1 – Intercompany Transactions - Heading
Chapter 4 – Intercompany Transactions
• Affiliated Cos do business with each other
– E.g., S sells merchandise to P
• Books of P & S fully reflect transactions
B k h ll f th l j l t i
2 – Parent & Subsidiary Shown As 1 Company in Consolidation Financial Statements
– Books have all of the regular journal entries – E.g., books have:
• S has A/R from P • P has A/P to S
• In Consolidation P & S are shown as 1 Co.
– E.g., Must eliminate intercompany accounts (A/R & A/P)E.g., Must eliminate intercompany accounts (A/R & A/P)
• Because one Co doesn’t not owe $ to itself
– These WS entries same regardless of accounting method
• Cost, Simple Equity or Sophisticated Equity Methods
3 – Intercompany Sales of Merchandise - Heading
Intercompany Sales of Merchandise
4 – Intercompany Sales of Merchandise E.g. - #1
• Assume P sells inventory to S
– Inv orig cost $1,000 – Inv sold by P to S for $1,200 – Inv sold by S for $1,500 to 3y , rdpartyp y
• W/O eliminations
– Total Sales & Total COGS too high
S P Total
Sales $1,500 $1,200 $2,700
L COGS 1200 1000 2200
Less: COGS 1200 1000 2200
5 – Intercompany Sales of Merchandise E.g. - #2
• Consolidation shows P & S as 1 Co • Need to eliminate intercompany sale
– Get rid of $1,200 transfer price
Get rid of $1 200 COGS based on intercompany sale – Get rid of $1,200 COGS based on intercompany sale
• If you do this:
Sales $1,500 ($1500 sale to 3rdparty)
Less: COGS 1000 ($1000 original cost to Parent) Less: COGS 1000 ($1000 original cost to Parent)
Gross Profit $500
• This is done in IS entry
– IS stands for Intercompany Sale 6 – Worksheet Entry Intracompany Sale of Merchandise E.g. - #3
IS D. Sales Revenue (1stSeller) $1,200
IS C. Cost of Goods Sold (2ndSeller) $1,200
7 – IA Entry
• If intercompany sale is credit sale:
– Must eliminate A/R & A/P
• Called Intercompany Accounts
Reporting as if P & S are 1Co • Reporting as if P & S are 1Co
– You don’t owe $ to yourself
• Use End of Year Balance of A/R&A/P
IA D. Accounts Payable (2y ( ndSeller)) $1,200,
IA C. Accounts Receivable (1stSeller) $1,200
8 – Division of Profit From Sale of Merchandise Inventory - #2
• In E.g. $500 profit
– Who gets it?
– Intercompany price divides it between P & S
• P gets $200 of profit ($1200 -$1000) &P gets $200 of profit ($1200 -$1000) & • S gets $300 of profit ($1500 - $1200)
• $1,200 price used to divide $500 profit between P&S:
S P Total
Sales $1,500 $1,200 $2,700
Less: COGS 1200 1000 2200
9 – Division of Profit From Sale of Merchandise Inventory - #2
• These WS entries are the same regardless of whether you have a NCI
• You are presenting both P&S as if they are 1 Co.
Th i t f NCI d ’t h thi
– The existence of NCI doesn’t change this – It only affects who gets equity
10 – EI Entry - Heading
EI Entry
• No real sale unless you have sale to 3
rdparty (unrelated)
• Without sale to 3
rdparty
11 – Need Sale to Unrelated Third Party
• Without sale to 3
rdparty
– Really just moving inventory from seller’s to buyer’s place of business
– Reporting as if 1 Co
• You can’t sell something to yourself
d – No rev recognized unless ultimate sale to 3rd
party
12 – Division of Profit From Sale of Merchandise Inventory - #2
S P Total Sales $1,500 $1,200 $2,700 Less: COGS 1200 1000 2200 d $ Less: COGS 1200 1000 2200 Gross Profit $300 $200 $500 Not Booked Booked
• If no sale to 3rdparty P has taken $200 profit on its books
• We want to delay $200K profit until S sells inv to 3rdParty
BIG PICTURE:
• Until sale to 3
rdparty
GAAP requires
– Seller does not recognizes profit from13 – Defer Profit Until Sale to Third Party
intercompany sale
– Intercompany profit deferred (suspended) until sale to 3rdparty
– Inventory reduced to orig cost
• After sale to 3
After sale to 3 party
rdparty
– P & S then report their share of profit on sale of merchandise
• If merchandise not sold to 3rdparty in 1styear: • 1st, do WS entries as if sale to outsider:
– Same as before 14 – EI Entry - #1
IS D. Sales Revenue (1stSeller) $1,200
IS C. Cost of Goods Sold (2ndSeller) $1,200
IA D. Accounts Payable (2ndSeller) $1,200
IA C. Accounts Receivable (1stSeller) $1,200
15 – EI Entry - #2
• Then, We need to:
– Eliminate markup from inventory
• Credit Inventory for amount of Seller’s deferred profit
– Eliminate Seller’s profit:p
• Debit COGS for amount of Seller’s deferred profit
– An increased COGS reduces profit – Allocate increased exp (COGS) to 1stSeller
• Done in EI Entry
– EI stands for Ending Inventory
• It suspends on WS (not books of P&S) the profit from the
EI D. Cost of Goods Sold $200
EI C. Inventory $200
It suspends on WS (not books of P&S) the profit from the 1stsale (and the corresponding mark up of inv) until after the inv is sold in the 2ndsale.
16 – EI entry E.g., - #101
• E.g., Assume
– P buys inv for $10,000
– P sells inv to S for $15,000 on credit
• 50% Mark Up
– S does not sell inv to 3rdparty in 1styear
• We do the following on the WS
IS D. Sales Revenue $15,000
IS C. Cost of Goods Sold $15,000
IA D. Accounts Payable $15,000
17 – EI Entry E.g., - #102
• S has all of inv at end of year • EI entry
– Defers P’s profit
EI D. Cost of Goods Sold $5,000
EI C Inventory $5 000
• Done with debit to COGS
– Reduces cost of inv to orig cost
• Done with credit to Inv
EI C. Inventory $5,000
18 – EI Entry E.g., - #102
Intercompany Sale D A/R 15000 Seller’s Books -- Revenue C Sales 15000 Seller’s Books Intercompany Sale D COGS 10000 Seller’s Books -- COGS C Inv 10000 Seller’s Books
• WS entries eliminate effects of intercompany sale
COGS C Inv. 10000 Seller s Books Intercompany Sale D Inv. 15000 Buyer’s Books -- Purchase Inventory C A/P 15000 Buyer’s Books
IS Entry D Sales 15000 WS C COGS 15000 WS IA Entry D A/P 15000 WS C A/R 15000 WS C A/R 15000 WS EI Entry D COGS 5000 WS C Inv 5000 WS
• After these entries NOTHING LEFT OF INTERCOMPANY SALE
19 – EI entry E.g., - #201
• What if S sold half of the inventory
– Half is still unsold.
• E.g., Assume
– P buys inv for $10,000
– P sells inv to S for $15,000 on credit
• 50% Mark Up
– S sells ½ of inv to 3rdparty in 1styear for $10,000 on credit
IS D. Sales Revenue $15,000
IS D. Sales Revenue $15,000
IS C. Cost of Goods Sold $15,000
IA D. Accounts Payable $15,000
IA C. Accounts Receivable $15,000
20 – EI Entry E.g., - #202
• S has ½ of inv at end of year • EI entry
– Defers P’s profit on unsold ½ of inv
EI D. Cost of Goods Sold $2,500
EI C Inventory $2 500
• Done with debit to COGS
– Reduces cost of ½ of inv to orig cost
• Done with credit to Inv
21 – EI Entry E.g., - #203
• If ½ of intercompany merchandise is sold to 3rd party for $10,000
– Sales Rev should be $10,000
• This is the sale to the 3rdparty – real sale – A/R should be $10,000
• This is the amount owed by 3rdparty – real A/R – COGS should be $5,000
• This is the original cost of the inventory sold to 3rdparty • ½ of orig cost ($10,000/2)g ( )
– Inv should go down by $5,000
• This is the original cost of the inventory sold to 3rdparty • ½ of orig cost
22
Intercompany Sale D A/R 15000 Seller’s Books
-- Revenue C Sales 15000 Seller’s Books
Intercompany Sale D COGS 10000 Seller’s Books
-- COGS C Inv. 10000 Seller’s Books
Intercompany Sale D Inv. 15000 Buyer’s Books
-- Purchase Inventory C A/P 15000 Buyer’s Books
3rdP t S l D A/R 10000 B ’ B k
3rdParty Sale D A/R 10000 Buyer’s Books
-- Revenue C Sales 10000 Buyer’s Books
3rdParty Sale D COGS 7500 Buyer’s Books
-- COGS C Inv. 7500 Buyer’s Books
IS Entry D Sales 15000 WS C COGS 15000 WS IA Entry D A/P 15000 WS C A/R 15000 WS EI Entry D COGS 2500 WS C Inv 2500 WS
• After you are done with these entries:
• Sales Rev $10K increase; A/R $10K increase • COGS $5,000 increase; Inv $5,000 decrease
23 – Division of Profit From Sale of Merchandise Inventory - #2
• If P is intercompany seller
– Nothing wrong with S’s inc
• Income Distribution Schedule of WS:
Subsidiary Income Distribution
Internally generated net income $50,000 Adjusted income $50,000 NCI share 20%
NCI $10,000
24 – Division of Profit From Sale of Merchandise Inventory - #2
• If P is intercompany seller & no sale to 3rdparty
– P’s inc has intercompany profit which must be deferred • Done with EI entry
• Increase in COGS fro EI entry reduces profits on WS
Parent Income Distribution Unrealized profit in
ending inventory
$5000 Internally generated net income
$100,000 – Given to intercompany seller in Income
Distribution Schedule
80% of Sub adjusted income of $50,000
40,000
25 – BI Entry - Heading
BI Entry
26 – BI Entry - #1
• What about the next year?
• If intercompany merchandise is sold to 3rdparty • Now, intercompany seller can take deferred profit
PROBLEM ll t k d f d i t
• PROBLEM seller took deferred intercompany profit last year on its books
– So, deferred intercompany profit is already reported in 1stseller’s RE
• 1st need to eliminate deferred intercompany profit from 1stseller’s beginning RE
profit from 1stseller s beginning RE
• 2nd give 1stseller deferred intercompany profit this year
27 – BI Entry - #2
• WS entry called BI for Beginning Inventory – Debit to RE reduces beginning balance of RE
• When P gets deferred profit that will
i RE t d f thi
increase RE at end of this year – Credit to COGS increases profits
• Given to intercompany seller
• Gives intercompany seller profit deferred from previous year
BI D. Retained Earnings $5,000
BI C. Cost of Goods Sold $5,000
28 – BI Entry Income Distribution Schedule - #1
• If P is intercompany seller
– Nothing wrong with S’s inc
I Di t ib ti S h d l f WS
Subsidiary Income Distribution
Internally generated net income $50,000 Adjusted income $50,000
• Income Distribution Schedule of WS:
NCI share 20%
29 –BI Entry Income Distribution Schedule - #2
• Assume
– P gets deferred profit from last year - $5K • BI Entry
Parent Income Distribution
Internally generated net income $100,000 Deferred Profit In Beginning
Inventory 5,000 80% of Subsidiary adjusted $ 40,000 income of $50,000 Controlling Interest $145,000
30 – Intercompany Sales of Merchandise – Miscellaneous Issues - Heading
Intercompany Sales of Merchandise
– Miscellaneous Issues
– Miscellaneous Issues
31 – Intercompany Sales of Merchandise – Miscellaneous Issues - Heading
Controlling Interest vs.
Non-Controlling Interest
Non-Controlling Interest
32 – Division of Profit From Sale of Merchandise Inventory - #2
• Remember that intercompany price divides it between P & S
– P gets $200 of profit ($1200 -$1000) & – S gets $300 of profit ($1500 - $1200)g p ( ) S P Total Sales $1,500 $1,200 $2,700 Less: COGS 1200 1000 2200 Gross Profit $300 $200 $500 Gross Profit $300 $200 $500
• This is important if NCI
– NCI gets share of S’s profit – NCI gets none of P’s profit
33 – Division of Profit From Sale of Merchandise Inventory - #1
NCI gets none of P s profit
34 – If Subsidiary is Intercompany Seller - #1
BI D. Retained Earnings $5,000
BI C. Cost of Goods Sold $5,000
• When P is intercompany seller • BI entry has debit to RE:
• When P is intercompany seller
• Use P’s RE
• When 100% owned S is intercompany seller
• Use P’s RE
– When S (with NCI) is intercompany seller
• Use P’s RE for CI share of deferred profit
• Use S’s remaining RE for NCI share of deferred profit
35 – If Subsidiary is Intercompany Seller - #1
• E.g., If P owns 80% of S, then split debit to RE:
BI D. Retained Earnings, Parent (80%) $4K
Retained Earnings, Sub. (20%) 1K
BI C. Cost of Goods Sold $5K
36 – Intercompany Sales of Merchandise – Miscellaneous Issues - Heading
Intercompany Sales of Merchandise
At Loss
37 – Periodic Inventory System
• What if intercompany sale produces a loss
– If inventory really dropped in value
I t ll i l
• Intercompany seller can recognize loss
• Can recognize loss w/o sale using LCM anyway
– If the loss is artificial
• Loss is deferred until sale to 3rdparty
38 – Intercompany Sales of Non-Depreciable Asset - Heading
Intercompany Sales of
Non-Depreciable Asset (Land)
Depreciable Asset (Land)
39 – Intercompany Sales of Non-Depreciable Asset - #1
• Intercompany sale of non-depreciable
asset (Land)
– gain deferred until asset sold to unrelated 3gain deferred until asset sold to unrelated 3rd party
• If asset never sold, deferral is permanent
• WS entry called LA Entry
– LA stands for Land or Land Adjustment
40 – Intercompany Sales of Non-Depreciable Asset - #1
• 1stYear
– Debit for gain defers intercompany seller’s gain – Credit eliminates mark-up (intercompany profit) from
LA D. Gain on Sale of Land $Mark-Up
Credit eliminates mark up (intercompany profit) from cost of Land
• Returns Land to its original cost
41 – Intercompany Sales of Non-Depreciable Asset - #2
• Later Years
• If P is intercompany seller
LA D. Retained Earnings, Parent $Mark-Up
LA C. Land $Mark-Up
• This WS entry done each year until Land is sold to 3rdparty
42 – Intercompany Sales of Non-Depreciable Asset - #3
• Year where Land sold to 3rdparty
– Still need to take it out of seller’s RE
• Doesn’t belong there YET D bit RE
LA D. Retained Earnings, Parent $Mark-Up
• Debit RE
– Allow intercompany seller to take profit
• Credit to Gain g p LA C . Gain on Intercompany Sale of Land $Mark-Up
43 – Intercompany Sales of Depreciable Assets - Heading
Intercompany Sales of Depreciable
Assets
Assets
44 – Intercompany Sales of Depreciable Asset - #1
• Gains from Intercompany sale of
depreciable assets are similar to Land
– Gain deferred until asset sold to unrelated 3Gain deferred until asset sold to unrelated 3rd party
– Write down asset back to orig cost.
• Also need to undo depreciation taken on
buyer’s books for mark-up
A t i b ’ b k t hi h l
– Asset is on buyer’s books at higher value
• It is producing too much depreciation
45 – F1 Worksheet Entry
• There are two FA entries
• First we eliminate the intercompany gain on the
FA1 D. Gain on Sale of Machinery
$10,000
FA1 C Machinery $10 000
sale of the machinery:
FA1 C. Machinery $10,000
46 – F2 Worksheet Entry
• Next, eliminate the increased depreciation expense on the machinery
– Just depreciation on the mark-up
FA2 D. Accumulated Depreciation $2,000
FA2 C. Depreciation Expense $2,000
p p
• This WS entry reduces expenses reported on • This WS entry reduces expenses reported on
buyer’s books
• It creates income on the WS (consolidation level)
• Who gets this income?
47 – Effect of Undoing Depreciation of Mark-Up - #1
• We give extra income to seller
• 1
styear seller loses gain
• 1
st& later years seller gets increased
• 1
st& later years seller gets increased
income
– Eventually, seller gets extra income = its deferred intercompany gain
– This can be seen in Income Distribution
S h d l f WS
Schedules of WS
48 – Effect of Undoing Depreciation of Mark-Up - #2
Subsidiary Income Distribution
I ll d i $25 000
Internally generated net income $25,000
Adjusted income $25,000
NCI share 20%
49 – Effect of Undoing Depreciation of Mark-Up - #3
Parent Income Distribution Unrealized gain on the sale of $10,000 Internally generated net income $30,000 machine 80% of Subsidiary adjusted income of $25,000 20,000 Gain realized through use of 2,000 through use of machine sold to Subsidiary Controlling Interest $42,000
50 – F1 Worksheet Entry – Second Year
• The FA1 entry in the second year, is as follows • Blue area reduces Machinery back to orig cost • Yellow area reduces what remains of intercompany
gain
FA1 D. Retained Earnings, Parent $8K gain
– Gain now in RE
– We disallowed $10K, but let seller have $2K more income
• Net is 8K
g ,
FA1 Accumulated Depreciation $2K
FA1 Cr. Machinery $10K
51 – F2 Worksheet Entry – Second Year
• FA2 entry in 2ndyear same as 1st:
FA2 D. Accumulated Depreciation $2,000
FA2 C. Depreciation Expense $2,000
52 – Income Distribution Schedules – Second Year - #1
• The Income Distribution Schedules for 2ndyear would appear as follows:
Subsidiary Income Distribution
Internally generated net income $24,000
Adjusted income $24,000
NCI h 20%
NCI share 20%
53 – Income Distribution Schedules – Second Year - #2
Parent Income Distribution
I ll d i $50 000
Internally generated net income $50,000 80% of Subsidiary income of $24K 19,200 Gain realized through use of
machine sold to Subsidiary
2,000
Controlling Interest $71,200
Controlling Interest $71,200
54 – F1 Worksheet Entry – Third Year
• The FA1 entry in the third year, is as follows • Blue area reduces Machinery back to orig cost • Yellow area reduces what remains of
intercompany gain
A1 R i d E i P $6 000
intercompany gain
– Gain now in RE
– We disallowed $10K, but let seller have $4K more income
• Net is 6K
FA1 D. Retained Earnings, Parent 1/1/2002
$6,000
FA1 Accumulated Depreciation 4,000
FA1 Cr. Machinery $10,000
55 – Intercompany Construction of Depreciable Assets - Heading
Intercompany Construction of
Depreciable Assets
Depreciable Assets
56 – Intercompany Construction of Depreciable Asset - #1
• What if one member of consolidation
group constructs asset for affiliated client?
– Builder is selling depreciable asset to ClientBuilder is selling depreciable asset to Client – Do the same entries we just talked about
• This subject introduces new entries
dealing with the construction period.
57 – Intercompany Construction of Depreciable Asset - #2
• Builder and client are using accounts that
are appropriate for two unrelated parties
– Wrong account names are being usedg g
– Using account names used by contractor and client
• But, we are presenting the two Cos as if
they are 1 Co.
We have to change the names of the – We have to change the names of the
accounts to reflect 1Co building asset for itself
58 – Intercompany Construction of Depreciable Asset - Builder’s entries - #1
• Look at the entries made by P&S on their books
• S (builder) records cost of construction during 1styear on S’s books:
D. Construction in Progress $200,000
C. Payables $200,000
“Construction in Progress” is the name used by a
contractor “Asset Under Construction is the name used by
1 year on S s books:
contractor. Asset Under Construction is the name used by a Co building its own Asset
Remember, we are presenting P&S as if one Co.
59 – Intercompany Construction of Depreciable Asset - Builder’s entries - #1A
Builder’s Balance Sheet
Const In Prog $200K Payables $200K
`
60 – Intercompany Construction of Depreciable Asset – Builder’s Entries - #2
• The S (builder) records billings on S’s books:
D. Contracts Receivable $150,000
C. Billings on Construction in Progress $150,000
• The Billings account is a contra account that reduces the Construction in Progress account. • The Contracts Receivable is an Intercompany Account – One Co cannot owe money to itself.
61 – Intercompany Construction of Depreciable Asset - Builder’s entries - #2A
Builder’s Balance Sheet
Const In Prog $200K Payables $200K Billings -150K
$50K
`
$50K Contract Rec. 150K
62 – Intercompany Construction of Depreciable Asset - Client’s entries - #1
D Assets Under Construction $150 000
• P (client) also records billings on P’s books:
D. Assets Under Construction $150,000
C. Contracts Payable $150,000
“Asset Under Construction” is the correct name for Co building an asset for itself, but the Amount ($150K) is too small. “Contracts Payable” is an Intercompany Account.
63 – Intercompany Construction of Depreciable Asset - Client’s entries - #1A
Builder’s Balance Sheet
Const In Prog $200K Payables $200K Billings -150K
$50K
`
$50K Contract Rec. 150K
Client’s Balance Sheet
$ $
Asset Und Constr. $150K Contract Pay. $150K
64 – LT1 Entry - #1
• On WS want to eliminate Intercompany Accounts (A/R & A/P):
LT1 D. Contracts Payable $150,000
LT1 C. Contracts Receivable $150,000
65 – LT1 Entry - #1A
Builder’s Balance Sheet
Const In Prog $200K Payables $200K Billings -150K
$50K
`
$50K Contract Rec. 150K
Client’s Balance Sheet
$ $
Asset Und Constr. $150K Contract Pay. $150K
66 – LT2 Entry - #1
• Also want to eliminate Construction in Progress account & Billings account
• Add unbilled construction cost to Asset Under
LT2 D. Billings on Construction in Progress $150,000 LT2 Assets Under Construction 50,000
• Add unbilled construction cost to Asset Under Construction.
LT2 C. Construction in Progress $200,000
67 – LT2 Entry - #1A
Builder’s Balance Sheet
Const In Prog $200K Payables $200K Billings -150K
$50K
`
$50K Contract Rec. 150K
Client’s Balance Sheet
$ $
Asset Und Constr. $150K Contract Pay. $150K
Add To Ass Und Constr. 50K
$200K
68 – End Result of LT1 & LT2 Entries
• After LT1 & LT2 entries, left with:
$
– $200,000 balance in Assets Under Construction, and
69 – Consolidated Balance Sheet After LT1 & LT2
Consolidated Balance Sheet
Asset Under Construction $200K Payables $200K
`
70 – Builder’s Intercompany Profit
(NOT ON TEST☺)
• Builder might take intercompany profit (Percentage of Completion Method):
D. Construction in Progress $50K
C. Earned Income on Long-Term Contract $50K
71 – LT 3 Entry
• If so, eliminate Builder’s profit on WS:
LT3 D. Earned Income on Long-Term Contract $50K
LT3 C. Construction in Progress $50K
72 – Intercompany Lending - Heading
73 – LN1 Entry
• If there is intercompany borrowing? • Eliminate the Intercompany note:
LN1 D. Notes Payable $10,000
LN1 C. Notes Receivable $10,000
• Eliminate the Intercompany note:
74 – LNs Entry
• Eliminate interest receivable and payable:
LN2 D. Interest Payable $400
LN2 C. Interest Receivable $400
75 – LN1 Entry
• Eliminate interest income and expense:
LN3 D. Interest Income $400