Chapter 6

INTERCOMPANY PROFIT TRANSACTIONS - PLANT ASSETS

Chapter Outline
SALE OF PLANT ASSETS TO AFFILIATED COMPANIES
A The sale of plant assets to affiliated companies at a price other than book va!e
create" an !nreai#e$ %ain or o"" to the con"oi$ate$ entit&.
' Gain or loss from the intercompany sale appear" in the inco(e "tate(ent o) the
"ein% a))iiate in the year of sale.
C The %ain or o"" i" !nreai#e$ from the viewpoint of the consolidated entity until:
The plant asset is "o$ to an o!t"i$e entit&, or
The asset i" )!& $epreciate$ thro!%h !"e *ithin the con"oi$ate$ entit&.
D The effects of unrealized gains and losses are:
Ei(inate$ )ro( inve"t(ent inco(e in a one-line consolidation (use of equity
method)
Ei(inate$ )ro( con"oi$ate$ )inancia "tate(ent" through woring paper
entries.
DO+NSTREAM INTERCOMPANY SALE OF LAND ,I!"tration 6--.
A !n the year of an intercompany sale of land, an entry is made in the consolidation
woring papers to ei(inate the )! a(o!nt o) the %ain on the "ae an$ re$!ce the
an$ acco!nt to it" co"t to the con"oi$ate$ entit&.
- This entr& i" the "a(e )or $o*n"trea( an$ !p"trea( intercompany land sales.
/ The parent company re$!ce" it" inve"t(ent inco(e an$ inve"t(ent acco!nt
for the unrealized intercompany profit.
' +hie the an$ i" he$ within the consolidated entity in years su"sequent to the year of
sale, a con"oi$ation *orkpaper entr& i" re0!ire$ each &ear to re$!ce the an$
acco!nt to it" co"t ba"i" (credit) and increase the investment account to esta"lish
reciprocity with the su"sidiary#s equity accounts at the "eginning of the period.
C $hen the an$ i" "o$ to an o!t"i$e entit&1 the parent co(pan& reco%ni#e" the
previo!"& $e)erre$ %ain from the intercompany sale.
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- . consolidation woring paper entry converts the gain on sale of land to the gain
to the consolidated entity and esta"lishes reciprocity "etween "eginning
investment and su"sidiary equity accounts.
/ The con"oi$ate$ %ain i" the $i))erence bet*een the co"t o) the an$ an$ the
)ina "ein% price to an outside entity.
2PSTREAM INTERCOMPANY SALE OF LAND ,I!"tration 6--.
A !n the year of the intercompany sale of land, the )! a(o!nt o) the %ain on the "ae i"
ei(inate$ )ro( the con"oi$ate$ )inancia "tate(ent" an$ the an$ i" reporte$ at
it" co"t to the con"oi$ate$ entit&.
' The parent company re$!ce" it" inve"t(ent inco(e )or on& it" proportionate "hare
o) the !nreai#e$ %ain "ecause the noncontrolling interest is also charged with its share
of the unrealized gain.
C !n the consolidation woring papers, noncontrolling interest e/pense is computed as the
"!b"i$iar&3s realized inco(e ti(e" the noncontroin% intere"t percenta%e.
- 0ealized income is the "!b"i$iar&3" reporte$ inco(e e"" !nreai#e$ %ain" an$
p!" !nreai#e$ o""e".
D +hie the an$ i" he$ within the consolidated entity in years su"sequent to the year of
sale, a con"oi$ation *orkin% paper i" re0!ire$ each &ear to:
- Re$!ce the an$ acco!nt to it" co"t ba"i",
/ Increa"e the inve"t(ent acco!nt )or it" "hare o) the !nreai#e$ %ain (this entry
esta"lishes reciprocity with the su"sidiary#s equity accounts at the "eginning of
the period), and
4 Decrea"e the be%innin% noncontroin% intere"t to it" baance at the en$ o) the
previo!" &ear (in other words, co(p!te noncontroin% intere"t on the ba"i"
o) reai#e$ inco(e rather than on the "asis of reported income).
E $hen the parent company "e" the an$ to an o!t"i$e entit&, the gain or loss to the
parent is converted to a %ain or o"" to the con"oi$ate$ entit& )or reportin% in the
con"oi$ate$ )inancia "tate(ent".
- The a(o!nt o) the %ain or o"" i" the $i))erence bet*een the co"t o) the an$
an$ )ina "ein% price to the o!t"i$e entit&.
/ . *orkin% paper entr& enter" the %ain )ro( the interco(pan& "ae1 increa"e"
the inve"t(ent acco!nt to e"tabi"h reciprocit& *ith be%innin% "!b"i$iar&
e0!it& acco!nt"1 an$ $ecrea"e" the be%innin% noncontroin% intere"t to its
"alance at the end of the previous year.
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4 On& the cre$it to the %ain on an$ i" $i))erent )ro( the entrie" in the previo!"
&ear in *hich the an$ *a" he$ within the consolidated entity.
5 2n the parent company#s "oos, the parent3" "hare o) the previo!"& $e)erre$
%ain )ro( the interco(pan& "ae i" reco%ni#e$ an$ reai#e$ *ith an entr&
that increa"e" inve"t(ent inco(e an$ the inve"t(ent acco!nt.
DO+NSTREAM SALES OF DEPRECIA'LE PLANT ASSETS ,I!"tration 6-/.
A In the &ear o) "ae1 the !nreai#e$ %ain )ro( a $o*n"trea( "ae o) pant a""et" i"
re)ecte$ in the parent co(pan&3" acco!nt".
- The !nreai#e$ %ain i" ei(inate$ in determining investment income under the
e0!it& (etho$.
/ The !nreai#e$ %ain $oe" not appear in the con"oi$ate$ inco(e "tate(ent.
The unrealized gain is removed from consolidated financial statements "y a
*orkin% paper entr& that ei(inate" the %ain an$ ret!rn" the pant a""et
to it" $epreciate$ co"t to the consolidated entity at the time of sale.
4 3e/t, $epreciation e6pen"e an$ acc!(!ate$ $epreciation are re$!ce$ in
the con"oi$ation *orkin% paper".
A$7!"t" the"e ite(" to the $epreciate$ co"t ba"i" to the con"oi$ate$
entit& at the en$ o) the &ear.
A$7!"t" $epreciation e6pen"e to the a(o!nt it *o!$ have been ha$ the
interco(pan& "ae not taken pace.
4y reducing depreciation e/pense, the %ain i" reco%ni#e$ on a piece(ea
ba"i" as the asset is used "y the consolidated entity.
5 The noncontroin% intere"t co(p!tation i" not a))ecte$.
' !n years su"sequent to the year of intercompany sale, a" the over"tate$ pant a""et i"
$epreciate$1 the parent co(pan& a$7!"t" it inve"t(ent inco(e for the piecemeal
recognition of the previously unrecognized gain.
- The )! a(o!nt o) the %ain from the intercompany sale will be reco%ni#e$
thro!%h inve"t(ent inco(e b& the en$ o) the !"e)! i)e o) the pant a""et.
/ .lso at the end of the plant asset#s useful life, the inve"t(ent acco!nt *i
re)ect the parent3" proportionate "hare o) the "!b"i$iar&3" !n$er&in%
e0!it&, assuming there are no other unrealized profits or cost-"oo value
differentials.

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2PSTREAM SALES OF DEPRECIA'LE PLANT ASSETS ,I!"tration 6-/.
A !n the year of an upstream sale at other than "oo value, the %ain or o"" i" re)ecte$ in
the "!b"i$iar& acco!nt".
- Inve"t(ent inco(e )or the &ear o) "ae i" a$7!"te$ )or the parent3" "hare o)
the !nreai#e$ %ain or o"" an$ the parent3" "hare o) an& piece(ea
reco%nition o) the %ain or o"" thro!%h $epreciation.
/ 3oncontrolling interest share is computed as the noncontrolling interest
ownership percentage times the su"sidiary#s reai#e$ inco(e8
0ealized income is the su"sidiary#s reporte$ net inco(e e"" the reai#e$
%ain p!" piece(ea reco%nition o) the %ain thro!%h $epreciation.
4 The !nreai#e$ %ain $oe" not appear in the con"oi$ate$ "tate(ent".
5 6onsolidation woring paper entries are required to ei(inate the e))ect" o) the
interco(pan& !p"trea( "ae8
The !nreai#e$ %ain i" ei(inate$ an$ the pant a""et i" ret!rne$ to it"
$epreciate$ co"t to the con"oi$ate$ entit& at the ti(e o) "ae.
E6ce"" $epreciation for the current year (depreciation in e/cess of the
amount that would have "een recorded had the intercompany sale not taen
place) i" ei(inate$ from the depreciation accounts. This is the piece(ea
reco%nition o) the %ain.
' !n years su"sequent to the year of the upstream intercompany sale, woring paper
entries:
Aocate the !nreai#e$ %ain "etween the investment account and "eginning
noncontrolling interest, and
Ret!rn the pant a""et an$ acc!(!ate$ $epreciation acco!nt" to a co"t
ba"i" to the consolidated entity.
- The de"it to noncontrolling interest a$7!"t" the be%innin% noncontroin%
intere"t baance o) the c!rrent &ear to the en$in% baance o) the previo!"
&ear.
/ The de"it to the investment account e"tabi"he" reciprocit& bet*een the
inve"t(ent acco!nt baance an$ the "!b"i$iar&3" e0!it& acco!nt" at the
be%innin% o) the perio$.
4 +hen the )! a(o!nt o) the !nreai#e$ %ain ha" been reai#e$ thro!%h
$epreciation1 no )!rther a$7!"t(ent" are nece""ar&.
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PLANT ASSETS SOLD AT OT9ER T9AN FAIR :AL2E
A .n intercompany sale of plant assets at a loss requires special eva!ation to en"!re the
o"" "ho!$ not have been reco%ni#e$ b& the "ein% a))iiate prior to the
interco(pan& "ae.
' Sae o) a""et" above )air va!e also creates pro"lems for the parties involved.
C $hile the process for consolidation does not change, questions regarding inappropriate
recognition of gains or losses could lead to charges o) i(proper "te*ar$"hip on the
part of corporate directors.
IN:ENTORY ITEMS SOLD INTERCOMPANY FOR 2SE AS PLANT ASSETS
A The !nreai#e$ %ain ,%ro"" pro)it. on the "ae i" reco%ni#e$ thro!%h $epreciation b&
the p!rcha"in% a))iiate.
' $oring paper entries in the year of intercompany sale:
- Re$!ce "ae" )or the interco(pan& "ae1 re$!ce co"t o) "ae" )or the co"t o)
the inventor& ite(1 an$ re$!ce the pant a""et to it" co"t ba"i" to the
con"oi$ate$ entit&.
/ Ei(inate $epreciation e6pen"e (piecemeal recognition of the gross profit on
sale occurs as the depreciation e/pense is eliminated).
C $oring paper entries in su"sequent years will:
Re$!ce the pant a""et to it" co"t ba"i",
Ei(inate $epreciation e6pen"e ,piecemeal recognition of the gross profit
on sale occurs as the depreciation e/pense is eliminated., and
E"tabi"h reciprocit& "etween "eginning-of-the-period equity and
investment amounts.
ELECTRONIC S2PPLEMENT
The electronic supplement discusses situations where the parent company uses either the
incomplete equity method or the cost method to account for its investment.
6ontinues the techniques used in applying an incomplete equity method when plant assets are
sold "etween the parent and su"sidiary.
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!llustration 1-(
INTERCOMPANY PROFITS ON LAND
) owns a 8'9 interest in :, acquired at fair value at the "eginning of &';l. <uring &';(
land that cost =(,-'' is sold intercompany for =&,-''. The land is sold to an outside entity in
&';> for =>,'''.
:eparate !ncomes &';l:
) :ells ?and to : : :ells ?and to )
<ownstream @pstream
) : ) :
:ales =-',''' =>',''' =-',''' =>','''
*/penses and cost
of sales (,',''') (&-,''') (,',''') (&-,''')
Gain on sale
of land (,''' (,'''
:eparate incomes =((,''' = -,''' =(',''' = 1,'''
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-'
:eparate !ncomes &';&:
:ales =--,''' =>-,''' =--,''' =>-,'''
*/penses and cost
of sales (,,,''') (&8,''') (,,,''') (&8,''')
:eparate incomes =((,''' = 1,''' =((,''' = 1,'''
:eparate !ncomes &';>:
:ales =1',''' =>7,''' =1',''' =>7,'''
*/penses and cost
of sales (-',''') (>',''') (-',''') (>',''')
Gain on sale
of land -'' -''
:eparate incomes =(',''' = 7,-'' =(',-'' = 7,'''
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-(

- DO+NSTREAM SALE - /;<I= =(,''' unrealized gain deferred
2ne-line consolidation entry:
!nvestment in : =>,-''
!ncome from : =>, -''
To record 8'9 of :As reported income and eliminate
unrealized profit on land. B6omputation: (=-,''' / 8'9) - =(,'''C
6onsolidation woring paper entries:
a Gain on sale of land =(,'''
?and =(,'''
To eliminate unrealized profit on sale of land to : and
reduce land to its cost "asis.
" !ncome from : =>,-''
!nvestment in : =>,-''
To eliminate investment income and return investment
account to its "eginning of the period "alance.
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/ DO+NSTREAM SALES - ></
2ne-line consolidation entry:
!nvestment in : =-,,''
!ncome from : =-,,''
To record 8'9 of :As reported income. 6omputation:
=1,''' / 8'9
6onsolidation woring paper entries:
a !nvestment in : =(,'''
?and =(,'''
To reduce land to its cost "asis and adDust investment
account to esta"lish reciprocity with :As "eginning of
the period equity accounts.
" !ncome from : =-,,''
!nvestment in : =-,,''
To eliminate investment income and return investment
account to its "eginning of the period "alance.
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->

4 DO+NSTREAM SALES - /;<4= ?and is sold to outside entity
2ne-line consolidation entry:
!nvestment in : =7,1-'
!ncome from : =7,1-'
To record 8'9 of :As reported income and recognize
the previously deferred profit on the sale of land to :.
6omputation: =7,-'' / 8'9 E =(,'''
6onsolidation woring paper entries:
a !nvestment in : =(,'''
Gain on sale of land =(,'''
To adDust gain on sale of land to the =(,-'' gain to
the consolidated entity.
" !ncome from : =7,1-'
!nvestment in : =7,1-'
To eliminate investment income and return investment
account to its "eginning of the period "alance.
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-,
5 2PSTREAM SALES - /;<I= =(,''' unrealized gain deferred
2ne-line consolidation entry:
!nvestment in : =,,-''
!ncome from : =,,-''
To record 8'9 of :As realized income. 6omputation:
(=1,''' - =(,''' unrealized profit) / 8'9
6onsolidation woring paper entries:
a Gain on sale of land =(,'''
?and =(,'''
To eliminate unrealized profit on sale of land to ) and
reduce land to its cost "asis.
" !ncome from : =,,-''
!nvestment in : =,,-''
To eliminate investment income and return investment
account to its "eginning of the period "alance.
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--
? 2PSTREAM SALES - /;</
2ne-line consolidation entry:
!nvestment in : =-,,''
!ncome from : =-,,''
To record 8'9 of :As reported income. 6omputation:
=1,''' / 8'9
6onsolidation woring paper entries:
a !nvestment in : = 8''
3oncontrolling interest-"eginning (''
?and =(,'''
To reduce land to its cost "asis and adDust investment
and "eginning noncontrolling interest amounts to esta"lish
reciprocity with the "eginning of the period equity
accounts of :.
" !ncome from : =-,,''
!nvestment in : =-,,''
To eliminate investment income and return investment
account to its "eginning of the period "alance.
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6 2PSTREAM SALE - /;<4= Sae to outside entity.
2ne-line consolidation entry:
!nvestment in : =7,(''
!ncome from : =7,(''
To record 8'9 of :As reported income and recognize the
previously deferred profit on the sale of land to :.
6omputation: =7,''' / 8'9 E =8''
6onsolidation woring paper entries:
a !nvestment in : = 8''
3oncontrolling interest (''
Gain on sale of land =(,'''
To adDust gain on sale of land to the =(,-'' gain to
the consolidated entity.
" !ncome from : =7,(''
!nvestment in : =7,(''
To eliminate investment income and return investment
account to its "eginning of the period "alance.
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!llustration 1-&
INTERCOMPANY SALE OF MAC9INERY
) owns a 8'9 interest in :, acquired at "oo value equal to fair value at the "eginning of &';!.
Part A 2n Fanuary (, &';l ) sells machinery with a "oo value of =,,''' and a ('-year
remaining useful life to : for =-,'''.
/;<- /;</
:eparate !ncomes :eparate !ncomes
) : ) :

:ales =-',''' =>',''' =--,''' =>-,'''
Gain on sale
of machinery (,'''
<epreciation e/pense ((',''') ( -,-'') ((',''') ( -,-'')
2ther e/penses (>',''') (&',''') (>,,''') (&,,''')
:eparate incomes =((,''' = ,,-'' =((,''' = -,-''
Part ' 2n Fanuary (, &';( : sells machinery with a "oo value of =,,''' and a ('-
year remaining useful life to ) for =-,'''.
/;<- /;</
:eparate !ncomes :eparate !ncomes
) : ) :

:ales =-',''' =>',''' =--,''' =>-,'''
Gain on sale
of machinery (,'''
<epreciation e/pense ((',-'') (-,''') ((',-'') ( -,''')
2ther e/penses (>',''') (&',''') (>,,''') (&,,''')
:eparate incomes = 8,-'' = 1,''' =(',-'' = 1,'''
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Part A= DO+NSTREAM SALE OF MAC9INERY - /;<I
(=(,''' gain - =('' unrealized gain deferred)
2ne-line consolidation entry:
!nvestment in : =>,(-'
!ncome from : =>,(-'
To record 8'9 share of :As net income less gain on
sale of machinery plus piecemeal recognition of
gain through depreciation. 6omputation:
(=,,-'' / 8'9) - =(,''' E =(''
6onsolidation woring paper entries:
a Gain on machinery =(,'''
Gachinery =(,'''
To eliminate unrealized gain and reduce machinery to a
cost "asis.
" .ccumulated depreciation-machinery = (''
<epreciation e/pense = (''
To eliminate the current yearAs effect of the
unrealized gain from depreciation accounts.
c !ncome from : =>,(-'
!nvestment in : =>,(-'
To eliminate investment income and adDust investment
account to its "eginning of the period "alance.
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Part A= DO+NSTREAM SALE OF MAC9INERY - /;</
(=('' of =8'' deferred gain is recognized in &';&)
2ne-line consolidation entry:
!nvestment in : =-,'-'
!ncome from : =-,'-'
6omputation:(=-,-'' / 8'9) E =(''
6onsolidation woring paper entries:
a .ccumulated depreciation-machinery = (''
<epreciation e/pense = (''
To eliminate current yearAs effect of unrealized profit
from depreciation accounts.
" !nvestment in : = 8''
.ccumulated depreciation (''
Gachinery =(,'''
To eliminate unrealized profit from machinery and
accumulated depreciation as of the "eginning of the
year and to adDust the investment account for the difference.
c !ncome from : =-,'-'
!nvestment in : =-,'-'
To eliminate investment income and adDust the
investment account to the "eginning of the period
"alance.
Part '= 2PSTREAM SALE OF MAC9INERY - /;<I
(=(,''' - =('' unrealized gain deferred)
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1'
2ne-line consolidation entry:
!nvestment in : =,,-8'
!ncome from : =,,-8'
6omputation: (=1,''' - =(,''' E =('') / 8'9
6onsolidation woring paper entries:
a Gain on sale of machinery =(,'''
Gachinery =(,'''
To eliminate unrealized gain and reduce machinery to a
cost "asis.
" .ccumulated depreciation-machinery = (''
<epreciation e/pense = (''
To eliminate the current yearAs effect of unrealized
gain from depreciation accounts.
c !ncome from : =,,-8'
!nvestment in : =,,-8'
To eliminate investment income and adDust investment
account to its "eginning of the period "alance.
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1(

Part '= 2PSTREAM SALE OF MAC9INERY - /;</
(=('' of =8'' deferred gain is recognized in &';&)
2ne-line consolidation entry:
!nvestment in : =-,,8'
!ncome from : =-,,8'
To record 8'9 of :As realized income. 6omputation:
(=1,''' E =('') / 8'9
6onsolidation woring paper entries:
a .ccumulated depreciation-machinery = (''
<epreciation e/pense = (''
To eliminate &';l unrealized gain from current
depreciation accounts.
" !nvestment in : = 7('
3oncontrolling interest-"eginning 8'
.ccumulated depreciation (''
Gachinery =(,'''
To eliminate unrealized profit from machinery and
accumulated depreciation and to esta"lish reciprocity
"etween the maDority and noncontrolling interests and
su"sidiary equity accounts as of the "eginning of the period.
c !ncome from : =-,,8'
!nvestment in : =-,,8'
To eliminate investment income and adDust the investment
account to the "eginning of the period "alance.
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1&