Download - CHAPTER 9
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CHAPTER 9
INTERCOMPANY INVENTORY TRANSFERS
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FOCUS OF CHAPTER 9
• Conceptual Issues• Procedures for Calculating Unrealized Profit• Procedures for Deferring Unrealized Profit:
– The Complete Equity Method– The Partial Equity Method– The Cost Method
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Conceptual Issues: Issue #1Should We or Shouldn’t We?
• Whether to Eliminate Intercompany Transactions in Consolidation:– No controversy—they must be
eliminated.– Not eliminating causes two problems:
• Meaningless double-counting of (1) sales and (2) cost and expenses.
• Potential to manipulate income.
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The Substance of Inventory Transfers
• The CONSOLIDATED Perspective:– Merely the physical movement of
inventory from one location to another location.
– Similar to the movement of inventory from one division to another division.
– NOT a bona fide transaction.• The SEPARATE COMPANY Perspective:
– A bona fide transaction.
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Conceptual Issues: Issue #2Which Measure of Profit To Use?
• Possible Theoretical Profit Measures:– Gross profit.– Operating profit.– Net income.
• Profit Measure Required To Be Used By GAAP:– GROSS PROFIT
(of the selling entity).Sales.................... $1,000Cost of sales....... (600) GROSS profit. $ 400
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Conceptual Issues: Issue #3Whether To Eliminate Income Tax Effects ?
• Income taxes on the selling entity’s UNREALIZED gross profit must also be eliminated.
• In this chapter :– No income tax entries are required.– Because we assume that the tax effects
have already been recorded in the parent’s or the subsidiary’s general ledger.• DONE FOR SIMPLICITY ONLY.
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Conceptual Issues: Issue #4Whether To Eliminate All or Some?
• DOWNSTREAM Sales to a Partially Owned Subsidiary:– Eliminate 100% of unrealized profit.– Fractional elimination is prohibited.
• UPSTREAM Sales from a Partially Owned Subsidiary:– Eliminate 100% of unrealized profit.– Fractional elimination is prohibited.
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Conceptual Issues: Issue #5Whether To Share the Deferral?
• DOWNSTREAM Sales to a Partially Owned Subsidiary:– Entire profit accrues to the parent—thus
sharing is not appropriate.• UPSTREAM Sales from a Partially
Owned Subsidiary:– Must share deferral with the NCI
shareholders (if amount is material).
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Inventory Transfers: A Whole New Slant on “Realization”
• REALIZATION—What to focus on for consolidated reporting purposes:– Not on whether the SELLER has—
• Delivered the product,• Collected on the sale, or• Reduced to an acceptable level the
uncertainty about the net cash flow effect of an earnings activity.
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Inventory Transfers: A Whole New Slant on “Realization”
• REALIZATION—What to focus on for consolidated reporting purposes:– But on whether the BUYER has:
• Resold the inventory to an outside unaffiliated customer.
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Inventory Transfers: Unrealized Profit—Searching for that Old Basis • The Objective:
– To change the inventory’s carrying value from the NEW basis of accounting to the OLD basis of accounting.
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Inventory Transfers: Calculating Unrealized Gross Profit—The Analysis
Amounts That Will ALWAYS Be Known (Given): Re- On Total Sold HandInterco. sales (NEW basis)............. $1,000 $200Interco. cost of sales (OLD basis).. (600) ____ ____ Gross Profit.................................... $ 400 Gross Profit Percentage............... 40%
CRITICAL ASSUMPTION: The gross profit percentage derivable from the total column applies to both (1) the inventory that has been resold AND (2) the inventory that is still on hand.
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Inventory Transfers: Calculating Unrealized Gross Profit—The Analysis
Completed Analysis: Re- On Total Sold HandInterco. sales (NEW basis).............. $1,000 $800 $200Interco. cost of sales (OLD basis).. (600) (480) (120) Gross Profit.................................... $ 400 $320 $ 80
REALIZED UNREALIZED The Inventory/COS Change in Basis Elimination Entry is derived from this analysis.
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Inventory Transfers: A Point to Remember
• Intercompany Sales and Intercompany Cost of Sales accounts are eliminated only in years in which intercompany sales occur.
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Inventory Transfers: The Two Procedural Methods
• MODULE 1: The Complete Equity Method:– Unrealized profit is deferred in the
selling entity’s general ledger.• MODULE 2: The Partial Equity Method:
– Unrealized profit is deferred in the consolidation process.
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Miscellaneous:Lower-of-Cost-or-Market Adjustments
• For consolidated reporting purposes, the appropriate valuation of intercompany- acquired inventory is:
– The lower of:(1) the selling entity’s cost or(2) the market value.
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Miscellaneous: Partial Ownerships—Reporting to the NCI Shareholders
• Under existing GAAP, a partially owned subsidiary:– Need not defer any of its unrealized
intercompany gross profit in reporting to its NCI shareholders.
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Review Question #1For 2006, Paxco reported $60,000 of intercompany sales (25% markup on cost and fully paid for by Y/E) to Saxco, which reported $20,000 of intercompany acquired inventory at 12/31/06. The unrealized profit at 12/31/06 is:A. $ -0- B. $4,000 C. $5,000 D. $20,000 E. None of the above.
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Review Question #1With Answer
For 2006, Paxco reported $60,000 of intercompany sales (25% markup on cost and fully paid for by Y/E) to Saxco, which reported $20,000 of intercompany acquired inventory at 12/31/06. The unrealized profit at 12/31/06 is:A. $ -0- B. $4,000 (20% of $20,000 Y/E inventory) C. $5,000 D. $20,000 E. None of the above.
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Review Question #2For 2006, Punco reported intercompany cost of sales of $1,600,000 (markup is 20% of transfer price) to Sunco, which reported $600,000 of intercompany acquired inventory at 12/31/06. The unrealized profit at 12/31/06 is:A. $80,000 B. $96,000 C. $120,000 D. $150,000 E. None of the above.
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Review Question #2With Answer
For 2006, Punco reported intercompany cost of sales of $1,600,000 (markup is 20% of transfer price) to Sunco, which reported $600,000 of intercompany acquired inventory at 12/31/06. The unrealized profit at 12/31/06 is:A. $80,000 B. $96,000 C. $120,000 (20% of $600,000 Y/E inventory)D. $150,000 E. None of the above.
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Review Question #3For 2006, Salco (80% owned by Palco) reported $800,000 of intercompany sales (1/3 markup on cost) to Palco, which resold $700,000 of this inventory by 12/31/06. The unrealized profit at 12/31/06 is:A. $20,000 B. $25,000 C. $26,667 D. $33,333 E. None of the above.
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Review Question #3With Answer
For 2006, Salco (80% owned by Palco) reported $800,000 of intercompany sales (1/3 markup on cost) to Palco, which resold $700,000 of this inventory by 12/31/06. The unrealized profit at 12/31/06 is:A. $20,000 B. $25,000 (25% x $100,000 inventory on hand)
C. $26,667 D. $33,333 E. None of the above.
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End of Chapter 9 Time to Clear Things Up—Any
Questions?