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Chapter 5

Intercompany
Profit
Transactions
Inventories

Intercompany Profits Inventories:


Objectives
1. Understand the impact of intercompany profit
in inventories on preparing consolidation
workpapers.
2. Apply the concepts of upstream versus
downstream inventory transfers.
3. Defer unrealized inventory profits remaining in
the ending inventory.
4. Recognize realized, previously deferred,
inventory profits in the beginning inventory.

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Objectives (cont.)
5. Adjust noncontrolling interest amounts in the
presence of intercompany inventory profits.

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Intercompany Profit Transactions Inventories

1: INTERCOMPANY
INVENTORY PROFITS

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Intercompany Transactions
For consolidated financial statements
intercompany balances and transactions shall be
eliminated. [FASB ASC 810-10-45-1]

Show income and financial position as if the


intercompany transactions had never taken
place.

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Intercompany Sales of Inventory


Profits on intercompany sales of inventory
Recognized if goods have been resold to
outsiders
Deferred if the goods are still held in inventory

Previously deferred profits in beginning


inventory are recognized in the period the
goods are sold. Assuming FIFO
Beginning inventories are sold
Ending inventories are from current purchases

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No Intercompany Profits in
Inventories
During 2011, Pet sold goods costing $1,000 to its
subsidiary, Sim, at a gross profit of 30%. Sim had none of
this inventory on hand at the end of 2011. The worksheet
entry for 2011:
Sales (-R, -SE)

1,429

Cost of sales (-E, +SE)

1,429

Eliminate intercompany sales = $1,000 / (1-30%) = $1,429

All intercompany sales of inventories have been resold to


outside parties, so remove the full sales price from both
sales and cost of sales.
Pet's sales are reduced $1,429.
Sim's cost of sales are reduced $1,429.
The same entry is used if Sim sells to Pet.
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Intercompany Profits Only in Ending


Inventories
Last year, 2011, Pal sold goods costing $500 to its
subsidiary, Sal, at a gross profit of 25%. Sal had none of
this inventory on hand at the end of 2011.
During 2012, Pal sold additional goods costing $900
to Sal at a gross profit of 40%. Sal has $200 of these
goods on hand at 12/31/2012. Worksheet entries
for 2012:

Sales (-R, -SE)

1,500

Cost of sales (-E, +SE)

1,500

Eliminate intercompany sales = $900 / (1-40%) = $1,500


Cost of sales (E, -SE)
Inventory (-A)

80
80

Defer profit in ending inventory = $200 x 40%


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Intercompany Profits Beginning and


Ending Inventories
Last year, 2011, Pam sold goods costing $300 to its
subsidiary, Sir, at mark-up of 25%. Sir had $120 of this
inventory on hand at the end of 2011.
During 2012, Pam sold additional goods costing $500 to
Sir at a 30% mark-up. Sir has $260 of these goods on
hand at 12/31/2012. Worksheet entries for 2012:
Sales (-R, -SE)

650

Cost of sales (-E, +SE)

650

Eliminate intercompany sales = $500 + 30%($500) = $650

Cost of sales (E, -SE)

60

Inventory (-A)

60

Defer profits in ending inventory = $260 x 30%/130%

Investment in Subsidiary (+A)


Cost of sales (-E, +SE)

24
24

Realize profits from beginning inventory = $120 x 25%/125% = $24

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Intercompany Profit Transactions Inventories

2: UPSTREAM &
DOWNSTREAM INVENTORY
SALES

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Upstream and Downstream Sales

Downstream
Sales

Parent sells to
subsidiary

Subsidiary
1

Parent
Subsidiary
2

Subsidiary sells
to parent

Subsidiary
3
Upstream Sales

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Intercompany Inventory Sales


The worksheet entries for eliminating intercompany profits for
downstream sales
Sales (-R, -SE)

XXX

Cost of sales (-E, +SE)

XXX

For the intercompany sales price

Cost of sales (E, -SE)

XX

Inventory (-A)

XX

For the profits in ending inventory

Investment in Subsidiary (+A)


Cost of sales (-E, +SE)

XX

For upstream sales, the last entry would include a debit to


For the profits in
beginningsharing
inventorythe realized profit between
noncontrolling
interest,
controlling and noncontrolling interests.
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XX

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Data for Example


For the year ended 12/31/2011:
Subsidiary income is $5,200
Subsidiary dividends are $3,000
Current amortization of acquisition price is $450

Intercompany (IC) sales information:


IC sales during 2011 were $650
IC profit in ending inventory $60
IC profit in beginning inventory $24

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Income Sharing with Downstream


Sales PARENT Makes Sale
Subsidiary net income
Current amortizations
Adjusted income

$5,200
(450)
$4,750

CI 80% share
$3,800
(60)
24

Defer profits in EI
Recognize profits in BI

Income
recognized

(60)

$3,764

24

$4,714

$2,400

Income from
subsidiary
NCI 20% share
$950

Subsidiary dividends
$3,000
When parent makes the IC
sale, the impact of deferring
and recognizing profits falls
all to the parent.

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$600
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Income Sharing with Upstream Sales


SUBSIDIARY Makes Sale
CI 80% share
Subsidiary net income
Current amortizations
Adjusted income
Defer profits in EI
Recognize profits in BI
Income recognized

$5,200
(450)
$4,750
(60)
24

$3,800
(48)
19.2
$3,771.2
$2,400

Income from
subsidiary
NCI 20% share

$4,714
$950.0

Subsidiary dividends

$3,000

When subsidiary makes the IC


sale, the impact of deferring and
recognizing profits is split among
controlling and noncontrolling
interests.

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(12.0)
4.8
$942.8
$600

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Intercompany Profit Transactions Inventories

3: UNREALIZED PROFITS
IN ENDING INVENTORIES

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Ending Inventory on Hand


Intercompany profits in ending inventory
Eliminate at year end

Working paper entry


Cost of sales (E, -SE)
Inventories (-A)

XXX
XXX

For the unrealized profit

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Parent Accounting
Pot owns 90% of Sot acquired at book value
(no amortizations). During the current year,
Sot reported $10,000 income. Pot sold goods to
Sot during the year for $15,000 including a
profit of $6,250. Sot still holds 40% of these
goods at the end of the year.
Unrealized profit in ending inventory
40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000) 2,500 unrealized profits = $6,500
Noncontrolling interest share
10%(10,000) = $1,000
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Entries
Pot's journal entry to record income (net of
unrealized profit).
Investment in Sot (+A)

6,500

Income from Sot (R, +SE)

6,500

Worksheet entries to eliminate intercompany sale


and unrealized profits
Sales (-R, -SE)

15,000

Cost of goods sold (-E, +SE)


Cost of goods sold (E, -SE)
Inventory (-A)
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15,000
2,500
2,500
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Worksheet Income Statement

Sales
Income from Sot

Pot

Sot

$100.
0

$50.0

6.5

Cost of sales

(60.0) (35.0)

Expenses

(15.0)

Consol
$135.0

6.5

0.0

2.5

15.
0

(82.5)
(20.0)

1.0
$31.5 $10.0

CR

15.0

(5.0)

Noncontrolling interest
share
Controlling interest
share

DR

(1.0)
$31.5

There would be a credit adjustment to Inventory for $2.5 on


the balance sheet portion of the worksheet.

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What if?
If the sales had been upstream, by Sot to Pot:
Unrealized profits in ending inventory
40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000 2,500) = $6,750
Noncontrolling interest share
10%(10,000 2,500) = $750
Upstream profits impact both:
Controlling interest share
Noncontrolling interest share

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Intercompany Profit Transactions Inventories

4: RECOGNIZING PROFITS
FROM BEGINNING
INVENTORIES

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Intercompany Profits in Beginning


Inventory
Unrealized profits in
ending inventory one year

Become

Profits to be recognized in the beginning


inventory of the next year!
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Intercompany Profit Transactions Inventories

5: IMPACT ON
NONCONTROLLING
INTEREST

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Direction of Sale and NCI


The impact of unrealized profits in ending
inventory and realizing profits in beginning
inventory depends on the direction of the
intercompany sales
Downstream sales
Full impact on parent

Upstream sales
Share impact between parent and noncontrolling
interest

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Calculating Income and NCI


Downstream sales:
Income from sub
= CI%(Sub's NI) Profits in EI + Profits in BI

Noncontrolling interest share


= NCI%(Sub's NI)

Upstream sales:
Income from sub
= CI%(Sub's NI Profits in EI + Profits in BI)

Noncontrolling interest share


= NCI%(Sub's NI Profits in EI + Profits in BI)

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Upstream Example with


Amortization
Perry acquired 70% of Salt on 1/1/2011 for $420 when Salt's
equity consisted of $200 capital stock and $200 retained
earnings. Salt's inventory was understated by $50 and building,
with a 20-year life, was understated by $100. Any excess is
goodwill.
2011
Perry
Separate income
Dividends

$1,250
$600

2012
Salt

Perry

$705 $1,500
$280

$600

Salt
$745
$300

During 2011, Salt sold goods for $700 to Perry at a 20%


markup. $240 of these goods were in Perry's ending inventory.
In 2012, Salt sold goods for $900 to Perry at a 25% markup and
Perry still had $100 on hand at the end of the year.
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Analysis and Amortization


Cost of 70% of Salt

$420

Implied value of Salt 420/.70

$600

Book value 200 + 200

400

Excess

Allocated to:
Inventory

$200

Unamort

Amort

Unamort

Amort

Unamort

1/1/11

2011

1/1/12

2012

12/31/12

50

(50)

Building

100

(5)

95

(5)

90

Goodwill

50

50

50

200

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(55)

145

(5)

140

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2011 Income Sharing (Upstream)


Salt's net income
Current
amortizations
Adjusted income

$705
(55)
$650

CI 70% share
$455
($28)
$427

Defer profits in EI
Income recognized

Income from Salt

(40)
$610

$196
NCI 30% share
$195

Subsidiary dividends

$280

($12)
$183
$84

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Perry's 2011 Equity Entries


Investment in Salt (+A)

420

Cash (-A)

420

For acquisition of 70% of Salt


Cash (+A)

196

Investment in Salt (-A)

196

For dividends received


Investment in Salt (+A)
Income from Salt (R, +SE)

427
427

For share of income

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2011 Worksheet Entries (1 of 3)


1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)

700

Cost of sales (-E, +SE)


Cost of Sales (E, -SE)

700
40

Inventory (-A)

40

3. Eliminate income & dividends from sub. and bring Investment


account to its beginning balance
Income from Salt (-R, -SE)

427

Dividends (+SE)

196

Investment in Salt (-A)

231

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2011 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings & dividends
Noncontrolling interest share (-SE)

183

Dividends (+SE)

84

Noncontrolling interest (+SE)


99
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock (-SE)

200

Retained earnings (-SE)

200

Inventory (+A)

50

Building (+A)

100

Goodwill (+A)

50

Investment in Salt (-A)

420

Noncontrolling interest (+SE)

180

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2011 Entries (3 of 3)
6. Amortize fair value/book value differentials
Cost of sales (E, -SE)

50

Inventory (-A)
Depreciation expense (E, -SE)
Building (-A)

50
5
5

7. Eliminate other reciprocal balances none

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2012 Income Sharing (Upstream)


Salt's net income
Current
amortizations
Adjusted income

$745
(5)
$740

CI 70% share
$518
($14)
$28

Defer profits in EI

(20)

Realize profits from


BI

40

Income recognized

$760

Subsidiary dividends

$300

$532
$210

Income from
Salt
NCI 30% share
$222
($6)
$12
$228

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$90

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Perry's 2012 Equity Entries


Cash (+A)

210

Investment in Salt (-A)

210

For dividends received


Investment in Salt (+A)
Income from Salt (R, +SE)

532
532

For share of income

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2012 Worksheet Entries (1 of 3)


1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales (-R, -SE)

900

Cost of sales (-E, +SE)


Cost of Sales (E, -SE)

900
20

Inventory (-A)
Investment in Salt (+A)

20
28

interest (-SE)
12 bring
3.Noncontrolling
Eliminate income
& dividends from sub. and
Investment
account
Cost of sales (-E,
+SE) to its beginning balance

Income from Salt (-R, -SE)

40

532

Dividends (+SE)

210

Investment in Salt (-A)

322

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2012 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share (-SE)

228

Dividends (+SE)

90

Noncontrolling interest (+SE)

138

5. Eliminate reciprocal Investment & sub's equity balances


Capital stock (-SE)

200

Retained earnings (-SE)

625

Inventory (+A)

Building (+A)

95

Goodwill (+A)

50

Investment in Salt (-A)

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2012 Entries (3 of 3)
6. Amortize fair value/book value differentials
Depreciation expense (E, -SE)

Building (-A)

7. Eliminate other reciprocal balances none

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