Advanced Accounting by Debra Jeter and Paul Chaney Chapter 7: Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment Slides Authored by Hannah Wong, Ph.D. Rutgers University

Intercompany Sales of Land (Nondepreciable Property) Parent Company Land Downstream Sale Upstream Sale Subsidiary

Financial Reporting Objectives To defer unrealized intercompany gains or losses until such property is sold to parties outside the affiliated group To present such property in the consolidated balance sheet at its cost to the affiliated group

Upstream Sales - Land An Example Parent Company Sells land for $500,000 Sells to outside party for $550,000 years later Purchased land for $300,000 80% owned Subsidiary S records gain on sale of land of $200,000

Upstream Sales - Land Cost and Partial Equity Methods Year of Intercompany Sale - EE Gain on sale of land 200,000 Land 200,000 To reduce the land to its historical cost paid by the selling affiliate To exclude the unrealized gain from consolidated net income

Upstream Sales - Land Cost and Partial Equity Methods Years after Intercompany Sale - EE Parent’s share of the unrealized gain Beginning R/E - P ($200,000 x 80%) 160,000 Beginning R/E - S ($200,000 x 20%) 40,000 Land 200,000 To reduce the land to its historical cost paid by the selling affiliate Noncontrolling interests’ share of the unrealized gain

Upstream Sales - Land Cost and Partial Equity Methods Year of Sale to Outside Party - EE Parent’s share of the unrealized gain Beginning R/E - P ($200,000 x 80%) 160,000 Beginning R/E - S ($200,000 x 20%) 40,000 Gain on sale of land 200,000 To record intercompany gain on sale of land, which is realized in the current year Noncontrolling interests’ share of the unrealized gain

Upstream Sales - Land Complete Equity Method Year of Intercompany Sales - Journal Entry Equity in subsidiary income 160,000 Investment in S 160,000 To exclude the parent’s share of the unrealized gain from equity in subsidiary income

Upstream Sales - Land Complete Equity Method Year of Intercompany Sale - EE Gain on sale of land 200,000 Land 200,000 To reduce the land to its historical cost paid by the selling affiliate To exclude the unrealized gain from consolidated net income

Upstream Sales - Land Complete Equity Method Years after Intercompany Sale - EE Parent’s share of the unrealized gain Investment in S 160,000 Beginning retained earnings - S 40,000 Land 200,000 To reduce the land to its historical cost paid by the selling affiliate Noncontrolling interests’ share of the unrealized gain

Upstream Sales - Land Complete Equity Method Year of Sale to Outside Party - EE Parent’s share of the unrealized gain Investment in S 160,000 Beginning retained earnings - S 40,000 Gain on sale of land 200,000 To record intercompany gain on sale of land, which is realized in the current year Noncontrolling interests’ share of the unrealized gain

Intercompany Sales Depreciable Property Parent Company Machinery, Equipment or Building Downstream Sale Upstream Sale Subsidiary

Financial Reporting Objectives To defer unrealized intercompany gains or losses until such property is sold to parties outside the affiliated group To present the depreciable property and related accounts (accumulated depreciation and depreciation expense) in the consolidated balance sheet based on its historical cost to the affiliated group

Downstream Sales - Equipment An Example Sold on 1/1/2002 for $900,000 90% owned Subsidiary Parent Company Purchased equipment for $1,350,000 Parent has recorded $600,000 Acc. Dep. On the equipment Equipment has remaining useful life of 3 years Note: it is the parent who records the intercompany profit, thus the parent’s income needs to be adjusted in consolidation

Downstream Sales - Equipment All Methods Year of Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350,000-900,000) 450,000 Gain on sale of equipment 150,000 Accumulated depreciation 600,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Downstream Sales - Equipment All Methods Year of Intercompany Sale The Depreciation EE Accumulated Depreciation 50,000 Depreciation Expense 50,000 To adjust depreciation expense from the recorded amount to the amount based on the original historical cost of equipment

Downstream Sales - Equipment Cost or Partial Equity Methods Years after Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350,000-900,000) 450,000 Beginning retained earnings - P 150,000 Accumulated depreciation 600,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Downstream Sales - Equipment Cost or Partial Equity Methods Years after Intercompany Sale The Depreciation EE Accumulated Depreciation 100,000 Beginning retained earnings - P 50,000 Depreciation Expense 50,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Downstream Sales - Equipment Complete Equity Methods Years after Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350,000-900,000) 450,000 Investment in S 150,000 Accumulated depreciation 600,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain from the investment account

Downstream Sales - Equipment Complete Equity Methods Years after Intercompany Sale The Depreciation EE Accumulated Depreciation 100,000 Investment in S 50,000 Depreciation Expense 50,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Upstream Sales - Equipment An Example Sold on 1/1/2002 for $600,000 Parent Company 90% owned Subsidiary Purchased equipment for $800,000 Subsidiary has recorded $300,000 Acc. Dep. on the equipment Equipment has remaining useful life of 5 years Note: it is the subsidiary who records the intercompany profit, thus the subsidiary’s income needs to be adjusted in consolidation

Upstream Sales - Equipment Cost and Partial Equity Methods Year of Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350,000-900,000) 450,000 Gain on sale of equipment 150,000 Accumulated depreciation 600,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Upstream Sales - Equipment Cost and Partial Equity Methods Year of Intercompany Sale The Depreciation EE Accumulated Depreciation 50,000 Depreciation Expense 50,000 To adjust depreciation expense from the recorded amount to the amount based on the original historical cost of equipment

Upstream Sales - Equipment Cost and Partial Equity Methods Years after Intercompany Sale To eliminate the parent’s and noncontrolling interests’ shares of unrealized gain recorded in prior years The Equipment EE Beginning retained earnings - P 85,000 Beginning retained earnings - S 15,000 Equipment (800,000-600,000) 200,000 Accumulated depreciation 300,000 To restore the equipment to its historical cost To restore the accumulated depreciation to its balance on the date of intercompany sale

Upstream Sales - Equipment Cost and Partial Equity Methods Years after Intercompany Sale The Depreciation EE Accumulated Depreciation 40,000 Depreciation Expense 20,000 Beginning retained earnings - P 17,000 Beginning retained earnings - P 3,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Upstream Sales - Equipment Cost and Partial Equity Methods Disposal of Equipment by Purchasing Affiliate The Disposal EE Beginning retained earnings - P 51,000 Beginning retained earnings - S 9,000 Gain on sale of equipment 60,000 i To include the intercompany profit, which is realized in the current year, in consolidated NI

Upstream Sales - Equipment Cost and Partial Equity Methods Noncontrolling Interest in Income Reported income of S Unrealized gain on upstream-sale of equipment Depreciation adjustment (gain realized through usage) Upstream-sale unrealized profit in ending inventory Upstream-sale realized profit in beginning inventory Adjusted NI of S x Noncontrolling % Noncontrolling interest in income

Upstream Sales - Equipment Cost and Partial Equity Methods Controlling Interest in Income Downstream-sale profit in ending inventory Reported income of P Downstream-sale realized profit in beginning inventory Unrealized gain on downstream-sale of equipment Depreciation adjustment (gain realized through usage) Amortization of purchase differential (Adjusted NI of S) x (P %) Consolidated income

Upstream Sales - Equipment 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 P% x (Unrealized gain on upstream-sale of equipment) Unrealized gain on downstream sale of equipment Accumulative amortization of purchase differential Consolidated R/E

Downstream Sales - Equipment Complete Equity Method Year of Intercompany Sale - JE The Gain JE: Equity in subsidiary income 85,000 Investment in S 85,000 to adjust subsidiary income downward for the unrealized gain on sale of equipment The Depreciation JE: Investment in S 17,000 Equity in subsidiary income 17,000 to adjust subsidiary income upward for the gain realized through usage

Downstream Sales - Equipment Complete Equity Method Year of Intercompany Sale - EE To restore the equipment to its historical cost The Equipment EE Equipment 100,000 Gain on sale of equipment 200,000 Accumulated depreciation 300,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Downstream Sales - Equipment Complete Equity Method Year of Intercompany Sale - EE The Depreciation EE Accumulated Depreciation 250,000 Depreciation Expense 20,000 To adjust depreciation expense from the recorded amount to the amount based on the original historical cost of equipment

Downstream Sales - EE Complete Equity Method Years after Intercompany Sale - EE To eliminate the unrealized gain from the investment account and 1/1 R/E - S The Equipment EE Investment in S 85,000 Beginning retained earnings - S 15,000 Equipment 200,000 Accumulated depreciation 300,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To restore the equipment to its historical cost

Downstream Sales - EE Complete Equity Method Years after Intercompany Sale - EE The Depreciation EE Accumulated Depreciation 40,000 Investment in S 17,000 Beginning retained earnings - S 3,000 Depreciation Expense 20,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Downstream Sales - EE Complete Equity Method Disposal of Equipment by Purchasing Affiliate The Disposal JE: Investment in S 51,000 Equity in subsidiary income 51,000 To adjust subsidiary income upward for the realized intercompany gain on sale of equipment

Downstream Sales - EE Complete Equity Method Disposal of Equipment by Purchasing Affiliate The Disposal EE Investment in S 51,000 Beginning retained earnings - S 9,000 Gain on sale of equipment 60,000 i To include the intercompany profit, which is realized in the current year, in consolidated NI

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