ACC 415 - Chapter 6 Notes PDF

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CHAPTER 6 Intercompany Inventory Transactions Chapter Objectives:  Understand what is meant by “intercompany transactions” and why they need to be eliminated  Understand and be able to prepare journal entries and consolidation entries following a downstream transfer of inventory  Understand and be able to prepare journal entries and consolidation entries following an upstream transfer of inventory Only transactions with parties outside the consolidated entity should be reflected on the consolidated financial statements • Receivables/Payables between parent and subsidiary need to be eliminated Accounts Payable XXX Accounts Receivable XXX • “Sales” of inventory between affiliated companies of a consolidated entity need to be eliminated • “unrealized profits and losses” of inventory transferred between affiliated companies of a consolidated entity need to be eliminated • Prevents double-counting sales Illustration 1: Sale from Parent to Subsidiaries to Outsider Assume the following sequence of transactions: Parent purchased 10 units of Product X for $10 from Outsider 1 Parent sold 10 units of Product X to Sub 1 for $12 Sub 1 sold 10 units of Product X to Sub 2 for $14 Sub 2 sold 10 units of Product X to Outsider 2 $16 Sales COGS Gross Profit

Parent 12 10 2

Sub 1 14 12 2

Sub 2 16 14 2

Total 42 36 6

What was the actual cost of inventory from “outsiders”? $10 What was actual sales to “outsiders”? $16 What was actual profit from transactions with “outsiders”? 16 – 10 = $6 What needs to be eliminated? Sales of $26; COGS of $26 No need to defer recognition of gross profit

1

Downstream sale of inventory (sale from parent to subsidiary)?  Scenario 1: Subsidiary sells to nonaffiliate in the same period  Scenario 2: Subsidiary sells to nonaffiliate in the next period  Scenario 3: Subsidiary holds inventory for two or more periods Scenario 1: subsidiary sells to nonaffiliate in the same period • In this scenario the purchase and sale from/to nonaffiliate has been completed by consolidated entity •

Consolidation/elimination entry: intercompany transfer eliminated in consolidation from parent’s sales and subsidiary’s cost of goods sold Sales (parent) XXX Cost of Goods Sold (subsidiary)

•

XXX

gross profit properly stated

Example 1: Downstream sale, Scenario 1 During the year, Popeye purchases inventory for $10,000 from a nonaffiliated entity and sells it to Sweet Pea for $14,000. Later that year, Sweet Pea sells the inventory to a nonaffiliated entity for $19,600. Prepare the entries Popeye and Sweet Pea would record on their books related to the purchase and sale of inventory: Popeye: Inventory Accounts Payable

10000

Accounts Receivable Sales Revenue

14000

Cost of Goods Sold Inventory

10000

10000 14000

10000

Sweet Pea: Inventory Accounts Payable

14000

Accounts Receivable Sales Revenue

19600

Cost of Goods Sold Inventory

14000

14000 19600

14000

2

Prepare the consolidation/elimination entry related to the intercompany transfer of inventory: Popeye 14,000 10,000 4,000

Sales Cost of Goods Sold Gross Profit Inventory

Sweet Pea 19,600 14,000 5,600

0

Combined 33,600 24,000 9,600

0

Consolidated Elimination 19,600 __14000__ 10,000 ____14000__ 9,600 0

0

0

0

Consolidation Entry: Sales

14000 Cost of Goods Sold

14000

Illustration 2: Sale from Parent to Subsidiaries (but not yet to Outsider) Assume the following sequence of transactions: Parent purchased 10 units of Product X for $10 from Outsider 1 Parent sold 10 units of Product X to Sub 1 for $12 Sub 1 sold 10 units of Product X to Sub 2 for $14 Sales COGS Gross Profit Inventory

Parent 12 10 2

Sub 1 14 12 2

Sub 2

Total 26 22 4

0

0

14

14

What was actual cost of inventory from “outsiders”? 10 What was actual sales to “outsiders”? 0 What was actual profit from transactions with “outsiders?” No sales, so no profit yet What needs to be eliminated (unrealized profit)? Sales of $26; COGS of $22; Inventory of $4

3

Scenario 2: subsidiary sells to nonaffiliate in next period Year 1 • parent defers unrealized gross profit by reducing Income and Investment accounts Parent:

Income

(down) Investment (down)

•

XXX XXX

elimination entry needed to adjust sales, cost of goods sold and inventory to consolidated amounts; effectively reduces (defers) consolidated income by unrealized amount Elimination: Investment Income Sales (parent) COGS (parent) Inventory (sub)

XXX XXX YYY ZZZ XXX

Year 2 • parent reverses deferral of unrealized gross profit (increases Income and Investment accounts) Parent:

•

Investment Income

XXX XXX

elimination entry needed to recognize income that was deferred in previous year Elimination

Income Investment Investment COGS

XXX XXX XXX XXX

Reduce COGS because reduced inventory at end of last year

4

Example 2: Downstream sale, Scenario 2: During the year, Popeye purchases inventory for $10,000 from a nonaffiliated entity and sells it to Sweet Pea for $14,000. In the subsequent year (20X2), Sweet Pea sells the inventory to a nonaffiliated entity for $19,600. Prepare the entries Popeye and Sweet Pea would record on their books in 20X1 related to the intercompany purchase/sale of inventory Popeye: Inventory Cash

10000

Cash

14000

10000

Sales Revenue

14000

Cost of Goods Sold Inventory

10000 10000

To defer Gross Profit (at end of year): Income from Sweet Pea Investment in Sweet Pea

4000 4000

Sweet Pea: Inventory Cash

14000 14000

Prepare the consolidation/elimination entry related to the intercompany transfer of inventory in 20X1: Popeye

Sweet Pea

Sales

__14000__

___0____

___14000_

___0____

___14000_

Cost of Goods Sold

__10000__

_0_

___10000_

___0_

___10000_

__4000__

___0____

___4000_

___0____

___4000_

__0___

___14000_

___14000_

___10000_

___4000_

Gross Profit Inventory

Combined Consolidated

Elimination

5

Consolidation Entry: Eliminate deferral recorded by Popeye Investment in Sweet Pea Income in Sweet Pea Eliminate intercompany sale Sales Cost of Goods Sold Inventory (deferred GP)

4000 4000 14000 10000 4000

Prepare the entries Popeye and Sweet Pea would record on their books in 20X2 related to the intercompany purchase/sale of inventory Popeye: Recognize Gross Profit Investment in Sweet Pea Income from Sweet Pea

4000 4000

Sweet Pea: Cash

19600

Sales Revenue Cost of Goods Sold Inventory

14000

19600 14000

Prepare the consolidation/elimination entry(ies) related to the intercompany transfer of inventory in 20X2: Popeye

Sweet Pea

Combined Consolidated

Elimination

Sales

___0____

____19600

___19600_

__19600__

___0____

Cost of Goods Sold

____0___

____14000

__14000_

___10000_

___4000____

Gross Profit

____0___

___5600_

__5600__

___9600__

___4000____

Inventory

____0___

___0____

__0_____

____0___

__0_____

6

Consolidation Entry: Eliminate deferral recorded by Popeye Investment in Sweet Pea Income in Sweet Pea

4000 4000

Eliminate intercompany sale Investment in Sweet Pea Cost of Goods Sold

4000 4000

Scenario 3: subsidiary holds inventory for two or more periods. Year 1: same equity-method entries and eliminations as under Scenario 2 Year 2 (and subsequent years, until inventory is sold to nonaffiliated): elimination entry required to correctly state inventory and Investment accounts Investment XXX Inventory XXX Period that inventory is sold: same as year 2 of Scenario 2 Example 3: Downstream Sale, Scenario 3 During the year, Popeye purchases inventory for $10,000 from a nonaffiliated entity and sells it to Sweet Pea for $14,000. Two years later, in 20X3, Sweet Pea sells the inventory to a nonaffiliated entity for $19,600 Prepare the consolidation/elimination entry related to the intercompany transfer of inventory in 20X2 Investment in Sweet Pea Inventory

4000 4000

7

How do you account for an upstream sale of inventory (sale from subsidiary to parent)? Scenario 1: parent sells to nonaffiliate in the same period • same as for downstream sale Scenario 2: parent sells to nonaffiliate in next period • Similar to downstream sale • Deferral of gross profit is only for parent’s proportional interest. Scenario 3: parent holds inventory for two or more periods. • Similar to downstream sale • While holding inventory, elimination entry required to adjust inventory made for parent’s proportional interest Example 4: Upstream Sale, Scenario 1 Popeye has an 80% interest in Sweet Pea. During the year, Sweet Pea purchases inventory for $10,000 from a nonaffiliated entity and sells it to Popeye for $14,000. Later that year, Popeye sells the inventory to a nonaffiliated entity for $19,600. Prepare the entries Popeye and Sweet Pea would record on their books related to the purchase and sale of inventory: Popeye: Entries recorded by popeye and sweet pea would be switched from Example 1 (downstream sale)

Sweet Pea:

Prepare the consolidation/elimination entry related to the intercompany transfer of inventory: Same as example 1 Sales (subsidiary) COGS (parent)

14000 14000

8

Example 5: Upstream Sale, Scenario 2: Popeye has an 80% interest in Sweet Pea. During the year, Sweet Pea purchases inventory for $10,000 from a nonaffiliated entity and sells it to Popeye for $14,000. In a subsequent year (20X2), Popeye sells the inventory to a nonaffiliated entity for $19,600. Prepare the entries Popeye and Sweet Pea would record on their books in 20X1 related to the intercompany purchase/sale of inventory Popeye: Inventory Cash

14000

Income from Sweet Pea Investment in Sweet Pea (4,000 * 80% = 3200)

3,200

14000 3,200

Sweet Pea: Inventory Cash

10000

Cash

14000

10000

Sales COGS

14000 10000

Inventory

10000

Prepare the consolidation/elimination entry related to the intercompany transfer of inventory in 20X1: Investment in Sweet Pea NCI in Assets Income from Sweet Pea NCI in Income Sales

3,200 800 3,200 800 14,000

COGS Inventory

10,000 4,000

9

Prepare the entries Popeye and Sweet Pea would record on their books in 20X2 related to the intercompany purchase/sale of inventory Popeye: Cash

19,600 Sales

COGS

19,600 14,000

Inventory

Investment in Sweet Pea Income from Sweet Pea

14,000

3,200 3,200

Sweet Pea:

none

Prepare the consolidation/elimination entry related to the intercompany transfer of inventory in 20X2: Income from Sweet Pea NCI in Income Investment in Sweet Pea NCI in Assets

3,200

Investment in Sweet Pea NCI In Assets COGS

3,200 800

800 3,200 800

4000

10

Example 6: Upstream Sale, Scenario 3 Popeye has an 80% interest in Sweet Pea. During the year, Sweet Pea purchases inventory for $10,000 from a nonaffiliated entity and sells it to Popeye for $14,000. In 20X5, Popeye sells the inventory to a nonaffiliated entity for $19,600 20X1: same as scenario 2 Prepare the consolidation/elimination entry related to the intercompany transfer of inventory in 20X2 Investment in Sweet Pea NCI in Assets Inventory

3,200 800 4000

20X3: Sam as Scenario 2, year 20X2

11...