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Intercompany transfers of services and noncurrent assets part 1

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Arthik Davianti

The document outlines GAAP requirements related to intercompany transfers of services and noncurrent assets, emphasizing that intercompany transactions must be eliminated during consolidation to accurately reflect financial performance. It discusses the treatment of gains or losses from such transfers, particularly focusing on non-depreciable and depreciable assets, as well as the equity method's adjustments for unrealized profits. Various illustrative examples delineate scenarios involving land transfers between parent companies and subsidiaries, highlighting the accounting entries necessary for accurate consolidated financial statements.

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Intercompany Transfers of Services and Noncurrent Assets (Part 1)
Source: BAKER CHRISTENSEN COTTLRELL Advanced Financial Accounting Ninth Edition McGRAW HILL INTERNATIONAL EDITION
Learning Objective 1 Understand and explain concepts associated with transfers of long-term assets and services.
Summary of GAAP Requirements for Preparing Consolidated Statements All intercompany transactions must be eliminated in consolidation. The full amount of unrealized intercompany profit or gain must be eliminated. The deferral is shared with NCI shareholders in upstream transactions.
Big Picture: The Consolidated Perspective From a consolidated viewpoint, the reported amount for a fixed asset cannot change merely because the asset has been moved to a different location within the consolidated group. Objective:  Undo the transfer.  Make it appear as if we only changed the estimated useful life of asset. P S Long-term Asset
Different Asset Types 1. Non-depreciable Assets • The transfer of non-depreciable assets is very similar to the transfer of inventory • Eliminate gains like unrealized gross profit 2. Depreciable Assets • Eliminate the seller’s gain • Adjust transferred asset back to old basis • Adjust depreciation back to what it would have otherwise been if the original owner had depreciated the asset based on the revised estimate of useful life
Intercompany Transfers of Services When one company purchases services from a related company, the purchaser typically records an expense and the seller records a revenue. • In the consolidation worksheet, an eliminating entry would be needed to reduce both revenue (debit) and expense (credit). • Because the revenue and expense are equal and both are eliminated, income is unaffected by the elimination. • The elimination is still important because otherwise both revenues and expenses are overstated.
Illustration (Baker et al. 2011, p. 307-309) • Intercompany sale process of land. • A series of transaction: (1) land purchased by Parent company from an unrelated party, (2) land sold to a subsidiary of Parent Company, and (3) land sold by subsidiary to an unrelated party: • Details of transactions: T1 – purchase by Parent Company from an outsider for $10,000 T2 – Sale from Parent Company to Subsidiary for $15,000 T3 – Sale from Subsidiary to an outsider for $25,000 • The amount of gain reported by each company and by the consolidated entity in a periods depends on the transactions occur during a period.
Illustration (continue) Case A All three transactions are completed in the same accounting period. Parent Company $ 5,000 ($15,000 - $10,000) Subsidiary Corporation 10,000 (25,000 - $15,000) Consolidated Entity 15,000 ($25,000 - $10,000) Case B Only transaction T1 is completed during the current period. Parent Company $ 0 Subsidiary Corporation 0 Consolidated Entity 0
Illustration (continue) Case C Transaction T1 and T2 are completed during the current period. Parent Company $ 5,000 ($15,000 - $10,000) Subsidiary Corporation 0 Consolidated Entity 0 Case D Only transaction T3 is completed during the current period, T1 and T2 occurred in a prior period. Parent Company $ 0 Subsidiary Corporation 10,000 (25,000 - $15,000) Consolidated Entity 15,000 ($25,000 - $10,000)
Learning Objective 2 Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following an intercompany land transfer.
Intercompany Land Transfers • If land is transferred between related companies at book value – no adjustment or elimination needed in consolidating financial statements. • Because there is no gain or loss, both income and assets are stated correctly in the consolidation. • Special treatment is needed if land transfer is more or less then book value – elimination of gain or loss. • There should be no gain or loss from related companies reported in the consolidated financial statements – until land is sold to other party.
Illustration (p. 310 - 311) Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000 Jan 1, 20X1 Jul 1, 20X1 Peerless Special $20 Product $35 Foods Purchase land Inter-corporate transfer of land Consolidated Entity
Illustration (continues) • Peerless records January 1, 20X1 (1) Land 20,000 Cash 20,000 Record land purchase July 1, 20X1 (2) Cash 35,000 Land 35,000 Record on Sale of land to Special Food
Illustration (continues) • Special Foods records July 1, 20X1 (3) Land 35,000 Cash 35,000 Record land purchase • Eliminating entry Gain on Sale of Land 15,000 Land 15,000 July 1, 20X1 (4) Income from Special Foods 15,000 Investment in Special Food 15,000 Defer gain on intercompany land sale to Special Foods
Assignment of Unrealized Profit Elimination Unrealized intercompany gains and losses must be eliminated in consolidating financial statements – regardless parent’s ownership of a subsidiary. Sale Elimination Downstream (parent to subsidiary) Against controlling interest Upstream (subsidiary to parent) Wholly owned subsidiary Against controlling interest Majority-owned subsidiary Proportionately against controlling and noncontrolling interests
Illustration • Purity Company owns 75% of the common stock of Southern Corp. • Purity reports operating income (excluding any investment income from Southern) of $100,000 • Southern reports net income of $60,000, included the income of selling affiliate is an unrealized gain of $10,000 from the intercompany transfer of asset.
Illustration (continues) • If the sale is a downstream transfer, all unrealized profit is to be eliminated from the controlling interest. • Consolidated net income (computed and allocated): Purity’s separate income $100,000 Less: Unrealized intercompany gain on downstream asset sale (10,000) Purity’s separate realized income $90,000 Southern’s net income 60,000 Consolidated net income $150,000 Income to noncontrolling interest ($60,000 x 0.25) (15,000) Income to controlling interest $135,000
Illustration (continues) • In the intercompany transfer is from subsidiary to parent, the unrealized profit on the upstream sale is eliminated proportionately from both the controlling and noncontrolling shareholders. • Consolidated net income (computed and allocated): Purity’s separate income $100,000 Southern’s net income $60,000 Less: Unrealized intercompany gain on downstream asset sale (10,000) Southern’s realized net income 50,000 Consolidated net income $150,000 Income to noncontrolling interest ($50,000 x 0.25) (12,500) Income to controlling interest $137,500
Example 1: 100% Ownership Land Transfer (Non-Depreciable) • On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. • In this example, we’ll do consolidation worksheet entries without adjusting the equity method accounts. • This is the modified equity method. • This is meant to be a conceptual exercise only. (We will switch to the fully adjusted equity method next.) Required: 1. Prepare the consolidation entry(ies) as of 12/31/X5 and 12/31/X6. 2. Prepare the consolidation entry at 12/31/X7, assuming that Stubben sold the land in 20X7 for $120,000.
Example 1: 100% Ownership Land Transfer (Non-Depreciable) On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. $40 Parker $100 Stubben $120 “Fake” Gain = $60 Gain = $20 Total Gain = $80 In 20X7
Example 1: Consolidation Entry at 12/31/X5 Requirement 1 – consolidation entry: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Gain +60 Consolidation Entry at 12/31/X5 Land +60 Gain on Sale of Land 60,000 Land 60,000 What happens to the gain? RE +60 Land +60
Example 1: Consolidation Entry at 12/31/X6 Requirement 1 – consolidation entry: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity RE +60 Land +60 Consolidation Entry at 12/31/X6 (and all years until land is sold) Retained Earnings 60,000 Land 60,000
Example 1: Consolidation Entry at 12/31/X7 Requirement 2 – consolidation entry after land sold: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity RE +60 Gain +20 What gain should Stubben report in 20X7 when the land is sold? Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Retained Earnings 60,000 Gain on Sale 60,000 • Thus, the consolidated gain is $80,000! • What’s the only problem with the partial equity method? • THE PARENT’S FINANCIAL STATEMENTS ARE NOT CORRECT!
Solution: Parker Company Equity Method Journal Entries Requirement 1 Consolidation Entry at 12/31/X5 Gain on Sale of Land 60,000 Land 60,000 Consolidation Entry at 12/31/X6 Retained Earnings 60,000 Land 60,000 Requirement 2 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Retained Earnings 60,000 Gain on Sale of Land 60,000
Equity Method Adjustment  After calculating the unrealized gain, simply make an extra adjustment to back it out.  Do this at the same time you record the parent’s share of the sub’s income. NI XXX Income from Sub XXX NI 60,000 Unreal. Gain 60,000 This ensures that the parent income is equal to the consolidated income. Investment in Sub Reverse later when the asset is sold!
Example 2: 100% Ownership Land Transfer • On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. • Now assume Parker adjusts for this transaction in the equity accounts. • This is the fully adjusted equity method! • How would your answers change? Required: 1. Prepare the consolidation entry(ies) as of 12/31/X5 and 12/31/X6. 2. Prepare the consolidation entry at 12/31/X7, assuming that Stubben sold the land in 20X7 for $120,000.
Example 2: 100% Ownership Land Transfer On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. $40 Parker $100 Stubben $120 “Fake” Gain = $60 Gain = $20 Total Gain = $80 In 20X7
ONE EXTRA STEP! Equity Method Adjustment Investment in Sub Income from Sub NI XXX XXX NI 60,000 Unreal. 60,000 Gain This defers the gain until later
Example 2: Consolidation Entry at 12/31/X5 Requirement 1: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Gain +60 What happens to the equity method accounts? • Eliminated in the consolidation. But we still need to fix the problem! Consolidation Entry at 12/31/X5 Land +60 Gain on Sale of Land 60,000 Land 60,000 RE correct Invest 60 Income from Sub 60 • The equity method adjustment “fixes” parent’s books! Same! What happens to the gain AND Income from Sub? Invest 60 Land +60 They cancel out!
Example 2: Consolidation Entry at 12/31/X6 Requirement 1: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Invest 60 Land +60 • The normal basic elimination entry will still eliminate BV of equity. • The investment account will be “over eliminated” and left with a 60,000 credit! • We can’t leave a “balance” in that account in the consolidated B/S! Consolidation Entry at 12/31/X6 (and all years until land is sold) Investment 60,000 Land 60,000 • This entry eliminates the investment account and fixes the land balance.
Example 2: Consolidation Entry at 12/31/X7 Requirement 1: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Invest 60 What gain should Stubben report in 20X7 when the land is resold? Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Investment 60,000 Gain on Sale 60,000 • Thus, the consolidated gain is $80,000! • We also reverse out the equity method deferral this year. • THE PARENT’S FINANCIAL STATEMENTS ARE ALWAYS CORRECT! Gain +20
Example 2: Solution Summary Requirement 1 Consolidation Entry at 12/31/X5 Gain on Sale of Land 60,000 Land 60,000 Consolidation Entry at 12/31/X6 Investment in Stubben 60,000 Land 60,000 Requirement 2 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Investment in Stubben 60,000 Gain on Sale of Land 60,000
Consolidation Worksheet—20X5 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 60,000 60,000 0 Income from Sub (60,000) Lower Basic 0 Balance Sheet Investment in Sub (60,000) Lower Basic 0 Land 100,000 60,000 40,000
Consolidation Worksheet—20X6 Adjustments Parent Sub DR CR Consol-idated Income Statement Balance Sheet Investment in Sub (60,000) Lower 60,000 Basic 0 Land 100,000 60,000 40,000
Consolidation Worksheet—20X7 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 20,000 60,000 80,000 Balance Sheet Investment in Sub (60,000) Lower 60,000 Basic 0 Land 0 0
Learning Objective 3 Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following a downstream land transfer.
Downstream Sale of Land • Peerless Products purchases 80% of the common stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000. • During 20X1, Peerless reports separate income of $140,000 and declares dividends of $60,000. • Special Foods reports net income of $50,000 and declares dividend of $30,000. • July 1, 20X1, Peerless sells land to Special Foods for $35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following years. P 80% S NCI 20%
Fully adjusted equity-method entries – 20X1 • 20X1 Peerless records its share of Special Foods’ income and dividend. (5) Investment in Special Foods 40,000 Income from Special Foods 40,000 Record Peerless’ 80% share of Special Foods’ 20X1 income (6) Cash 24,000 Investment in Special Foods 24,000 Record Peerless’ 80% share of Special Foods’ 20X1 dividend
Fully adjusted equity-method entries – 20X1 • Under the fully adjusted equity method, Peerless defers the entire $15,000 using the following entry: (7) Income from Special Foods 15,000 Investment in Special Foods 15,000 Defer gain on intercompany land sale to Special Foods • Objectives: (1) Peerless income is overstated by $15,000, the adjustment to Income from Special Foods offsets this overstatement – Peerless net income is now correct, and (2) Special Foods’ land account is currently overstated by $15,000 (was recorded for $20,000 but purchased for $35,000), reduction on the investment account offsets the overstatement and defer the unrealized gain.
Basic investment account elimination entry: Common stock 200,000 Retained earnings 100,000 Income from Special Foods 25,000 NCI in NI of Special Foods 10,000 Dividend declared 30,000 Investment in Special Foods 241,000 NCI in NA of Special Foods 64,000
Consolidation Worksheet—20X1 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 15,000 15,000 0 Income from Sub 25,000 25,000 Basic 0 Balance Sheet Investment in Sub 241,000 241,000 Basic 0 Land 155,000 75,000 15,000 215,000
Group Exercise 1: Partial Ownership Land Transfer • Stubben Corporation is a 90%-owned subsidiary of Parker Corporation, acquired for $270,000 on 1/1/X5. • Investment cost was equal to book value and fair value. • Stubben’s net income in 20X5 was $70,000, and Parker’s income, excluding its income from Stubben, was $90,000. • Parker’s income includes a $10,000 unrealized gain on land that cost $40,000 and was sold to Stubben for $50,000. • Assume that Stubben sold the land in 20X7 for $65,000. Assume Parker adjusts for this transaction in the equity accounts. NOTE: This is a downstream transaction. Required: 1. What entry(ies) would Parker make in 20X5 and 20X7? 2. Prepare the consolidation entries at 12/31/X5, 12/31/X6, and 12/31/X7. P 90% S NCI 10%
Group Exercise 1: Solution Requirement 1 20X5 Equity Method Entries 20X7 Equity Method Entry (after Stubben resold the land)
Group Exercise 1: Solution Requirement 2 Consolidation Entry at 12/31/X5 Consolidation Entry at 12/31/X6 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Consolidation Worksheet—20X5 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 10,000 10,000 0 Income from Sub 53,000 53,000 Basic 0 Balance Sheet Investment in Sub 323,000 323,000 Basic 0 Land 50,000 10,000 40,000
Consolidation Worksheet—20X6 Adjustments Parent Sub DR CR Consol-idated Income Statement Balance Sheet Investment in Sub (10,000) Lower 10,000 Basic 0 Land 50,000 10,000 40,000
Learning Objective 4 Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following an upstream land transfer.
Illustration (p. 318 - 321) Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000 Peerless Product Jul 1, 20X1 Jan 1, 20X1 Special Foods $35 $20 Purchase land Inter-corporate transfer of land Consolidated Entity
Upstream Sale of Land • Peerless Products purchases 80% of the common stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000. • During 20X1, Peerless reports separate income of $140,000 and declares dividends of $60,000. • Special Foods reports net income of $50,000 and declares dividend of $30,000. • July 1, 20X1, Special Foods sells land to Peerless for $35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following years. P 80% S NCI 20%
• 20X1 Peerless records its share of Special Foods’ income and dividend under the fully adjusted method: (8) Investment in Special Foods 40,000 Income from Special Foods 40,000 Record Peerless’ 80% share of Special Foods’ 20X1 income (9) Cash 24,000 Investment in Special Foods 24,000 Record Peerless’ 80% share of Special Foods’ 20X1 dividend
Fully adjusted equity-method entries – 20X1 • Under the fully adjusted equity method, Peerless Inc. defers relative share of the unrealized gross profit is $12,000 (15,000 X 0.80) (10) Income from special Foods 12,000 Investment in Special Foods 12,000 Defer gain on intercompany land sale to Special Foods. Until resold to external party by Special Food, the carrying value of land must be reduces each time consolidated statements are prepared
Basic investment account elimination entry: Common stock 200,000 Retained earnings 100,000 Income from Special Foods 40,000 NCI in NI of Special Foods 10,000 Dividend declared 30,000 Investment in Special Foods 256,000 NCI in NA of Special Foods 64,000
Partially Owned Upstream Sales Equity Method Adjustment • Similar to what we did with inventory transfers: we must share deferral with the NCI shareholders • Simply split up the adjustment for unrealized gains proportionately. NI 52,000 52,000 NI Unreal. 3,000 Gain To NCI Shareholders P 80% S NCI 20% Equity Method Adjustments Investment in Special Foods 12,000 Income from Special Foods Unreal. Gain 12,000 40,000
Group Exercise 2: Partial Ownership Land Transfer • Stubben Corporation is a 90%-owned subsidiary of Parker Corporation, acquired for $270,000 on 1/1/X5. • Investment cost was equal to book value and fair value. • Stubben’s net income in 20X5 was $70,000, and Parker’s income, excluding its income from Stubben, was $90,000. • Stubben’s income includes a $10,000 unrealized gain on land that cost $40,000 and was sold to Parker for $50,000. • Assume that Parker sold the land in 20X7 for $65,000. • Assume Parker adjusts for this transaction in the equity accounts. • Assume that Stubben sold the land in 20X7 for $65,000. • Assume Parker adjusts for this transaction in the equity accounts. Required: 1. What entry(ies) would Parker make in 20X5 and 20X7? 2. Prepare the consolidation entries at 12/31/X5, 12/31/X6, and 12/31/X7. P 90% S NCI 10%
Partially Owned Upstream Sales Equity Method Adjustment • Similar to what we did with inventory transfers: we must share deferral with the NCI shareholders • Simply split up the adjustment for unrealized gains proportionately. NI 63,000 63,000 NI Unreal. 1,000 Gain To NCI Shareholders P 90% S NCI 10% Equity Method Adjustments Investment in Stubben 9,000 Income from Stubben Unreal. Gain 9,000 54,000
Solution: Parker Company Equity Method Journal Entries Requirement 1 20X5 Equity Method Entries 20X7 Equity Method Entry (after Stubben resold the land)
Solution: Parker Company Equity Method Journal Entries Requirement 2 Consolidation Entry at 12/31/X5 Consolidation Entry at 12/31/X6 Requirement 3 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Consolidation Worksheet—20X5 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 10,000 10,000 0 Income from Sub 54,000 54,000 Basic 0 Balance Sheet Investment in Sub 324,000 324,000 Basic 0 Land 50,000 10,000 40,000
Consolidation Worksheet—20X6 Adjustments Parent Sub DR CR Consol-idated Income Statement Income from Sub Basic 0 Balance Sheet Investment in Sub (9,000) Lower 9,000 Basic 0 NCI in NA 1,000 1,000 Lower Land 50,000 10,000 40,000
Consolidation Worksheet—20X7 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 15,000 10,000 25,000 Income from Sub Basic 0 Balance Sheet Investment in Sub (9,000) Lower 9,000 Basic 0 NCI in NA 1,000 1,000 Lower Land 0

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Intercompany transfers of services and noncurrent assets part 1

  • 1. Intercompany Transfers of Services and Noncurrent Assets (Part 1)
  • 2. Source: BAKER CHRISTENSEN COTTLRELL Advanced Financial Accounting Ninth Edition McGRAW HILL INTERNATIONAL EDITION
  • 3. Learning Objective 1 Understand and explain concepts associated with transfers of long-term assets and services.
  • 4. Summary of GAAP Requirements for Preparing Consolidated Statements All intercompany transactions must be eliminated in consolidation. The full amount of unrealized intercompany profit or gain must be eliminated. The deferral is shared with NCI shareholders in upstream transactions.
  • 5. Big Picture: The Consolidated Perspective From a consolidated viewpoint, the reported amount for a fixed asset cannot change merely because the asset has been moved to a different location within the consolidated group. Objective:  Undo the transfer.  Make it appear as if we only changed the estimated useful life of asset. P S Long-term Asset
  • 6. Different Asset Types 1. Non-depreciable Assets • The transfer of non-depreciable assets is very similar to the transfer of inventory • Eliminate gains like unrealized gross profit 2. Depreciable Assets • Eliminate the seller’s gain • Adjust transferred asset back to old basis • Adjust depreciation back to what it would have otherwise been if the original owner had depreciated the asset based on the revised estimate of useful life
  • 7. Intercompany Transfers of Services When one company purchases services from a related company, the purchaser typically records an expense and the seller records a revenue. • In the consolidation worksheet, an eliminating entry would be needed to reduce both revenue (debit) and expense (credit). • Because the revenue and expense are equal and both are eliminated, income is unaffected by the elimination. • The elimination is still important because otherwise both revenues and expenses are overstated.
  • 8. Illustration (Baker et al. 2011, p. 307-309) • Intercompany sale process of land. • A series of transaction: (1) land purchased by Parent company from an unrelated party, (2) land sold to a subsidiary of Parent Company, and (3) land sold by subsidiary to an unrelated party: • Details of transactions: T1 – purchase by Parent Company from an outsider for $10,000 T2 – Sale from Parent Company to Subsidiary for $15,000 T3 – Sale from Subsidiary to an outsider for $25,000 • The amount of gain reported by each company and by the consolidated entity in a periods depends on the transactions occur during a period.
  • 9. Illustration (continue) Case A All three transactions are completed in the same accounting period. Parent Company $ 5,000 ($15,000 - $10,000) Subsidiary Corporation 10,000 (25,000 - $15,000) Consolidated Entity 15,000 ($25,000 - $10,000) Case B Only transaction T1 is completed during the current period. Parent Company $ 0 Subsidiary Corporation 0 Consolidated Entity 0
  • 10. Illustration (continue) Case C Transaction T1 and T2 are completed during the current period. Parent Company $ 5,000 ($15,000 - $10,000) Subsidiary Corporation 0 Consolidated Entity 0 Case D Only transaction T3 is completed during the current period, T1 and T2 occurred in a prior period. Parent Company $ 0 Subsidiary Corporation 10,000 (25,000 - $15,000) Consolidated Entity 15,000 ($25,000 - $10,000)
  • 11. Learning Objective 2 Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following an intercompany land transfer.
  • 12. Intercompany Land Transfers • If land is transferred between related companies at book value – no adjustment or elimination needed in consolidating financial statements. • Because there is no gain or loss, both income and assets are stated correctly in the consolidation. • Special treatment is needed if land transfer is more or less then book value – elimination of gain or loss. • There should be no gain or loss from related companies reported in the consolidated financial statements – until land is sold to other party.
  • 13. Illustration (p. 310 - 311) Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000 Jan 1, 20X1 Jul 1, 20X1 Peerless Special $20 Product $35 Foods Purchase land Inter-corporate transfer of land Consolidated Entity
  • 14. Illustration (continues) • Peerless records January 1, 20X1 (1) Land 20,000 Cash 20,000 Record land purchase July 1, 20X1 (2) Cash 35,000 Land 35,000 Record on Sale of land to Special Food
  • 15. Illustration (continues) • Special Foods records July 1, 20X1 (3) Land 35,000 Cash 35,000 Record land purchase • Eliminating entry Gain on Sale of Land 15,000 Land 15,000 July 1, 20X1 (4) Income from Special Foods 15,000 Investment in Special Food 15,000 Defer gain on intercompany land sale to Special Foods
  • 16. Assignment of Unrealized Profit Elimination Unrealized intercompany gains and losses must be eliminated in consolidating financial statements – regardless parent’s ownership of a subsidiary. Sale Elimination Downstream (parent to subsidiary) Against controlling interest Upstream (subsidiary to parent) Wholly owned subsidiary Against controlling interest Majority-owned subsidiary Proportionately against controlling and noncontrolling interests
  • 17. Illustration • Purity Company owns 75% of the common stock of Southern Corp. • Purity reports operating income (excluding any investment income from Southern) of $100,000 • Southern reports net income of $60,000, included the income of selling affiliate is an unrealized gain of $10,000 from the intercompany transfer of asset.
  • 18. Illustration (continues) • If the sale is a downstream transfer, all unrealized profit is to be eliminated from the controlling interest. • Consolidated net income (computed and allocated): Purity’s separate income $100,000 Less: Unrealized intercompany gain on downstream asset sale (10,000) Purity’s separate realized income $90,000 Southern’s net income 60,000 Consolidated net income $150,000 Income to noncontrolling interest ($60,000 x 0.25) (15,000) Income to controlling interest $135,000
  • 19. Illustration (continues) • In the intercompany transfer is from subsidiary to parent, the unrealized profit on the upstream sale is eliminated proportionately from both the controlling and noncontrolling shareholders. • Consolidated net income (computed and allocated): Purity’s separate income $100,000 Southern’s net income $60,000 Less: Unrealized intercompany gain on downstream asset sale (10,000) Southern’s realized net income 50,000 Consolidated net income $150,000 Income to noncontrolling interest ($50,000 x 0.25) (12,500) Income to controlling interest $137,500
  • 20. Example 1: 100% Ownership Land Transfer (Non-Depreciable) • On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. • In this example, we’ll do consolidation worksheet entries without adjusting the equity method accounts. • This is the modified equity method. • This is meant to be a conceptual exercise only. (We will switch to the fully adjusted equity method next.) Required: 1. Prepare the consolidation entry(ies) as of 12/31/X5 and 12/31/X6. 2. Prepare the consolidation entry at 12/31/X7, assuming that Stubben sold the land in 20X7 for $120,000.
  • 21. Example 1: 100% Ownership Land Transfer (Non-Depreciable) On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. $40 Parker $100 Stubben $120 “Fake” Gain = $60 Gain = $20 Total Gain = $80 In 20X7
  • 22. Example 1: Consolidation Entry at 12/31/X5 Requirement 1 – consolidation entry: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Gain +60 Consolidation Entry at 12/31/X5 Land +60 Gain on Sale of Land 60,000 Land 60,000 What happens to the gain? RE +60 Land +60
  • 23. Example 1: Consolidation Entry at 12/31/X6 Requirement 1 – consolidation entry: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity RE +60 Land +60 Consolidation Entry at 12/31/X6 (and all years until land is sold) Retained Earnings 60,000 Land 60,000
  • 24. Example 1: Consolidation Entry at 12/31/X7 Requirement 2 – consolidation entry after land sold: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity RE +60 Gain +20 What gain should Stubben report in 20X7 when the land is sold? Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Retained Earnings 60,000 Gain on Sale 60,000 • Thus, the consolidated gain is $80,000! • What’s the only problem with the partial equity method? • THE PARENT’S FINANCIAL STATEMENTS ARE NOT CORRECT!
  • 25. Solution: Parker Company Equity Method Journal Entries Requirement 1 Consolidation Entry at 12/31/X5 Gain on Sale of Land 60,000 Land 60,000 Consolidation Entry at 12/31/X6 Retained Earnings 60,000 Land 60,000 Requirement 2 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Retained Earnings 60,000 Gain on Sale of Land 60,000
  • 26. Equity Method Adjustment  After calculating the unrealized gain, simply make an extra adjustment to back it out.  Do this at the same time you record the parent’s share of the sub’s income. NI XXX Income from Sub XXX NI 60,000 Unreal. Gain 60,000 This ensures that the parent income is equal to the consolidated income. Investment in Sub Reverse later when the asset is sold!
  • 27. Example 2: 100% Ownership Land Transfer • On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. • Now assume Parker adjusts for this transaction in the equity accounts. • This is the fully adjusted equity method! • How would your answers change? Required: 1. Prepare the consolidation entry(ies) as of 12/31/X5 and 12/31/X6. 2. Prepare the consolidation entry at 12/31/X7, assuming that Stubben sold the land in 20X7 for $120,000.
  • 28. Example 2: 100% Ownership Land Transfer On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000. $40 Parker $100 Stubben $120 “Fake” Gain = $60 Gain = $20 Total Gain = $80 In 20X7
  • 29. ONE EXTRA STEP! Equity Method Adjustment Investment in Sub Income from Sub NI XXX XXX NI 60,000 Unreal. 60,000 Gain This defers the gain until later
  • 30. Example 2: Consolidation Entry at 12/31/X5 Requirement 1: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Gain +60 What happens to the equity method accounts? • Eliminated in the consolidation. But we still need to fix the problem! Consolidation Entry at 12/31/X5 Land +60 Gain on Sale of Land 60,000 Land 60,000 RE correct Invest 60 Income from Sub 60 • The equity method adjustment “fixes” parent’s books! Same! What happens to the gain AND Income from Sub? Invest 60 Land +60 They cancel out!
  • 31. Example 2: Consolidation Entry at 12/31/X6 Requirement 1: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Invest 60 Land +60 • The normal basic elimination entry will still eliminate BV of equity. • The investment account will be “over eliminated” and left with a 60,000 credit! • We can’t leave a “balance” in that account in the consolidated B/S! Consolidation Entry at 12/31/X6 (and all years until land is sold) Investment 60,000 Land 60,000 • This entry eliminates the investment account and fixes the land balance.
  • 32. Example 2: Consolidation Entry at 12/31/X7 Requirement 1: Parker Stubben Assets = Liabilities + Equity Assets = Liabilities + Equity Invest 60 What gain should Stubben report in 20X7 when the land is resold? Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Investment 60,000 Gain on Sale 60,000 • Thus, the consolidated gain is $80,000! • We also reverse out the equity method deferral this year. • THE PARENT’S FINANCIAL STATEMENTS ARE ALWAYS CORRECT! Gain +20
  • 33. Example 2: Solution Summary Requirement 1 Consolidation Entry at 12/31/X5 Gain on Sale of Land 60,000 Land 60,000 Consolidation Entry at 12/31/X6 Investment in Stubben 60,000 Land 60,000 Requirement 2 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7) Investment in Stubben 60,000 Gain on Sale of Land 60,000
  • 34. Consolidation Worksheet—20X5 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 60,000 60,000 0 Income from Sub (60,000) Lower Basic 0 Balance Sheet Investment in Sub (60,000) Lower Basic 0 Land 100,000 60,000 40,000
  • 35. Consolidation Worksheet—20X6 Adjustments Parent Sub DR CR Consol-idated Income Statement Balance Sheet Investment in Sub (60,000) Lower 60,000 Basic 0 Land 100,000 60,000 40,000
  • 36. Consolidation Worksheet—20X7 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 20,000 60,000 80,000 Balance Sheet Investment in Sub (60,000) Lower 60,000 Basic 0 Land 0 0
  • 37. Learning Objective 3 Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following a downstream land transfer.
  • 38. Downstream Sale of Land • Peerless Products purchases 80% of the common stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000. • During 20X1, Peerless reports separate income of $140,000 and declares dividends of $60,000. • Special Foods reports net income of $50,000 and declares dividend of $30,000. • July 1, 20X1, Peerless sells land to Special Foods for $35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following years. P 80% S NCI 20%
  • 39. Fully adjusted equity-method entries – 20X1 • 20X1 Peerless records its share of Special Foods’ income and dividend. (5) Investment in Special Foods 40,000 Income from Special Foods 40,000 Record Peerless’ 80% share of Special Foods’ 20X1 income (6) Cash 24,000 Investment in Special Foods 24,000 Record Peerless’ 80% share of Special Foods’ 20X1 dividend
  • 40. Fully adjusted equity-method entries – 20X1 • Under the fully adjusted equity method, Peerless defers the entire $15,000 using the following entry: (7) Income from Special Foods 15,000 Investment in Special Foods 15,000 Defer gain on intercompany land sale to Special Foods • Objectives: (1) Peerless income is overstated by $15,000, the adjustment to Income from Special Foods offsets this overstatement – Peerless net income is now correct, and (2) Special Foods’ land account is currently overstated by $15,000 (was recorded for $20,000 but purchased for $35,000), reduction on the investment account offsets the overstatement and defer the unrealized gain.
  • 41. Basic investment account elimination entry: Common stock 200,000 Retained earnings 100,000 Income from Special Foods 25,000 NCI in NI of Special Foods 10,000 Dividend declared 30,000 Investment in Special Foods 241,000 NCI in NA of Special Foods 64,000
  • 42. Consolidation Worksheet—20X1 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 15,000 15,000 0 Income from Sub 25,000 25,000 Basic 0 Balance Sheet Investment in Sub 241,000 241,000 Basic 0 Land 155,000 75,000 15,000 215,000
  • 43. Group Exercise 1: Partial Ownership Land Transfer • Stubben Corporation is a 90%-owned subsidiary of Parker Corporation, acquired for $270,000 on 1/1/X5. • Investment cost was equal to book value and fair value. • Stubben’s net income in 20X5 was $70,000, and Parker’s income, excluding its income from Stubben, was $90,000. • Parker’s income includes a $10,000 unrealized gain on land that cost $40,000 and was sold to Stubben for $50,000. • Assume that Stubben sold the land in 20X7 for $65,000. Assume Parker adjusts for this transaction in the equity accounts. NOTE: This is a downstream transaction. Required: 1. What entry(ies) would Parker make in 20X5 and 20X7? 2. Prepare the consolidation entries at 12/31/X5, 12/31/X6, and 12/31/X7. P 90% S NCI 10%
  • 44. Group Exercise 1: Solution Requirement 1 20X5 Equity Method Entries 20X7 Equity Method Entry (after Stubben resold the land)
  • 45. Group Exercise 1: Solution Requirement 2 Consolidation Entry at 12/31/X5 Consolidation Entry at 12/31/X6 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
  • 46. Consolidation Worksheet—20X5 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 10,000 10,000 0 Income from Sub 53,000 53,000 Basic 0 Balance Sheet Investment in Sub 323,000 323,000 Basic 0 Land 50,000 10,000 40,000
  • 47. Consolidation Worksheet—20X6 Adjustments Parent Sub DR CR Consol-idated Income Statement Balance Sheet Investment in Sub (10,000) Lower 10,000 Basic 0 Land 50,000 10,000 40,000
  • 48. Learning Objective 4 Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary following an upstream land transfer.
  • 49. Illustration (p. 318 - 321) Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000 Peerless Product Jul 1, 20X1 Jan 1, 20X1 Special Foods $35 $20 Purchase land Inter-corporate transfer of land Consolidated Entity
  • 50. Upstream Sale of Land • Peerless Products purchases 80% of the common stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000. • During 20X1, Peerless reports separate income of $140,000 and declares dividends of $60,000. • Special Foods reports net income of $50,000 and declares dividend of $30,000. • July 1, 20X1, Special Foods sells land to Peerless for $35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following years. P 80% S NCI 20%
  • 51. • 20X1 Peerless records its share of Special Foods’ income and dividend under the fully adjusted method: (8) Investment in Special Foods 40,000 Income from Special Foods 40,000 Record Peerless’ 80% share of Special Foods’ 20X1 income (9) Cash 24,000 Investment in Special Foods 24,000 Record Peerless’ 80% share of Special Foods’ 20X1 dividend
  • 52. Fully adjusted equity-method entries – 20X1 • Under the fully adjusted equity method, Peerless Inc. defers relative share of the unrealized gross profit is $12,000 (15,000 X 0.80) (10) Income from special Foods 12,000 Investment in Special Foods 12,000 Defer gain on intercompany land sale to Special Foods. Until resold to external party by Special Food, the carrying value of land must be reduces each time consolidated statements are prepared
  • 53. Basic investment account elimination entry: Common stock 200,000 Retained earnings 100,000 Income from Special Foods 40,000 NCI in NI of Special Foods 10,000 Dividend declared 30,000 Investment in Special Foods 256,000 NCI in NA of Special Foods 64,000
  • 54. Partially Owned Upstream Sales Equity Method Adjustment • Similar to what we did with inventory transfers: we must share deferral with the NCI shareholders • Simply split up the adjustment for unrealized gains proportionately. NI 52,000 52,000 NI Unreal. 3,000 Gain To NCI Shareholders P 80% S NCI 20% Equity Method Adjustments Investment in Special Foods 12,000 Income from Special Foods Unreal. Gain 12,000 40,000
  • 55. Group Exercise 2: Partial Ownership Land Transfer • Stubben Corporation is a 90%-owned subsidiary of Parker Corporation, acquired for $270,000 on 1/1/X5. • Investment cost was equal to book value and fair value. • Stubben’s net income in 20X5 was $70,000, and Parker’s income, excluding its income from Stubben, was $90,000. • Stubben’s income includes a $10,000 unrealized gain on land that cost $40,000 and was sold to Parker for $50,000. • Assume that Parker sold the land in 20X7 for $65,000. • Assume Parker adjusts for this transaction in the equity accounts. • Assume that Stubben sold the land in 20X7 for $65,000. • Assume Parker adjusts for this transaction in the equity accounts. Required: 1. What entry(ies) would Parker make in 20X5 and 20X7? 2. Prepare the consolidation entries at 12/31/X5, 12/31/X6, and 12/31/X7. P 90% S NCI 10%
  • 56. Partially Owned Upstream Sales Equity Method Adjustment • Similar to what we did with inventory transfers: we must share deferral with the NCI shareholders • Simply split up the adjustment for unrealized gains proportionately. NI 63,000 63,000 NI Unreal. 1,000 Gain To NCI Shareholders P 90% S NCI 10% Equity Method Adjustments Investment in Stubben 9,000 Income from Stubben Unreal. Gain 9,000 54,000
  • 57. Solution: Parker Company Equity Method Journal Entries Requirement 1 20X5 Equity Method Entries 20X7 Equity Method Entry (after Stubben resold the land)
  • 58. Solution: Parker Company Equity Method Journal Entries Requirement 2 Consolidation Entry at 12/31/X5 Consolidation Entry at 12/31/X6 Requirement 3 Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
  • 59. Consolidation Worksheet—20X5 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 10,000 10,000 0 Income from Sub 54,000 54,000 Basic 0 Balance Sheet Investment in Sub 324,000 324,000 Basic 0 Land 50,000 10,000 40,000
  • 60. Consolidation Worksheet—20X6 Adjustments Parent Sub DR CR Consol-idated Income Statement Income from Sub Basic 0 Balance Sheet Investment in Sub (9,000) Lower 9,000 Basic 0 NCI in NA 1,000 1,000 Lower Land 50,000 10,000 40,000
  • 61. Consolidation Worksheet—20X7 Adjustments Parent Sub DR CR Consol-idated Income Statement Gain on Sale 15,000 10,000 25,000 Income from Sub Basic 0 Balance Sheet Investment in Sub (9,000) Lower 9,000 Basic 0 NCI in NA 1,000 1,000 Lower Land 0