1. Intercompany Inventory Transactions
Chapter 06
Intercompany Inventory Transactions
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2. Understand and explain intercompany transfers and why they must be
Learning Objective 1
Understand and explain intercompany transfers and why they must be
eliminated.

3. Road Map: Intercompany Transactions
Typical intercompany transactions
Intercompany reciprocal accounts (Chapter 4)
Inventory transfers (Chapter 6)
Fixed asset transfers (Chapter 7)
Intercompany Indebtedness (Chapter 8)

4. Arm’s-Length Transactions
Q: What are “Arm’s-length” Transactions? A: “Transactions that take place between completely independent parties.”

5. Categories of Transactions
Arm’s Length Transactions
The only transactions that can be reported in the consolidated statements.
We want to report the results of our interactions with outside parties!
Non-Arm’s Length Transactions
Usually referred to as “related party transactions.”
Include all intercompany transactions.

6. Types of “Related Party” Transactions
Involving only Individuals
Transactions among family members
Involving Corporations
With management and other employees
With directors and stockholders
With affiliates (controlled entities)
Probably constitutes at least 99% of all corporate related-party transactions

7. Necessity of Eliminating Intercompany Transactions
Eliminate all intercompany transactions in consolidation:
Because they are internal transactions from a consolidated perspective.
Not because they are related-party transactions.
Only transactions with outside unrelated parties can be reported in the consolidated statements.

8. Let’s work through an example:
Assume Parent Co. owns 100% of Sub Co.
The following intercompany transactions occurred during the year:
Parent loaned $500 to Sub. To keep things simple, assume that there is no interest revenue or interest expense associated with this loan.
Parent made a sale to Sub for $400 cash. The inventory had originally cost Parent $250. Sub then sold that same inventory to an outsider for $500.
Parent made a sale to Sub for $300 cash. The inventory had originally cost Parent $200. Sub has not yet sold that same inventory to an outsider.
 What consolidation worksheet entries would you make?

9. (a) Loan from Parent to Sub
Does this transaction include outsiders?
Cancel!
Parent:
Receivable 500
Cash 500
Parent
Sub
$500
Sub:
Cash 500
Payable 500
Reverse the entries made by the parent and the sub.
To eliminate intercompany loans:
Loan Payable 500
Loan Receivable 500

10. (b) Sale from Parent to Sub to Outsider
Arm’s
Length
Keep Parent’s COGS
Keep Sub’s Sale
Are these legitimate transactions?
Parent
Sub
$250
$400
$500
Get rid of Sub’s COGS
Get rid of Parent’s Sale
Keep
This
Purchase
Eliminate effect
of this internal
Transaction
Keep
This
Sale
Internal (fake)

11. (b) Sale from Parent to Sub to Outsider
Which transactions are legitimate?
Parent’s sale to Sub:
Sub’s sale to Outsider:
Parent:
Cash 400
Sales 400
COGS 250
Inventory 250
Cancel!
Sub:
Cash 500
Sales 500
COGS 400
Inventory 400
Sub:
Inventory 400
Cash 400
Cancel!
Reverse the rest!
To eliminate sale from Parent to Sub to Outsider:
Sales (parent to sub) 400
Cost of Goods Sold (to outsider) 400

12. (c) Sale From Parent to Sub (Not Outside)
Is this a legitimate arm’s length transaction?
Parent:
Cash 300
Sales 300
COGS 200
Inventory 200
Parent
Sub
$200
$300
Keep
this
purchase
Eliminate effect
of this internal
transaction
Sub:
Inventory 300
Cash 300
Summary of the Transaction:
Parent purchased inventory for $200.
Parent sold the inventory to a Sub for $300.
Reverse the entries made by the parent and sub.

13. (c) Sale From Parent to Sub (Not Outside)
Reverse the entries made by the parent and sub.
Cancel!
Parent:
Cash 300
Sales 300
COGS 200
Inventory 200
Parent
Sub
$300
Sub:
Inventory 300
Cash 300
To eliminate sale from Parent to Sub, not yet to Outsider:
Sales 300
Cost of Goods Sold 200
Inventory 100
(net)

14. Summary of Consolidation Entries:
To eliminate intercompany loans:
Loan Payable 500
Loan Receivable 500
To eliminate sale from Parent to Sub to Outsider:
Sales 400
Cost of Goods Sold 400
To eliminate sale from Parent to Sub, not yet to Outsider:
Sales 300
Cost of Goods Sold 200
Inventory 100