10
CHAPTER 10
INTERCOMPANY INVENTORY
TRANSFERS
Slide 10-1
Copyright © 2000 by Harcourt, Inc. All rights reserved.
10
FOCUS OF CHAPTER 10
 Conceptual Issues
 Procedures for Calculating Unrealized Profit
 Procedures for Deferring Unrealized Profit:
 The Complete Equity Method
 The Partial Equity Method
 The Cost Method
Slide 10-2
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Conceptual
Issues:
Issue
#1-10
Should We or Shouldn’t We?
 Whether to Eliminate Intercompany
Transactions in Consolidation:
 No controversy--they must be eliminated.
 Not eliminating causes two problems:
 Meaningless double-counting of
(1) sales and (2) cost and expenses.
 Potential to manipulate income.
Slide 10-3
Copyright © 2000 by Harcourt, Inc. All rights reserved.
10
The Substance of Inventory Transfers
 The CONSOLIDATED Perspective:
 Merely the physical movement of inventory
from one location to another location.
 Similar to the movement of inventory
from one division to another division.
 NOT a bona fide transaction.
 The SEPARATE COMPANY Perspective:
 A bona fide transaction.
Slide 10-4
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Conceptual
Issues:
Issue
#2-10
Which Measure of Profit To Use?
 Possible Theoretical Profit Measures:
 Gross profit.
 Operating profit.
 Net income.
 Profit Measure Required To Be Used
By GAAP:
Sales.................... $1,000
 GROSS PROFIT
Cost of sales....... (600)
(of the selling entity). GROSS profit. $ 400
Slide 10-5
Copyright © 2000 by Harcourt, Inc. All rights reserved.
10 Conceptual Issues: Issue #3--Whether
To Eliminate Income Tax Effects ?
 Income taxes on the selling entity’s
UNREALIZED gross profit must also be
eliminated.
 In this chapter :
 No income tax entries are required.
 Because we assume that the tax effects have
already been recorded in the parent’s or
the subsidiary’s general ledger.
 DONE FOR SIMPLICITY ONLY.
Slide 10-6
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Conceptual
Issues:
Issue
#4-10
Whether To Eliminate All or Some?
DOWNSTREAM Sales to a Partially
Owned Subsidiary:
 Eliminate 100% of unrealized profit.
 Fractional elimination is prohibited.
UPSTREAM Sales from a Partially
Owned Subsidiary:
 Eliminate 100% of unrealized profit.
 Fractional elimination is prohibited.
Slide 10-7
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Conceptual
Issues:
Issue
#5-10
Whether To Share the Deferral?
DOWNSTREAM Sales to a Partially
Owned Subsidiary:
 Entire profit accrues to the parent-thus sharing is not appropriate.
UPSTREAM Sales from a Partially
Owned Subsidiary:
 Must share deferral with the NCI
shareholders (if amount is material).
Slide 10-8
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Inventory
Transfers:
A
Whole
New
10
Slant on “Realization”
 REALIZATION--What to focus on for
consolidated reporting purposes:
 Not on whether the SELLER has- Delivered the product,
 Collected on the sale, or

Reduced to an acceptable
level the
uncertainty about the net cash flow
effect of an earnings activity.
Slide 10-9
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Inventory
Transfers:
A
Whole
New
10
Slant on “Realization”
 REALIZATION--What to focus on for
consolidated reporting purposes:
 But on whether the BUYER has-
Resold the inventory to an
outside unaffiliated
customer.
Slide 10-10
Copyright © 2000 by Harcourt, Inc. All rights reserved.
10 Inventory Transfers: Unrealized Profit-Searching for that Old Basis
 The Objective:
 To change the inventory’s carrying value
from the NEW
basis of accounting to
the OLD basis of accounting.
Slide 10-11
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Inventory
Transfers:
Calculating
10
Unrealized Gross Profit--The Matrix
Amounts That Will ALWAYS Be Known (Given):
ReOn
Total
Sold Hand
Interco. sales (NEW basis)............. $1,000
$200
Interco. cost of sales (OLD basis).. (600) ____ ____
Gross Profit.................................... $ 400
Gross Profit Percentage...............
40%
CRITICAL ASSUMPTION:
The gross profit percentage derivable from the total
column applies to both (1) the inventory that has been
resold AND (2) the inventory that is still on hand.
Slide 10-12
Copyright © 2000 by Harcourt, Inc. All rights reserved.
Inventory
Transfers:
Calculating
10
Unrealized Gross Profit--Matrix
Completed Analysis:
Total
Interco. sales (NEW basis).............. $1,000
Interco. cost of sales (OLD basis).. (600)
Gross Profit.................................... $ 400
ReOn
Sold Hand
$800 $200
(480) (120)
$320
$ 80
REALIZED
UNREALIZED
The Inventory/COS Change in Basis Elimination Entry
is derived from this analysis.
Slide 10-13
Copyright © 2000 by Harcourt, Inc. All rights reserved.