ch06 EDIT

6
Elimination of Unrealized
Profit on Intercompany
Sales of Inventory
Advanced Accounting, Fifth Edition
Slide
6-1
Upstream and Downstream Sales of Inventory
Company P
P sells inventory S2 sells inventory

Downstream Upstream
S1 sells inventory
Horizontal
Company S1 Company S2
Consolidated Entity
Profit (loss) tidak boleh diakui jika belum terjual ke pihak

ketiga.
Profit (loss) harus dieliminasi di consolidation working paper.
Slide
6-2
LO 4 Upstream and downstream sales.
Effects of Intercompany Sales of Merchandise on
the Determination of Consolidated Balances
The financial reporting objectives are:

 Consolidated sales include only sales with parties outside
the affiliated group.
 Consolidated cost of sales includes only the cost to the

affiliated group of goods that have been sold to parties
outside the affiliated group.
 Consolidated inventory on the balance sheet is recorded at

its cost to the affiliated group.
Objective is to eliminate the effects of intercompany sales as if they

had never occurred.
Slide
6-3
LO 1 Financial reporting objectives for intercompany sales.
Downstream
Intercompany Sales of Merchandise
Sales
Determination of Consolidated Sales, Cost of Sales,

and Inventory Balances Assuming Downstream Sales
E6-7: (Downstream Sales-variation) Perkins Company owns

85% of Sheraton Company. Perkins Company sells merchandise to
Sheraton Company at 20% above cost. During 2011 and 2012,
such sales amounted to $450,000 and $486,000, respectively.
At the end of each year, Sheraton Company had sold all of
inventory purchased from Perkins to third parties.
Required: Prepare the workpaper entries necessary to eliminate
the effects of the intercompany sales for 2011.
Slide
6-4
LO 6 Consolidated workpapers for downstream sales.
Downstream
Sales
E6-7: Summary of 2011 Intercompany Sales

(COGS) (Inventory)
Total Resold On Hand
Intercompany Sales $ 450,000 $ 450,000 $ -
Intercompany COGS 375,000 375,000 -
Gross profit $ 75,000 $ 75,000 $ -
1. The “Total” column represents the Sales and COGS booked by

Perkins to record the sale to Sheraton. The Sales amount also
represents the cost of the inventory recorded by Sheraton.
2. The “Resold” column represents intercompany inventory that was
resold to third parties. Portions resold are recorded in COGS.
3. “On Hand” represents intercompany inventory still on hand in the
affiliated group.
Slide
6-5
Downstream
Sales

(COGS) (Inventory)
Intercompany Sales $ 450,000 $ 450,000 $ -
Intercompany COGS 375,000 375,000 -
Gross profit $ 75,000 $ 75,000 $ -
Prepare the workpaper entry to eliminate intercompany

sales for 2011.
Sales 450,000
Cost of Goods Sold (Purchases) 450,000
To eliminate intercompany sales of merchandise
Slide
6-6
Downstream
Sales
Determination of Consolidated Sales, Cost of Sales,

and Inventory Balances Assuming Downstream Sales
E6-7: (Downstream Sales) Perkins Company owns 85% of
Sheraton Company. Perkins Company sells merchandise to
Sheraton Company at 20% above cost. During 2011 and 2012,
such sales amounted to $450,000 and $486,000, respectively.
At the end of each year, Sheraton Company had in its inventory
one-third of the amount of goods purchased from Perkins during
that year.
Required: Prepare the workpaper entries necessary to eliminate
the effects of the intercompany sales for 2011 and 2012.
Slide
6-7
Downstream
Sales
2011 (COGS) (Inventory)

Intercompany Sales $ 450,000 $ 300,000 $ 150,000
Intercompany COGS 375,000 250,000 125,000
Gross profit $ 75,000 $ 50,000 $ 25,000
Prepare the workpaper entry to eliminate intercompany sales

for 2011.
Sales 450,000
Cost of Goods Sold (purchases) 450,000
Cost of Goods Sold (ending inventory) 25,000
Inventory 25,000
To eliminate intercompany sales and defer unrealized profit
Slide
6-8
Downstream
Sales
E6-7: 2011 (COGS) (Inventory)
Alternate Intercompany Sales $ 450,000 $ 300,000 $ 150,000
View Gross profit $ 75,000 $ 50,000 $ 25,000
Workpaper entry to eliminate intercompany sales for 2011.

Sales 1 450,000
Cost of Goods Sold 1 375,000
Cost of Goods Sold 2 50,000
Inventory 3 25,000
1. Original Sales and COGS recorded by Perkins (parent) is reversed.

2. COGS overstated by Sheraton on resale of goods to third parties.
3. Inventory on hand is overstated on Sheraton’s books by $25,000 unrealized profit.
Slide
6-9
Downstream
Sales
E6-7: Prepare the workpaper entry to eliminate intercompany

sales for 2012.
2011 Unrealized Profit in Inventory

(COGS) (Inventory)
Intercompany Sales $ 150,000
Intercompany COGS 125,000
Gross profit $ 25,000
Cost or Partial Equity Method *

Retained earnings 25,000
Cost of Goods Sold (beg. inventory) 25,000
To realize the gross profit in inventory deferred in the prior period.
* If the complete equity method is used, the debit is to the Investment account.
Slide
6-10
Downstream
Sales
E6-7: Prepare the workpaper entry to eliminate intercompany

sales for 2012.
2012 Intercompany Sales

(COGS) (Inventory)
Gross profit $ 81,000 $ 54,000 $ 27,000
Sales 486,000
Cost of Goods Sold (ending inventory) 27,000
Inventory 27,000
Slide
6-11
Determination of Amount of Intercompany Profit

Gross profit bisa memakai persentase dari harga pokok atau
dari harga jual. When stated as a percentage of cost, it is
referred to as “markup”.
Inventory Pricing Adjustments
The amount of intercompany profit subject to elimination
should be reduced to the extent that the related goods have
been written down by the purchasing affiliate.
Slide
6-12
LO 2 Determining the amount of intercompany profit.
Determination of Proportion of Intercompany Profit

to Be Eliminated
“The amount of intercompany profit or loss to be
eliminated . . . is not affected by the existence of a minority
[noncontrolling] interest.
The complete elimination of the intercompany profit or loss is
consistent with the underlying assumption that consolidated
statements represent the financial position and operating
results of a single business enterprise.” [FASB ASC paragraph
810-10-45-18]
Slide
6-13
LO 3 Eliminating 100% of intercompany profit.
Cost Method: Consolidated Statements
Workpaper—Upstream Sales
Determination of the Noncontrolling Interest in

Combined Income—Upstream or Horizontal Sales
NCI in Income hanya dipengaruhi penjualan upstream atau
horizontal tetapi tidak penjualan downstream.
Slide
6-14
LO 5 Noncontrolling interest (NCI) for upstream sales.
Upstream
Cost Method: Consolidated Workpaper
Sales
P6-7: Paque Corporation owns 90% of the common stock of

Segal Company. The stock was purchased for $810,000 on
January 1, 2009, when Segal Company’s retained earnings were
$150,000.
The January 1, 2013, inventory of Paque Corporation includes
$45,000 of profit recorded by Segal Company on 2012 sales.
During 2013, Segal Company made intercompany sales of
$300,000 with a markup of 20% of selling price. The ending
inventory of Paque Corporation includes goods purchased in
2013 from Segal Company for $75,000.
Required: Prepare the worksheet entries and the consolidated
statements workpaper for the year ended December 31, 2013.
Slide
6-15
LO 6 Consolidated workpapers for upstream Sales- Cost Method.
Upstream
Sales
P6-7: Prepare the worksheet entries for Dec. 31, 2013.
Acquisition date retained earnings - Segal $ 150,000

Retained earnings 1/1/13 - Segal 180,000
Increase 30,000
Ownership percentage 90%
$ 27,000
1. Investment in Segal 27,000

Beg. Retained Earnings - Pague Co. 27,000
To establish reciprocity/convert to equity as of 1/1/2013.
Slide
6-16
Upstream
Sales

(COGS) (Inventory)
Gross profit $ 60,000 $ 45,000 $ 15,000
2. Sales 300,000
3. Cost of Good Sold (ending inventory) 15,000
Inventory 15,000
Slide
6-17
Upstream
Sales

(COGS) (Inventory)
Intercompany Sales
Intercompany COGS
4. Retained Earnings ($45,000 x 90%) 40,500

Noncontrolling Interest ($45,000 x 10%) 4,500
Slide
6-18
Upstream
Sales
5. Dividend Income ($60,000 x 90%) 54,000

Dividends Declared 54,000
To eliminate intercompany dividends
6. Beg. Retained Earnings - Segal 180,000

Common Stock - Segal 750,000
Investment in Segal 837,000
Noncontrolling Interest 93,000
To eliminate investment account and create NCI account
Slide
6-19
Upstream
Sales
P6-7:
Eliminations Consolidated
Income Statement Paque Segal Debit Credit NCI Balances
Sales $ 1,650,000 $ 795,000 300,000 (2) $ 2,145,000
Dividend income 54,000 54,000 (5) -
Total revenue 1,704,000 795,000 2,145,000
Cost of goods sold 1,290,000 517,500 15,000 (3) 300,000 (2) 1,477,500
45,000 (4)
Other expenses 310,500 206,250 516,750
Total cost and expense 1,600,500 723,750 1,994,250
Net income 103,500 71,250 150,750
Noncontrolling interest 10,125 (10,125)
Net income $ 103,500 $ 71,250 $ 369,000 $ 345,000 $ 10,125 $ 140,625
Retained Earnings Statement

Retained earnings, 1/1
Paque 811,500 40,500 (4) 27,000 (1) 798,000
Segal 180,000 180,000 (6) -
Net income 103,500 71,250 369,000 345,000 10,125 140,625
Dividends declared (150,000) (60,000) 54,000 (5) (6,000) (150,000)
Retained earnings, 12/31 $ 765,000 $ 191,250 $ 589,500 $ 426,000 $ 4,125 $ 788,625
NCI in Consolidated Income = 10%  ($71,250 + $45,000 – $15,000) = $10,125

Slide
6-20
Upstream
Sales
P6-7:
Balance Sheet Paque Segal Debit Credit NCI Balances
Cash $ 93,000 $ 75,000 $ 168,000
Accounts receivable 319,500 168,750 488,250
Inventory 210,000 172,500 15,000 (3) 367,500
Investment in Segal 810,000 27,000 (1) 837,000 (6) -
Other assets 750,000 630,000 1,380,000
Total assets $ 2,182,500 $ 1,046,250 $ 2,403,750
-
Accounts payable $ 105,000 $ 45,000 $ 150,000
Other current liabilities 112,500 60,000 172,500
Common stock 1,200,000 750,000 750,000 (6) 1,200,000
Retained earnings 765,000 191,250 589,500 426,000 4,125 788,625
NCI in net assets 4,500 (4) 93,000 (6) 88,500
92,625 92,625
Total liab. & equity $ 2,182,500 $ 1,046,250 $ 1,371,000 $ 1,371,000 $ 2,403,750
Slide
6-21
Cost Method—Analysis of Consolidated Net
Income and Consolidated Retained Earnings
Consolidated Net Income

Consolidated net income is the parent company’s. Selain
berasal dari income perusahaan induk sendiri juga disertai
adjustment yang didapat sewaktu mengakuisi perusahaan anak
serta terjadi penjualan antar perusahaan induk dan anak.
Slide
6-22
Upstream
Cost Method: Consolidated Net Income
Sales
P6-7: Prepare a calculation of Paque’s share of Segal’s income.

Reported income of Segal $ 71,250
Less: amortization of difference between
implied and book value 0
Less: unrealized profit on 2013 sales to Paque (15,000)
Plus: profit on prior year's sales to Paque realized
in transactions with third parties in 2013 45,000
Subsidiary income included in consolidated income $ 101,250
Paque's share of Segal’s income ($101,250 x 90%) $ 91,125

NCI share of Segal’s income ($101,250 x 10%) 10,125
Subsidiary income included in consolidated income $ 101,250
Slide
6-23
Upstream
Cost Method: Consolidated Net Income
Sales
P6-7: Prepare a calculation of CI in Consolidated Income.

Paque's net income $103,500
Less: subsidiary dividend income (54,000)
Paque's net income from its independent operations 49,500
Less: unrealized profit on 2013 sales to Segal 0
Plus: profit on prior year's sales to Segal realized
in transactions with third parties in 2013 0
Paque's income from independent operations that
has been realized in transactions with third parties 49,500
Paque's share of Segal’s income (previous slide) 91,125
Controlling interest in Consolidated net income $140,625
Slide
6-24
Cost Method—Analysis of Consolidated Net
Income and Consolidated Retained Earnings
Consolidated Retained Earnings

Consolidated Consolidated retained earnings is the parent’s cost
basis retained earnings that has been realized in transactions
with third parties
plus (minus) the parent’s share of the increase (decrease) in
subsidiary retained earnings that has been realized in
transactions with third parties from the date of acquisition to
the current date
plus (minus) the cumulative effect of adjustments to date
relating to the amortization, depreciation, and impairment of
differences between implied and book values.
Slide
6-25
Upstream
Partial Equity Method: Workpaper
Sales
P6-13: (Note: This is the same problem as Problem 6-7, but

assuming the use of the partial equity method.)
Paque Corporation owns 90% of the common stock of Segal
Company. The stock was purchased for $810,000 on January 1,
2009, when Segal Company’s retained earnings were $150,000.
During 2013, Segal Company made intercompany sales of $300,000
with a markup of 20% of selling price. The ending inventory of
Paque Corporation includes goods purchased in 2013 from Segal
Company for $75,000. Paque Corporation uses the partial equity
method to record its investment in Segal Company.
Slide
6-26
LO 6 Consolidated workpapers – partial equity method.
Upstream
Sales
1. Equity in Subsidiary Income 64,125

Investment in Segal Company 10,125
Dividends declared ($60,000 x 90%) 54,000
To reverse the effect of parent entries for subsidiary
dividends and income
Slide
6-27
Upstream
Sales

(COGS) (Inventory)
Gross profit $ 60,000 $ 45,000 $ 15,000
2. Sales 300,000
3. Cost of Goods Sold (end. inventory) 15,000
Inventory 15,000
Slide
6-28
Upstream
Sales

(COGS) (Inventory)
Intercompany Sales
Intercompany COGS
4. Retained Earnings ($45,000 x 90%) 40,500

Slide
6-29
Upstream
Sales

Slide
6-30
Upstream
Sales
P6-13:
Sales $ 1,650,000 $ 795,000 300,000 (2) $ 2,145,000
Equity in Segal income 64,125 64,125 (1) -
Total revenue 1,714,125 795,000 2,145,000
45,000 (4)
Other expenses 310,500 206,250 516,750
Net income 113,625 71,250 150,750
Net income $ 113,625 $ 71,250 $ 379,125 $ 345,000 $ 10,125 $ 140,625

Paque 838,500 40,500 (4) 798,000
Segal 180,000 180,000 (5) -
Net income 113,625 71,250 379,125 345,000 10,125 140,625

Slide
6-31
Upstream
Sales
P6-13:
Cash $ 93,000 $ 75,000 $ 168,000
Inventory 210,000 172,500 15,000 (3) 367,500
Investment in Segal 847,125 837,000 (5) -
(1)
10,125
Other assets 750,000 630,000 1,380,000
Total assets $ 2,219,625 $ 1,046,250 $ 2,403,750
-
(5)
Common stock 1,200,000 750,000 750,000 1,200,000
(4) (5)
NCI in net assets 4,500 93,000 88,500
92,625 92,625
Slide
6-32
Partial Equity Method—Analysis of Consolidated
Net Income and Consolidated Retained Earnings
Consolidated Net Income Same as Cost Method
Consolidated net income is the parent’s income from its

independent operations that has been realized in
transactions with third parties
plus (minus) subsidiary income (loss) that has been
realized in transactions with third parties
plus or minus adjustments for the period relating to the
depreciation, amortization, and impairment of
Slide
6-33
Partial Equity Method—Analysis of Consolidated
Net Income and Consolidated Retained Earnings

When the parent uses the partial equity method, the parent’s
share of subsidiary income since acquisition is already included
in the parent’s reported retained earnings.
Consequently, consolidated retained earnings is calculated as
the parent’s recorded partial equity basis retained earnings that
has been realized in transactions with third parties plus or
minus the cumulative effect of the adjustments to date relating
to the depreciation, amortization, and impairment of
Slide
6-34
Partial
Equity
P6-13: Calculate consolidated retained earnings on Dec. 31,

2013.
Paque's Retained Earnings on 12/31/13 $ 802,125

Unrealized profit on downstream sales 0
Unrealized profit on upstream sales ($15,000 x 90%) (13,500)
Consolidated retained earnings on 12/31/2013 $ 788,625
Slide
6-35
Upstream
Complete Equity Method: Workpaper
Sales
P6-17: (Note: This is the same problem as Problem 6-7 and 6-13,
but assuming the use of the complete equity method.)
Paque Corporation owns 90% of the common stock of Segal
Company. The stock was purchased for $810,000 on January 1,
2009, when Segal Company’s retained earnings were $150,000.
During 2013, Segal Company made intercompany sales of $300,000
with a markup of 20% of selling price. The ending inventory of
Paque Corporation includes goods purchased in 2013 from Segal
Company for $75,000. Paque Corporation uses the complete equity
method to record its investment in Segal Company.
Slide
6-36
LO 6 Consolidated workpapers – complete equity method.
Upstream
Sales
1. Equity in Subsidiary Income 91,125

Investment in Segal Company 37,125
Dividends declared ($60,000 x 90%) 54,000
To reverse the effect of parent company entries
for subsidiary dividends and income
Slide
6-37
Upstream
Sales

(COGS) (Inventory)
Gross profit $ 60,000 $ 45,000 $ 15,000
2. Sales 300,000
3. Cost of Goods Sold (end. inventory) 15,000
Inventory 15,000
Slide
6-38
Upstream
Sales

(COGS) (Inventory)
Intercompany Sales
Intercompany COGS
4. Retained earnings ($45,000 x 90%) 40,500

To realize the gross profit in inventory deferred in the prior period
Slide
6-39
Upstream
Sales

Slide
6-40
Upstream
Sales
P6-17:
Sales $ 1,650,000 $ 795,000 300,000 (2) $ 2,145,000
Equity in Segal income 91,125 91,125 (1) -
Total revenue 1,741,125 795,000 2,145,000
45,000 (4)
Other expenses 310,500 206,250 516,750
Net income 140,625 71,250 150,750
Net income $ 140,625 $ 71,250 $ 406,125 $ 345,000 $ 10,125 $ 140,625

Paque 798,000 798,000
Segal 180,000 180,000 (5) -
Net income 140,625 71,250 406,125 345,000 10,125 140,625

Slide
6-41
Upstream
Sales
P6-17:
Cash $ 93,000 $ 75,000 $ 168,000
Inventory 210,000 172,500 15,000 (3) 367,500
Investment in Segal 833,625 40,500 (4) 837,000 (5) -
37,125 (1)
Other assets 750,000 630,000 1,380,000
Total assets $ 2,206,125 $ 1,046,250 $ 2,403,750
-
Common stock 1,200,000 750,000 750,000 (5) 1,200,000
NCI in net assets 4,500 (4) 93,000 (5) 88,500
92,625 92,625
Slide
6-42
Complete Equity Method—Analysis of
Consolidated Net Income and Consolidated
Retained Earnings
Under the complete equity method:

 Consolidated net income equals the parent company’s
recorded income.
 Consolidated retained earnings equals the parent
company’s recorded retained earnings.
Slide
6-43
Summary of Workpaper Entries Illustration 6-21
To eliminate intercompany sales: Parent Selling (Downstream)

All Methods Sales X
Purchases (Cost of Sales) X
To eliminate intercompany profit in ending inventory:
All Methods Ending Inventory (Cost of Sales) X
Inventory (Balance Sheet) X
To recognize intercompany profit in beginning inventory
realized during the year:
Cost or Partial Beg. Retained Earnings—Parent X
Equity Methods Beg. Inventory - Income
Statement (Cost of Sales) X
Complete Equity Investment in S Company X
Method Beg. Inventory - Income
Statement (Cost of Sales) X
Slide
6-44
Summary of Workpaper Entries Illustration 6-21
To eliminate intercompany sales: Subsidiary Selling (Upstream)

All Methods Sales X
Purchases (Cost of Sales) X
To eliminate intercompany profit in ending inventory:
All Methods Ending Inventory (Cost of Sales) X
Inventory (Balance Sheet) X
To recognize intercompany profit in beginning inventory
realized during the year:
Cost or Partial Beg. Retained Earnings—Parent X
Equity Methods NCI in Equity X
Cost of Sales (beg. inventory) X
Complete Equity Investment in S Company X

Method NCI in Equity X
Slide Cost of Sales (beg. inventory) X
6-45
Intercompany Profit Prior To Parent–
Subsidiary Affiliation
Generally accepted accounting standards are silent as

to the appropriate treatment of unrealized profit on
assets that result from sales between companies prior
to affiliation (preaffiliation profit).
The question is whether preaffiliation profit should be
eliminated in consolidation. In our opinion, workpaper
entries eliminating preaffliation profit are
inappropriate.
Slide
6-46
LO 7 Intercompany profit prior to affiliation.

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6

Advanced Accounting, Fifth Edition

P sells inventory S2 sells inventory

Profit (loss) tidak boleh diakui jika belum terjual ke pihak

The financial reporting objectives are:

 Consolidated cost of sales includes only the cost to the

 Consolidated inventory on the balance sheet is recorded at

Objective is to eliminate the effects of intercompany sales as if they

Determination of Consolidated Sales, Cost of Sales,

E6-7: (Downstream Sales-variation) Perkins Company owns

E6-7: Summary of 2011 Intercompany Sales

1. The “Total” column represents the Sales and COGS booked by

E6-7: Summary of 2011 Intercompany Sales

Prepare the workpaper entry to eliminate intercompany

Determination of Consolidated Sales, Cost of Sales,

2011 (COGS) (Inventory)

Prepare the workpaper entry to eliminate intercompany sales

Workpaper entry to eliminate intercompany sales for 2011.

1. Original Sales and COGS recorded by Perkins (parent) is reversed.

E6-7: Prepare the workpaper entry to eliminate intercompany

2011 Unrealized Profit in Inventory

Cost or Partial Equity Method *

E6-7: Prepare the workpaper entry to eliminate intercompany

2012 Intercompany Sales

Determination of Amount of Intercompany Profit

Determination of Proportion of Intercompany Profit

Determination of the Noncontrolling Interest in

P6-7: Paque Corporation owns 90% of the common stock of

P6-7: Prepare the worksheet entries for Dec. 31, 2013.

Acquisition date retained earnings - Segal $ 150,000

1. Investment in Segal 27,000

P6-7: Prepare the worksheet entries for Dec. 31, 2013.

2013 Intercompany Sales

P6-7: Prepare the worksheet entries for Dec. 31, 2013.

2012 Unrealized Profit in Inventory

4. Retained Earnings ($45,000 x 90%) 40,500

P6-7: Prepare the worksheet entries for Dec. 31, 2013.

5. Dividend Income ($60,000 x 90%) 54,000

6. Beg. Retained Earnings - Segal 180,000

Retained Earnings Statement

NCI in Consolidated Income = 10%  ($71,250 + $45,000 – $15,000) = $10,125

Consolidated Net Income

P6-7: Prepare a calculation of Paque’s share of Segal’s income.

Paque's share of Segal’s income ($101,250 x 90%) $ 91,125

P6-7: Prepare a calculation of CI in Consolidated Income.

Consolidated Retained Earnings

P6-13: (Note: This is the same problem as Problem 6-7, but

P6-13: Prepare the worksheet entries for Dec. 31, 2013.

1. Equity in Subsidiary Income 64,125

P6-13: Prepare the worksheet entries for Dec. 31, 2013.

2013 Intercompany Sales

P6-13: Prepare the worksheet entries for Dec. 31, 2013.

2012 Unrealized Profit in Inventory

4. Retained Earnings ($45,000 x 90%) 40,500

P6-13: Prepare the worksheet entries for Dec. 31, 2013.

5. Beg. Retained Earnings - Segal 180,000

Retained Earnings Statement

NCI in Consolidated Income = 10%  ($71,250 + $45,000 – $15,000) = $10,125

Consolidated Net Income Same as Cost Method

Consolidated net income is the parent’s income from its

Consolidated Retained Earnings

P6-13: Calculate consolidated retained earnings on Dec. 31,

Paque's Retained Earnings on 12/31/13 $ 802,125