CHAPTER
4
Transactions: Merchandise,
Plant Assets, and Notes
Fundamentals of Advanced Accounting
1st Edition
Fischer, Taylor, and Cheng
Intercompany Transactions
• Transactions between parent and sub
• Must be eliminated
– Consolidated statements represent separate
companies as if they were one entity
• Common intercompany transactions
–
–
–
–
Merchandise for resale
Land
Fixed assets
Notes receivable/payable
Chapter 4, Slide #2
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Sales Effect on Gross Profit
• Parent sells inventory to Sub:
Cost = $1,000 Sell price = $1,200
• Sub sells to outside party:
Cost = $1,200 Sell price = $1,500
Includes
Interco. Sales
Sales
Less: Cost of Sales
Gross Profit
GP %
Excludes
Interco. Sales
2,700
2,200
500
1,500
1,000
500
19%
33%
•Gross Profit is unaffected.
•Gross Profit % is distorted unless intercompany transactions are
eliminated.
Chapter 4, Slide #3
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Transactions
• Intercompany receivables/payables must be
eliminated!
– Represent transfers of funds
– Internal loans
• No profit on intercompany sales can be
recognized!
– Unless goods are sold to an outside party
Chapter 4, Slide #4
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Elimination of Intercompany Inventory Sales
• Discussed in four sections
– No intercompany goods in beginning or
ending inventory
– Intercompany goods in ending inventory
– Intercompany goods in both beginning and
ending inventory
– Intercompany goods in both beginning and
ending inventory: Periodic inventory
method
Chapter 4, Slide #5
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
No Intercompany Goods –
Beginning or Ending Inventory
Review worksheet 4-1
• P owns 80% of S’ stock.
• Purchase price = pro rata share of sub’s book
value.
• P uses the equity method.
Chapter 4, Slide #6
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
No Intercompany Goods –
Beginning or Ending Inventory (Continued)
Sales
Less: Cost of Goods Sold
Gross Profit
Other Expenses
Subsidiary Income
Net income
Parent
700,000
510,000
190,000
(90,000)
60,000
160,000
Sub
500,000
350,000
150,000
(75,000)
75,000
•Sub sells inventory to parent
•Cost = $80,000 Sell price = $100,000 GP% = 20%
•Parent sells inventory to third party
•Cost = $100,000 Sell price = $150,000
•Parent owes $25,000 to sub for inventory purchases
Chapter 4, Slide #7
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
No Intercompany Goods –
Beginning or Ending Inventory (Continued)
CY1
Sub Income - Par
Invest. In Sub - Par
60,000
60,000
(Eliminates current year income and creates date alignment)
EL
Common Stock - Sub
Retained Earnings - Sub
Invest. In Sub - Par
80,000
56,000
136,000
(Eliminates investment account against 80% of equity)
IS
Sales
Cost of goods sold**
100,000
100,000
(Eliminates intercompany merchandise sales)
IA
Account payable
Accounts receivable
25,000
25,000
(Eliminates intercompany unpaid trade balances)
**Includes $80,000 C of G S from Sub to Parent and $20,000 C of G S from Parent
to outside party.
Chapter 4, Slide #8
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Inventory Remains in
Ending Inventory
Review worksheet 4-2
• Assume same facts as to acquisition.
• Sub sells inventory to parent
– Cost = $80,000 Sell price = $100,000 GP% = 20%
• Parent sells inventory to third party
– Cost = $60,000 Sell price = $90,000
• Intercompany inventory of $40,000 in parent’s
ending inventory
• Parent owes $25,000 to sub for inventory
purchases
Chapter 4, Slide #9
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Inventory Remains in
Ending Inventory (continued)
CY1
Sub Income - Par
Invest. In Sub - Par
60,000
60,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub
Retained Earnings - Sub
Invest. In Sub - Par
80,000
56,000
136,000
(Eliminates investment account against 80% of equity)
IS
Sales
Cost of goods sold
100,000
100,000
(Eliminates intercompany merchandise sales)
EI
Cost of goods sold
Inventory
8,000
8,000
(Eliminates intercompany profit in ending inventory)
IA
Account payable
Accounts receivable
(Eliminates intercompany unpaid trade balances)
Chapter 4, Slide #10
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
25,000
25,000
Intercompany Inventory in
Beginning and Ending Inventory
Sales
Less: Cost of Goods Sold
Gross Profit
Other Expenses
Subsidiary Income
Net income
Parent
800,000
610,000
190,000
(120,000)
48,000
118,000
Sub
600,000
440,000
160,000
(100,000)
60,000
•Parent’s 1/1 inventory includes $40,000 of interco. goods.
•Sub sold $120,000 of goods to parent.
•Sub recorded 20% gross profit on interco. sales.
•Parent owes $60,000 to sub for inventory at 12/31.
•Parent’s 12/31 inventory includes $30,000 of interco.
goods.
Chapter 4, Slide #11
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Inventory Remains in
Ending Inventory – Journal Entries
CY1
Sub Income - Par
Invest. In Sub - Par
48,000
48,000
(Eliminates current year income and creates date alignment)
EL
Common Stock - Sub
Retained Earnings - Sub
Invest. In Sub - Par
80,000
116,000
196,000
(Eliminates investment account against 80% of equity)
BI
Retained Earnings 1/1 - Par
Retained Earnings 1/1 - Sub
Invest. In Sub - Par
6,400
1,600
8,000
(Eliminates profit in beginning inventory and reduces current year C of G S)
IS
Sales
Cost of goods sold
120,000
(Eliminates intercompany merchandise sales)
Chapter 4, Slide #12
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
120,000
Intercompany Inventory Remains in
Ending Inventory – Journal Entries (continued)
EI
Cost of goods sold
Inventory
6,000
6,000
(Eliminates intercompany profit in ending inventory)
IA
Account payable
60,000
Accounts receivable
60,000
(Eliminates intercompany unpaid trade balances)
Review worksheet 4-3
Chapter 4, Slide #13
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Eliminations for Periodic Inventories
Review worksheet 4-4
• Beginning inventory balances appear in the
trial balance
• Purchases account appears in trial balance
• Entry BI credits beginning inventory balance
• Entry IS credits the purchases account
• Ending inventory balances appear as:
– A debit to inventory
– A credit to cost of goods sold
Chapter 4, Slide #14
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Sales of Plant Assets
• Any plant asset can be sold between parent and
sub
• Sale of assets can result in gains/losses
• Buyer records asset at purchase price (includes
gain/loss)
• In consolidation, sale of plant assets are
considered internal transfers
• Depreciable vs. non-depreciable asset transfer
– Non-depreciable: defer gain until sold to outside party
– Depreciable: amortize gain/loss over useful life
• Adjust depreciation of transferred asset in
consolidation to reflect original cost
Chapter 4, Slide #15
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Sale of Non-Depreciable Asset
•Elimination entry “LA”
– Eliminates the interco. gain in year of sale
– Eliminates the interco. gain from retained
earnings in years subsequent to sale
– Reclassifies gain from retained earnings to
current year gain/loss
Example
•Sub (80% owned) sells land to Parent
•Sale price: $30,000
•Cost: $20,000
•$10,000 gain is deferred
Chapter 4, Slide #16
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Example: Sub (80%) Sells Land to Parent
Gain is deferred until land is sold to outside party!
Year of sale: LA
Gain on land sale 10,000
Land
10,000
Later years: LA
RE - Sub
RE - Parent
Land
2,000
8,000
10,000
Year of sale to third party:
LA RE - Sub
2,000
RE – Parent
8,000
Gain on land sale
10,000
Chapter 4, Slide #17
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Sale of Depreciable Asset
•Elimination entries “F”
– F1:
• Year of sale: Eliminates the interco. gain
• Years subsequent to sale:
– Eliminates the interco. gain from retained
earnings
– Corrects accumulated depreciation
– F2:
• Adjusts depreciation back to calculation
based on historical cost
Chapter 4, Slide #18
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Sale of Depreciable Asset (Example)
Example
• Parent sells machine to Sub
• Sale price: $30,000
• Historical cost: $32,000
• Accumulated depreciation: $12,000
• $10,000 gain based on $20,000 net
book value
• Sub assumes 5 year remaining life
Chapter 4, Slide #19
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Sale of Depreciable Asset –
Elimination Entries
Year of sale:
F1 Gain on sale of machine 10,000
Machine
10,000
(Defer gain on sale and return asset to cost)
F2 Accum. Depreciation
Depreciation Expense
2,000
2,000
(Reduce to depreciation based on historical cost)
Chapter 4, Slide #20
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Sale of Depreciable Asset –
Elimination Entries (continued)
Year after sale:
F1 Retained earnings
Accum. Depreciation
Machine
8,000
2,000
10,000
(Defer gain on sale and return asset to cost)
F2 Accum. Depreciation
Depreciation Expense
2,000
2,000
(Reduce to depreciation based on historical cost)
Chapter 4, Slide #21
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Fixed Asset Worksheets
WS 4-5 (year of sale)
•
•
•
F1 removes $10,000 profit from machinery; defers
$10,000 gain
F2 adjusts depreciation and realizes $2,000 gain
IDS takes away $10,000 from P [seller], gives back
$2,000
WS 4-6 (end of second period after sale)
•
•
•
F1 removes profit from machinery; corrects last year's
depreciation and defers $8,000 profit as of 1/1/X2
F2 adjusts depreciation and realizes $2,000 gain
IDS just gives back $2,000 currently realized gain to P
Chapter 4, Slide #22
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Debt
• Common for parent to lend funds to sub
• Parent charges sub interest
• Entry LN:
– LN1
• Eliminates intercompany debt
• Eliminates accrued interest
– LN2
• Eliminates intercompany interest revenue/expense
Chapter 4, Slide #23
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Debt - Example
•
•
•
•
•
7/1 Sub borrows 10,000 from Parent
Maturity: 1 year
Interest rate: 8%
Interest due at maturity
Interest accrued at 12/31: $400
Chapter 4, Slide #24
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Intercompany Debt –
Elimination Entries
LN1
Note payable
10,000
Note receivable
10,000
Interest payable
400
Interest receivable
400
(Eliminate interco. debt and accrued interest)
LN2
Interest income
Interest expense
(Eliminate interco. interest)
Chapter 4, Slide #25
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
400
400