Chapter 6 Intercompany Profit Transactions Plant Assets by

Chapter 6: Intercompany Profit Transactions – Plant Assets by Jeanne M. David, Ph. D. , Univ. of Detroit Mercy to accompany Advanced Accounting, 10 th edition by Floyd A. Beams, Robin P. Clement, Joseph H. Anthony, and Suzanne Lowensohn © Pearson Education, Inc. publishing as Prentice Hall 6 -1

Intercompany Profits – Plant Assets: Objectives 1. Assess the impact of intercompany profit on transfers of plant assets in preparing consolidations working papers. 2. Defer unrealized profits on asset transfers by either the parent or subsidiary. 3. Recognize realized, previously deferred profits on asset transfers by the parent or subsidiary. 4. Adjust the calculation of noncontrolling interest amounts in the presence of intercompany profits on asset transfers. © Pearson Education, Inc. publishing as Prentice Hall 6 -2

Intercompany Profit Transactions – Plant Assets 1: Transfers of Plant Assets © Pearson Education, Inc. publishing as Prentice Hall 6 -3

Intercompany Fixed Asset Sales Intercompany sales of nondepreciable fixed assets: • In year of intercompany sale – Defer any gain or loss – Restate fixed asset to cost • In years of continued ownership – Adjust investment account to defer gain or loss (adjust noncontrolling interest too, if upstream sale) – Restate fixed asset to cost • In year of sale to outside entity – Adjust investment account (and noncontrolling interest if upstream sale) – Recognize the previously deferred gain or loss © Pearson Education, Inc. publishing as Prentice Hall 6 -4

Intercompany Sale of Land • Park owns 90% of Stan, acquired at cost equal to fair value. In 2009, Park sells (downstream) land to Stan and records a $10 gain. In 2013, Stan sells the land to an outside entity at a $15 gain. Stan's separate income was $70 in 2009, $80 per year for 2010 to 2012, and $90 in 2013. © Pearson Education, Inc. publishing as Prentice Hall 6 -5

2009 Calculations Defer the unrealized gain, with full effect to Park • Park's Income from Stan 90%(70) – 10 = $53 • Noncontrolling interest share 10%(70) = $7 Elimination entry for 2009 Worksheet Gain on sale of land Land © Pearson Education, Inc. publishing as Prentice Hall 10 6 -6

2010 to 2012 Calculations Continue to defer gain, with full effect to Park • Park's Income from Stan 90%(80) = $72 • Noncontrolling interest share 10%(80) = $8 Elimination entry for Worksheets in 2010 to 2012 Investment in Stan Land © Pearson Education, Inc. publishing as Prentice Hall 10 6 -7

2013 Calculations Recognize the previously deferred gain, with full effect to Park • Park's Income from Stan 90%(90) + 10 = $91 • Noncontrolling interest share 10%(90) = $9 Elimination entry for 2013 Worksheet Investment in Stan 10 Gain on sale of land 10 © Pearson Education, Inc. publishing as Prentice Hall 6 -8

Intercompany Profit Transactions – Plant Assets 2: Deferring Unrealized Profits © Pearson Education, Inc. publishing as Prentice Hall 6 -9

Unrealized Profits on Fixed Assets Unrealized profit or loss on nondepreciable fixed assets – Defer in year of intercompany sale – Continue deferring by adjusting the investment in subsidiary (and noncontrolling interest if upstream) – Recognize full profit or loss upon resale to outside entity © Pearson Education, Inc. publishing as Prentice Hall 6 -10

Depreciable Fixed Assets Gains and losses on intercompany sales of depreciable fixed assets – Defer in period of intercompany sale – Recognize gain or loss over remaining life of asset • Adjust asset and depreciation down for gains • Adjust asset and depreciation up for losses – Recognize any unamortized gain or loss upon sale to outside entity © Pearson Education, Inc. publishing as Prentice Hall 6 -11

Downstream Example Perry owns 80% of Soper, acquired at cost equal to fair value. On 1/1/09, Perry sells equipment to Soper at a $30 profit. The equipment has a remaining life of 5 years from 1/1/09. Soper disposes of the equipment at book value at the end of 5 years. Soper's income is $70 in 2009, $80 per year for 2010 to 2012, and $90 in 2013. © Pearson Education, Inc. publishing as Prentice Hall 6 -12

2009 Calculations Defer the unrealized gain and amortize it over 5 years with full effect to Perry 30 gain / 5 years = $6 • Perry's Income from Soper 80%(70) – 30 + 6 = $32 • Noncontrolling interest share 20%(70) = $14 Elimination entry for 2009 Worksheet Gain on sale of equipment Equipment Accumulated depreciation Depreciation expense © Pearson Education, Inc. publishing as Prentice Hall 30 6 6 6 -13

Intercompany Profit Transactions – Plant Assets 3: Recognizing Realized, Previously Deferred Profits © Pearson Education, Inc. publishing as Prentice Hall 6 -14

Previously Deferred Gains/Losses Recognize over the life of the depreciable asset – Downstream sales • Adjust investment in subsidiary account – Upstream sales • Adjust investment in subsidiary account and noncontrolling interest, proportionately – Intercompany sales at a gain • Adjust asset and depreciation down – Intercompany sales at a loss • Adjust asset and depreciation up © Pearson Education, Inc. publishing as Prentice Hall 6 -15

2010 to 2012 Calculations Continue to recognize part of the gain, with full effect to Perry • Perry's Income from Soper 80%(80) + 6 = $70 • Noncontrolling interest share 20%(80) = $16 Elimination entry for Worksheets in 2010 Investment in Soper 24 Accumulated depreciation 6 Equipment 30 Accumulated depreciation 6 Depreciation expense 6 © Pearson Education, Inc. publishing as Prentice Hall 6 -16

Entries (cont. ) Worksheet entries for 2011 Investment in Soper Accumulated depreciation Equipment Accumulated depreciation Depreciation expense Worksheet entries for 2012 Investment in Soper Accumulated depreciation Equipment Accumulated depreciation Depreciation expense © Pearson Education, Inc. publishing as Prentice Hall 18 12 30 6 6 12 18 30 6 6 6 -17

2013 Calculations Recognize the remaining deferred gain, with full effect to Perry • Perry's Income from Soper 80%(90) + 6 = $78 • Noncontrolling interest share 20%(90) = $18 Elimination entries for 2013 Worksheet Investment in Soper 6 Accumulated depreciation 24 Equipment 30 Accumulated depreciation 6 Depreciation expense 6 © Pearson Education, Inc. publishing as Prentice Hall 6 -18

Intercompany Profit Transactions – Plant Assets 4: Impact on Noncontrolling Interest © Pearson Education, Inc. publishing as Prentice Hall 6 -19

Sharing Unrealized Gain or Loss Upstream sales of fixed assets require: – Deferring the gain or loss on the sale – Recognizing a portion of the gain or loss as the asset depreciates – Writing off any unrecognized gain or loss upon the sale of the asset – Sharing the gains and losses between the controlling and noncontrolling interests Upstream sales impact noncontrolling interests! © Pearson Education, Inc. publishing as Prentice Hall 6 -20

Upstream Example Pail owns 70% of Shovel, acquired at cost equal to fair value. On 1/1/09, Shovel sells equipment to Pail at a $40 profit. The equipment has a remaining life of 5 years from 1/1/09. Pail Uses the equipment for four years, then sells it at a profit at the start of 2013. Shovel's income is $70 in 2009, $80 per year for 2010 to 2012, and $90 in 2013. © Pearson Education, Inc. publishing as Prentice Hall 6 -21

2009 Calculations Defer the unrealized gain and amortize it over 5 years sharing the gain 40 gain / 5 years = $8 • Pail's Income from Shovel 70%(70 – 40 + 8) = $26. 6 • Noncontrolling interest share 30%(70 – 40 + 8) = $11. 4 Elimination entry for 2009 Worksheet Gain on sale of equipment 40 Equipment 40 Accumulated depreciation 8 Depreciation expense 8 © Pearson Education, Inc. publishing as Prentice Hall 6 -22

2010 to 2012 Calculations Continue to recognize part of the gain, sharing its effect between the controlling and noncontrolling interests • Pail's Income from Shovel 70%(80 + 8) = $61. 6 • Noncontrolling interest share 30%(80 + 8) = $26. 4 © Pearson Education, Inc. publishing as Prentice Hall 6 -23

2010 Worksheet Entries Elimination entry for Worksheets in 2010 Investment in Shovel Noncontrolling interest Accumulated depreciation Equipment Accumulated depreciation Depreciation expense © Pearson Education, Inc. publishing as Prentice Hall 22. 4 9. 6 8. 0 40. 0 8. 0 6 -24

2011 Worksheet Entries Worksheet entries for 2011 Investment in Shovel Noncontrolling interests Accumulated depreciation Equipment Accumulated depreciation Depreciation expense © Pearson Education, Inc. publishing as Prentice Hall 16. 8 7. 2 16. 0 40 8. 0 6 -25

2012 Worksheet Entries Worksheet entries for 2012 Investment in Shovel Noncontrolling interest Accumulated depreciation Equipment Accumulated depreciation Depreciation expense © Pearson Education, Inc. publishing as Prentice Hall 11. 2 4. 8 24. 0 40. 0 8. 0 6 -26

2013 Calculations Recognize the remaining deferred gain, sharing the impact with controlling and noncontrolling interests • Unamortized gain = 1 year at $8 • Pail's Income from Shovel 70%(90 + 8) = $68. 6 • Noncontrolling interest share 30%(90 + 8) = $29. 4 Elimination entries for 2013 Worksheet Investment in Shovel 5. 6 Noncontrolling interests 2. 4 Accumulated depreciation 32. 0 Equipment 40. 0 Accumulated depreciation 8. 0 Gain on sale of equipment 8. 0 © Pearson Education, Inc. publishing as Prentice Hall 6 -27

Sale at Other Than Fair Value Intercompany sales of fixed assets at prices other than fair value – Deserve scrutiny by shareholders – Sales above fair value move additional cash to the seller – Sales below fair value transfer valuable goods to the buyer – There is a transfer of wealth between the affiliated companies, and between the controlling and noncontrolling interests © Pearson Education, Inc. publishing as Prentice Hall 6 -28

Inventory Items Fixed Assets An intercompany sale of inventory which is acquired as a fixed asset – Unrealized profit is removed from cost of sales in year of sale – Profit is recognized over the fixed asset's life Cost of sales Equipment Accumulated depreciation Depreciation expense © Pearson Education, Inc. publishing as Prentice Hall XXX X X 6 -29

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