CHAPTER
Transactions: Merchandise, Plant Assets, and Notes
Fundamentals of Advanced Accounting 1st Edition
Fischer, Taylor, and Cheng
44
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #2
Intercompany Transactions
• Transactions between parent and sub• Must be eliminated
– Consolidated statements represent separate companies as if they were one entity
• Common intercompany transactions– Merchandise for resale– Land– Fixed assets– Notes receivable/payable
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #3
Intercompany Sales Effect on Gross Profit
• Parent sells inventory to Sub:Cost = $1,000 Sell price = $1,200
• Sub sells to outside party:Cost = $1,200 Sell price = $1,500
Includes Interco. Sales
Excludes Interco. Sales
Sales 2,700 1,500Less: Cost of Sales 2,200 1,000Gross Profit 500 500GP % 19% 33%
•Gross Profit is unaffected.
•Gross Profit % is distorted unless intercompany transactions are eliminated.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #4
Intercompany Transactions
• Intercompany receivables/payables must be eliminated!– Represent transfers of funds– Internal loans
• No profit on intercompany sales can be recognized!– Unless goods are sold to an outside party
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #5
Elimination of Intercompany Inventory Sales
• Discussed in four sections– No intercompany goods in beginning or
ending inventory– Intercompany goods in ending inventory– Intercompany goods in both beginning and
ending inventory– Intercompany goods in both beginning and
ending inventory: Periodic inventory method
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #6
No Intercompany Goods – Beginning or Ending Inventory
Review worksheet 4-1
• P owns 80% of S’ stock.• Purchase price = pro rata share of sub’s book
value.• P uses the equity method.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #7
No Intercompany Goods – Beginning or Ending Inventory (Continued)
Parent SubSales 700,000 500,000Less: Cost of Goods Sold 510,000 350,000Gross Profit 190,000 150,000Other Expenses (90,000) (75,000)Subsidiary Income 60,000Net income 160,000 75,000
•Sub sells inventory to parent•Cost = $80,000 Sell price = $100,000 GP% = 20%
•Parent sells inventory to third party•Cost = $100,000 Sell price = $150,000
•Parent owes $25,000 to sub for inventory purchases
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #8
No Intercompany Goods – Beginning or Ending Inventory (Continued)
CY1 Sub Income - Par 60,000Invest. In Sub - Par 60,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub 80,000 Retained Earnings - Sub 56,000
Invest. In Sub - Par 136,000(Eliminates investment account against 80% of equity)
IS Sales 100,000Cost of goods sold** 100,000
(Eliminates intercompany merchandise sales)
IA Account payable 25,000Accounts receivable 25,000
(Eliminates intercompany unpaid trade balances)**Includes $80,000 C of G S from Sub to Parent and $20,000 C of G S from Parent
to outside party.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #9
Intercompany Inventory Remains in Ending Inventory
Review worksheet 4-2• Assume same facts as to acquisition.• Sub sells inventory to parent
– Cost = $80,000 Sell price = $100,000 GP% = 20%
• Parent sells inventory to third party– Cost = $60,000 Sell price = $90,000
• Intercompany inventory of $40,000 in parent’s ending inventory
• Parent owes $25,000 to sub for inventory purchases
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #10
Intercompany Inventory Remains in Ending Inventory (continued)
CY1 Sub Income - Par 60,000Invest. In Sub - Par 60,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub 80,000 Retained Earnings - Sub 56,000
Invest. In Sub - Par 136,000(Eliminates investment account against 80% of equity)
IS Sales 100,000Cost of goods sold 100,000
(Eliminates intercompany merchandise sales)
EI Cost of goods sold 8,000Inventory 8,000
(Eliminates intercompany profit in ending inventory)
IA Account payable 25,000Accounts receivable 25,000
(Eliminates intercompany unpaid trade balances)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #11
Intercompany Inventory in Beginning and Ending Inventory
Parent SubSales 800,000 600,000Less: Cost of Goods Sold 610,000 440,000Gross Profit 190,000 160,000Other Expenses (120,000) (100,000)Subsidiary Income 48,000Net income 118,000 60,000
•Parent’s 1/1 inventory includes $40,000 of interco. goods.•Sub sold $120,000 of goods to parent.•Sub recorded 20% gross profit on interco. sales.•Parent owes $60,000 to sub for inventory at 12/31.•Parent’s 12/31 inventory includes $30,000 of interco. goods.
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #12
Intercompany Inventory Remains in Ending Inventory – Journal Entries
CY1 Sub Income - Par 48,000Invest. In Sub - Par 48,000
(Eliminates current year income and creates date alignment)
EL Common Stock - Sub 80,000Retained Earnings - Sub 116,000
Invest. In Sub - Par 196,000(Eliminates investment account against 80% of equity)
BI Retained Earnings 1/1 - Par 6,400Retained Earnings 1/1 - Sub 1,600
Invest. In Sub - Par 8,000(Eliminates profit in beginning inventory and reduces current year C of G S)
IS Sales 120,000Cost of goods sold 120,000
(Eliminates intercompany merchandise sales)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #13
Intercompany Inventory Remains in Ending Inventory – Journal Entries (continued)
EI Cost of goods sold 6,000Inventory 6,000
(Eliminates intercompany profit in ending inventory)
IA Account payable 60,000Accounts receivable 60,000
(Eliminates intercompany unpaid trade balances)
Review worksheet 4-3
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #14
Eliminations for Periodic Inventories
Review worksheet 4-4• Beginning inventory balances appear in the
trial balance• Purchases account appears in trial balance• Entry BI credits beginning inventory balance• Entry IS credits the purchases account• Ending inventory balances appear as:
– A debit to inventory– A credit to cost of goods sold
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #15
Intercompany Sales of Plant Assets
• Any plant asset can be sold between parent and sub
• Sale of assets can result in gains/losses• Buyer records asset at purchase price (includes
gain/loss)• In consolidation, sale of plant assets are
considered internal transfers• Depreciable vs. non-depreciable asset transfer
– Non-depreciable: defer gain until sold to outside party– Depreciable: amortize gain/loss over useful life
• Adjust depreciation of transferred asset in consolidation to reflect original cost
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #16
Sale of Non-Depreciable Asset
•Elimination entry “LA” – Eliminates the interco. gain in year of sale– Eliminates the interco. gain from retained
earnings in years subsequent to sale– Reclassifies gain from retained earnings to
current year gain/lossExample•Sub (80% owned) sells land to Parent•Sale price: $30,000•Cost: $20,000•$10,000 gain is deferred
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #17
Example: Sub (80%) Sells Land to Parent
Year of sale: LA Gain on land sale 10,000Land 10,000
Gain is deferred until land is sold to outside party!
Later years: LA RE - Sub 2,000RE - Parent 8,000
Land 10,000
Year of sale to third party:LA RE - Sub 2,000
RE – Parent 8,000Gain on land sale 10,000
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #18
Sale of Depreciable Asset
•Elimination entries “F” – F1:
• Year of sale: Eliminates the interco. gain• Years subsequent to sale:
– Eliminates the interco. gain from retained earnings
– Corrects accumulated depreciation – F2:
• Adjusts depreciation back to calculation based on historical cost
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #19
Sale of Depreciable Asset (Example)
Example• Parent sells machine to Sub • Sale price: $30,000• Historical cost: $32,000• Accumulated depreciation: $12,000• $10,000 gain based on $20,000 net
book value• Sub assumes 5 year remaining life
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #20
Sale of Depreciable Asset – Elimination Entries
Year of sale:
F1 Gain on sale of machine 10,000Machine 10,000
(Defer gain on sale and return asset to cost)
F2 Accum. Depreciation 2,000 Depreciation Expense 2,000 (Reduce to depreciation based on historical cost)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #21
Sale of Depreciable Asset – Elimination Entries (continued)
Year after sale:
F1 Retained earnings 8,000Accum. Depreciation 2,000
Machine 10,000 (Defer gain on sale and return asset to cost)
F2 Accum. Depreciation 2,000 Depreciation Expense 2,000 (Reduce to depreciation based on historical cost)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #22
Fixed Asset Worksheets
WS 4-5 (year of sale)• F1 removes $10,000 profit from machinery; defers
$10,000 gain• F2 adjusts depreciation and realizes $2,000 gain• IDS takes away $10,000 from P [seller], gives back
$2,000
WS 4-6 (end of second period after sale)• F1 removes profit from machinery; corrects last year's
depreciation and defers $8,000 profit as of 1/1/X2• F2 adjusts depreciation and realizes $2,000 gain• IDS just gives back $2,000 currently realized gain to P
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #23
Intercompany Debt
• Common for parent to lend funds to sub• Parent charges sub interest• Entry LN:
– LN1• Eliminates intercompany debt• Eliminates accrued interest
– LN2• Eliminates intercompany interest revenue/expense
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #24
Intercompany Debt - Example
• 7/1 Sub borrows 10,000 from Parent• Maturity: 1 year• Interest rate: 8%• Interest due at maturity• Interest accrued at 12/31: $400
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 4, Slide #25
Intercompany Debt – Elimination Entries
LN1 Note payable 10,000Note receivable 10,000
Interest payable 400Interest receivable 400
(Eliminate interco. debt and accrued interest)
LN2 Interest income 400 Interest expense 400 (Eliminate interco. interest)