Chapter 4, Topic 1
Chapter 4
Intercompany Transactions: Topic 1, Topic 1
Merchandise
Dr. Chula King
Advanced Accounting
The University of West Florida
1
Student Learning Outcomes
• Explain why transactions between members of a consolidated firm should not be reflected in the consolidated financial statements
• Defer intercompany profits on merchandise Defer intercompany profits on merchandise
sales when appropriate and eliminate the double counting of sales between affiliates
• Next topic: Intercompany sales of depreciable assets and intercompany loans and notes
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Back to Intermediate I: Perpetual Inventory System
• Purchased $10,000 of inventory for cash:
Inventory
Cash
10,000
10,000
• Sold all of the inventory for $15,000:
Cash
15,000
,
Sales
15,000
Cost of Goods Sold (COGS) 10,000
Inventory
10,000
• Gross Profit = Sales – COGS = 15,000 – 10,000 = 5,000
• Gross Profit % = Gross Profit ÷ Sales = 5,000 ÷ 15,000 = 33%
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1
Chapter 4, Topic 1
The Problem
Company A
10,000
10 000
Inventory 10,000
Cash
10,000
C h
10 000
Cash
15,000
Sales
15,000
COGS
10,000
Inventory
10,000
Company B
15 000
15,000
Inventory 15,000
Cash
15,000
C h
15 000
Cash
20,000
Sales
20,000
COGS
15,000
Inventory
15,000
20,000
20 000
What is the combined sales? 15,000 + 20,000 = 35,000
What is the combined COGS?10,000 + 15,000 = 25,000
What sales should be recognized by the group?
What COGS should be recognized by the group?
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The Culprit
10,000
10 000
Company A
Company B
Inventory 10,000
Cash
C h
10,000
10 000
Cash
15,000
Sales
15,000
COGS
10,000
Inventory
10,000
Inventory 15,000
Cash
C h
15,000
15 000
Cash
20,000
Sales
20,000
COGS
15,000
Inventory
15,000
15 000
15,000
20,000
20 000
What is the combined sales? 15,000 + 20,000 = 35,000
What is the combined COGS?10,000 + 15,000 = 25,000
What sales should be recognized by the group?
What COGS should be recognized by the group?
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The Solution
• Eliminate the intercompany sale:
Sales
15,000
COGS
15,000
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2
Chapter 4, Topic 1
What if the Intercompany Inventory is Still on Hand?
Company A
Inventory 10,000
Cash
10,000
C h
10 000
Cash
15,000
Sales
15,000
COGS
10,000
Inventory
10,000
10,000
10 000
Company B
15 000
15,000
Inventory 15,000
Cash
15,000
C h
15 000
What is book value of ending inventory? 15,000
What should be the value of the ending inventory?
What is the culprit? The $5,000 gross profit from the
intercompany sale (15,000-10,000)
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The Solution
• Eliminate the gross profit in the ending inventory
Whose?
COGS
5,000
Th Seller’s!
S ll ’ !
Inventory
5,000
000 The
Why the Seller’s?
Just because!
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From Intermediate II
• Ending inventory is overstated Cost of goods sold is understated  Net Income is overstated  Retained earnings is overstated
• What about next year?
– Beginning inventory is overstated and Retained earnings is overstated
• So What?
– Must eliminate gross profit from beginning inventory
– Retained earnings
5,000
Whose?
Cost of Goods Sold
5,000 The Seller’s!
Just because!
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Chapter 4, Topic 1
The Rules
• The SELLER is charged for ALL Income effects of the eliminations.
• Eliminate the intercompany sale
– Sales (seller)
S l ( ll )
COGS (seller)
• Because the seller is charged with both income statement components of the intercompany sale, the effect on income is zero.
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The Rules (continued)
• Eliminate gross profit in beginning inventory (overstatement of beginning inventory)
– Gross profit % x intercompany goods in beginning inventory
– Parent is the seller:
Parent is the seller:
• Retained Earnings (parent/seller)
COGS (parent/seller)
– Subsidiary is the seller:
• Retained Earnings (parent %)
Retained Earnings (subsidiary NCI%)
COGS (subsidiary/seller)
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The Rules (continued)
• Eliminate gross profit in ending inventory (overstatement of ending inventory)
– Gross Profit % x intercompany goods in ending inventory
– COGS (seller)
Inventory
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Chapter 4, Topic 1
Anything Else?
• Lower of Cost or Market (LOCOM)
• Back to Intermediate I
– Cost versus Market  Lower of cost or market
– If market is lower
Elimination of Gross Profit in E/I
• COGS
Inventory
 COGS
Inventory
• LOCOM to intercompany goods
– Any LOCOM applied has already eliminated part or all of the gross profit in ending inventory
– Elimination entry eliminates any remaining gross profit in ending inventory
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Example
• P Corporation owns 80% of S Company. During 20X1 P sold $80,000 in goods to S for $100,000. S held $20,000 of goods purchased from P in its beginning inventory, and $30,000 from P in its beginning inventory and $30 000
of such goods in its ending inventory. What elimination entries would be required?
• Gross profit = $100,000 – $80,000 = $20,000
• Gross profit % = $20,000 ÷ 100,000 = 20%
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The Facts
• P (the parent) is the seller
• Intercompany sales = $100,000
• Gross profit in beginning inventory = 20% x $20,000 = $4,000
$20 000 $ 000
• Gross profit in ending inventory = 20% x $30,000 = $6,000
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Chapter 4, Topic 1
Elimination Entries
• Sales (P)
100,000
COGS (P)
100,000
(to eliminate intercompany sale)
• R/E‐P
4,000
COGS (P)
4,000
(to eliminate gross profit in beginning inventory)
• COGS (P)
6,000
Inventory
6,000
(to eliminate gross profit in ending inventory)
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What if S had been the seller?
• Sales (S)
100,000
COGS (S)
100,000
(to eliminate intercompany sale)
• R/E‐P (80% x 4,000)
3,200
R/E‐S (20% x 4,000)
R/E S (20% 4 000)
800
COGS (S)
4,000
(to eliminate gross profit in beginning inventory)
• COGS (S)
6,000
Inventory
6,000
(to eliminate gross profit in ending inventory)
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Concluding Comments
• Intercompany sales of inventory must be eliminated to avoid double counting
• The Rules
– The SELLER is charged for ALL Income effects of the eliminations.
th li i ti
– Eliminate the intercompany sale
– Eliminate gross profit in beginning inventory; parent is seller – R/E‐P; Subsidiary is seller – split R/E
– Eliminate gross profit in ending inventory, adjusted for any LOCOM valuation
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Chapter 4, Topic 1
The Next Step
• Topic 2 – Intercompany sales of depreciable assets and intercompany loans and notes
• Work Exercise 3
Intercompany
sales
l off inventory
i
• Work Problems 2, 4, 5
k
bl
2
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