Slide
5-1
Chapter Five
Consolidated
Financial
Statements –
Intercompany
Asset
Transactions
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-2
Intercompany Inventory
Transactions


McGraw-Hill/Irwin
Transactions between the
parent and subsidiary are
viewed as “internal”
transactions of a single
economic entity.
The effects of those
transactions should be
“eliminated” from the
consolidated financial
statements.
© The McGraw-Hill Companies, Inc., 2004
Slide
5-3
Intercompany Inventory
Transactions
ENTRY TI
On the consolidation worksheet, eliminate ALL
intercompany sales/purchases of inventory.
The elimination amount is the $-amount
assigned as the “sales price” of the transfer.
CONSOLIDATION JOURNAL
Date
Description
Page
Debit
ENTRY TI
Sales
Cost of Goods Sold
##
Credit
$$$
$$$
Purchases component of COGS.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-4
Unrealized Inventory Gains
Year of Transfer
ENTRY G
Despite Entry TI, ending inventory is still
overstated by the amount of gain on the
inventory that is still unsold at year end.
We must eliminate the unrealized gain as
follows:
CONSOLIDATION JOURNAL
Date
Description
ENTRY G
Cost of Goods Sold
Inventory
Page
Debit
##
Credit
$$$
$$$
Ending Inventory component of COGS.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-5
Unrealized Inventory Gains
Year Following Year of Transfer
ENTRY *G
If the inventory was sold during the year, the
gain is now in Retained Earnings and must
be moved back to Income.
Subsidiary (In case of an upstream)
CONSOLIDATION JOURNAL
Date
Description
ENTRY *G
R/E (Beg. Bal. of seller)
COGS (Beg. Inv. Component)
Page
Debit
##
Credit
$$$
$$$
Note – this part of the entry serves to increase the income for
the current year (very important for upstream!)
© The McGraw-Hill Companies, Inc., 2004
McGraw-Hill/Irwin
Slide
5-6
Unrealized Inventory Gains
Year Following Year of Transfer
ENTRY *G
If the transfer of inventory is DOWNSTREAM &
if the parent uses the Equity Method, then
the following entry is used to recognize the
remaining unrealized profit left at the end of
the previous year. (see explanation on next slide)
CONSOLIDATION JOURNAL
Date
Description
ENTRY *G
Equity in Subsidiary Income
COGS (Beg. Inv. Component)
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
© The McGraw-Hill Companies, Inc., 2004
Slide
5-7
Unrealized Inventory Gains
Year Following Year of Transfer
Recall from chapter 1, that the Equity Method, treats
upstream sales the same way as downstream sales
and that the following deferred (original) entry is
made (which is reversed in the following year, when
the inventory item is sold)
(see page 18)
JOURNAL
Date
Description
Equity in Subsidiary Income
Investment in Subsidiary
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
© The McGraw-Hill Companies, Inc., 2004
Slide
5-8
Unrealized Inventory Gains
Year Following Year of Transfer
A “C” Conversion entry may be required if a
method other than the equity method were
being used.
In such a case, the deferral of unrealised gains’
impact on the subsidiary’s net income (and
ultimately, the parent company’s income
accrual) are ignored for downstream sales,
but are adjusted for on upstream sales
(because they affect the subsidiary’s net
income)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-9
Inventory Transfers
Example
On April 5, 2005 World Co (parent) buys
1,000 widgets from Sub, Inc. for
$500,000. The widgets originally cost
Sub, Inc. $400,000.
At year-end on December 31, 2005,
World Co. still had 250 of the units on
hand.
Record the consolidation entries on
12/31/05 to eliminate the unrealized
gain.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-10
World Co.'s Consolidation Journal
Date
Description
Debit
31-Dec Sales
500,000
Cost of Goods Sold
Credit
500,000
{
Entry
TI
Inventory Transfers
Example
First, the entire
intercompany transfer
must be eliminated.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-11
Inventory Transfers
Example
Entry
TI
G
World Co.'s Consolidation Journal
Date
Description
Debit
31-Dec Sales
500,000
Cost of Goods Sold
31-Dec Cost of Goods Sold
Inventory
Credit
500,000
25,000
25,000
Next, we must eliminate the unrealized gain:
Original
Unrealized
%
Unsold
=
×
Gain
Gain
= $
$ 100,000 ×
25%
25,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-12
Unrealized Inventory Gains
Effect on Noncontrolling Interest

If the transfer is DOWNSTREAM, then any
resulting unrealized gain belongs to the parent.
 No effect on Noncontrolling Interest i.e.
NCI’s share of income = NCI % x Sub Net Income

If the transfer is UPSTREAM, then any resulting
unrealized gain belongs to the subsidiary.
 Noncontrolling Interest must be adjusted for the
unrealized gain. (see next slide)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-13
Unrealized Inventory Gains
Effect on Noncontrolling Interest
Noncontrolling Interest in Sub Net Income = the
noncontrolling % of the sub’s net income, AFTER
eliminating both UPSTREAM unrealized intercompany
profits (i.e. those reversed from prior year and those
deferred from current year
Subsidiary Net Income (Loss)
Less(Add): Upstream, unrealized,
intercompany gain (losses)
= Subsidiary Net Income (Loss)
Available to Noncontrolling Shareholders
× Noncontrolling %
= Noncontrolling Interest in Subsidiary Net Income
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-14
Intercompany Land Transfers
Eliminating Unrealized Gains
ENTRY TL
If land is transferred between the parent and
sub at a gain, the gain is considered
unrealized and must be eliminated.
By crediting land for the same amount, this
effectively returns the land to its carrying
value on the date of transfer.
CONSOLIDATION JOURNAL
Date
Description
ENTRY TL
Gain on Sale of Land
Land
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
© The McGraw-Hill Companies, Inc., 2004
Slide
5-15
Intercompany Land Transfers
Eliminating Unrealized Gains
ENTRY *GL
As long as the land remains on the books of the buyer,
the unrealized gain must be eliminated at the end of
each fiscal period.
The original gain appeared on last period’s income
statement. Now, the gain resides in R/E. Therefore,
when we eliminate the gain, it must come from R/E.
CONSOLIDATION JOURNAL
Date
Description
ENTRY *GL
R/E (Beg. Bal. of seller)
Land
Page
Debit
##
Credit
$$$
$$$
If it were a downstream sale and the equity method were being used
by the parent, the Investment account would have been debited. (See
page 227)
© The McGraw-Hill Companies, Inc., 2004
McGraw-Hill/Irwin
Slide
5-16
Intercompany Land Transfers
Eliminating Unrealized Gains
ENTRY *GL (Year of sale)
In the year of disposal, modify the entry *GL, so
that the unrealized gain must be eliminated
one more time, and also recognized as a
REALIZED gain in the current period’s
consolidated financial statements.
CONSOLIDATION JOURNAL
Date
Description
ENTRY *GL (Year of sale)
R/E (Beg. Bal. of seller)
Gain on Sale of Land
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
© The McGraw-Hill Companies, Inc., 2004
Slide
5-17
Land Transfers
Example
On June 25, 2004 World Co.
(parent) sells a 30 acre tract of
land originally costing $600,000
to Sub, Inc. for $750,000.
At year-end on December 31, 2006
Sub Inc. still owns the land.
Record the appropriate
consolidation entry on 12/31/06.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-18
Entry
*GL
Land Transfers
Example
World Co.'s Consolidation Journal
Date
Description
Debit
31-Dec Retained Earnings
150,000
Land
Credit
150,000
This entry must be made at the end
of each year as long as the land is
still on the books.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-19
The Effect of Land Transfers on
Noncontrolling Interests
If the transfer is
DOWNSTREAM,
there is no
effect on
noncontrolling
interest.
McGraw-Hill/Irwin
What if the
land transfer is
UPSTREAM?
© The McGraw-Hill Companies, Inc., 2004
Slide
5-20
The Effect of Land Transfers on
Noncontrolling Interests
If the transfer is
DOWNSTREAM,
there is no
effect on
noncontrolling
interest.
McGraw-Hill/Irwin
If the transfer is
UPSTREAM, the
gain is attributed to
the SUBSIDIARY!
All noncontrolling
interest balances
are to be based on
the subsidiary’s net
income
EXCLUDING the
intercompany gain
(as before)
© The McGraw-Hill Companies, Inc., 2004
Slide
5-21
Intercompany Transfer of
Depreciable Assets
ENTRY TA
In the year of transfer, the unrealized gain must
be eliminated and the assets restated to
original historical cost.
CONSOLIDATION JOURNAL
Date
Description
ENTRY TA (Year of transfer)
Gain on Sale of Equipment
Equipment
Accumulated Depreciation
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
$$$
© The McGraw-Hill Companies, Inc., 2004
Slide
5-22
Intercompany Transfer of
Depreciable Assets
ENTRY ED
In addition, the buyer’s depreciation is based
on the inflated transfer price. The excess
depreciation expense must be eliminated.
CONSOLIDATION JOURNAL
Date
Description
ENTRY ED (Year of transfer)
Accumulated Depreciation
Depreciation Expense
McGraw-Hill/Irwin
Page
Debit
##
Credit
$$$
$$$
© The McGraw-Hill Companies, Inc., 2004
Slide
5-23
Intercompany Transfer of
Depreciable Assets
In Years Following the Year of Transfer
The equipment is carried on the individual
books at a different amount than on the
consolidated books.
These amounts change each year as
depreciation is computed.
To get the worksheet adjustments,
compare the individual records to the
consolidated records.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-24
Intercompany Transfer of
Depreciable Assets
Big Wheel Trucking (BWT) owns 80% of Quick
Delivery, Inc. On 1/1/04, Quick Delivery has a
truck on the books with an original cost of
$100,000, and accumulated depreciation of
$60,000 (4 year remaining useful life, $0
salvage value, straight-line).
Quick Delivery sells the truck to BWT for
$80,000.
Analyze the information in preparation for
making entries on 12/31/05.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-25
Intercompany Transfer of
Depreciable Assets
BWT's
Consolidated
Account
Records
Perspective
Equipment, 12/21/05 $ 80,000
Acc. Depr. - 12/31/05
(40,000)
Depr. Exp. - 12/31/05
20,000
1/1/05 R/E effect
Worksheet
Adjustments
(20,000)
On BWT’s books, the annual depreciation =
$80,000 ÷ 4 yrs. = $20,000 per year.
The 1/1/05 R/E effect = the original gain of
$40,000 on Quick Delivery’s books less 1
year of depreciation.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-26
Intercompany Transfer of
Depreciable Assets
BWT's
Consolidated
Worksheet
Account
Records
Perspective
Adjustments
Equipment, 12/21/05 $ 80,000 $
100,000
Acc. Depr. - 12/31/05
(40,000)
(80,000)
Depr. Exp. - 12/31/05
20,000
10,000
1/1/05 R/E effect
(20,000)
10,000
For the consolidated entity, the annual
depreciation = $40,000 remaining BV ÷ 4 yrs. =
$10,000 per year.
The Acc. Depr. At 12/31/05 = $60,000 accumulated
depreciation at 1/1/04 + 2 years of depreciation.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-27
Intercompany Transfer of
Depreciable Assets
BWT's
Consolidated
Worksheet
Account
Records
Perspective
Adjustments
Equipment, 12/31/05 $ 80,000 $
100,000 $
20,000
Acc. Depr. - 12/31/05
(40,000)
(80,000)
(40,000)
Depr. Exp. - 12/31/05
20,000
10,000
(10,000)
1/1/05 R/E effect
(20,000)
10,000
30,000
The consolidation worksheet
adjustments appear in the
last column.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
5-28
Intercompany Transfer of
Depreciable Assets
ENTRY *TA (Subsequent Years)
The adjustment to fixed assets and
depreciation expense must be made in each
succeeding period. The entry for the
BWT/Quick Delivery Consolidation is:
CONSOLIDATION JOURNAL
Date
Description
ENTRY *TA (subsequent yrs.)
Equipment
R/E (Beg. of period)
Accumulated Depr.
Page
Debit
##
Credit
20,000
30,000
50,000
As with land, if it were a downstream sale and the equity method
were being used by the parent, the Investment account would have
been
debited. (See page 231)
© The McGraw-Hill Companies, Inc., 2004
McGraw-Hill/Irwin
Slide
5-29
Intercompany Transfer of
Depreciable Assets
ENTRY ED (Subsequent Years)
In addition, we must adjust for the difference in
Depreciation Expense on the two income
statements. The entry for our example is:
CONSOLIDATION JOURNAL
Date
Description
ENTRY ED (Subsequent Year)
Accumulated Depreciation
Depreciation Expense
McGraw-Hill/Irwin
Page
Debit
##
Credit
10,000
10,000
© The McGraw-Hill Companies, Inc., 2004
Slide
5-30
End of Chapter 5
Hey, Chester, ol’
buddy!
I’m thinkin’ we
need to switch
desks in a little
“intercompany”
transfer.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004