Slide
6-1
6
Elimination of Unrealized
Profit on Intercompany
Sales of Inventory
Advanced Accounting, Fourth Edition
Slide
6-2
Learning Objectives
Slide
6-3
1.
Describe the financial reporting objectives for intercompany sales of
inventory.
2.
Determine the amount of intercompany profit, if any, to be eliminated
from the consolidated statements.
3.
Understand the concept of eliminating 100% of intercompany profit not
realized in transactions with outsiders, and know the authoritative
position.
4.
Distinguish between upstream and downstream sales of inventory.
5.
Compute the noncontrolling interest in consolidated net income for
upstream and downstream sales, when not all the inventory has been sold
to outsiders.
6.
Prepare consolidated workpapers for firms with upstream and
downstream sales using the cost, partial equity, and complete equity
methods.
7.
Discuss the treatment of intercompany profit earned prior to the parent
subsidiary affiliation.
Upstream and Downstream Sales of Inventory
Company P
P sells inventory
Downstream
Company S1
S2 sells inventory
Upstream
S1 sells inventory
Horizontal
Company S2
Consolidated Entity
Profit (loss) that has not been realized through subsequent
sales to third parties must be eliminated in the preparation
of consolidated financial statements.
Slide
6-4
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
6-5
LO 1 Financial reporting objectives for intercompany sales.
Intercompany Sales of Merchandise
Downstream
Sales
Determination of Consolidated Sales, Cost of Sales,
and Inventory Balances Assuming Downstream Sales
E6-7: 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
6-6
LO 6 Consolidated workpapers for downstream sales.
Intercompany Sales of Merchandise
Downstream
Sales
E6-7: Summary of 2011 Intercompany Sales
Intercompany Sales
Intercompany COGS
Gross profit
$
$
Total
450,000
375,000
75,000
(COGS)
Resold
$
450,000
375,000
$
75,000
(Inventory)
On Hand
$
$
-
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
affiliate group.
Slide
6-7
LO 6 Consolidated workpapers for downstream sales.
Downstream
Sales
Intercompany Sales of Merchandise
E6-7: Summary of 2011 Intercompany Sales
Intercompany Sales
Intercompany COGS
Gross profit
$
$
Total
450,000
375,000
75,000
(COGS)
Resold
$
450,000
375,000
$
75,000
(Inventory)
On Hand
$
$
-
Prepare the workpaper entry to eliminate intercompany
sales for 2011.
Sales
Cost of Goods Sold (Purchases)
450,000
450,000
To eliminate intercompany sales of merchandise
Slide
6-8
LO 6 Consolidated workpapers for downstream sales.
Intercompany Sales of Merchandise
Determination of Amount of Intercompany Profit
Gross profit may be stated either as a percentage of sales or
as a percentage of cost.
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
6-9
LO 2 Determining the amount of intercompany profit.
Intercompany Sales of Merchandise
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. [Accounting Research
Bulletin (ARB) No. 51, paragraph 14] [ASC 810-10-45-6]
Slide
6-10
LO 3 Eliminating 100% of intercompany profit.
Consolidated Retained Earnings
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%)
Consolidated retained earnings on 12/31/2013
Slide
6-11
(13,500)
$ 788,625
LO 6 Consolidated workpapers – partial equity method.
Complete Equity Method: Workpaper
Upstream
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.
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. Paque Corporation uses the complete equity
method to record its investment in Segal Company.
Slide
6-12
LO 6 Consolidated workpapers – complete equity method.
Complete Equity Method: Workpaper
Upstream
Sales
P6-17: Prepare the worksheet entries for Dec. 31, 2013.
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
6-13
LO 6 Consolidated workpapers – complete equity method.
Upstream
Sales
Complete Equity Method: Workpaper
P6-17: Prepare the worksheet entries for Dec. 31, 2013.
2013 Intercompany Sales
Intercompany Sales
Intercompany COGS
Gross profit
$
$
(COGS)
(Inventory)
Total
Resold
On Hand
300,000 $
225,000 $
75,000
240,000
180,000
60,000
60,000 $
45,000 $
15,000
2. Sales
Cost of Goods Sold (purchases)
3. Cost of Goods Sold (end. inventory)
Inventory
300,000
300,000
15,000
15,000
To eliminate intercompany sales and defer unrealized profit
Slide
6-14
LO 6 Consolidated workpapers – complete equity method.
Upstream
Sales
Complete Equity Method: Workpaper
P6-17: Prepare the worksheet entries for Dec. 31, 2013.
2012 Unrealized Profit in Inventory
(COGS)
Resold
Total
Intercompany Sales
Intercompany COGS
Gross profit
$
(Inventory)
On Hand
45,000
4. Retained earnings ($45,000 x 90%)
Noncontrolling Interest ($45,000 x 10%)
Cost of Goods Sold (beg. inventory)
40,500
4,500
45,000
To realize the gross profit in inventory deferred in the prior period
Slide
6-15
LO 6 Consolidated workpapers – complete equity method.
Complete Equity Method: Workpaper
Upstream
Sales
P6-17: Prepare the worksheet entries for Dec. 31, 2013.
5. Beg. Retained Earnings - Segal
Common Stock - Segal
180,000
750,000
Investment in Segal
Noncontrolling Interest
837,000
93,000
To eliminate investment account and create NCI account
Slide
6-16
LO 6 Consolidated workpapers – complete equity method.
Upstream
Sales
Complete Equity Method: Workpaper
P6-17:
Income Statement
Sales
Equity in Segal income
Total revenue
Cost of goods sold
Other expenses
Total cost and expense
Net income
Noncontrolling interest
Net income
Paque
$ 1,650,000
91,125
1,741,125
1,290,000
Segal
$ 795,000
795,000
517,500
310,500
1,600,500
140,625
$
Retained Earnings Statement
Retained earnings, 1/1
Paque
Segal
Net income
Dividends declared
Retained earnings, 12/31
$
140,625
Eliminations
Debit
Credit
(2)
300,000
91,125 (1)
15,000
(3)
300,000
45,000
NCI
(2)
Consolidated
Balances
$
2,145,000
2,145,000
1,477,500
(4)
206,250
723,750
71,250
$
71,250
$ 406,125
$ 345,000
$
$
516,750
1,994,250
150,750
(10,125)
140,625
10,125
(6,000)
4,125 $
798,000
140,625
(150,000)
788,625
10,125
10,125
798,000
180,000
180,000
140,625
71,250
406,125
(150,000)
(60,000)
788,625 $ 191,250 $ 586,125
(5)
345,000
54,000
$ 399,000
(1)
$
NCI in Consolidated Income = 10%  ($71,250 + $45,000 – $15,000) = $10,125
Slide
6-17
LO 6 Consolidated workpapers – complete equity method.
Upstream
Sales
Complete Equity Method: Workpaper
P6-17:
Balance Sheet
Cash
Accounts receivable
Inventory
Investment in Segal
Other assets
Total assets
Paque
$
93,000
319,500
210,000
833,625
$
Accounts payable
$
Other current liabilities
Common stock
Retained earnings
NCI in net assets
Total liab. & equity $
Slide
6-18
750,000
2,206,125
105,000
112,500
1,200,000
788,625
2,206,125
$
Eliminations
Debit
Credit
Segal
75,000
168,750
172,500
40,500
$
$
$
(4)
15,000
837,000
37,125
NCI
(3)
(5)
(1)
630,000
1,046,250
$
45,000
60,000
750,000
191,250
1,046,250
Consolidated
Balances
$
168,000
488,250
367,500
-
$
750,000
586,125
4,500
$
1,381,125
(5)
(4)
399,000
93,000
$ 1,381,125
(5)
4,125
88,500
92,625
$
1,380,000
2,403,750
150,000
172,500
1,200,000
788,625
92,625
2,403,750
LO 6 Consolidated workpapers – complete equity method.
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
6-19
LO 6 Consolidated workpapers – complete equity method.
Summary of Workpaper Entries
To eliminate intercompany sales:
All Methods
Illustration 6-21
Parent Selling (Downstream)
Sales
X
Cost of Sales (purchases)
X
To eliminate intercompany profit in ending inventory:
All Methods
Cost of Sales (ending inventory)
Inventory
X
X
To recognize intercompany profit in beginning inventory
realized during the year:
Slide
6-20
Cost or Partial
Equity Methods
Beg. Retained Earnings—Parent
Cost of Sales (beg. inventory)
X
Complete Equity
Method
Investment in S Company
Cost of Sales (beg. inventory)
X
X
X
Summary of Workpaper Entries
To eliminate intercompany sales:
All Methods
Illustration 6-21
Subsidiary Selling (Upstream)
Sales
X
Cost of Sales (purchases)
X
To eliminate intercompany profit in ending inventory:
All Methods
Cost of Sales (ending inventory)
Inventory
X
X
To recognize intercompany profit in beginning inventory
realized during the year:
Cost or Partial
Equity Methods
Complete Equity
Method
Slide
6-21
Beg. Retained Earnings—Parent
NCI in Equity
Cost of Sales (beg. inventory)
X
X
Investment in S Company
NCI in Equity
Cost of Sales (beg. inventory)
X
X
X
X