Chapter Five

Consolidated Financial
StatementsIntra-Entity
Asset Transactions

Intra-entity Transactions
2

Transactions between the parent and

subsidiary are considered internal
transactions of a single economic entity.

The effects of these intra-entity

transactions should be eliminated from
the consolidated financial statements.

Thus, consolidated statements only

reflect transactions with outside parties.

Intra-entity Transactions
Inventory Transfers
3

ENTRY TI
Eliminate all intra-entity sales/purchases of
inventory, by eliminating the sales price of the
transfer which one company recorded as sales,
and the other recorded as cost of goods sold.

Note: Assuming inventory has been re-sold to

a third-party, both companies have debited
COGS and credited Sales for the same

Intra-entity Transactions
Inventory Transfers
4

ENTRY G
Despite Entry TI, ending inventory is still overstated by
the amount of gain on any inventory that remains
unsold at year end.
We must eliminate the unrealized gain as follows:

Note: Any inventory that was marked-up in an

I/C transfer must be returned to its original
cost if it has not been sold to an outside party.

Intra-entity Transactions
Inventory Transfers
5

ENTRY *G
In the year that the inventory is subsequently
sold to a third party, the I/C gain is in beginning
Retained Earnings on the sellers books, and
must be moved to Consolidated Income.

Note: The separate records of each company

still contain the I/C transactions, including any
gain that was recorded at the time they

Unrealized Inventory Gain Other issues

6

Does it matter if the sale

is
Upstream or Downstream?

If its DOWNSTREAM, then any unrealized gain

YES!!
belongs to the parent.
If its UPSTREAM, then any unrealized gain
belongs to the subsidiary.

We will reduce the Subs net income by the unrealized gain

prior to calculating the noncontrolling interests share.

Note: FASB does not provide clear guideline on the

allocation of the unrealized gain between the
parent and non-controlling Interest (see page 209 of textbook)

Unrealized Gross Profits

Effect on Noncontrolling Interest
7

According to FASB ASC paragraph 810-10-45-6:

The amount of intra-entity profit or loss to be eliminated is

not affected by the existence of a noncontrolling interest.

The complete elimination of the intra-entity profit or loss is

consistent with the underlying assumption that consolidated
financial statements represent the financial position and
operating results of a single economic entity.

The elimination of the intra-entity profit or loss may be

allocated proportionately between the parent and
noncontrolling interest.

In this class, the noncontrolling interests share of

consolidated net income is computed based on the reported
income of the subsidiary after adjustment for any unrealized
upstream gross profits.

Intra-entity Transactions
Inventory Transfers
8

ENTRY *G

If the transfer of inventory is downstream AND the

parent uses the equity method, then parents retained
earnings are appropriately stated.
The following entry is used to recognize the remaining
unrealized profit left at the end of the previous year.

Note: Investment in Subsidiary account

replaces the Retained Earnings account used
for
Note:upstream
an acceptable sales.
alternative to Investment in Subsidiary account
is the Equity in Subsidiary Income (see footnote 6 in the textbook).

Downstream Transfers When

Parent Uses Equity Method
9

For intra-entity beginning inventory profits

resulting from downstream transfers when
the parent applies the equity method:
Parents retained earnings are
appropriately stated due to intra-entity
profit deferrals and recognition.
The subsidiary retained earnings reflect
none of the intra-entity profit and require
no adjustment.
The parents investment account at
beginning of Year 2 contains a credit from
the deferral of Year 1 downstream profits.
Worksheet Entry *G transfers the Year 1
Investment account credit to a Year 2
earnings credit via COGS to recognize the

10

Intra-entity Transactions
Upstream Inventory Transfer

10

Large Company owns 100% of the voting

stock of Small Company.
During 2010, Large buys 800 widgets from
Small for $80,000.
The widgets originally cost Small $50,000.
At year-end on December 31, 2010, Large still
had 200 of the units on hand.

Prepare the consolidation entries on

12/31/10 to
eliminate the
unrealized gain.

11

Intra-entity Transactions
Upstream Inventory Transfer

11

First, the entire intraentity transfer must be

eliminated.

12

Intra-entity Transactions
Upstream Inventory Transfer

12

Next, eliminate the unrealized gain:

Original Gain x % Unsold = Unrealized Gain
$30,000 x (200/800) = $7,500

13

Intra-entity Transactions
Upstream Inventory Transfer

13

And in a subsequent year when

the inventory is sold to a third
party, we will reverse Entry G to
realize the gain.

14

Intra-entity Transactions
Inventory Transfer

14

And the exception is

If the transfer is downstream and the
parent uses the equity method, then
their Retained Earnings balance has
already been adjusted for the gain, and
we adjust the Investment in Subsidiary
account instead.

15

The Effect of Land Transfers on

Noncontrolling Interests

15

DOWNSTREAM
transfers have
no effect on
noncontrolling
interest.

UPSTREAM transfers
have a gain on the
SUBSIDIARY books!
All noncontrolling
interest balances are
based on the subs
net income
EXCLUDING the
intra-entity gain

Problem 31:

16

Problem 31:

17

Problem 31:

18

Problem 31:

19

Problem 31:

20

Problem 31:

21

22

Intra-entity Transactions
Land Transfer

22

ENTRY TL
If land is transferred between the parent and
sub at a gain, the gain is considered
unrealized and must be eliminated.

Note: By crediting land for the same amount,

this effectively returns the land to its
carrying value on the date of transfer.

23

Intra-entity Transactions Land Transfer

23

ENTRY *GL
As long as the land remains on the books of
the buyer, the unrealized gain must be
eliminated at the end of each fiscal period.

Note: The original gain was closed to R/E at the

end of that period. When we eliminate the gain
in subsequent years, it must come from R/E.

24

Intra-entity Land Transfers

Eliminating Unrealized Gains

24

ENTRY *GL (Year of sale)

In the period the land is sold to a third party,
the unrealized gain must be eliminated one
more time, and also finally recognized as a
REALIZED gain in the current periods
consolidated financial statements.

Note: Modify the entry to credit the Gain

account instead of Land.

Intra-entity Transactions
Depreciable Asset Transfers

25

25

Example of Depreciable Asset

Transfer

Able Co and Baker Co are related

parties.
Able purchased equipment for
$100,000 several years ago, and has
recorded $40,000 of depreciation since
that time.
Baker buys the equipment from Able
for $90,000 on 1/1/10.

5-26

Intra-entity Transactions
Depreciable Asset Transfers

26

On the Sellers Books:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000
Accumulated Depreciation . . . . . . . . .40,000
Equipment . . . . . . . . . . . . . . . . . . . . . $100,000
Gain on Sale of Equipment . . . . . . . . . . 30,000
NOTE: The seller WOULD record depreciation expense at $6,000 per
year if they had not sold the equipment.

On the Buyers Books:

Equipment. . . . . . . . . . . . . . . . . . . . . $90,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000
NOTE: The buyer WILL record $9,000 per year in depreciation based
on the remaining life.

27

Intra-entity Transactions -Depreciable Asset Transfers

27

ENTRY TA
In the year of transfer, the unrealized gain must be
eliminated and the assets restated to original
historical cost.

28

Intra-entity Transactions -Depreciable Asset Transfers

28

ENTRY ED
In addition, the buyers depreciation is
based on the inflated transfer price.
The excess depreciation expense must
be eliminated.

29

Intra-entity Transactions -Depreciable Asset Transfers

29

In Years Following the Year of Transfer

Equipment is carried on the individual books at
a different amount than on the consolidated
books.
The amounts change each year as depreciation
is computed.

To get the worksheet adjustments,

compare the individual records to the
consolidated records.

30

Intra-entity Transactions -Depreciable Asset Transfers

30

On Bakers (buyers) books, the annual

depreciation = $90,000 10 yrs. = $9,000
per year.
The 1/1/11 R/E effect = the original gain of
$30,000 on Ables (sellers) books less one
year of depreciation.

31

Intra-entity Transactions -Depreciable Asset Transfers

31

For the consolidated entity, the annual depreciation =

$48,000 remaining BV 8 yrs. = $6,000 per year.
The Accumulated Depreciation at 12/31/11 =
$40,000 accumulated depreciation at 12/31/09 + two
years of depreciation.

32

Intra-entity Transactions -Depreciable Asset Transfers

32

The consolidation worksheet adjustments

appear in the last column.

33

Intra-entity Transactions -Depreciable Asset Transfers

33

ENTRY *TA (Subsequent Years)

The adjustment to fixed assets and
depreciation expense must be made in each
succeeding period. The entry for the
consolidation is:

34

Intra-entity Transactions -Depreciable Asset Transfers

34

ENTRY ED (Subsequent Years)

In addition, we must adjust for the
difference in Depreciation Expense
on the two income statements. The
entry for our example is:

35

Intra-entity Transactions
Depreciable Asset Transfers

35

And the exception is

If the transfer is downstream and the
parent uses the equity method, then
their Retained Earnings balance has
already been reduced for the gain,
and we adjust the Investment
account instead.

36

Summary
36

Transfers of assets among related parties

are common.

In consolidated financial statements, the

effects of these transfers must be
removed.

Transfers of depreciable assets create

the additional accounting issue of
differing depreciation expense. This
effect is eliminated on the consolidation
worksheets.

37

Possible Criticisms
37

No formal accounting pronouncements

address valuation of noncontrolling
interests in intra-entity gains.

Traditionally, the deferral of gains

from upstream sales is presumed to
affect the noncontrolling interest,
whereas downstream sales do not.

WHAT DO YOU THINK???