Chapter 4
Intercompany
Sales
Typical intercompany transactions
Merchandise for resale
Land
Fixed assets
Long-term construction contracts
Notes receivable/ payable
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Merchandise sales:
No inventories
Outside
Co. S
Co. P
Outside
$80 S buys
$100  P buys
$125 to outside
Separate statements
Co. S
Co. P
Sales $100
$ 125
CofGS 80
100
Consolidated statement
for Company SP
Sales
$125
Cost of Goods Sold 80
The “intercompany sale”
of $100 is eliminated on
the worksheet.
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Intercompany price
Does the intercompany price matter?
Yes: If there is a NCI. If S was 80% owned by
P, NCI gets $4 (20% x $20) and
controlling interest gets $41(80% x $20
+ $25)
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Merchandise sales:
Unsold goods
Outside
Co. S
Co. P
Outside
$80  $100 [in end inv]
Separate statements:
S has sales of $100, C of GS of $80
P has inventory with cost of $100
Consolidated Statements:
SP has inventory with a cost of $80
• The “intercompany sale” of $100 is eliminated
• The inventory is restated to $80
• The $20 profit is not recognized until the goods are
sold by P to the outside world
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The normal merchandise
procedures
 IS Eliminate intercompany “middle sale” - no
impact on income but overstates sales and cost of
goods
 BI Restore beginning inventory (included in C of
GS) to cost and correct beginning Retained
Earnings - this shifts profit from last year to this
year
 EI Restore ending inventory to cost and adjust C
of GS - this defers profit to next year
 IA Eliminate intercompany trade debt and
interest (if any)
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Mark-up confusion
Mark-up on cost is not the same
as gross profit!
Marking a $10 cost unit up 25%
$10.00  125% = $12.50
provides a gross profit of 20%
$2.50  $12.50 = 20%
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Merchandise example
 S (P owns 80%) buys goods for $80,000 and sells
them to P for $100,000, all sales are at 20% GP
 P had $10,000 of intercompany goods in
beginning inventory and $15,000 of such goods
in its ending inventory
 P owed S $8,000 for intercompany goods at year
end
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Consolidation Procedures
Needed
IS - eliminate sale from subsidiary to parent
BI - reduce cost of goods sold for profit in beginning
inventory and correct beginning retained earnings
(allocated 20/80 because sale was by subsidiary)
EI- reduce ending inventory and increase cost of
goods sold (deduct for ending inventory was too
great)
IA - Eliminate intercompany trade balance
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Worksheet eliminations
Partial Worksheet
Ending inventory
Accounts receivable
Accounts payable
RE - Co. S
RE - Co. P
Sales
Cost of goods sold
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Trial Balances
Co P
Co S
15,000
8,000
8,000
50,000
120,000
130,000 100.000
95,000 80,000
Eliminations
Dr
Cr
EI
3,000
IA 8,000
IA 8,000
BI
400
BI 1,600
IS 100,000
EI 3,000 IS 100,000
BI
2,000
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Adjustments on the IDS
End Inv profit (EI)
SUB
3,000 Int Generated Inc
Beg Inv profit (BI)
Adjusted Inc
NCI %
NCI
20,000
2,000
19,000
20%
3,800
PARENT
Int Generated Inc
35,000
80% of $19,000
Co. S’s adjusted inc 15,200
Controlling Interest 50,200
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Worksheet 4-3
 The 4 eliminations are IS, IA, BI, EI
 RE split for beginning inventory because sub
sold it. If parent was seller, adjustments only to
parent RE
 Seller’s profit is adjusted through IDS. In this
case the adjustments went to the sub (seller).
They would go to Parent if parent was seller
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Worksheet 4-3 (continued)
 If there is an LCM adjustment, only the
remaining profit is eliminated
 Phony losses (sales below market value) are also
eliminated
 Worksheet 4-4 shows the same adjustments for a
periodic inventory
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Intercompany land sales
Gain is deferred until land is sold to outside company
Year of sale: LA
Gain of seller
Land
Run adjustment through seller’s IDS
20,000
Later years: LA
20,000
RE (split?)
Land
Adjustment is split only if seller was Sub
20,000
20,000
Year of outside sale:
LA
RE (split?)
20,000
Gain (loss) on land sale
20,000
Seller may finally recognize gain; credit to seller’s IDS
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Intercompany fixed asset sale:
Year of sale
Sold 5 year machine, cost $20,000, for $30,000 on 1/1/x1
Theory - Defer gain and earn it back over period of use. The
allocation method matches the depreciation method (straight-line
for this example)
Year of sale:
F1 Gain (seller) 10,000
Machine
10,000
F2 Accum depr 2,000
Dep Expense
2,000
defer gain on sale
return asset to cost
reduce to depr. on cost
recognize 1/5 profit
IDS - deduct original profit from seller and add profit equal to
depreciation adjustment
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Intercompany fixed asset sale:
Year subsequent to inter-company sale
End of second year:
Adjust asset at start of year
F1 RE (split?)
8,000
deferred gain on 1/1/2
Accum Depr
2,000
adjust prior year’s depr.
Machine
10,000 return asset to cost
RE adjustment is split only when sub is seller
Adjust current year depreciation
F2 Accum Depr
2,000
reduce to depr on cost
Depr Expense
2,000 recognize 1/5 profit
IDS - seller gets profit equal to depreciation adjustment
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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 1/1/2
 (F2) adjusts depreciation and realizes $2,000 gain
 IDS just gives back $2,000 currently realized gain to P
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Fixed asset worksheets, continued
WS 4-7 (Asset sold to outside party at end of second year)
 Machinery and accumulated depreciation are not there to
adjust
 The $6,000 remaining gain at the start of the year is now
earned - sale to outside occurred
 Adding the $6,000 deferred gain to the recorded $4,000
loss created a gain on the consolidated statement of
$2,000. Entry is F3
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Long-term construction contracts
Completed - like any other fixed asset sale
Not Complete - Completed Contract Method:
Eliminate seller’s Billings and Cost of Construction in
Progress; adjust buyer’s Asset Under Construction for
unbilled costs incurred by seller
Eliminate intercompany debt balance
Not Complete - Percentage of Completion:
Key is to defer profit recorded by builder and restore asset
under construction to cost
Eliminate intercompany debt balance
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