Chapter 4 Intercompany Sales

C42 Typical intercompany transactions uMerchandise for resale uLand uFixed assets uLong-term construction contracts uNotes receivable/ payable

C43 Merchandise sales: No inventories OutsideCo. SCo. POutside $80  S buys $100  P buys $125  to outside Consolidated statement for Company SP Sales$125 Cost of Goods Sold80 The “intercompany sale” of $100 is eliminated on the worksheet. Separate statements Co. SCo. P Sales$100$ 125 CofGS80100

C44 Intercompany price Does the intercompany price matter? Yes: If there is a NCI. If S was 80% owned by P, NCI gets $4 (20% x $20) and controlling interest gets $41(80% x $20 + $25)

C45 Merchandise sales: Unsold goods Separate statements: uS has sales of $100, C of GS of $80 uP has inventory with cost of $100 Consolidated Statements: uSP has inventory with a cost of $80 OutsideCo. SCo. POutside $80  $100  [in end inv] The “intercompany sale” of $100 is eliminated The inventory is restated to $80 The $20 profit is not recognized until the goods are sold by P to the outside world

C46 The normal merchandise procedures ¶ IS Eliminate intercompany “middle sale” - no impact on income but overstates sales and cost of goods · BI Restore beginning inventory (included in C of GS) to cost and correct beginning Retained Earnings - this shifts profit from last year to this year ¸ EI Restore ending inventory to cost and adjust C of GS - this defers profit to next year ¹ IA Eliminate intercompany trade debt and interest (if any)

C47 Mark-up confusion Mark-up on cost is not the same as gross profit! Marking a $10 cost unit up 25% $10.00  125% = $12.50 provides a gross profit of 20% $2.50  $12.50 = 20%

C48 Merchandise example uS (P owns 80%) buys goods for $80,000 and sells them to P for $100,000, all sales are at 20% GP uP had $10,000 of intercompany goods in beginning inventory and $15,000 of such goods in its ending inventory uP owed S $8,000 for intercompany goods at year end

C49 Consolidation Procedures Needed IS - eliminate sale from subsidiary to parent BI - reduce cost of goods sold for profit in beginning inventory and correct beginning retained earnings (allocated 20/80 because sale was by subsidiary) EI- reduce ending inventory and increase cost of goods sold (deduct for ending inventory was too great) IA - Eliminate intercompany trade balance

C410 Worksheet eliminations

C411 Adjustments on the IDS SUB End Inv profit (EI)3,000Int Generated Inc20,000 Beg Inv profit (BI)2,000 Adjusted Inc 19,000 NCI %20% NCI3,800 PARENT Int Generated Inc35,000 80% of $19,000 Co. S’s adjusted inc15,200 Controlling Interest50,200

C412 Worksheet 4-3 uThe 4 eliminations are IS, IA, BI, EI uRE split for beginning inventory because sub sold it. If parent was seller, adjustments only to parent RE uSeller’s profit is adjusted through IDS. In this case the adjustments went to the sub (seller). They would go to Parent if parent was seller

C413 Worksheet 4-3 (continued) uIf there is an LCM adjustment, only the remaining profit is eliminated uPhony losses (sales below market value) are also eliminated uWorksheet 4-4 shows the same adjustments for a periodic inventory

C414 Intercompany land sales Year of sale:LAGain of seller20,000 Land20,000 Run adjustment through seller’s IDS Gain is deferred until land is sold to outside company Later years:LARE (split?)20,000 Land20,000 Adjustment is split only if seller was Sub Year of outside sale: LARE (split?)20,000 Gain (loss) on land sale20,000 Seller may finally recognize gain; credit to seller’s IDS

C415 Intercompany fixed asset sale: Year of sale Sold 5 year machine, cost $20,000, for $30,000 on 1/1/x1 Theory - Defer gain and earn it back over period of use. The allocation method matches the depreciation method (straight-line for this example) Year of sale: F1Gain (seller)10,000 defer gain on sale Machine10,000 return asset to cost F2Accum depr2,000 reduce to depr. on cost Dep Expense2,000 recognize 1/5 profit IDS - deduct original profit from seller and add profit equal to depreciation adjustment

C416 Intercompany fixed asset sale: Year subsequent to inter-company sale End of second year: Adjust asset at start of year F1RE (split?)8,000deferred gain on 1/1/2 Accum Depr2,000adjust prior year’s depr. Machine10,000return asset to cost RE adjustment is split only when sub is seller Adjust current year depreciation F2Accum Depr2,000reduce to depr on cost Depr Expense2,000recognize 1/5 profit IDS - seller gets profit equal to depreciation adjustment

C417 Fixed asset worksheets WS 4-5 (year of sale) u(F1) removes $10,000 profit from machinery, defers $10,000 gain u(F2) adjusts depreciation and realizes $2,000 gain uIDS takes away $10,000 from P [seller], gives back $2,000 WS 4-6 (end of second period after sale) u(F1) removes profit from machinery, corrects last year's depreciation and defers $8,000 profit as of 1/1/2 u(F2) adjusts depreciation and realizes $2,000 gain uIDS just gives back $2,000 currently realized gain to P

C418 Fixed asset worksheets, continued WS 4-7 (Asset sold to outside party at end of second year) uMachinery and accumulated depreciation are not there to adjust uThe $6,000 remaining gain at the start of the year is now earned - sale to outside occurred uAdding the $6,000 deferred gain to the recorded $4,000 loss created a gain on the consolidated statement of $2,000. Entry is F3

C419 Long-term construction contracts Completed - like any other fixed asset sale Not Complete - Completed Contract Method: Eliminate seller’s Billings and Cost of Construction in Progress; adjust buyer’s Asset Under Construction for unbilled costs incurred by seller Eliminate intercompany debt balance Not Complete - Percentage of Completion: Key is to defer profit recorded by builder and restore asset under construction to cost Eliminate intercompany debt balance