Intercompany Profit Transactions – Plant Assets Chapter 6: Intercompany Profit Transactions – Plant Assets Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 1

Intercompany Profits – Plant Assets: Objectives Assess the impact of intercompany profit on transfers of plant assets in preparing consolidations workpapers. Defer unrealized profits on plant asset transfers by either the parent or subsidiary. Recognize realized, previously-deferred profits on plant asset transfers. Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

1: Transfers of Plant Assets Intercompany Profit Transactions – Plant Assets 1: Transfers of Plant Assets Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Intercompany Fixed Asset Sales Intercompany sales of nondepreciable fixed assets: In year of intercompany sale Defer any gain or loss Restate fixed asset to cost In years of continued ownership Adjust investment account to defer gain or loss (adjust noncontrolling interest too, if upstream sale) In year of sale to outside entity Adjust investment account (and noncontrolling interest if upstream sale) Recognize the previously deferred gain or loss Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Intercompany Sale of Land Pak owns 90% of San, acquired at cost equal to fair value. In 2011, Pak sells (downstream) land to San and records a $10 gain. In 2015, San sells the land to an outside entity at a $15 gain. San's separate income was $70 in 2011, $80 per year for 2012 to 2014, and $90 in 2015. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2011 Calculations Defer the unrealized gain, with full effect to Pak Pak's Income from San 90%(70) – 10 = $53 Noncontrolling interest share 10%(70) = $7 Elimination entry for 2011 Worksheet Gain on sale of land (-Ga, -SE) 10 Land (-A) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2012 to 2014 Calculations Continue to defer gain, with full effect to Pak Pak's Income from San 90%(80) = $72 Noncontrolling interest share 10%(80) = $8 Elimination entry for Worksheets in 2012 to 2014 Investment in San (+A) 10 Land (-A) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2015 Calculations Recognize the previously deferred gain, with full effect to Pak Pak's Income from San 90%(90) + 10 = $91 Noncontrolling interest share 10%(90) = $9 Elimination entry for 2015 Worksheet Investment in San (+A) 10 Gain on sale of land (Ga, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

2: Deferring Unrealized Profits Intercompany Profit Transactions – Plant Assets 2: Deferring Unrealized Profits Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Unrealized Profits on Fixed Assets Unrealized profit or loss on nondepreciable fixed assets Defer in year of intercompany sale Continue deferring by adjusting the investment in subsidiary (and noncontrolling interest if upstream) Recognize full profit or loss upon resale to outside entity Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Depreciable Fixed Assets Gains and losses on intercompany sales of depreciable fixed assets Defer in period of intercompany sale Recognize gain or loss over remaining life of asset Adjust asset and depreciation down for gains Adjust asset and depreciation up for losses Recognize any unamortized gain or loss upon sale to outside entity Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Downstream Example Per owns 80% of Sop, acquired at cost equal to fair value. On 1/1/2011, Per sells machinery to Sop at a $30 profit. The machinery has a remaining life of 5 years from 1/1/2011. Sop disposes of the machinery at book value at the end of 5 years. Sop's income is $70 in 2011, $80 per year for 2012 to 2014, and $90 in 2015. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2011 Calculations Defer the unrealized gain and amortize it over 5 years with full effect to Per 30 gain / 5 years = $6 Per's Income from Sop 80%(70) – 30 + 6 = $32 Noncontrolling interest share 20%(70) = $14 Elimination entry for 2011 Worksheet Gain on sale of machinery (-Ga, -SE) 30 Machinery (-A) Accumulated depreciation (+A) 6 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

3: Recognizing Realized, Previously Deferred Profits Intercompany Profit Transactions – Plant Assets 3: Recognizing Realized, Previously Deferred Profits Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Previously Deferred Gains/Losses Recognize over the life of the depreciable asset Downstream sales Adjust investment in subsidiary account Upstream sales Adjust investment in subsidiary account and noncontrolling interest, proportionately Intercompany sales at a gain Adjust asset and depreciation down Intercompany sales at a loss Adjust asset and depreciation up Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2012 to 2014 Calculations Continue to recognize part of the gain, with full effect to Per Per's Income from Sop 80%(80) + 6 = $70 Noncontrolling interest share 20%(80) = $16 Elimination entry for Worksheets in 2012 Investment in Sop (+A) 24 Accumulated depreciation (+A) 6 Machinery (-A) 30 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Entries (cont.) Worksheet entries for 2013 Worksheet entries for 2014 Investment in Sop (+A) 18 Accumulated depreciation (+A) 12 Machinery (-A) 30 6 Depreciation expense (-E, +SE) Investment in Sop (+A) 12 Accumulated depreciation (+A) 18 Machinery (-A) 30 6 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2015 Calculations Recognize the remaining deferred gain, with full effect to Per Per's Income from Sop 80%(90) + 6 = $78 Noncontrolling interest share 20%(90) = $18 Elimination entries for 2015 Worksheet Investment in Sop (+A) 6 Accumulated depreciation (+A) 24 Machinery (-A) 30 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

4: Impact on Noncontrolling Interest Intercompany Profit Transactions – Plant Assets 4: Impact on Noncontrolling Interest Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Sharing Unrealized Gain or Loss Upstream sales of fixed assets require: Deferring the gain or loss on the sale Recognizing a portion of the gain or loss as the asset depreciates Writing off any unrecognized gain or loss upon the sale of the asset Sharing the gains and losses between the controlling and noncontrolling interests Upstream sales impact noncontrolling interests! Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Upstream Example Pail owns 70% of Shovel, acquired at cost equal to fair value. On 1/1/2011, Shovel sells machinery to Pail at a $40 profit. The machinery has a remaining life of 5 years from 1/1/2011. Pail uses the machinery for four years, then sells it at a profit at the start of 2015. Shovel's income is $70 in 2011, $80 per year for 2012 to 2014, and $90 in 2015. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2011 Calculations Defer the unrealized gain and amortize it over 5 years sharing the gain 40 gain / 5 years = $8 Pail's Income from Shovel 70%(70 – 40 + 8) = $26.6 Noncontrolling interest share 30%(70 – 40 + 8) = $11.4 Elimination entry for 2011 Worksheet Gain on sale of machinery (-Ga, -SE) 40 Machinery (-A) Accumulated depreciation (+A) 8 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2012 to 2014 Calculations Continue to recognize part of the gain, sharing its effect between the controlling and noncontrolling interests Pail's Income from Shovel 70%(80 + 8) = $61.6 Noncontrolling interest share 30%(80 + 8) = $26.4 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2012 Worksheet Entries Elimination entry for Worksheets in 2012 Investment in Shovel (+A) 22.4 Noncontrolling interest (-SE) 9.6 Accumulated depreciation (+A) 8.0 Machinery (-A) 40.0 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2013 Worksheet Entries Worksheet entries for 2013 Investment in Shovel (+A) 16.8 Noncontrolling interests (-SE) 7.2 Accumulated depreciation (+A) 16.0 Machinery (-A) 40 8.0 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2014 Worksheet Entries Worksheet entries for 2014 Investment in Shovel (+A) 11.2 Noncontrolling interest (-SE) 4.8 Accumulated depreciation (+A) 24.0 Machinery (-A) 40.0 8.0 Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2015 Calculations Recognize the remaining deferred gain, sharing the impact with controlling and noncontrolling interests Unamortized gain = 1 year at $8 Pail's Income from Shovel 70%(90 + 8) = $68.6 Noncontrolling interest share 30%(90 + 8) = $29.4 Elimination entries for 2015 Worksheet Investment in Shovel (+A) 5.6 Noncontrolling interests (-SE) 2.4 Accumulated depreciation (+A) 32.0 Machinery (-A) 40.0 8.0 Gain on sale of machinery (Ga, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Sale at Other Than Fair Value Intercompany sales of fixed assets at prices other than fair value Deserve scrutiny by shareholders Sales above fair value move additional cash to the seller Sales below fair value transfer valuable goods to the buyer There is a transfer of wealth between the affiliated companies, and between the controlling and noncontrolling interests Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Inventory Items  Fixed Assets An intercompany sale of inventory which is acquired as a fixed asset Unrealized profit is removed from cost of sales in year of sale Profit is recognized over the fixed asset's life Cost of sales (E, -SE) XXX Machinery (-A) Accumulated depreciation (+A) X Depreciation expense (-E, +SE) Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall