12/12/2017
Intercompany Profits – Inventories:
Chapter 5
Intercompany
Profit
Transactions –
Inventories
Objectives (cont.)
5. Adjust noncontrolling interest amounts in the
presence of intercompany inventory profits.
© Pearson Education Limited 2015
Intercompany Transactions
For consolidated financial statements
– “intercompany balances and transactions shall be
eliminated.” [FASB ASC 810-10-45-1]
Show income and financial position as if the
intercompany transactions had never taken
place.
© Pearson Education Limited 2015
Objectives
1. Understand the impact of intercompany profit
in inventories on preparing consolidation
workpapers.
2. Apply the concepts of upstream versus
downstream inventory transfers.
3. Defer unrealized inventory profits remaining in
the ending inventory.
4. Recognize realized, previously deferred,
inventory profits in the beginning inventory.
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Intercompany Profit Transactions – Inventories
1: INTERCOMPANY
INVENTORY PROFITS
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Intercompany Sales of Inventory
Profits on intercompany sales of inventory
– Recognized if goods have been resold to
outsiders
– Deferred if the goods are still held in inventory
Previously deferred profits in beginning
inventory are recognized in the period the
goods are sold. Assuming FIFO
– Beginning inventories are sold
– Ending inventories are from current purchases
5-5 © Pearson Education Limited 2015 5-6
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No Intercompany Profits in Intercompany Profits Only in Ending

Inventories Inventories
During 2012, Pet sold goods costing $1,000 to its Last year, 2011, Pal sold goods costing $500 to its
subsidiary, Sim, at a gross profit of 30%. Sim had none of subsidiary, Sal, at a gross profit of 25%. Sal had none of
this inventory on hand at the end of 2011. The worksheet this inventory on hand at the end of 2011.
entry for 2011: During 2012, Pal sold additional goods costing $900
to Sal at a gross profit of 40%. Sal has $200 of these
goods on hand at 12/31/2012. Worksheet entries for
Sales (-R, -SE) 1,429
2012:
Cost of sales (-E, +SE) 1,429
Eliminate intercompany sales = $1,000 / (1-30%) = $1,429
Sales (-R, -SE) 1,500
Cost of sales (-E, +SE) 1,500
All intercompany sales of inventories have been resold to
outside parties, so remove the full sales price from both Eliminate intercompany sales = $900 / (1-40%) = $1,500
sales and cost of sales. Cost of sales (E, -SE) 80
Pet's sales are reduced $1,429. Inventory (-A) 80
Sim's cost of sales are reduced $1,429.
The same entry is used if Sim sells to Pet. Defer profit in ending inventory = $200 x 40%

© Pearson Education Limited 2015 5-7 © Pearson Education Limited 2015 5-8

Intercompany Profits Beginning and

Ending Inventories
Last year, 2011, Pam sold goods costing $300 to its Intercompany Profit Transactions – Inventories
subsidiary, Sir, at mark-up of 25%. Sir had $120 of this
inventory on hand at the end of 2011. 2: UPSTREAM &
During 2012, Pam sold additional goods costing $500 to
Sir at a 30% mark-up. Sir has $260 of these goods on
DOWNSTREAM
hand at 12/31/2012. Worksheet entries for 2012: INVENTORY SALES
Sales (-R, -SE) 650
Cost of sales (-E, +SE) 650
Eliminate intercompany sales = $500 + 30%($500) = $650
Cost of sales (E, -SE) 60
Inventory (-A) 60
Defer profits in ending inventory = $260 x 30%/130%
Investment in Subsidiary (+A) 24
Cost of sales (-E, +SE) 24
Realize profits from beginning inventory = $120 x 25%/125% = $24

© Pearson Education Limited 2015 5-9 © Pearson Education Limited 2015 5-10

Upstream and Downstream Sales Intercompany Inventory Sales

The worksheet entries for eliminating intercompany profits for
downstream sales
Downstream Sales (-R, -SE) XXX
Sales
Cost of sales (-E, +SE) XXX
For the intercompany sales price
Cost of sales (E, -SE) XX
Parent sells to Parent Subsidiary sells Inventory (-A) XX
subsidiary to parent For the profits in ending inventory
Investment in Subsidiary (+A) XX
Subsidiary Subsidiary Subsidiary Cost of sales (-E, +SE) XX
1 2 3 For the profits in beginning inventory
Upstream Sales For upstream sales, the last entry would include a debit to
noncontrolling interest, sharing the realized profit between
controlling and noncontrolling interests.

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Income Sharing with Downstream

Data for Example
Sales – PARENT Makes Sale

For the year ended 12/31/2011:

Subsidiary net income $5,200 CI 80% share
– Subsidiary income is $5,200 Current amortizations (450) $3,800
– Subsidiary dividends are $3,000 Adjusted income $4,750
(60)
– Current amortization of acquisition price is $450 Defer profits in EI (60) 24
Recognize profits in BI 24 $3,764 Income from
Intercompany (IC) sales information: Income
subsidiary

– IC sales during 2011 were $650 recognized $4,714 $2,400 NCI 20% share
– IC profit in ending inventory $60 Subsidiary dividends $3,000 $950
– IC profit in beginning inventory $24
When parent makes the IC
sale, the impact of deferring
and recognizing profits falls
all to the parent. $600

© Pearson Education Limited 2015 5-13 © Pearson Education Limited 2015 5-14

Income Sharing with Upstream Sales

– SUBSIDIARY Makes Sale
Intercompany Profit Transactions – Inventories
CI 80% share

Subsidiary net income $5,200 $3,800 3: UNREALIZED PROFITS

(48)
IN ENDING INVENTORIES
Current amortizations (450)
Adjusted income $4,750 19.2
$3,771.2 Income from
Defer profits in EI (60) subsidiary
Recognize profits in BI 24
$2,400
Income recognized $4,714
NCI 20% share

Subsidiary dividends $3,000 $950.0

(12.0)

When subsidiary makes the IC 4.8

sale, the impact of deferring and $942.8
recognizing profits is split among
controlling and noncontrolling
interests. $600

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Ending Inventory on Hand Parent Accounting

Pot owns 90% of Sot acquired at book value
Intercompany profits in ending inventory (no amortizations). During the current year,
– Eliminate at year end Sot reported $10,000 income. Pot sold goods to
Working paper entry Sot during the year for $15,000 including a
profit of $6,250. Sot still holds 40% of these
Cost of sales (E, -SE) XXX goods at the end of the year.
Inventories (-A) XXX Unrealized profit in ending inventory
For the unrealized profit 40%(6,250) = $2,500
Pot's Income from Sot
90%(10,000) – 2,500 unrealized profits = $6,500
Noncontrolling interest share
10%(10,000) = $1,000

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Entries Worksheet – Income Statement

Pot's journal entry to record income (net of Pot Sot DR CR Consol
unrealized profit). $100.
Sales 0 $50.0 15.0 $135.0
Investment in Sot (+A) 6,500 Income from Sot 6.5 6.5 0.0
15.
Income from Sot (R, +SE) 6,500 Cost of sales (60.0) (35.0) 2.5 0 (82.5)
Worksheet entries to eliminate intercompany sale Expenses (15.0) (5.0) (20.0)
and unrealized profits Noncontrolling interest
share 1.0 (1.0)
Sales (-R, -SE) 15,000 Controlling interest
share $31.5 $10.0 $31.5
Cost of goods sold (-E, +SE) 15,000
There would be a credit adjustment to Inventory for $2.5 on
Cost of goods sold (E, -SE) 2,500
the balance sheet portion of the worksheet.
Inventory (-A) 2,500

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What if?
If the sales had been upstream, by Sot to Pot: Intercompany Profit Transactions – Inventories
Unrealized profits in ending inventory 4: RECOGNIZING PROFITS
40%(6,250) = $2,500
Pot's Income from Sot
FROM BEGINNING
90%(10,000 – 2,500) = $6,750 INVENTORIES
Noncontrolling interest share
10%(10,000 – 2,500) = $750

Upstream profits impact both:

– Controlling interest share
– Noncontrolling interest share

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Intercompany Profits in Beginning

Inventory
Intercompany Profit Transactions – Inventories

Unrealized profits in 5: IMPACT ON

ending inventory one year NONCONTROLLING
INTEREST
Become

Profits to be recognized in the beginning

inventory of the next year!
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Direction of Sale and NCI Calculating Income and NCI

The impact of unrealized profits in ending Downstream sales:

inventory and realizing profits in beginning Income from sub
inventory depends on the direction of the = CI%(Sub's NI) – Profits in EI + Profits in BI
intercompany sales Noncontrolling interest share
Downstream sales = NCI%(Sub's NI)

– Full impact on parent Upstream sales:

Income from sub
Upstream sales
= CI%(Sub's NI – Profits in EI + Profits in BI)
– Share impact between parent and noncontrolling
interest Noncontrolling interest share
= NCI%(Sub's NI – Profits in EI + Profits in BI)

© Pearson Education Limited 2015 5-25 © Pearson Education Limited 2015 5-26

Upstream Example with

Analysis and Amortization
Amortization
Perry acquired 70% of Salt on 1/1/2011 for $420 when Salt's Cost of 70% of Salt $420
equity consisted of $200 capital stock and $200 retained
earnings. Salt's inventory was understated by $50 and building, Implied value of Salt 420/.70 $600
with a 20-year life, was understated by $100. Any excess is Book value 200 + 200 400
goodwill. Excess $200
2011 2012
Perry Salt Perry Salt
Unamort Amort Unamort Amort Unamort
Separate income $1,250 $705 $1,500 $745
Allocated to: 1/1/11 2011 1/1/12 2012 12/31/12
Dividends $600 $280 $600 $300 Inventory 50 (50) 0 0 0
Building 100 (5) 95 (5) 90
During 2011, Salt sold goods for $700 to Perry at a 20% Goodwill 50 0 50 0 50
markup. $240 of these goods were in Perry's ending inventory. 200 (55) 145 (5) 140
In 2012, Salt sold goods for $900 to Perry at a 25% markup and
Perry still had $100 on hand at the end of the year.

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2011 Income Sharing (Upstream) Perry's 2011 Equity Entries

Salt's net income $705 Investment in Salt (+A) 420

CI 70% share
Current
amortizations (55) $455 Cash (-A) 420
Adjusted income $650 ($28)
$427 For acquisition of 70% of Salt
Income from Salt
Defer profits in EI (40) Cash (+A) 196
Income recognized $610 $196
Investment in Salt (-A) 196
For dividends received
NCI 30% share
Subsidiary dividends $280 $195 Investment in Salt (+A) 427
($12) Income from Salt (R, +SE) 427
$183
For share of income
$84

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2011 Worksheet Entries (1 of 3) 2011 Entries (2 of 3)

1. Adjust for errors & omissions - none 4. Record noncontrolling interest in sub's earnings & dividends
2. Eliminate intercompany profits and losses
Noncontrolling interest share (-SE) 183
Dividends (+SE) 84
Sales (-R, -SE) 700
Noncontrolling interest (+SE) 99
Cost of sales (-E, +SE) 700
5. Eliminate reciprocal Investment & sub's equity balances
Cost of Sales (E, -SE) 40
Inventory (-A) 40 Capital stock (-SE) 200
Retained earnings (-SE) 200
3. Eliminate income & dividends from sub. and bring Investment Inventory (+A) 50
account to its beginning balance Building (+A) 100
Income from Salt (-R, -SE) 427 Goodwill (+A) 50
Investment in Salt (-A) 420
Dividends (+SE) 196
Noncontrolling interest (+SE) 180
Investment in Salt (-A) 231

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2011 Entries (3 of 3) 2012 Income Sharing (Upstream)

6. Amortize fair value/book value differentials Salt's net income $745

Current CI 70% share
amortizations (5) $518
Adjusted income $740 ($14)
Cost of sales (E, -SE) 50 $28
Inventory (-A) 50 Defer profits in EI (20) $532 Income from
Realize profits from Salt
Depreciation expense (E, -SE) 5 BI 40 $210
Building (-A) 5 Income recognized $760
NCI 30% share
$222
Subsidiary dividends $300
($6)
7. Eliminate other reciprocal balances – none $12
$228

$90
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Perry's 2012 Equity Entries 2012 Worksheet Entries (1 of 3)

1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Cash (+A) 210
Sales (-R, -SE) 900
Investment in Salt (-A) 210 Cost of sales (-E, +SE) 900
For dividends received Cost of Sales (E, -SE) 20
Inventory (-A) 20
Investment in Salt (+A) 532
Investment in Salt (+A) 28
Income from Salt (R, +SE) 532 Noncontrolling interest (-SE) 12
Cost of sales (-E, +SE) 40
For share of income
3. Eliminate income & dividends from sub. and bring
Investment account to its beginning balance
Income from Salt (-R, -SE) 532
Dividends (+SE) 210
Investment in Salt (-A) 322

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2012 Entries (2 of 3) 2012 Entries (3 of 3)

4. Record noncontrolling interest in sub's earnings & 6. Amortize fair value/book value differentials
dividends
Depreciation expense (E, -SE) 5
Noncontrolling interest share (-SE) 228
Dividends (+SE) 90 Building (-A) 5
Noncontrolling interest (+SE) 138
7. Eliminate other reciprocal balances – none
5. Eliminate reciprocal Investment & sub's equity balances
Capital stock (-SE) 200
Retained earnings (-SE) 625
Inventory (+A) 0
Building (+A) 95
Goodwill (+A) 50
Investment in Salt (-A) 679
Noncontrolling interest (+SE) 291

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