1 Intercompany Transactions - Heading 2 Parent & Subsidiary Shown As 1 Company in Consolidation Financial Statements Chapter 4 Intercompany Transactions Affiliated Cos do business with each other E.g., S sells merchandise to P Books of P & S fully reflect transactions Books have all of the regular journal entries E.g., books have: S has A/R from P P has A/P to S In Consolidation P & S are shown as 1 Co. E.g., Must eliminate intercompany accounts (A/R & A/P) Because one Co doesn t not owe $ to itself These WS entries same regardless of accounting method Cost, Simple Equity or Sophisticated Equity Methods 3 Intercompany Sales of Merchandise - Heading 4 Intercompany Sales of Merchandise E.g. - #1 Intercompany Sales of Merchandise Assume P sells inventory to S Inv orig cost $1,000 Inv sold by P to S for $1,200 Inv sold by S for $1,500 to 3 rd party W/O eliminations Total Sales & Total COGS too high S P Total Sales $1,500 $1,200 $2,700 Less: COGS 1200 1000 2200 Gross Profit $300 $200 $500 1
5 Intercompany Sales of Merchandise E.g. - #2 6 Worksheet Entry Intracompany Sale of Merchandise E.g. - #3 Consolidation shows P & S as 1 Co Need to eliminate intercompany sale Get rid of $1,200 transfer price Get rid of $1,200 COGS based on intercompany sale If you do this: Sales $1,500 ($1500 sale to 3 rd party) This is done in IS entry IS stands for Intercompany Sale IS D. Sales Revenue (1 st Seller) $1,200 IS C. Cost of Goods Sold (2 nd Seller) $1,200 Less: COGS 1000 ($1000 original cost to Parent) Gross Profit $500 7 IA Entry 8 Division of Profit From Sale of Merchandise Inventory - #2 If intercompany sale is credit sale: Must eliminate A/R & A/P Called Intercompany Accounts Reporting as if P & S are 1Co You don t owe $ to yourself Use End of Year Balance of A/R&A/P IA D. Accounts Payable (2 nd Seller) $1,200 IA C. Accounts Receivable (1 st Seller) $1,200 In E.g. $500 profit Who gets it? Intercompany price divides it between P & S P gets $200 of profit ($1200 -$1000) & S gets $300 of profit ($1500 - $1200) $1,200 price used to divide $500 profit between P&S: S P Total Sales $1,500 $1,200 $2,700 Less: COGS 1200 1000 2200 Gross Profit $300 $200 $500 2
9 Division of Profit From Sale of Merchandise Inventory - #2 10 EI Entry - Heading These WS entries are the same regardless of whether you have a NCI You are presenting both P&S as if they are 1 Co. The existence of NCI doesn t change this It only affects who gets equity EI Entry 11 Need Sale to Unrelated Third Party 12 Division of Profit From Sale of Merchandise Inventory - #2 No real sale unless you have sale to 3 rd party (unrelated) Without sale to 3 rd party Really just moving inventory from seller s to buyer s place of business Reporting as if 1 Co You can t sell something to yourself No rev recognized unless ultimate sale to 3 rd party S P Total Sales $1,500 $1,200 $2,700 Less: COGS 1200 1000 2200 Gross Profit $300 $200 $500 Not Booked Booked If no sale to 3 rd party P has taken $200 profit on its books We want to delay $200K profit until S sells inv to 3 rd Party 3
13 Defer Profit Until Sale to Third Party BIG PICTURE: Until sale to 3 rd party GAAP requires Seller does not recognizes profit from intercompany sale Intercompany profit deferred (suspended) until sale to 3 rd party Inventory reduced to orig cost Aftersaleto3 to rd party P & S then report their share of profit on sale of merchandise 14 EI Entry - #1 If merchandise not sold to 3 rd party in 1 st year: 1 st, do WS entries as if sale to outsider: Same as before IS D. Sales Revenue (1 st Seller) $1,200 IS C. Cost of Goods Sold (2 nd Seller) $1,200 IA D. Accounts Payable (2 nd Seller) $1,200 IA C. Accounts Receivable (1 st Seller) $1,200 15 EI Entry - #2 Then, We need to: Eliminate markup from inventory Credit Inventory for amount of Seller s deferred profit Eliminate Seller s profit: Debit COGS for amount of Seller s deferred profit An increased COGS reduces profit Allocate increased exp (COGS) to 1 st Seller Done in EI Entry EI stands for Ending Inventory It suspends on WS (not books of P&S) the profit from the 1 st sale (and the corresponding mark up of inv) until after the inv is sold in the 2 nd sale. EI D. Cost of Goods Sold $200 EI C. Inventory $200 16 EI entry E.g., - #101 E.g., Assume P buys inv for $10,000 P sells inv to S for $15,000 on credit 50% Mark Up S does not sell inv to 3 rd party in 1 st year We do the following on the WS IS D. Sales Revenue $15,000 IS C. Cost of Goods Sold $15,000 IA D. Accounts Payable $15,000 IA C. Accounts Receivable $15,000 4
17 EI Entry E.g., - #102 S has all of inv at end of year EI entry Defers P s profit Done with debit to COGS Reduces cost of inv to orig cost Done with credit to Inv EI D. Cost of Goods Sold $5,000 EI C. Inventory $5,000 18 EI Entry E.g., - #102 WS entries eliminate effects of intercompany sale Intercompany Sale D A/R 15000 Seller s Books -- Revenue C Sales 15000 Seller s Books Intercompany Sale D COGS 10000 Seller s Books -- COGS C Inv. 10000 Seller s Books Intercompany Sale D Inv. 15000 Buyer s Books -- Purchase Inventory C A/P 15000 Buyer s Books IS Entry D Sales 15000 WS C COGS 15000 WS IA Entry D A/P 15000 WS C A/R 15000 WS EI Entry D COGS 5000 WS C Inv 5000 WS After these entries NOTHING LEFT OF INTERCOMPANY SALE 19 EI entry E.g., - #201 What if S sold half of the inventory Half is still unsold. E.g., Assume P buys inv for $10,000 P sells inv to S for $15,000 on credit 50% Mark Up S sells ½ of inv to 3 rd party in 1 st year for $10,000 on credit IS D. Sales Revenue $15,000 IS C. Cost of Goods Sold $15,000 IA D. Accounts Payable $15,000 IA C. Accounts Receivable $15,000 20 EI Entry E.g., - #202 S has ½ of inv at end of year EI entry Defers P s profit on unsold ½ of inv Done with debit to COGS Reduces cost of ½ of inv to orig cost Done with credit to Inv EI D. Cost of Goods Sold $2,500 EI C. Inventory $2,500 5
21 EI Entry E.g., - #203 If ½ of intercompany merchandise is sold to 3 rd party for $10,000 Sales Rev should be $10,000 This is the sale to the 3 rd party real sale A/R should be $10,000 This is the amount owed by 3 rd party real A/R COGS should be $5,000 This is the original cost of the inventory sold to 3 rd party ½ of orig cost ($10,000/2) Inv should go down by $5,000 This is the original cost of the inventory sold to 3 rd party ½ of orig cost 22 Intercompany Sale D A/R 15000 Seller s Books -- Revenue C Sales 15000 Seller s Books Intercompany Sale D COGS 10000 Seller s Books -- COGS C Inv. 10000 Seller s Books Intercompany Sale D Inv. 15000 Buyer s Books -- Purchase Inventory C A/P 15000 Buyer s Books 3 rd Party Sale D A/R 10000 Buyer s Books -- Revenue C Sales 10000 Buyer s Books 3 rd Party Sale D COGS 7500 Buyer s Books -- COGS C Inv. 7500 Buyer s Books IS Entry D Sales 15000 WS C COGS 15000 WS IA Entry D A/P 15000 WS C A/R 15000 WS EI Entry D COGS 2500 WS C Inv 2500 WS After you are done with these entries: Sales Rev $10K increase; A/R $10K increase COGS $5,000 increase; Inv $5,000 decrease 23 Division of Profit From Sale of Merchandise Inventory - #2 If P is intercompany seller Nothing wrong with S s inc Income Distribution Schedule of WS: Subsidiary Income Distribution Internally generated net income $50,000 Adjusted income $50,000 NCI share 20% NCI $10,000 24 Division of Profit From Sale of Merchandise Inventory - #2 If P is intercompany seller & no sale to 3 rd party P s inc has intercompany profit which must be deferred Done with EI entry Increase in COGS fro EI entry reduces profits on WS Given to intercompany seller in Income Distribution Schedule Unrealized profit in ending inventory Parent Income Distribution $5000 Internally generated net income 80% of Sub adjusted income of $50,000 $100,000 40,000 Controlling Interest $135,000 6
25 BI Entry - Heading 26 BI Entry - #1 BI Entry What about the next year? If intercompany merchandise is sold to 3 rd party Now, intercompany seller can take deferred profit PROBLEM seller took deferred d intercompany profit last year on its books So, deferred intercompany profit is already reported in 1 st seller s RE 1 st need to eliminate deferred intercompany profit from 1 st seller s s beginning RE 2 nd give 1 st seller deferred intercompany profit this year 27 BI Entry - #2 28 BI Entry Income Distribution Schedule - #1 WS entry called BI for Beginning Inventory Debit to RE reduces beginning balance of RE When P gets deferred profit that will increase RE at end of this year Credit to COGS increases profits Given to intercompany seller Gives intercompany seller profit deferred from previous year BI D. Retained Earnings $5,000 If P is intercompany seller Nothing wrong with S s inc Income Distribution ib ti Schedule of WS: Subsidiary Income Distribution Internally generated net income $50,000 Adjusted income $50,000 NCI share 20% NCI $10,000 BI C. Cost of Goods Sold $5,000 7
29 BI Entry Income Distribution Schedule - #2 30 Intercompany Sales of Merchandise Miscellaneous Issues - Heading Assume P gets deferred profit from last year - $5K BI Entry Parent Income Distribution Internally generated net income $100,000 Deferred Profit In Beginning 5,000 Inventory 80% of Subsidiary adjusted 40,000 income of $50,000 Controlling Interest $145,000 Intercompany Sales of Merchandise Miscellaneous Issues 31 Intercompany Sales of Merchandise Miscellaneous Issues - Heading 32 Division of Profit From Sale of Merchandise Inventory - #2 Controlling Interest vs. Non-Controlling Interest Remember that intercompany price divides it between P & S P gets $200 of profit ($1200 -$1000) & S gets $300 of profit ($1500 - $1200) S P Total Sales $1,500 $1,200 $2,700 Less: COGS 1200 1000 2200 Gross Profit $300 $200 $500 8
33 Division of Profit From Sale of Merchandise Inventory - #1 This is important if NCI NCI gets share of S s profit NCI gets none of P s Ps profit 34 If Subsidiary is Intercompany Seller - #1 BI entry has debit to RE: BI D. Retained Earnings $5,000 BI C. Cost of Goods Sold $5,000 When P is intercompany seller Use P s RE When 100% owned S is intercompany seller Use P s RE When S (with NCI) is intercompany seller Use P s RE for CI share of deferred profit Use S s remaining RE for NCI share of deferred profit 35 If Subsidiary is Intercompany Seller - #1 36 Intercompany Sales of Merchandise Miscellaneous Issues - Heading E.g., If P owns 80% of S, then split debit to RE: BI D. Retained Earnings, Parent (80%) $4K Retained Earnings, Sub. (20%) 1K BI C. Cost of Goods Sold $5K Intercompany Sales of Merchandise At Loss 9
37 Periodic Inventory System 38 Intercompany Sales of Non-Depreciable Asset - Heading What if intercompany sale produces a loss If inventory really dropped in value Intercompany seller can recognize loss Can recognize loss w/o sale using LCM anyway If the loss is artificial Loss is deferred until sale to 3 rd party Intercompany Sales of Non- Depreciable Asset (Land) 39 Intercompany Sales of Non-Depreciable Asset - #1 40 Intercompany Sales of Non-Depreciable Asset - #1 Intercompany sale of non-depreciable asset (Land) gain deferred until asset sold to unrelated 3 rd party If asset never sold, deferral is permanent WS entry called LA Entry LA stands for Land or Land Adjustment 1 st Year Debit for gain defers intercompany seller s gain Credit eliminates mark-up (intercompany profit) from cost of Land Returns Land to its original cost LA D. Gain on Sale of Land $Mark-Up LA C. Land $Mark-Up 10
41 Intercompany Sales of Non-Depreciable Asset - #2 42 Intercompany Sales of Non-Depreciable Asset - #3 Later Years If P is intercompany seller LA D. Retained Earnings, Parent $Mark-Up LA C. Land $Mark-Up Year where Land sold to 3 rd party Still need to take it out of seller s RE Doesn t belong there YET Debit RE Allow intercompany seller to take profit Credit to Gain LA D. Retained Earnings, Parent $Mark-Up This WS entry done each year until Land is sold to 3 rd party LA C Gain on Intercompany. Sale of Land $Mark-Up 43 Intercompany Sales of Depreciable Assets - Heading 44 Intercompany Sales of Depreciable Asset - #1 Intercompany Sales of Depreciable Assets Gains from Intercompany sale of depreciable assets are similar to Land Gain deferred until asset sold to unrelated 3 rd party Write down asset back to orig cost. Also need to undo depreciation taken on buyer s books for mark-up Asset is on buyer s books at higher h value It is producing too much depreciation Need to undo that extra depreciation exp 11
45 F1 Worksheet Entry 46 F2 Worksheet Entry There are two FA entries First we eliminate the intercompany gain on the sale of the machinery: FA1 D. Gain on Sale of Machinery $10,000 FA1 C. Machinery $10,000000 Next, eliminate the increased depreciation expense on the machinery Just depreciation on the mark-up FA2 D. Accumulated Depreciation $2,000 FA2 C. Depreciation Expense $2,000 This WS entry reduces expenses reported on buyer s books It creates income on the WS (consolidation level) Who gets this income? 47 Effect of Undoing Depreciation of Mark-Up - #1 48 Effect of Undoing Depreciation of Mark-Up - #2 We give extra income to seller 1 st year seller loses gain 1 st & later years seller gets increased income Eventually, seller gets extra income = its deferred intercompany gain This can be seen in Income Distribution Schedules of WS Subsidiary Income Distribution Internally generated net income $25,000 Adjusted income $25,000 NCI share 20% NCI $5,000 12
49 Effect of Undoing Depreciation of Mark-Up - #3 50 F1 Worksheet Entry Second Year Unrealized gain on the sale of machine Parent Income Distribution $10,000 Internally generated net income 80% of Subsidiary adjusted income of $25,000 $30,000 20,000 Gain realized 2,000 through use of machine sold to Subsidiary Controlling Interest $42,000 The FA1 entry in the second year, is as follows Blue area reduces Machinery back to orig cost Yellow area reduces what remains of intercompany gain Gain now in RE We disallowed $10K, but let seller have $2K more income Net is 8K FA1 D. Retained Earnings, g, Parent $8K FA1 Accumulated Depreciation $2K FA1 Cr. Machinery $10K 51 F2 Worksheet Entry Second Year 52 Income Distribution Schedules Second Year - #1 FA2 entry in 2 nd year same as 1 st : FA2 D. Accumulated Depreciation $2,000 FA2 C. Depreciation Expense $2,000 The Income Distribution Schedules for 2 nd year would appear as follows: Subsidiary Income Distribution Internally generated net income $24,000 Adjusted income $24,000 NCI share 20% NCI $4,800 13
53 Income Distribution Schedules Second Year - #2 Parent Income Distribution Internally generated net income $50,000000 80% of Subsidiary income of $24K 19,200 Gain realized through use of 2,000 machine sold to Subsidiary Controlling Interest $71,200 54 F1 Worksheet Entry Third Year The FA1 entry in the third year, is as follows Blue area reduces Machinery back to orig cost Yellow area reduces what remains of intercompany gain Gain now in RE We disallowed $10K, but let seller have $4K more income Net is 6K FA1 D. Retained dearnings, Parent $6,000 1/1/2002 FA1 Accumulated Depreciation 4,000 FA1 Cr. Machinery $10,000 55 Intercompany Construction of Depreciable Assets - Heading 56 Intercompany Construction of Depreciable Asset - #1 Intercompany Construction of Depreciable Assets What if one member of consolidation group constructs asset for affiliated client? Builder is selling depreciable asset to Client Do the same entries we just talked about This subject introduces new entries dealing with the construction period. 14
57 Intercompany Construction of Depreciable Asset - #2 Builder and client are using accounts that are appropriate for two unrelated parties Wrong account names are being used Using account names used by contractor and client But, we are presenting the two Cos as if they are 1 Co. We have to change the names of the accounts to reflect 1Co building asset for itself 58 Intercompany Construction of Depreciable Asset - Builder s entries - #1 Look at the entries made by P&S on their books S (builder) records cost of construction during 1 st year on Ss S s books: D. Construction in Progress $200,000 C. Payables $200,000 Construction in Progress is the name used by a contractor. Asset Under Construction is the name used by a Co building its own Asset Remember, we are presenting P&S as if one Co. 59 Intercompany Construction of Depreciable Asset - Builder s entries - #1A 60 Intercompany Construction of Depreciable Asset Builder s Entries - #2 ` Builder s Balance Sheet Const In Prog $200K Payables $200K The S (builder) records billings on S s books: D. Contracts Receivable $150,000 C. Billings on Construction in Progress $150,000 The Billings account is a contra account that reduces the Construction in Progress account. The Contracts Receivable is an Intercompany Account One Co cannot owe money to itself. 15
61 Intercompany Construction of Depreciable Asset - Builder s entries - #2A 62 Intercompany Construction of Depreciable Asset - Client s entries - #1 ` Builder s Balance Sheet Const In Prog $200K Payables $200K Billings -150K $50K Contract Rec. 150K P (client) also records billings on P s books: D. Assets Under Construction $150,000000 C. Contracts Payable $150,000 Asset Under Construction is the correct name for Co building an asset for itself, but the Amount ($150K) is too small. Contracts Payable is an Intercompany Account. 63 Intercompany Construction of Depreciable Asset - Client s entries - #1A 64 LT1 Entry - #1 ` Builder s Balance Sheet Const In Prog $200K Payables $200K Billings -150K $50K Contract Rec. 150K On WS want to eliminate Intercompany Accounts (A/R & A/P): Client s Balance Sheet Asset Und Constr. $150K Contract Pay. $150K LT1 D. Contracts Payable $150,000 LT1 C. Contracts Receivable $150,000 16
65 LT1 Entry - #1A 66 LT2 Entry - #1 ` Builder s Balance Sheet Const In Prog $200K Payables $200K Billings -150K $50K Contract Rec. 150K Also want to eliminate Construction in Progress account & Billings account Add unbilled construction cost to Asset Under Construction. Client s Balance Sheet Asset Und Constr. $150K Contract Pay. $150K LT2 D. Billings on Construction in Progress $150,000 LT2 Assets Under Construction 50,000 LT2 C. Construction in Progress $200,000 67 LT2 Entry - #1A 68 End Result of LT1 & LT2 Entries ` Builder s Balance Sheet Const In Prog $200K Payables $200K Billings -150K $50K Contract Rec. 150K After LT1 & LT2 entries, left with: $200,000 balance in Assets Under Construction, and Payables of $200,000 Client s Balance Sheet Asset Und Constr. $150K Contract Pay. $150K Add To Ass Und Constr. 50K $200K 17
69 Consolidated Balance Sheet After LT1 & LT2 70 Builder s Intercompany Profit ` Consolidated Balance Sheet Asset Under Construction $200K Payables $200K (NOT ON TEST ) Builder might take intercompany profit (Percentage of Completion Method): D. Construction in Progress $50K C. Earned Income on Long-Term Contract $50K 71 LT 3 Entry 72 Intercompany Lending - Heading If so, eliminate Builder s profit on WS: Intercompany Lending LT3 D. Earned Income on Long-Term Contract $50K LT3 C. Construction in Progress $50K 18
73 LN1 Entry 74 LNs Entry If there is intercompany borrowing? Eliminate the Intercompany note: LN1 D. Notes Payable $10,000 LN1 C. Notes Receivable $10,000 Eliminate interest receivable and payable: LN2 D. Interest Payable $400 LN2 C. Interest Receivable $400 75 LN1 Entry Eliminate interest income and expense: LN3 D. Interest Income $400 LN3 C. Interest Expense $400 19