presentation hopresentation hoyle 5e chapter 005

8/13/2019 Presentation HoPresentation Hoyle 5E Chapter 005

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Chapter Five

Consolidated

Financial

Statements

Intra-Entity AssetTransactions

McGraw-Hill/Irwin Copyri ght 2013 by The McGraw-Hi ll Companies, Inc. All ri ghts reserved.


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5-2

Main topic chapter 5

Many companies are affiliated in a vertical integrated

chain of organizations.

Inter-entity asset transactions take place: sale and

purchase of inventoryor long-term assets.

The elimination of the accounting effects created bythese intra-entity transactions is one of the most

significant problems in the consolidation process.

To defer unrealized gains to establish within

the consolidated statements both:

historical cost balances and

recognize appropriate income


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5-3

Learning objectives chapter 5

1. Understand why intra-entity asset transactions

create accounting effects within the financial records

of affiliatedcompanies that must be eliminated or

adjustedin preparing consolidated financialstatements.

2. Understand that when companies affiliated through

common control engage in intra-entity inventory

transfers, consolidation procedures are acquired to

eliminate sales and purchase balances.

3. Understand why consolidated entities defer intra-

entity gross profit in ending inventory and the

consolidation procedures required to recognize

profits when actually earned.

After studying this chapter, you should be able to:


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5-4

Learning objectives chapter 5

4. Understand that the consolidation process for inventory

transfersis designed to defer the unrealized portion of anintra-entity gross profit from the year of transfer into the

year of disposal or consumption.

5. Understand the difference between upstream and

downstream intra-entity transfersand how each affects

the computation of noncontrolling interest balances.

6. Prepare the consolidation entry to remove any unrealized

gain created by the intra-entity transfer of land from the

accounting records of the year of transfer and

subsequent years.7. Prepare the consolidation entries to remove the effects

of upstream and downstream intra-entity fixed assets

transfersacross affiliated entities.


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5-5

Intra-entity Transactions

When companies affiliated through common control

engage in intra-entity inventory transfers, consolidation

procedures are required to eliminate sales and

purchases balances.

Transactions between a parent and subsidiary are

considered internal transactions of a single entity.

Effects of intra-entity transactions should be eliminated

from the consolidated financial statements.

LO 1

Consolidated statements must reflect only

transactions with outside parties.


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Parent

Sub

Parent

Sub

Downstream

Sales

Upstream

Sales

Remember

Parent and sub operate separately and maintain their

own record-keeping: they record sale and purchase in

the regular way: consolidation is ones a year.

Parent and sub charge a transfer price: market price,

cost + margin, or negotiated.


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Sales and Purchases-

Intra-entity

Exhibit page 200Arlington Company owns Zirkin Company.

Arlington acquired inventory at cost of $50,000 and sells this

goods to Zirkin for $80,000.

LO 2

Both affiliated entities record the transfer of Arlington to Zirkin as

a normal sale / purchase:

Arlington:

Accounts Receivable 80,000

Sales 80,000

GOCS 50,000

Inventory 50,000

Zirkin:

Inventory 80,000

Accounts Payable 80,000


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The total recorded amounts are deleted.


Intra-entity

ENTRY TI (Transferred Inventory)Eliminate all intra-entity sales/purchases of inventoryby eliminating the sales price of the transfer whichone company records as sales, and the other records ascost of goods sold.

Consolidation Record Page ##

Sales 80,000

Cost of Goods Sold 80,000

ENTRY TI eliminates transferred inventory


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Intra-entity

New consolidatedbalances:

Sales 0

GOCS 30,000 credit

Inventory 30,000 debit

Contains

Unrealized

Gross Profit

GOCS to low,thus profits to

high


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Note: The consolidated company has earned the profiton any

portion of the intra-entity transaction that was sold to

unrelated parties and does not need to make an

adjustment for the sold items for consolidation purposes.

Unrealized Gross Profit

Intra-entity

ENTRY G (Gross Profit)Despite Entry TI, ending inventory may still be overstated due to thetransfer price exceeding historical cost. Intra-entity profits that remain

unrealized at year-end must be removed in arriving at consolidated

figures. Unrealized gain is eliminated as follows in Year 1:

LO 3


Cost of Goods Sold (ending Inventory component) 30,000

Inventory (Balance Sheet account) 30,000

ENTRY G removes unrealized gross profit created by intra-entity sale.


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Exercises LO 1+2+3

Problems:

1, 2, 4, 5, 10, 11, 12, 15.


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Intra-entity

At the beginning of the second year, the figures in therecording system of both affiliated parties still includes:

The profit will be realized in the second year.

The balances must be removed with reverence to the

consolidation at the end of the second year.

LO 4

Arlington:

Retained Earnings: a profit of $30,000

Zirkin:

Inventory: $80,000.

When Zirkin sells these products to outside parties, GOCS is

$30,000 to high.


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Intra-entity

ENTRY *G

From a consolidated view, the buyers Cost of Goods Sold (the

beginning inventory component) and the sellers Retained Earnings

accounts as of the beginning of Year 2 contain the unrealized

profit, and must both be reduced in Entry *G in Year 2.


Retained Earnings (beginning balance of seller) 30,000

COGS (beginning Inventory component of buyer) 30,000

ENTRY *G removes unrealized gross profit from beginning figures so that

it is recognized in the consolidated income in the period in which it is

earned.


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Unrealized Inventory Gain

Downstream Transfers

Worksheet Entry TI: Sales xxxGOCS xxx

and Entry G: COGS xxx

Inventory xxx

are standard, regardless of the circumstances of the

consolidation.

But Entry *G differs from just presented IF:

1. the original transfer is downstream(parents) and

2. the parent applies the Equity Method for internal

accounting purposes.Because by Entry I: Investment income xxx

Investment in Sub xxx

unrealized gross profits are already deferred.


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ENTRY *GIf the transfer of inventory is downstreamAND the parent

uses the Equity Method, the following new version of

Entry *G is applied:

Investment in Subsidiary account replaces the Retained

Earnings account used for upstream sales.

This compensates the credit balance of the Investment

account by Entry I.


Investment in Subsidiary 30,000

COGS (beginning Inventory component) 30,000

ENTRY *G


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Unrealized Inventory Gain -


For intra-entity beginning inventory profits resulting from

downstream transfers when the parent applies the Equity

Method:

1. Parents Retained Earnings are appropriatelystated due

to intra-entity profit deferrals and recognition.2. The subsidiary Retained Earnings reflect none of the

intra-entity profit and require no adjustment.

3. The parents Investment account at beginning of Year 2

contains a credit from the deferral of Year 1 downstream

profits.4. Worksheet Entry *G transfers the Year 1 Investment

account credit to a Year 2 earnings credit via COGS to

recognize the profit in the year of sale to outsiders.


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Exercises LO 4

Problem:

28.


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Unrealized Gross Profits

Effect on Noncontrolling Interest

Accounts affected by intra-entity transactions:

Revenues

Cost of Goods Sold

Expenses Noncontrolling Interest in Subsidiarys Net Income

Retained Earnings at the Beginning of the Year

Inventory

Land, Buildings, and Equipment

Noncontrolling Interest in Subsidiary at End of Year.

LO 5


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Unrealized Gross Profits

Effect on Noncontrolling Interest

The complete elimination of the intra-entity profit or loss isconsistent with the underlying assumption that

consolidated financial statements represent the financial

position and operating results of a single economic entity.

According to FASB ASC paragraph 810-10-45-6:

The amount of intra-entity profit or loss to be eliminated is

not affected by the existence of a noncontrolling interest.

The elimination of the intra-entity profit or loss may be

allocated proportionately between the parent and

noncontrolling interest.


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Intra-Entity Inventory Downstream

Transfer - Example

Top Company acquires 80 percent of the voting stock

of Bottom Company on January 1, 2012.

Top pays $400,000.

Acquisition-date fair value of noncontrolling interest

is $100,000.Top allocates the entire $50,000 excess fair value over

book value to adjust a database owned by Bottom to

fair value.

The database has an estimated remaining life of 20years.


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Intra-Entity Inventory Downstream

Transfer - Example

The subsidiary reports net income of $30,000 in 2012 and $70,000 in2013, the current year.

Dividend payments are $20,000 in the first year and $50,000 in the

second.

A $10,000 intra-entity debt exists as of December 31, 2013.

Intra-entity inventory transfers between the two companies:

2012 2013

Transfer prices . . . . . . . . . . . . . . . . . . . . . . . . $80,000 $100,000

Historical cost . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000 70,000

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000 $ 30,000

Year-end Inventory balance (transfer price) $16,000 $ 20,000

Gross profit percentage . . . . . . . . . . . . . . . . . . X 25% X30%

Gross profit remaining in year-end inventory $ 4,000 $ 6,000


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Intra-Entity Inventory Transfers

Example

Three entries require attention in the calculation ofnoncontrolling interest in the subs Net Income December 31,

2013.

Entry *G removes unrealized gross profits (25% rate) carried over

from the previous period intra-entity downstream sales.

Entry *G reduces Cost of Goods Sold (or beginning inventory

component) which creates an increase in current year income.Gross profit is correctly recognized in 2013 when inventory is sold to

an outside party.

The debit to the Investment in Bottom account brings that account

to a zero balance in consolidation.


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Intra-Entity Inventory

Downstream Transfer - Example

Entry TI eliminates the intra-entity sales/purchases for 2013.

Entry G defers the unrealized gross profit (30% rate) of$6,000 remaining at the end of 2013.

Entry G eliminates the overstatement of Inventory as well as

the ending component of Cost of Goods Sold which

decreases consolidated income.


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UpstreamInventory Transfer

A different set of consolidation procedures is

necessary if the intra-entity transfers are upstream.

Upstream gross profits are attributed to the subsidiary,

Bottom, not the parent, Top:

Because inventory transfers are upstream from

Bottom to Top, only 80% of the profit deferral and

subsequent recognition is allocated to the parents

Equity Earnings and Investment account.

Intra-entity profit reallocation across time affects

both the subsidiarysreported income and the


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Upstream Inventory Transfer

The records of the two companies change to

reflect the parents application of the Equity

Method for upstream sales.

Entry *G reduces Bottoms beginning 2013

Retained Earnings balance, and decreases Cost

of Goods Sold which increases consolidated

Net Income to recognize profit earned in 2013by sales to outsiders.

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Intra-entity Transactions Upstream Inventory Transfer

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A credit to Cost of Goods Sold increases consolidated netincome to recognize that the profit has been earned in 2013

by sales to outsiders.

As of January 1, 2013, $16,000 of transfers remain inTops inventory, and $4,000 of gross profit (25%) is unearned

from a consolidated perspective. Also, Bottoms beginning

Retained Earnings are overstated by $4,000, the gross profit

from 2012 intra-entity transfers.


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Intra-entity Transactions Upstream vs. Downstream transfers

Compare the Entry *G for the downstreamand upstream

transfers to see the difference in the transactions.

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Upstream Inventory Transfer

Entry S eliminates a portion of the parents investment

account and provides the initial noncontrolling interestbalance.

The entry also removes stockholdersequity accounts of

the subsidiary as of the beginning of the current year.

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Upstream vs. Downstream transfers

To better understand how the Entry S differs, comparethe entries for the downstream and upstreamtransfers.

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Exercises LO 5

Problems:

3, 6, 7, 13, 17, 19, 21, 27, 29, 31, 32.

I i T i


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Land Transfer

If landis transferred between the parent and sub at again, the gain is considered unrealized and must be

eliminated until the moment of selling to an outside

party.

Two differences compared with intra-entity inventory

transfers:

No use of sales/purchases accounts,

Buyer often holds land for years if not permanently:

realizing profit takes a long time.

LO 6

I i T i


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Land Transfer

Exhibit page 220-222Hastings Company owns Patrick Company.

July 1, 2013 Hastings sells land to Patrick at transfer price: $100,000,

historical cost: $60,000.

Both affiliated entities record the transfer :

Hastings:

Cash 100,000

Land 60,000

Gain on Sale of Land 40,000

Patrick:

Land 100,000

Cash 100,000

I t tit T ti


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Land 40,000 debit

Gain on Sale of Land 40,000 credit

Unrealized GrossProfit in financialrecords of seller

Capitalization ofinflated transferprice in financialrecords of buyer


Land Transfer

I t tit T ti


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Land Transfer

ENTRY TLFor consolidated purpose the unrealized gain is must

be eliminated.



Land 40,000

ENTRY TL eliminates effects of intra-entity transfer of land in year

of transfer.

Note: By crediting land for the same amount, this

effectively returns the land to its carrying value

on the date of transfer (historical cost).

I t tit T ti


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OrInvestmentaccount, if

downstream

and Equitymethod

Intra-entity Transactions -

Land Transfer

ENTRY *GLAs long as the land remains on the books of the buyer,the unrealized gain must be eliminated at the end ofeach fiscal period.

Note: The original gain was closed to Retained Earningsat the end of each period. When we eliminate thegain in subsequent years, it must come fromRetained Earnings.

Consolidation Record Page ##Retained Earnings (beginning balance of seller) 40,000

Land 40,000

ENTRY *GL eliminates effects of intra-entity transfer of land in

subsequent years.


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I t tit L d T f


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Intra-entity Land Transfers

Eliminating Unrealized GainsENTRY *GL (Year of sale to outside party)

In the period the land is sold to a third party, theunrealized gain must be eliminated one more time,and also finally recognized as a REALIZED gain in thecurrent periods consolidated financial statements.

Note: Modify the entry to credit the Gain accountinstead of Land.


Retained Earnings (Hastings) 40,000


To remove intra-entity gain from year of transfer so that total

profit can be recognized in current period when land is sold to anoutside party.

Th Eff t f L d T f


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The Effect of Land Transfers on

Noncontrolling Interests

DOWNSTREAM transfers

have no effect on


UPSTREAM transfers have a gain on the

SUBSIDIARY books!

All noncontrolling interest balances arebased on the subs net income

EXCLUDING the intra-entity gain.

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Exercises LO 6

Problem:

36.

I t tit T tiLO 7


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Intra-entity TransactionsDepreciable Asset Transfers

Example

Able Co. and Baker Co. are related parties.

Able purchased equipment for $100,000 several

years ago, and has recorded $40,000 of depreciationsince that time.

Baker buys the equipment from Able for $90,000 on

1/1/12.

The equipment has a remaining useful life of 10years.

LO 7

I t tit T ti


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Intra-entity Transactions -Depreciable Asset Transfers

On the Sellers Books:Cash . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000

Accumulated Depreciation . . . . . . . . . 40,000

Equipment . . . . . . . . . . . . . . . . . . . . $100,000

Gain on Sale of Equipment . . . . . . . . . 30,000

NOTE: The seller WOULD record depreciation expense at $6,000 peryear year if they had not sold the equipment ($60,000 / 10).

On the Buyers Books:

Equipment. . . . . . . . . . . . . . . . . . . . . $90,000Cash . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000

NOTE: The buyer WILL record $9,000 per year in depreciation based

on the remaining life ($90,000 / 10).

I t tit T ti


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Accumulated Depreciation 40,000 debit

Equipment 10,000 credit

Gain on Sale of Equipment 30,000 credit

Unrealized GrossProfit in financialrecords of seller

Transfer price$90,000, although

book value is$60,000


Depreciable Asset Transfers

Intra entit Transactions


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ENTRY TAIn the year of transfer, the unrealized gain must be

eliminated and the assets restated to original

historical cost.



Intra entity Transactions


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ENTRY EDIn addition, the buyers depreciation is based on the

inflated transfer price. The excess depreciation

expense must be eliminated.





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In Years Following the Year of Transfer

Equipment is carried on the individual books at a

different amount than on the consolidated books.

The amounts change each year as depreciation iscomputed.

To get the worksheet adjustments, compare the

individual records to the consolidated records.





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Two years after transfer:

The 1/1/13 Retained Earnings effect = the original gain of$30,000 on Ables (sellers) books less $9,000, one year of

depreciation.



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ENTRY *TA (Subsequent Years)The adjustment to fixed assets and depreciation

expense must be made in each succeeding period.

The entry for Consolidation is:





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ENTRY ED (Subsequent Years)In addition, the Depreciation Expense andAccumulated Depreciation accounts must be adjusted.



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Intra-entity Transactions Depreciable Asset Transfers

If the transfer is downstreamand the parent uses theEquity Method, then their Retained Earnings balance has

already been reduced for the gain, and we adjust the

Investment account instead.


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Summary

Transfers of assets among related parties are common.

Inventory transfers are the most prevalent form of intra-

entity asset transaction. Despite being only a transfer, one

company records a sale while the other reports a purchase.

These balances are reciprocalsthat must be offset on the

worksheet in the process of producing consolidated figures.

Transfers of depreciable assets create the additional

accounting issue of differing depreciation expense. Thiseffect is eliminatedon the consolidation worksheets.

In consolidated financial statements, the effects of these

transfers must be removed.


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Summary

Investment

in sub

Dividend of

sub

Income of

sub

Amortization

excess FV

Intra-entity

inventorytransactions

Intra-entity

landtransactions

Intra-entity

depreciable assetstransactions

EM

Investment in sub

account + - + - +/- +/- +/-

EM

Equity income

account + - +/- +/- +/-

PEM

Investment in sub

account + - + +/- +/- +/-

PEM

Equity income

account + - + +/- +/- +/-

IVM

Investment in subaccount + + +/- +/- +/-

IVM

Equity income

account+ +/- +/- +/-


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Exercises LO 7

Problems:

8, 9, 18, 20, 22, 23, 24, 25, 26, 30, 33, 34, 35.

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