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IntraEntity Transactions

Course: BUS 402, Fall 2010
School: Rhode Island
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Normalbusiness operations 2. BusinesscombinationsofentitiesatdifferentlevelsofthevaluechaininwhichacquirerticallyIntegratedParentSubsidiary PurchasessalestransactionsbetweentheParentandSubsidiary UniversityofRhodeIsland BUS402AdvancedAccounting20102011 JosephM.DAdamo CourseOutline#6:IntraEntityTransactions I. Page1of16 IntraEntitySalesofInventory A. NatureandPurposeofTransactions 1. Ver seekscompetitiveadvantagesbygainingcontrolofitssuppliers(thesupplyend)andits distributionchannels(thedemandend) OneEntityPerspective:thegoodsstaywithin(intra)theoneeconomicentityuntilsold tooutsidecustomers OtherCombinations B. InventorypurchasessalestransactionsbetweentheParentandSubsidiary LessLikely EliminateSaleandPurchaseTransactions 1. EliminateRevenueandExpenserecordedbyIntraEntitySellerandBuyer Eliminatesalesagainstcostofsalesevenifsomeintraentityitemsremainininventory SeparatelyAccountforintraentityitemsremainingininventory Youcantsellandbuysomethingtoandfromyourself. 2. EliminationAvoidsGrossUp Preventsentitiesfrominflatingsalesvolumebyintraentitytransactions CourseOutline#6:IntraEntityTransactions 3. Page2of16 Wanttoaccuratelydepictrelationshipsamongsales,costofgoodssoldandprofits EffectonProfits None EliminationEntry Equalreductionofsalesrevenueandcostofsalesexpense ALWAYSELIMINATE100%REGARDLESSOFPARENTSPERCENTAGECONTROLLINGINTEREST C. EliminateSellersProfitfromRemainingIntraEntity Inventory Eliminate100%oftheintraentitysellersprofitfromtheintraentitybuyersinventoryfromthe consolidatedstatementsregardlessofparentspercentagecontrollinginterest YoucantrecognizeaprofitonitemsinEIthatyousoldtoandboughtfromyourself. 1. ReturnsInventorytotheIntraEntitySellersOriginalCostBasis 2. Removetheintraentitysellersprofitfromtheintraentitybuyersinventoryandoffset againstcostofsales EliminationEffectProfits Decreaseprofitofintraentityseller a. b. DownstreamTransactions ParentsellstoSub Intraentityprofitwasrecordedonparentsbooks UpstreamTransactions SubsellstoParent Intraentityprofitwasrecordedonsubsbooks Relevantwhenanoncontrollinginterestinthesubsidiaryexists(lessthan100% ownership) REMEMBER:Eliminationentriesareworksheetentriesonly. CourseOutline#6:IntraEntityTransactions 3. Page3of16 BeginningInventoryEffect D. Intraentitybuyers costofgoodssold inthefollowingperiod overstated byintraentity profitinEIthatcarriesovertoBI Intraentitysellersbeginningretainedearningsinthefollowingperiodoverstatedby intraentityprofitrecognizedonitsbooks EliminateIntraEntityReceivablesandPayables Eliminate100%oftheintraentityreceivables(DuefromAffiliate)andpayables(DuetoAffiliate) fromconsolidatedstatementsregardlessofparentspercentagecontrollinginterest Youcantbedueandowemoneyfromandtoyourself. Example: During2011,PeppaCorp.acquiredacontrollinginterestinoneofitskeysuppliers,SaltInc. Accordingtoitsrecords,PeppaCorp.purchasedmerchandisefromSaltInc.during2011atacostof $4,500,000.Salt Inc.recognizedagrossprofitof30%onitssalestoPeppaCorp. Bytheendoftheyear,PeppaCorp.sold$4,000,000ofthemerchandisepurchasedfromSaltInc.tooutside customersfor$5,700,000.Thus,atDecember31,2011,PeppaCorp.sinventoryincluded$500,000ofmerchandise purchasedfromSaltInc. OnDecember31,2011,PeppaCorp.owedSaltInc.$225,000foritsmostrecentpurchase. 1. Completethefollowingtablethatillustratestheeffectsoftheintraentitytransactionsonthe booksofthe individualcompaniesandascombined(notconsolidated)entities. SaltInc. Sales PeppaCorp. $4,500,000 Sales Combined $5,700,000 $10,200,000 CourseOutline#6:IntraEntityTransactions Page4of16 CostofGoodsSold 3,150,000 CostofGoodsSold 4,000,000 7,150,000 GrossProfit $1,350,000 GrossProfit $1,700,000 $3,050,000 Inventory $500,000 $500,000 30%x$4,500,000 Identifytheeffectsoftheintraentitytransactionsthatmustbe eliminatedtopresentthetwocompaniesasa singleeconomicentityintheconsolidatedfinancialstatements. 2. Combined Sales Sales& Purchases Subtotal SellersProfitin Consolidated BuyersEI $10,200,000 (4,500,000) $5,700,000 CostofgoodsSold 7,150,000 (4,500,000) 2,650,000 150,000 2,800,000 GrossProfit $3,050,000 $3,050,000 $500,000inEIX 30%SellersGP $2,900,000 Inventory $500,000 $500,000 (150,000) $350,000 $4,000,000 $4,500,000 X$3,150,000= $2,800,000 $5,700,000 $500,000 $4,500,000 X$3,150,000=$350,000 UPSTREAMTRANSACTIONIntraentityprofitof$150,000waseliminatedfromthesubsnetearningsonthe worksheet. Example:(continued) ConsolidationEntry Eliminate100%ofIntraEntityTransactionsincludingReceivablesandPayables ResultsinConsolidatedFinancialStatementsfromoneentityperspective ConsolidationofPeppaCorp.andScaryInc.@December31,2011 DATE 12/31/11 WORKSHEETENTRYONLY Sales(Salt) DEBIT 4,500,000 CostofGoodsSold(Peppa) CostofGoodsSold(Peppa) CREDIT 4,500,000 150,000 CourseOutline#6:IntraEntityTransactions Page5of16 12/31/11 Inventory(Peppa) 12/31/11 150,000 $500,000x30% AccountsPayable(Peppa) 225,000 AccountsReceivable(Salt) 225,000 AtDecember31,2012,thedeferredgrossprofitintheintraentityendinginventory@12/31/2011mustbe eliminatedfromcostofgoodssoldofthecurrentperiodandoffsetagainstthebeginningbalanceofretained earnings. ConsolidationofPeppaCorp.andScaryInc.@December31,2012 12/31/12 RetainedEarnings(SaltsBeginning) CostofGoodsSold(Peppa) II. IntraEntityLoans A. NatureandPurposeofTransactions 1. FinancialAssistanceIntraentitylendingborrowing 150,000 150,000 CourseOutline#6:IntraEntityTransactions Page6of16 Notegivesintraentitylenderhigherpriorityatborrowersbankruptcy 2. Lenderreceivespromissorynotefromborrower Oneeconomicentitybuttwoseparatelegalentitiesifoneentitygoesbankrupt,the otherstillcontinues IncreasedBorrowingCapacity a. AcquireewithStrongFinancialPosition b. Waspopulartostructureanacquisitionspecificallytokeepafinanciallystrong subasaseparatelegalentityfromparentabletoborrowmoreastwolegal entitiesthanasone Subuseditsfinancialstrengthtoborrowonbehalfoftheparent FinanceSubsidiaries CaptiveFinanceCompanies 3. Whollyownedsubsidiariesgenerallydesignedtofinanceandmanagespecific creditactivitiesofparents Typicallystructuredwiththeabilitytoissuetheirowndebttofinanceparents salescreditcards,consumerandbusinessloans,leases,etc. SpecialPurposeEntities Createdforspecific,narrowpurposes Oftenestablishedaslimitedliabilitycorporationsorlimitedpartnerships Entitiestypicallycontrolledbycontractualarrangement Mustbeconsolidatedunlessveryspecificlegalconditionsaremet FromHasbrosAnnualReport: TheCompanyispartytoanaccountsreceivablesecuritizationprogramwherebytheCompanysells,onanongoingbasis,substantiallyallofits U.S.tradeaccountsreceivabletoabankruptcyremotespecialpurposeentity,HasbroReceivablesFunding,LLC("HRF").HRFisconsolidatedwith theCompanyforfinancialreportingpurposes.ThesecuritizationprogramthenallowsHRFtosell,onarevolvingbasis,anundividedfractional CourseOutline#6:IntraEntityTransactions Page7of16 ownershipinterestofupto$250,000intheeligiblereceivablesitholdstocertainbankconduits.DuringtheperiodfromthefirstdayoftheOctober fiscalmonththroughthelastdayofthefollowingJanuaryfiscalmonth,thislimitpreviouslywasincreasedto$300,000.Theprogramprovidesthe Companywithasourceofworkingcapital.BasedontheamountofeligibleaccountsreceivableasofDecember 27,2009,theCompanyhad availabilityunderthisprogramtosell$300,000,ofwhichnoamountswereutilized.In2010,thefacilitywasamendedtoextendtheagreement throughJanuary2011.Pursuanttothisamendment,thelimitwillbe$250,000fortheextensionperiod. B. ConsolidationsandBasicIntraEntityNotes Youcantlendandborrowmoneytoandfromyourselfandthereforeyoumust: 1. EliminateNotesReceivableandPayable Youcantbedueoroweabalanceonmoneythatyoucantlendandborrowtoandfromyourself. 2. EliminateInterestRevenueandExpense Youcantearnorincurinterestonmoneythatyoucantlendandborrowtoandfromyourself. 3. EliminateInterestReceivableandPayable Youcantbedueoroweinterestfromortoyourselfthatyoucantearnorincur. Example: 6/1through12/31 7mos. OnJune1,2011,SaltInc.borrowed$500,000fromPeppaCorp.andsignedan18monthnotebearing9%interest annually.Interestisduequarterly.Allinterestpaymentswereproperlymadein2011. On9/1and12/1in2011 paymentsfor6mos.madevs.7mos.used 1mo.due 1. Completethefollowingtablethatillustratestheeffectsoftheintraentitytransactionsonthebooksofthe individualcompanies. SaltInc. NotesPayable PeppaCorp. Calculations $500,000 NotesReceivable $500,000 InterestExpense $26,250 InterestRevenue $26,250 500,000x.09x7/12=26,250 InterestPayable $3,750 $3,750 500,000x.09x1/12=3,750 ConsolidationEntry DATE 12/31/11 InterestReceivable Eliminate100%ofIntraEntityTransactionsincludingReceivablesandPayables WORKSHEETENTRYONLY NotesPayable(Salt) DEBIT 500,000 NotesReceivable(Peppa) InterestRevenue(Peppa) CREDIT 500,000 26,250 CourseOutline#6:IntraEntityTransactions Page8of16 12/31/11 InterestExpense(Salt) 12/31/11 InterestPayable(Salt) 26,250 3,750 InterestReceivable(Peppa) III. 3,750 IntraEntitySalesofLongLivedAssets A. NatureandPurposeofTransactions B. Transferrightsandrisksofownershipbetweenseparatelegalentities land,otherplantassets, intangibleassets ConsolidationProcessPretendsaleneveroccurred Youcantsellandbuypropertytoandfromyourselfandthereforeyoumust: 1. EliminateIntraEntityGainorLossonSalenotrealizedfromoneentityperspective Youcanthaveagainorlossonpropertythatyoucantselltoyourself. 2. ReturnAccountstoSellersBalancesPretendsaleneveroccurred 3. AdjustDepreciationorAmortizationtoReflectSellersBasis asifthesalenever happened LandExample: OnOctober1,2011,PeppaCorp.soldaplotoflandtoSaltInc.for$1,200,000.ThelandoriginallycostPeppaCorp. $975,000. CourseOutline#6:IntraEntityTransactions Page9of16 Identifythejournalentriesactuallyrecordedbythecompaniesrelativetotheland. 1. OnPeppaCorp.sBooks: DATE ACCOUNTNAMES 10/1 2011 DEBIT Cash CREDIT 1,200,000 Land 975,000 GainonSaleofLand 225,000 OnSaltInc.sBooks: DATE ACCOUNTNAMES 10/1 2011 DEBIT Land CREDIT 1,200,000 Cash 1,200,000 LandExample:(continued) OnOctober1,2011,PeppaCorp.soldaplotoflandtoSaltInc.for$1,200,000.ThelandoriginallycostPeppaCorp. $975,000. 2. Combinethetwoentriestoseetheirneteffectsonthecombinedentities. DATE 10/1 2011 ACCOUNTNAMES DEBIT Cash(Peppa) 1,200,000 Land(Salt) CREDIT 225,000 1,200,000 Land(Peppa) 975,000 GainonSaleofLand(Peppa) Cash(Salt) Fromaoneentityperspective: 225,000 1,200,000 Cashbalancedidntchangeshiftedpockets CVofLandincreasedbygain CourseOutline#6:IntraEntityTransactions ConsolidationEntry Eliminate100%ofIntraEntityTransactionpretendsaleneverhappened DATE 12/31/11 Page10of16 WORKSHEETENTRYONLY GainonSaleofLand(Peppa) DEBIT CREDIT 225,000 Land(Salt) 225,000 Landbackto$975,000onConsolidatedSFP DepreciableAssetExample: OnOctober1,2011,PeppaCorp.solditsfleetofdeliverytruckstoSaltInc.for$3,000,000.Thevehiclesoriginally costPeppaCorp.$5,000,000andhadbeendepreciatedusingthestraightlinemethodtoa carryingvalueof $2,400,000withfouryearsremainingintheirusefullifeasofthedateofsale .SaltInc.willdepreciatetheassetsusing thestraightlinemethodover4years. Identifythejournalentriesthatwereactuallyrecordedbythetwocompaniesrelativetotheintraentitysale andsubsequentuseoftheasset. 1. OnPeppaCorp.sBooks: DATE 10/1 2011 ACCOUNTNAMES Cash AccumulatedDepreciationHC5,000,000CV$2,400,000=AD DEBIT X3,000,000 2,600,000 CREDIT CourseOutline#6:IntraEntityTransactions Page11of16 2,000,000 X5,000,000 DeliveryTrucks GainonSaleofDeliveryTrucks$3M$2.4M 600,000 OnSaltInc.sBooks: DATE ACCOUNTNAMES 10/1 2011 DeliveryTrucks DEBIT X3,000,000 Cash 12/31 2011 DepreciationExpense CREDIT X3,000,000 ($3,000,0000)4yearsX3/12 187,500 AccumulatedDepreciation 187,500 Identifythesummarycombinedeffectsofthejournalentriesthatwereactuallyrecordedbythetwo companiesrelativetotheintraentitysaleoftheasset. 2. DATE 10/1 2011 ACCOUNTNAMES AccumulatedDepreciation(Peppa) DEBIT 2,600,000 DeliveryTrucks(DifferencebetweenPeppaandSalt) GainonSaleofDeliveryTrucks(Peppa) Fromaoneentityperspective: CREDIT Cashbalancedidntchangeshiftedpockets CVofTrucksincreasedbygainthroughtwoaccounts 2,000,000 600,000 CourseOutline#6:IntraEntityTransactions Page12of16 DepreciableAssetExample:(continued) Identifytheentrythatwasactuallyrecordedfordepreciationafterthesaleandtheentrythat wouldhave 3. beenrecordedfordepreciationifthesalenevertookplace. DATE 12/31 2011 ACCOUNTNAMES DEBIT DepreciationExpense(Salt) CREDIT 187,500 AccumulatedDepreciation(Salt) 187,500 ActuallyrecordedbySaltperabove 12/31 2011 DepreciationExpense(Peppa) 150,000 ($2,400,0000)4X3/12 AccumulatedDepreciation(Peppa) 150,000 WouldhavebeenrecordedbyPeppaifthesaleneverhappened Fromaoneentityperspective: ConsolidationEntry DATE 12/31/11 Actuallyrecorded$187,500insteadof$150,000$37,500extra Toomuchdepreciationrecordedbecauseofthegainrecognized Eliminate100%ofIntraEntityTransactionsincludingB/SEffects,Receivablesand Payables WORKSHEETENTRYONLY DeliveryTrucks(Peppa) DEBIT DifferenceOriginalHCvs.NewHC GainonSaleofDeliveryTrucks(Peppa) ALWAYS 100% AccumulatedDepreciation(Peppa) 12/31/11 2,000,000 600,000 2,600,000 TotalSellerAD AccumulatedDepreciation(Salt) 187,500 DepreciationExpense(Salt) 12/31/11 DepreciationExpense(PeppasBasis) AccumulatedDepreciation(PeppasBasis) CREDIT 187,500 150,000 150,000 CourseOutline#6:IntraEntityTransactions IV. Page13of16 IntraEntityInvestmentinBonds A. NatureandPurposeofTransactions B. ConsolidationProcessPretendtheinvestmentcancelledthedebt Youcantownaninvestmentinabondthatyouissuedandyoucanthavealiabilitytoyourself. 1. EliminateBondholdersInvestmentagainstBondIssuersLiability Effectivelyanearlyextinguishmentofdebtresultinginagain(loss) Constructivegain(loss)reportedinnetearnings Gain(Loss)fromanearlyextinguishmentofdebt CVofthebondliability Amountpaidtobuybond = Gain(Loss) 2. EliminateInterest RevenueagainstExpense ReceivableagainstPayable Example: OnNovember1,1996,SaltInc.issued$40,000,000of20yearbondsbearing8.0%interestpayablesemiannuallyon May1andNovember1.Thebondssoldfor$38,838,488thatresultedinayieldrateof8.3%. 1. PreparethejournalentrytorecordtheissuanceofthebondsbySaltInc.onNovember1,1996 OnSaltInc.sBooks: DATE ACCOUNTNAMES DEBIT CREDIT CourseOutline#6:IntraEntityTransactions 11/1 1996 Page14of16 Cash 38,838,488 DiscountonBondsPayable 1,161,512 BondsPayable 40,000,000 Example:(continued) HereisapartialamortizationscheduleforSaltInc.sbonds: Period Date 30 31 11/1/2011 5/1/2012 Interest Expense @8.3%ofCV 1,639,954 CashPaidfor Interest @8%ofFace 1,600,000 Amortization 39,954 CarryingValue ofBonds $39,516,960 39,556,914 OnNovember1,2011,PeppaCorp.purchased$5,000,000ofSaltInc.s20yearbondsfor$4,979,773whichresulted inayieldrateof8.1%. 2. IdentifytheamountsreportedbyPeppaCorp.andSaltInc.relativetothe$5,000,000ofbondsonNovember 1,2011. PeppaCorp. SaltInc. HeldtoMaturityInvestmentinBonds $4,979,773 PercentageOwnedbyPeppa: BondsPayable(carryingvalue) $4,939,620 SaltsCarryingValueofBondsOwnedbyPeppa: $5,000,000$40,000,000=1/8 3. $39,516,960X1/8=$4,939,620 ComputetheconstructivegainorlossfromtheeffectiveextinguishmentofaportionofSaltInc.sbondliability thatresultedfromtheintraentityinvestmentbyPeppaCorp. CVof$4,939,620ofdebtpaidoffwith$4,979,773 Lossof$40,153 HereisapartialamortizationscheduleforSaltInc.sbondsPeppaCorp.sinvestmentinSaltInc.sbondsandSalt Inc.sbondspayableownedbyPeppaCorp.: PeppaCorp.sInvestment SaltInc.sBondsPayable CourseOutline#6:IntraEntityTransactions Page15of16 inSaltInc.sBonds Period Interest Revenue Cash Interest 30 @8.1% @8% 31 201,681 32 201,749 33 ownedByPeppaCorp. Carrying Value Interest Expense Cash Interest Carrying Value 4,979,773 @8.3% @8% 4,939,620 200,000 4,981,454 204,994 200,000 4,944,614 200,000 4,983,203 205,201 200,000 4,949,816 201,820 200,000 4,985,023 205,417 200,000 4,955,233 34 201,893 200,000 4,986,916 205,642 200,000 4,960,875 35 201,970 200,000 4,988,886 205,876 200,000 4,966,752 36 202,050 200,000 4,990,936 206,120 200,000 4,972,872 37 202,133 200,000 4,993,069 206,374 200,000 4,979,246 38 202,219 200,000 4,995,288 206,639 200,000 4,985,885 39 202,309 200,000 4,997,597 206,914 200,000 4,992,799 40 202,403 200,000 5,000,000 207,201 200,000 5,000,000 Example:(continued) 4. Identifytheadjustingjournalentriesthatwereactuallyrecordedbythetwocompaniesrelativetotheintra entitybondsonDecember31,2011andtheireffectsontheinvestmentandbondliability. PeppaCorpsBooks DAT E 12/31 2011 ACCOUNTNAMES InterestReceivable InvestmentinBonds SaltInc.sBooks DEBIT CREDIT 12/31 2011 66,667 560 InterestRevenue DATE ACCOUNTNAMES DEBIT InterestExpense 68,331 InterestPayable 67,227 66,667 DiscountonBonds 1,664 Revenuefor2mos. $201,681X2/6=$67,227 Expensefor2mos. $204,994X2/6=$68,331 Receivablefor2mos. $200,000X2/6=$66,667 Payablefor2mos. Investment@11/1/2011 $4,979,773 CVofBonds@11/1/2011 Amortizationfor2mos. 560 Investment@12/31/2011 $4,980,333 CREDIT $66,667 $4,939,620 Amortizationfor2mos. 1,664 CVofBonds@12/31/2011 4,941,284 CourseOutline#6:IntraEntityTransactions Page16of16 FaceValue 5,000,000 DiscountBalance ConsolidationEntry DATE 12/31/11 58,716 Eliminate100%ofIntraEntityTransactionsincludingReceivablesandPayables WORKSHEETENTRYONLY BondsPayable(Salt) DEBIT CREDIT 5,000,000 LossonExtinguishmentofDebt 40,153 InterestRevenue(Peppa) 67,227 InterestPayable 66,667 DiscountonBonds InvestmentinBonds(Peppa) 58,716 4,980,333 InterestExpense 68,331 InterestReceivable 66,667

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