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CHAPTER 5: INTERCOMPANY ASSET TRANSACTIONS Worksheet adjustments are required when one affiliate transfers assets to another affiliate and records a profit. As we discussed in Chapter 1, profits are earned only when the affiliates sell to enterprises outside the consolidated group. I. Objectives of elimination entries : 1. Proper valuation in the consolidated balance sheet (maintain historical cost to the combined entity 2. Matching in the consolidated income statement (defer the unrealized gain until it is sold to an unrelated third party, or used up in operations) II. Two basic types of inter-company profit transactions . 1. Inter-company inventory sales (gain realized when sold - next period 2. Inter-company fixed asset sales a. Land (gain realized when sold) b. Depreciable asset (as it is used over the life of the asset) III. Inter-company profit in inventory P owns a controlling interest in S Inventory Purchase Cost = $10 sells to Price = $15 The accounting systems of the two companies will record the transfer as a sale by P and a purchase by S On P's books On S's books Cash $15 Purchases $15 Sales $15 Cash $15 1. Several worksheet problems are thus created : a. From a consolidated standpoint, both sales and purchases are overstated by $15. b. If the inter-company purchases remain in inventory at year-end, ending inventory is overstated. Chapter 5: Study Notes 1
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c. Inter-company inventory profits complicate the allocation of consolidated net income to the controlling andnon-controlling interests. d. The way the parent maintains the investment account changes the form of the elimination entries. Cost and Partial Equity create one form and Equity creates a different form. e. The direction of sale (upstream or downstream) causes differences in elimination entries. f. The consolidation shifts the gain from the period of transfer into the time period when the goods are sold to outside parties. 2. Example - Inter-company profit in inventory Company P sells to Company S ( downstream ) merchandise at a 25% gross profit rate. At the consolidated worksheet date, the following amounts of intercompany purchases remain in S's inventory accounts. Beginning inventory $ 45,000 Ending inventory 57,000 Inter-company sales (gross) 250,000 The key to understanding the elimination entries for inventory is to remember the CGS equation. *G TI G CGS = BI + Purchases – EI Each right hand component in the equation implies an elimination entry. The author of your text labels these: TI - elimination of the T ransfers of I nventory; sales and purchases balances are eliminated in total because the transaction was not made with an outside, unrelated party. G - Removal of unrealized G ains in EI on both the balance sheet & in the CGS component on the income statement *G - removal of unrecognized G ains in the BI component of the CGS and Beg RE of the seller because the the effects of the transfer carry over into the subsequent period. If the equity method was used and it is a downstream transfer, the RE account will be correct
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