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Intercompany
Inventory
Transactions
McGraw-Hill/Irwin
6-2
6-3
Arms-Length Transactions
Q: What are Arms-length
Transactions?
A:
6-4
Categories of Transactions
Arms Length Transactions
The
We
referred
transactions.
Include
to
as related
party
Involving Corporations
With
With
With
of all
6-6
Necessity of Eliminating
Intercompany Transactions
Eliminate
all
intercompany
transactions in consolidation:
Because
Not
because
transactions.
they
are
related-party
Only
Intercompany Transactions:
Additional Opportunities for Fraud
Intercompany transactions
sometimes
occur to
conceal
embezzlements.
overstate
reported profits.
+ 2
5
6-8
Not a transaction
person.
with
non-family
6-9
Example 2:
Sale from Parent to Sub to
Outsider
Parent has 19 subsidiaries.
Parent has received a $1 order from an
outsider.
Parent sells inventory to Sub 1 for $1.
obsolete
Correcting Entries
Conceptually, how would you correct each of these
three problems?
Easy! To eliminate intercompany loans:
Loan Payable
Just
Loan Receivable
reverse
Easy!
Just
reverse
xxx
xxx
Sub:
Cash
500
Payable
500
500
500
6-14
Keep
This
Purchase
Sub $500
Eliminate effect
of this internal
Transaction
Keep
This
Sale
6-15
Unadjusted
Consolidated
Parent
Subsidiary
Totals
$400
$500
$900
-250
$ 150
-400
$ 100
-650
$ 250
(400)
(400)
$500
-250
$ 250
Keep
this
purchase
Sub
Eliminate effect
of this internal
transaction
Parent:
Cash
400
Sales
400
COGS 250
Inventory
250
Sub:
Inventory400
Cash
400
6-17
Item
Amounts
Sales
Cost of goods
sold
Gross profit
Inventory
$400
-250
$ 150
$
-0-
-0-
$400
(400) $
-250
$ 150
(250)
-0-0$400
$400
(150)
-0-0-0$ 250
Keep
This
Purchase
Sub $400
Eliminate effect
of this internal
Transaction
Keep
This
Sale
6-19
Item
Amounts
Sales
Cost of goods
sold
Gross profit
Inventory
$ 400
-250
$ 150
$
-0-
400
$ 800
-320
80
-570
$ 230
$80
$80
(400) $ 400
(370)
-200
$ 200
(30) $
50
Summary of Consolidation
Entries:
To eliminate intercompany loans:
Loan Payable
Loan Receivable
500
500
not
a
6-22
Sales $ 600
COGS 500
GP
$ 100
Sub
100
6-23
Group Practice
Assume Parent Co. owns 80% of Sub Co.
The following intercompany transactions occurred
during the year:
6-24
Consolidation Entries
To eliminate intercompany loans:
Loan Payable
Loan Receivable
100
100
To correct inventory
Equityvalue
Method Entry:
Income from Sub
Investment in Sub
120
120
6-25
FIRSTTo
YEAR
SECOND
YEAR
120
120
120
6-26
Up
m strea
Do
m wnst
rea
NCI
P
S
6-27
FIRST To
YEAR
SECOND
YEAR
120
6-29
Additional Considerations
Sale from
another
one
subsidiary
to
occur
under
Additional Considerations
Lower-of-cost-or-market
6-31
Lower-of-Cost-or-Market Example
Assume that a parent company purchases inventory for
$20,000 and sells it to its subsidiary for $35,000. The
subsidiary still holds the inventory at year-end and
determines that its market value (replacement cost) is
$25,000 at that time. The subsidiary writes the inventory
down from $35,000 to its lower market value of $25,000 at
the end of the year and records the following entry:
Write-down Inventory to Market Value:
Loss on Decline in Value of Inventory 10,000
Inventory
10,000
Make the following worksheet eliminating entry:
Sales
35,000
Cost of Goods sold
Inventory
Loss on Decline in Value of Inventory
20,000
5,000
10,000
6-32
Conclusion
The End
6-33
Exercise
Pisa Company acquired 75 percent of Siena
Company on January 1, 20X3 for $712,500. The fair
value of the noncontrolling interest was equal to 25
percent of book value. On the date of acquisition,
Siena had common stock outstanding of $300,000
and a balance in retained earnings of $650,000.
During 20X3, Siena purchased inventory for $35,000
and sold it to Pisa for $50,000. Of this amount, Pisa
reported $20,000 in ending inventory in 20X3 and
later sold it in 20X4. In 20X4, Pisa sold inventory it
had purchased for $40,000 to Siena for $60,000.
Siena sold $45,000 of this inventory in 20X4. Income
and dividend information for Siena for 20X3 and
20X4 are as follows:
34
Exercise (2)
Pisa Company uses equity method.
Required:
a. Present the worksheet elimination entries
necessary to prepare consolidated financial
statements for 20X3.
b. Present the worksheet elimination entries
necessary to prepare consolidated financial
statements for 20X4.
35
Answer (a)
36
Answer (a)-2
37
Answer (b)
38
Answer (b)-2
39