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Chapter 6:

Intercompany Profit Transactions Plant Assets

to accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-1

Intercompany Profits Plant Assets: Objectives

1. Assess the impact of intercompany profit on transfers of plant assets in preparing consolidations workpapers. 2. Defer unrealized profits on plant asset transfers by either the parent or subsidiary. 3. Recognize realized, previously-deferred profits on plant asset transfers. 4. Adjust the calculations of noncontrolling interest share in the presence of intercompany profits on plant asset transfers.
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-2

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Intercompany Fixed Asset Sales

Intercompany sales of nondepreciable fixed assets: In year of intercompany sale Defer any gain or loss Restate fixed asset to cost In years of continued ownership Adjust investment account to defer gain or loss (adjust noncontrolling interest too, if upstream sale) Restate fixed asset to cost In year of sale to outside entity Adjust investment account (and noncontrolling interest if upstream sale) Recognize the previously deferred gain or loss
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-4

Intercompany Sale of Land

Pak owns 90% of San, acquired at cost equal to fair value. In 2011, Pak sells (downstream) land to San and records a \$10 gain. In 2015, San sells the land to an outside entity at a \$15 gain. San's separate income was \$70 in 2011, \$80 per year for 2012 to 2014, and \$90 in 2015.

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

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2011 Calculations
Defer the unrealized gain, with full effect to Pak Pak's Income from San 90%(70) 10 = \$53 Noncontrolling interest share 10%(70) = \$7 Elimination entry for 2009 Worksheet Gain on sale of land (-Ga, -SE) Land (-A) 10 10

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2012 to 2014 Calculations

Continue to defer gain, with full effect to Pak Pak's Income from San 90%(80) = \$72 Noncontrolling interest share 10%(80) = \$8 Elimination entry for Worksheets in 2012 to 2014

10
10

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

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2015 Calculations
Recognize the previously deferred gain, with full effect to Pak Pak's Income from San 90%(90) + 10 = \$91 Noncontrolling interest share 10%(90) = \$9 Elimination entry for 2015 Worksheet

Investment in San (+A) Gain on sale of land (Ga, +SE)

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

10 10

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Unrealized Profits on Fixed Assets

Unrealized profit or loss on nondepreciable fixed assets Defer in year of intercompany sale Continue deferring by adjusting the investment in subsidiary (and noncontrolling interest if upstream) Recognize full profit or loss upon resale to outside entity

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Depreciable Fixed Assets

Gains and losses on intercompany sales of depreciable fixed assets Defer in period of intercompany sale Recognize gain or loss over remaining life of asset Adjust asset and depreciation down for gains Adjust asset and depreciation up for losses Recognize any unamortized gain or loss upon sale to outside entity

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

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Downstream Example
Per owns 80% of Sop, acquired at cost equal to fair value. On 1/1/2011, Per sells machinery to Sop at a \$30 profit. The machinery has a remaining life of 5 years from 1/1/2011. Sop disposes of the machinery at book value at the end of 5 years. Sop's income is \$70 in 2011, \$80 per year for 2012 to 2014, and \$90 in 2015.

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

6-12

2011 Calculations
Defer the unrealized gain and amortize it over 5 years with full effect to Per 30 gain / 5 years = \$6 Per's Income from Sop 80%(70) 30 + 6 = \$32 Noncontrolling interest share 20%(70) = \$14 Elimination entry for 2011 Worksheet
Gain on sale of machinery (-Ga, -SE) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE) 30

30
6 6
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Previously Deferred Gains/Losses

Recognize over the life of the depreciable asset Downstream sales Adjust investment in subsidiary account Upstream sales Adjust investment in subsidiary account and noncontrolling interest, proportionately Intercompany sales at a gain Adjust asset and depreciation down Intercompany sales at a loss Adjust asset and depreciation up
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-15

2012 to 2014 Calculations

Continue to recognize part of the gain, with full effect to Per Per's Income from Sop 80%(80) + 6 = \$70 Noncontrolling interest share 20%(80) = \$16 Elimination entry for Worksheets in 2012 Investment in Sop (+A) 24 Accumulated depreciation (+A) 6 Machinery (-A) 30 Accumulated depreciation (+A) 6 Depreciation expense (-E, +SE) 6
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-16

Entries (cont.)
Worksheet entries for 2013
Investment in Sop (+A) Accumulated depreciation (+A) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE) 18 12 30 6 6

Worksheet entries for 2014

Investment in Sop (+A) Accumulated depreciation (+A) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE)
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

12 18 30
6 6
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2015 Calculations
Recognize the remaining deferred gain, with full effect to Per Per's Income from Sop 80%(90) + 6 = \$78 Noncontrolling interest share 20%(90) = \$18 Elimination entries for 2015 Worksheet Investment in Sop (+A) 6 Accumulated depreciation (+A) 24 Machinery (-A) 30 Accumulated depreciation (+A) 6 Depreciation expense (-E, +SE) 6
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-18

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Sharing Unrealized Gain or Loss

Upstream sales of fixed assets require: Deferring the gain or loss on the sale Recognizing a portion of the gain or loss as the asset depreciates Writing off any unrecognized gain or loss upon the sale of the asset Sharing the gains and losses between the controlling and noncontrolling interests Upstream sales impact noncontrolling interests!
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-20

Upstream Example
Pail owns 70% of Shovel, acquired at cost equal to fair value. On 1/1/2011, Shovel sells machinery to Pail at a \$40 profit. The machinery has a remaining life of 5 years from 1/1/2011. Pail uses the machinery for four years, then sells it at a profit at the start of 2015. Shovel's income is \$70 in 2011, \$80 per year for 2012 to 2014, and \$90 in 2015.

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

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2011 Calculations
Defer the unrealized gain and amortize it over 5 years sharing the gain 40 gain / 5 years = \$8 Pail's Income from Shovel 70%(70 40 + 8) = \$26.6 Noncontrolling interest share 30%(70 40 + 8) = \$11.4 Elimination entry for 2011 Worksheet Gain on sale of machinery (-Ga, -SE) 40 Machinery (-A) 40 Accumulated depreciation (+A) 8 Depreciation expense (-E, +SE) 8
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-22

2012 to 2014 Calculations

Continue to recognize part of the gain, sharing its effect between the controlling and noncontrolling interests Pail's Income from Shovel 70%(80 + 8) = \$61.6 Noncontrolling interest share 30%(80 + 8) = \$26.4

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2012 Worksheet Entries

Elimination entry for Worksheets in 2012

Investment in Shovel (+A) Noncontrolling interest (-SE) Accumulated depreciation (+A) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE)

40.0 8.0 8.0

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2013 Worksheet Entries

Worksheet entries for 2013

Investment in Shovel (+A) Noncontrolling interests (-SE) Accumulated depreciation (+A) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE)

40 8.0 8.0

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2014 Worksheet Entries

Worksheet entries for 2014

Investment in Shovel (+A) Noncontrolling interest (-SE) Accumulated depreciation (+A) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE)

40.0 8.0 8.0

Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

6-26

2015 Calculations
Recognize the remaining deferred gain, sharing the impact with controlling and noncontrolling interests Unamortized gain = 1 year at \$8 Pail's Income from Shovel 70%(90 + 8) = \$68.6 Noncontrolling interest share 30%(90 + 8) = \$29.4 Elimination entries for 2015 Worksheet Investment in Shovel (+A) 5.6 Noncontrolling interests (-SE) 2.4 Accumulated depreciation (+A) 32.0 Machinery (-A) 40.0 Accumulated depreciation (+A) 8.0 Gain on sale of machinery (Ga, +SE) 8.0
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-27

Sale at Other Than Fair Value

Intercompany sales of fixed assets at prices other than fair value Deserve scrutiny by shareholders Sales above fair value move additional cash to the seller Sales below fair value transfer valuable goods to the buyer There is a transfer of wealth between the affiliated companies, and between the controlling and noncontrolling interests
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall 6-28

Inventory Items Fixed Assets

An intercompany sale of inventory which is acquired as a fixed asset Unrealized profit is removed from cost of sales in year of sale Profit is recognized over the fixed asset's life Cost of sales (E, -SE) Machinery (-A) Accumulated depreciation (+A) Depreciation expense (-E, +SE)
Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall

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