Chapter 6 CHAPTER SIX ELIMINATION OF UNREALIZED PROFIT ON INTERCOMPANY SALES OF INVENTORY 1. DEFINITIONS A. Affiliated group is used to refer to a parent and all subsidiaries for which consolidated financial statements are prepared; alternatively, this group may be referred to as the consolidated entity. B. D ownstream sales : Sales from a parent company to one or more of its subsidiaries. C. Upstream sales: Sales from subsidiaries to the parent company. D. Horizontal sales: Sales from one subsidiary to another subsidiary. E. Unrealized intercompany profit (loss): Profit (loss) that has not been realized from the point of view of the consolidated entity through subsequent sales to third parties. It must be eliminated in the preparation of consolidated financial statements. II. EFFECTS OF INTERCOMPANY SALES OF MERCHANDISE ON THE DETERMINATION OF CONSOLIDATED BALANCES A. Objectives and Assumptions 1. The workpaper procedures illustrated in this chapter are designed to accomplish the following financial reporting objectives in the consolidated financial statements. a. Consolidated sales include only sales with parties outside the affiliated group. b. Consolidated cost of sales includes only the cost to the affiliated group of goods that have been sold to parties outside the affiliated group. c. Consolidated inventory on the Balance Sheet is recorded at its cost to the affiliated group. 2. Stated another way, the objective of eliminating the effects of intercompany sales of merchandise is to present consolidated balances for sales, cost of sales, and inventory as if the intercompany sale had never occurred. As a result, the recognition of income or loss on the intercompany transaction, including its allocation between the noncontrolling and controlling interests, is deferred until the profit or loss is confirmed by sales of the merchandise to nonaffiliates. 3. In order to concentrate on intercompany profit eliminations and adjustments, reporting complications relating to accounting for the difference between implied and book value are avoided in all illustrations by assuming that all acquisitions are made at the book value of the acquired interest in net assets and that the book value of the subsidiary company's net assets equals their fair value on the date the parent company's interest is acquired. It is also assumed that the affiliates file consolidated income tax returns. If the affiliates file separate tax returns, deferred tax issues arise. These are addressed in the appendix to this chapter. 1
Chapter 6 B. Determination of Consolidated Sales, Cost of Sales, and Inventory Balances Assuming Downstream Sales 1. Cost or Partial Equity Method 2. Complete Equity Method C. Determination of Amount of Intercompany Profit 1. In the preceding examples, the amount of intercompany profit subject to elimination was calculated on the basis of the selling affiliate's gross profit rate . This is the concept that is normally applied in practice. An alternative
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- Fall '13
- Generally Accepted Accounting Principles, Parent company, consolidated net income