uses the equity method of pre-consolidation investment bookkeeping.
[I_gain] Entry in Year Outside of Sale
[I_gain] DR Equity investment 30, CR Gain on sale of equipment 30
Intercompany elimination entry in the year of sale to an unaffiliated company
To increase the Equity Investment account for the remaining unconfirmed profit and recognize the deferred gain on the sale
the total gain reported in the consolidated IS is 80 (50 byy the sub in its IS and the recognition of the 30 deferred profit balance remaining on Jan 1,2026)
LO5 Describe the accounting for intercompany sales of non-depreciable noncurrent assets between the parent and the subsidiary when the parent uses the cost method of pre-consolidation investment bookkeeping.
Cost Method- Intercomp sale of land (same example)
Seller's journal entry: DR Cash 100, CR Land 80, CR Gain on sale 20
To record the sale of land
Buyer's journal entry: DR Land 100, CR Cash 100
To record the purchase of land
There is no [C] entry (related to intercompany profits) under the cost method.
The parent company makes the following consolidation entry in the year of sale:
[I_gain] DR Gain on sale 20, CR Land 20
Intercompany elimination entry in the year of sale
To defer the gain on sale and to restate the Land account to its pre-sale reported amount
In periods after the year of the initial transaction, the retained earnings of the parent company will still have the $20 of intercompany profits included in it.
For example, during 2018's consolidation procedures, the parent will propose the following [ADJ] entry in addition to the [I_gain] entry:
[ADJ] DR Retained earnings (P) @ BOY 20, CR Equity investment @ BOY 20
Restate the Equity Investment account from cost to "as if" equity method
reduces boy RE account to back out the 20 gain on sale
[I_gain] DR Equity investment 20, CR Land 20
Intercompany elimination entry in the years after intercompany sale
To defer the gain on sale and to restate the Land account to its pre-sale reported amount
reduces the land account to its presale bal of 80 with a corresponding reduction of the equity investment account
When the asset is ultimately resold to an independent party:
DR Cash 150, CR Land 100, CR Gain on sale 50
To record the sale of Land to an unaffiliated company
The following consolidating entries are necessary to:
Bring forward the Equity Investment account
Correct the beginning balance of the parent's retained earnings
Recognize the full $70 of Gain on Sale of Land in 2016
Consolidating Entries:
[ADJ] DR Retained earnings (P) @ BOY 20, CR Equity investment @ BOY 20
Restate the Equity Investment account from cost to "as if" equity method
reduces the boy RE to bakc out 20 gain on sale
[I_gain] DR Equity investment 20, CR Gain on sale of land 20
Intercompany elimination entry in the year of sale to an unaffiliated company
recognizes the deferred gain w inc in equity investment account
LO6 Describe the accounting for intercompany sales of depreciable noncurrent assets between the parent and the subsidiary when the parent uses the cost method of pre-consolidation investment bookkeeping.
Intercomp sale of equipment (same ex)
Assume that on Jan 1,2014, P sells equip to sub:
og cost: a50 (60 of depr)
cash sales price: 135
depr is 10 yr, SL w no SV
As before the consold process begins w [ADJ] entry
then the [I_gain] and [I_depr] entries are the same as before
Under the cost method, in periods after the yr of the initial transaction, the beg RE of the parent comp will still include the unconfirmed intercomp profits
The amnt of the [ADJ] will change during the depr life of the intercomp asset bc…
the amnt of the unconfirmed profit changes each yr
the amnt of the change in the sub’s RE changes each yr
[ADJ] entry Depr Assets:
Each yr, beg in 2015, the parent comp will need to propose a catch up [adj] entry to make the P’s boy inv and Re accounts be on an “as if equity method” basis
For ex, during 2015’s consold procedures, the P will propose the following [ADJ] entry to the boy account balances:
[ADJ] DR Retained earnings (P) @ BOY 60, CR Equity investment @ BOY 60
Restate the Equity Investment account from cost to "as if" equity method
60 is the [adj] amnt from the 2015 column in the table
In addition, the P will propose the following [E] and [I] consold entries in 2015:
[ADJ] DR Equity investment 22.5, CR Retained earnings (S) @ BOY 22.5
Eliminates the parent's BOY investment account against the subsidiary's BOY stockholders' equity
22.5 is the amount from the [E] consolidation entry in 2015
[Igain] DR Equity investment 37.5, DR Equipment 15.0, CR Accumulated depreciation 52.5
Intercompany elimination entry in the first year following sale to restore original cost and adjust BOY accounts
37.5, 15.0, and 52.5 are the amounts from the [I] consolidation entry in 2015
[Idep] DR Accumulated depreciation 7.5, CR Depreciation expense 7.5
To eliminate excess depreciation expense and adjust accumulated depreciation from BOY to EOY
7.5 is the amount from the [I] consolidation entry in 2015
Effect of [ADJ] Entry
The [ADJ] adjustment adjusted the parent's pre-consolidation financial statements to an "as-if-equity-method" basis.
This means that the [I] entries are identical to the [I] consolidating entries proposed in the equity method example illustrated in Exhibit 4.20