0. Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 6: Elimination of Unrealized
Profit on Intercompany
Sales of Inventory
Slides Authored by Hannah Wong, Ph.D.
Rutgers University

1. Intercompany Sales of Inventory
Parent Company
Downstream Sale
Upstream Sale
Subsidiary
Subsidiary
Horizontal Sale

2. Financial Reporting Objectives
Consolidated sales = sales with parties outside the affiliated group
Consolidated COGS = cost to the affiliated group of goods that have been sold to outside parties
Consolidated inventory = inventory at its cost to the affiliated group

3. Financial Reporting Objectives
To present consolidated balances of sales, cost of sales, and inventory as if the intercompany sale had never occurred.

4. Downstream Sales : No Unrealized Profit
Outsider
Supplier
Parent
Company
Purchased
for
$200,000
Sold for
$250,000
Sold for
$270,000
Subsidiary
Outside
Customer

5. Downstream Sales No Unrealized Profit - EE
Purchases ,000
To eliminate intercompany
purchase that the
subsidiary has recorded
To eliminate
intercompany sale
that the parent
has recorded

6. Downstream Sales: Unrealized Profit in Ending Inventory
Outsider
Supplier
Parent
Company
Purchased
for
$200,000
Sold for
$250,000
Note: it is the parent who records the intercompany profit, thus the parent’s income needs to be adjusted in consolidation
Sold 60%
of goods
Subsidiary
Outside
Customer

7. Downstream Sales - EE Year of Intercompany Sale
Purchases ,000
Ending Inventory - Inc. state. (COGS) 20,000
Inventory - balance sheet 20,000
To eliminate intercompany sale and purchases
To exclude the unrealized
profit from consolidated
net income
To exclude the unrealized
profit from ending inventory

8. Downstream Sales - EE Year after Intercompany Sale
Cost or Partial Equity Methods
Beginning R/E - P ,000
Beginning Inventory - Inc. State. (Cost of sales) ,000
The intercompany profit in
beginning inventory is
excluded from last year’s
consolidated NI, hence
this year’s 1/1 R/E
To include the intercompany
profit in beginning inventory,
which is realized
in the current year

9. Downstream Sales - EE Year after Intercompany Sale
Complete Equity Method
Investment in S ,000
Beginning Inventory - Inc. State. (Cost of sales) ,000
The intercompany profit in
beginning inventory is
excluded from last year’s
consolidated NI, hence
the investment account
To include the intercompany
profit in beginning inventory,
which is realized
in the current year

10. Amount of Intercompany Profit
Gross profit method
intercompany profit that should be eliminated
= ending inventory of buying affiliate
x selling affiliate’s gross profit rate
(i.e., gross profit / cost)

11. Elimination of Downstream Intercompany Profit
eliminate the parent’s and the noncontrolling stockholders’ portion of intercompany profit despite partial ownership of the parent
required by current GAAP
Partial elimination
eliminate only the parent’s portion of intercompany profit

12. Upstream Sales Outsider Supplier Subsidiary Parent Outside Company
Purchase
Intercompany
Sale
Note: it is the subsidiary who records the intercompany profit, thus the subsidiary’s income needs to be adjusted in consolidation
Parent
Company
Outside
Customer
Sell

13. Upstream Sales An Example
Parent
Company
$400,000
intercompany
merchandise in
ending inventory
80% owned
Subsidiary
Profit margin
= 25%
x selling price
Total sales
$700,000

14. Upstream Sales Cost or Partial Equity Methods
Year of Intercompany Sale - EE’s
Sales ,000
Purchases ,000
Ending Inventory - Inc. state. (COGS) ,000
Inventory - balance sheet ,000
To eliminate intercompany sale and purchases
To exclude the unrealized
profit (400,000x25%)
from consolidated
net income
To exclude the unrealized
profit from ending inventory

15. Upstream Sales - EE Cost or Partial Equity Methods
Year after Intercompany Sale - EE’s
Parent’s share of unrealized
profit in beginning inventory
Beginning R/E - P ($100,000x80%) ,000
Beginning R/E - S ($100,000x20%) ,000
Beginning Inventory - Inc. State. (Cost of sales) ,000
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
Noncontrolling interests’ share
of unrealized profit in
beginning inventory

16. Cost or Partial Equity Methods
Noncontrolling Interest in Income
Reported income of S
Upstream-sale profit in ending inventory
Upstream-sale profit in beginning inventory
Adjusted NI of S x
Noncontrolling %
Noncontrolling interest in income

17. Cost and Partial Equity Methods
Controlling Interest in Income
Downstream-sale profit in ending inventory
Reported income of P
Downstream-sale profit in beginning inventory
Amortization of purchase
differential
(Adjusted NI of S) x (P %)
Consolidated income

18. Cost and Partial Equity Methods
Consolidated Retained Earnings
P% x (Upstream-sale profit in P’s ending inventory)
Reported R/E of P
Downstream-sale profit in S’s ending inventory
P’s share of increase in
S R/E since acquisition
Accumulative amortization of purchase differential
Consolidated R/E

19. Upstream Sales Complete Equity Method
Year of Intercompany Sales - Journal Entries
Equity in subsidiary income ,000
Investment in S ,000
To exclude the unrealized profit (400,000x25%)
from equity in subsidiary income

20. Upstream Sales Complete Equity Method
Year after Intercompany Sales - Journal Entries
Investment in S ,000
Equity in subsidiary net income 80,000
To include in equity in subsidiary income the intercompany
profit, which is realized in the current year

21. Upstream Sales Complete Equity Method
Year of Intercompany Sales - EE’s
Sales ,000
Purchases ,000
Ending Inventory - Income Statement 100,000
Inventory - Balance Sheet ,000
To eliminate intercompany sale and purchases
To exclude the unrealized profit (400,000x25%)
from equity in subsidiary income

22. Upstream Sales Complete Equity Method
Year after Intercompany Sale - EE
Parent’s share of unrealized
profit in beginning inventory
Investment in S ,000
Beginning retained earnings - S 20,000
1/1 Inventory - Income Statement ,000
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
Noncontrolling interests’ share
of unrealized profit in
beginning inventory

23. Upstream Sales Complete Equity Method
Consolidated net income
= Reported net income of Parent
Consolidated retained earnings
= Reported retained earnings of Parent

24. Advanced Accounting by Debra Jeter and Paul Chaney
Copyright © 2001 John Wiley & Sons, Inc. All rights reserved.
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