BAB 6 INTERCOMPANY PROFIT TRANSACTIONS-PLANT ASSETS

1.1. INTERCOMPANY PROFITS ON NONDEPRECIABLE PLANT ASSETS

The transfer of nondepreciable plant assets between affiliates at a price other than book
value gives rise to unrealized profit or loss to the consolidated entity. These transactions might
include intercompany sales of land or of intangible assets that have an indefinite life, and are
therefore not amortized. An intercompany gain or loss appears in the income statement of the
selling affiliate in the year of sale. However, such gain or loss is unrealized and must be eliminated
from investment income in a one-line consolidation by the parent. We also eliminate its effects in
preparing consolidated financial statements.
Intercompany transfers of plant assets are much less frequent than intercompany
inventory transfers. They most likely occur when mergers are completed, as a part of a
reorganization of the combined companies.
The direction of intercompany sales of plant assets, like intercompany sales of inventory
items, is important in evaluating the effect of unrealized profit on parent and consolidated
financial statements. A gain or loss on sales downstream from parent to subsidiary is initially
included in parent income and must be eliminated. The amount of elimination is 100 percent,
regardless of the noncontrolling interest percentage. Subsidiary accounts include any profit or
loss from upstream sales from subsidiary to parent. The parent recognizes only its share of the
subsidiary’s income, so only the parent’s proportionate share of unrealized profits should be
eliminated. The effect on consolidated net income is the same as for the parent.This section of
the chapter discusses and illustrates accounting practices for intercompany sales of land, covering
both downstream and upstream sales. Accounting for intercompany sales of any non-amortizable
asset will receive similar treatment.

Downstream Sale of Land

Son Corporation is a 90 percent–owned subsidiary of Pop Corporation, acquired for $540,000 on
January 1, 2016. Investment cost was equal to book value and fair value of the interest acquired.
Son’s net income for 2016 was $140,000, and Pop’s income, excluding income from Son, was
$180,000. Pop’s income includes a $20,000 unrealized gain on land that cost $80,000 and was
sold to Son for $100,000. Accordingly, Pop makes the following entries in accounting for its
investment in Son at December 31, 2016:
Investment in Son ( + A) 126,000
Income from Son (R, + SE) 126,000
( To record 90% of Son’s $140,000 reported income.)
Income from Son ( - R, - SE) 20,000
Investment in Son ( - A) 20,000
(To eliminate unrealized profit on land sold to Son.)
The overvalued land will continue to appear in the separate balance sheet of Son in subsequent
years until it is sold outside of the consolidated entity, but the gain on land does not appear in
the separate income statements of Pop in subsequent years. Therefore, entry a as shown in
Exhibit 6-1 applies only in the year of the intercompany sale.
YEARSSUBSEQUENT TOINTERCOMPANYSALE Here is the adjustment to reduce land to its cost
to the consolidated entity in years subsequent to the year of the intercompany downstream sale:
Investment in Son ( + A) 20,000
Land ( − A) 20,000
To reduce land to its cost basis and adjust the investment account to establish
reciprocity with Son’s equity accounts at the beginning of the period.
The debit to the investment account adjusts its balance to establish reciprocity with the
subsidiary
equity accounts at the beginning of each subsequent period in which the land is held. For
example,
the investment account balance at December 31, 2016, is $646,000. This is $20,000 less than
Pop’s
underlying equity in Son of $666,000 on that date ($740,000 * 90%)The difference arises from
the entry on Pop’s books to reduce investment income and the investment account for the
intercompany profit in the year of sale.
Exhibit 6-1 presents a consolidation workpaper for Pop and Subsidiary for 2016. Separate
summary financial statements for Pop and Son appear in the first three columns.
Gain on the sale of land should not appear in the consolidated income statement, and the land
should be included in the consolidated balance sheet at its original cost of $80,000. Entry a
eliminates the gain on sale of land and reduces the land account to $80,000—its cost to the
consolidated
entity. This is the only entry that is significantly different from previous chapters.