Advanced Accounting

by Debra Jeter and Paul Chaney

Chapter 6: Elimination of
Unrealized
Profit on Intercompany
Sales of Inventory

Slides Authored by Hannah Wong, Ph.D.

Rutgers University
obj 6-1
 Intercompany Sales of Inventory

Parent Company

Downstream Sale
Upstream Sale

Subsidiary
Subsidiary
Horizontal Sale

obj 1 6-2
 Financial Reporting Objectives

Consolidated sales = sales with

parties outside the affiliated group
Consolidated COGS = cost to the
affiliated group of goods that have
been sold to outside parties
Consolidated inventory =
inventory at its cost to the
affiliated group
obj 1 6-3
 Financial Reporting Objectives

To present
consolidated
balances of sales,
cost of sales, and
inventory as if the
intercompany sale
had never occurred.
obj 1 6-4
 Downstream Sales :
No Unrealized Profit

Outsider Parent
Supplier Purchased Company
for
$200,000

Sold for
$250,000

Sold for
$270,000
Subsidiary Outside
Customer

obj 2 6-5
 Downstream Sales
No Unrealized Profit - EE

Sales 250,000

Purchases 250,000

To eliminate To eliminate intercompany

intercompany sale purchase that the
that the parent subsidiary has recorded
has recorded

obj 2 6-6
 Downstream Sales:
Unrealized Profit in Ending Inventory

Outsider Parent
Supplier Purchased Company
for
$200,000
Sold for
$250,00
0
Note: it is the parent
who records the
intercompany profit, thus
the parents income needs Sold 60%
to be adjusted in of goods Outside
Subsidiary
consolidation Customer

obj 2 6-7
 Downstream Sales - EE
Year of Intercompany Sale
Sales 250,000
Purchases 250,000

To eliminate intercompany sale and purchases

Ending Inventory - Inc. state. (COGS) 20,000

Inventory - balance sheet 20,000

To exclude the unrealized

profit from consolidated To exclude the unrealized
net income profit from ending inventory

obj 2 6-8
 Downstream Sales - EE
Year after Intercompany Sale

Cost or Partial Equity Methods

Beginning R/E - P 20,000

Beginning Inventory - Inc. State. (Cost of sales) 20,000

The intercompany profit in

beginning inventory is To include the intercompany
excluded from last years profit in beginning inventory,
consolidated NI, hence which is realized
this years 1/1 R/E in the current year

obj 2 6-9
 Downstream Sales - EE
Year after Intercompany Sale

Complete Equity Method

Investment in S 20,000
Beginning Inventory - Inc. State. (Cost of sales) 20,000

The intercompany profit in

beginning inventory is
excluded from last years
consolidated NI, hence
the investment account
obj 2
To include the intercompany
profit in beginning inventory,
which is realized
in the current year
6 - 10
 Amount of Intercompany Profit

Gross profit method

intercompany profit that should be eliminated
= ending inventory of buying affiliate
x selling affiliates gross profit rate
(i.e., gross profit / cost)

obj 2 6 - 11
 Elimination of Downstream
Intercompany Profit
100% elimination
eliminatethe parents and the noncontrolling
stockholders portion of intercompany profit
despite partial ownership of the parent
required by current GAAP

Partial elimination
eliminate
only the parents portion of
intercompany profit

obj 3 6 - 12
 Upstream Sales

Outsider Purchase
Supplier Subsidiary

Intercompany
Sale
Note: it is the subsidiary
who records the
intercompany profit, thus
the subsidiarys income
needs to be adjusted in Parent Outside
Sell
consolidation Customer
Company

obj 4 6 - 13
 Upstream Sales
An Example

$400,000
Profit margin intercompany
80% owned Parent
= 25% merchandise in
Subsidiary Total sales Company
x selling price ending
$700,000 inventory

obj 4, 6 - 14
 Upstream Sales
Cost or Partial Equity Methods

Year of Intercompany Sale - EEs

Sales 700,000
Purchases 700,000
To eliminate intercompany sale and purchases

Ending Inventory - Inc. state. (COGS) 100,000

Inventory - balance sheet
100,000
To exclude the unrealized
profit (400,000x25%) To exclude the unrealized
from consolidated profit from ending inventory
net income
obj 4, 6 - 15
 Upstream Sales - EE
Cost or Partial Equity Methods
Year after Intercompany Sale - EEs

Parents share of unrealized

profit in beginning inventory

Beginning R/E - P ($100,000x80%) 80,000

Beginning R/E - S ($100,000x20%) 20,000
Beginning Inventory - Inc. State. (Cost of sales)
100,000

To include the intercompany

Noncontrolling interests share profit in beginning inventory,
of unrealized profit in which is realized
beginning inventory in the current year

obj 4, 6 - 16
 Cost or Partial Equity Methods

Noncontrolling Interest in Income

Reported income of S
Upstream-sale profit in Upstream-sale profit in
ending inventory beginning inventory

Adjusted NI of S
x Noncontrolling %

Noncontrolling interest in income

obj 4, 6 - 17
 Cost and Partial Equity Methods

Controlling Interest in Income

Downstream-sale profit Reported income of P

in ending inventory
Downstream-sale profit
Amortization of purchase
differential in beginning inventory

(Adjusted NI of S) x (P %)

Consolidated income

obj 4, 6 - 18
 Cost and Partial Equity Methods

Consolidated Retained Earnings

P% x (Upstream-sale profit
in Ps ending inventory) Reported R/E of P

Downstream-sale profit
in Ss ending inventory Ps share of increase in
Accumulative amortization S R/E since acquisition
of purchase differential

Consolidated R/E

obj 4, 6 - 19
 Upstream Sales
Complete Equity Method

Year of Intercompany Sales - Journal Entries

Equity in subsidiary income 80,000

Investment in S 80,000

To exclude the unrealized profit (400,000x25%)

from equity in subsidiary income

obj 4, 6 - 20
 Upstream Sales
Complete Equity Method

Year after Intercompany Sales - Journal Entries

Investment in S 80,000
Equity in subsidiary net income
80,000

To include in equity in subsidiary income the intercompany

profit, which is realized in the current year

obj 4, 6 - 21
 Upstream Sales
Complete Equity Method
Year of Intercompany Sales - EEs
Sales 700,000
Purchases 700,000

To eliminate intercompany sale and purchases

Ending Inventory - Income Statement 100,000

Inventory - Balance Sheet 100,000

To exclude the unrealized profit (400,000x25%)

from equity in subsidiary income

obj 4, 6 - 22
 Upstream Sales
Complete Equity Method
Year after Intercompany Sale - EE
Parents share of unrealized
profit in beginning inventory

Investment in S 80,000
Beginning retained earnings - S 20,000
1/1 Inventory - Income Statement 100,000

Noncontrolling interests share To include the intercompany

of unrealized profit in profit in beginning inventory,
beginning inventory which is realized
in the current year

obj 4, 6 - 23
 Upstream Sales
Complete Equity Method

Consolidated net income

= Reported net income of Parent

Consolidated retained earnings

= Reported retained earnings of Parent

obj 4, 6 - 24
 Add Excel for L06

obj 6 6 - 25
 Preaffiliation Profit
Should We Eliminate?

GAAP is silent as to elimination of

preaffiliation profit.
If selling company is the
subsidiary, the retained earning is
eliminated in consolidation.
If selling company is the parent,
elimination would cause double
counting of profit.

obj 7 6 - 26
 Advanced Accounting
by
Debra Jeter and Paul Chaney

Copyright 2003 John Wiley & Sons, Inc. All rights reserved.
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obj 6 - 27