advanced accounting - chapter 5

Unrealized Inventory Gain -  Downstream Transfers: TI and G

Worksheet entries to eliminate sales/purchases balances (Entry TI) and to remove unrealized gross profit from ending Inventory in Year 1 (Entry G) are standard, regardless of the circumstances of the consolidation.

Intra-entity Transactions - Downstream Transfers: Entry G* - If the transfer of inventory is DOWNSTREAM AND the parent uses the equity method, the following entry is used to recognize the remaining unrealized profit left at the end of the previous year.

DR Investment in Subsidiary CR COGs (Beg. Inv. Component)

Intra-entity Transactions - Upstream vs. Downstream transfers Compare the Entry *G for the downstream and upstream transfers to see the difference in the transactions.

Downstream - DR Investment in S - CR COGS Upstream - DR RE S - CR COGs

Intra-entity Transactions - Upstream Inventory Transfer As of January 1, 2013, $16,000 of transfers remain in P's inventory, and $4,000 of gross profit (25%) is unearned from a consolidated perspective.

RE S - 4,000 COGS - 4,000 A credit to Cost of Goods Sold increases consolidated net income to recognize that the profit has been earned in 2013 by sales to outsiders.

What about the inventory of the intra-entity transfer that was sold?

The consolidated company has earned the profit on 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.

How to journalize S entry in subsequent years after unrealized profit (if upstream)

DR CS DR RE as of 1/1 less any deferred income for previous year) CR Investment in S (% of total) CR NCI (% of total)

Intra-entity Transactions -- Depreciable Asset Transfers - example - Able purchased equipment for $100,000 and has recorded $40,000 of depreciation since that time. - Baker buys equipment from Able for $90,000 on 1/1/12. Remaining life=10 years. Sellers books

DR Cash 90,000 DR Accum Depr 40,000 CR Equip - 100,000 CR Gain on Sale 30,000 NOTE: Seller would record deprec exp at 6,000 / year if had not sold equip

TA - subsequent years (yr 3)

DR Equip - 20,000 DR R/E (20,000 - 4,000 - 4,000) - 12,000 CR - Accum Deprec - 32,000

Intra-entity Transactions -- Depreciable Asset Transfers - in years following 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 is computed. - To get the worksheet adjustments, compare the individual records to the consolidated records.

Unrealized Gross Profits -Effect on Noncontrolling Interest. Accounts affected by intra-entity transactions:

- Revenues - Cost of Goods Sold - Expenses - Noncontrolling Interest in Subsidiary's Net Income - Retained Earnings at the Beginning of the Year - Inventory - Land, Buildings, and Equipment - Noncontrolling Interest in Subsidiary at End of Year

Calculating share of NI for upstream vs downstream transfers

- downstream = (sub's NI less amortization) x % of ownership. This total + realized NI - deferred NI = portion of income - upstream = total of sub's NI, less amortization + realized NI - Deferred NI. This total is then multiplied by percentage of ownership

the effect of land transfers on NCI

- downstream = no effect on NCI - upstream = UPSTREAM transfers have a gain on the SUBSIDIARY books! All NCI balances are based on the sub's net income EXCLUDING the intra-entity gain.

Intra-entity Transactions - Upstream Inventory Transfer A different set of consolidation procedures is necessary if the intra-entity transfers are upstream.

-Upstream gross profits are attributed to the subsidiary, not the parent, -Because inventory transfers are upstream, only 80% of the profit deferral and subsequent recognition is allocated to the parent's equity earnings and investment account. -Intra-entity profit reallocation across time affects both the subsidiary's reported income and the noncontrolling interest.

Intra-entity Transactions - Upstream vs. Downstream transfers - ENTRY S

1 - Downstream - to remove S's SE accts and portion of investment balance. BV at beginning of year 2 - upstream - same as above, but adjusted by G*. Adjusted BV at beginning of year

Intra-entity Transactions --Land Transfer Entry GL ENTRY *GL

As long as the land remains on the books of the buyer, the unrealized gain must be eliminated at the end of each fiscal period. DR RE CR Land The original gain was closed to R/E at the end of that period. When we eliminate the gain in subsequent years, it must come from R/E.

Inventory 2012 (price $80,000; cost $60,000; balance $16,000). 2013 (price $100,000; cost $70,000. balance 20,000). G* for 12/31/13

Investment in S 4,000 COGs 4,000 60/80=75%. 25% GM. 16,000x.25=4,000

Intra-entity Transactions - Downstream Transfers: Entry G* - If the transfer of inventory is UPSTREAM AND the parent uses the equity method, the following entry is used to recognize the remaining unrealized profit left at the end of the previous year.

Investment in Subsidiary account replaces the Retained Earnings account used for upstream sales. So: DR RE CR COGs (Beg. Inv. Component)

how to calculate consolidate COGs

P COGs + S COGs - intra-entity transfers - previous year's deferred profit + this year's deferred profits

to determine net income after gain on transfer of depreciable asset

P's NI S's NI (Amortization) (Gain on sale) removed Deprec (remove excess depreciation) note: deprec. if BV deprec was 10,000 and deprec based on buyer's amount is 16,000, add 6,000 to Net Income to remove excess depreciation)

Inventory 2012 (price $80,000; cost $60,000; balance $16,000). 2013 (price $100,000; cost $70,000. balance 20,000). TI for 12/31/13

Sales 100,000 COGs 100,000

Intra-Entity Inventory Downstream Transfer - Example P acquires 80% of S on 1/1/12 for $400,000. FV of NCI is $100,000. $50,000 excess fair value towards database (20 year life). NI 2012=$30,000; 2013=$70,000. Div 2012=$20,000; 2013=$50,000. Intra-entity debt $10,000.

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Unrealized Inventory Gain - Downstream Transfers: G*

the procedure to eliminate intra-entity gross profit from Year 2's beginning account balances differs from the Entry *G just presented IF: (1) the original transfer is downstream (parent's) and (2) the parent applies the equity method for internal accounting purposes.

Intra-entity Transactions -- Depreciable Asset Transfers If transfer is downstream and parent uses equity method

then their RE balance has already been reduced for the gain, and we adjust the Investment account instead. DR Equip 10,000 DR Investment in S 27,000 CR Accum Dep 37,000 ED is same

Inventory 2012 (price $80,000; cost $60,000; balance $16,000). 2013 (price $100,000; cost $70,000. balance 20,000). G for 12/31/13

COGS - 6,000 Inventory - 6,000 70/100=.7. GM=30%. 20x.3=6,000

For intra-entity beginning inventory profits resulting from downstream transfers when the parent applies the equity method:

1 - Parent's RE are appropriately stated due to intra-entity profit deferrals and recognition. 2 - The subsidiary RE reflect none of the intra-entity profit and require no adjustment. 3 - The parent's 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.

After TA, enter ED for the year (yr 1)

DR - Accum Dep - 4,000 CR - Deprec Exp - 4,000 to reduce overstatement of Deprec. Exp (historical = 12,000. new is 16,000

Intra-entity Transactions -- Depreciable Asset Transfers Entry ED - subsequent years

DR Accum Dep - 3,000 CR Deprec Exp - 3,000 to remove excess depr. exp. and adjust accum deprec to its correct 12/31 balance.

ED - subsequent year (yr 2)

DR Accum Deprec - 4,000 CR Deprec Exp - 4,000 to reverse excess deprec for year 2

ED - subsequent year (yr 3)

DR Accum Deprec - 4,000 CR Deprec Exp - 5,000 to reverse excess deprec

G entry

DR COGS CR Inventory To remove unrealized GP created by intra-entity sale (the gross margin for the unsold portion)

Intra-entity Transactions -- Depreciable Asset Transfers Entry TA - subsequent years

DR Equip - 10,000 DR RE - 27,000 CR Accum Deprec - 37,000 To return the equipment account to original historical cost and correct 1/1/13 balances in RE and Accum Depr.

TA - subsequent years (yr 2)

DR Equip - 20,000 (same every year) DR R/E - 16,000 (20,000 gain - 4,000 excess deprec) CR Accum Deprec 36,000 Adjusts RE at beginning of year for yr 1

TA end of yr 1. Sold equip for 80,000. original cost 100,000. BV 60,000

DR Equip -- 20,000 (returns equip to 100,000) DR Gain on sale - 20,000 (reverses gain) CR Accum Deprec - returns Accum to original Accum Deprec)

Intra-entity Transactions -- Depreciable Asset Transfers - example - Able purchased equipment for $100,000 and has recorded $40,000 of depreciation since that time. - Baker buys equipment from Able for $90,000 on 1/1/12. Remaining life=10 years. Buyer's books

DR Equip 90,000 CR Cash 90,000 NOTE: Buyer will record 9,000 per year in deprec.

Intra-Entity Inventory Transfers Example Three entries require attention in the calculation of noncontrolling interest in the sub's net income December 31, 2013: Consolidating Entry G*

DR Investment in S CR COGS 1 - removes unrealized gross profits (% rate) carried over from the previous period intra-entity downstream sales 2 - 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. 3 - The debit to the Investment in Bottom account brings that account to a zero balance in consolidation.

Entry G* - entry

DR R/E (beginning balance of seller) CR COGS (beginning inventory of component)

TI - entry

DR Sales CR COGS eliminates transferred inventory. Total recorded amounts deleted

Intra-entity Transactions -- Depreciable Asset Transfers - example - Able purchased equipment for $100,000 and has recorded $40,000 of depreciation since that time. - Baker buys equipment from Able for $90,000 on 1/1/12. Remaining life=10 years. Entry TA - year of purchase

DR gain on equip - 30,000 DR Equip 10,000 CR Accum Dep 40,000 To remove unrealized gain and return equip accounts to balances based on original historical cost

ENTRY G (Gross Profit)

Despite Entry TI, ending inventory may still be overstated due to the transfer 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 in Year 1:

ENTRY TI (Transferred Inventory)

Eliminate all intra-entity sales/purchases of inventory by eliminating the sales price of the transfer - which one company records as sales, and the other records as cost of goods sold.

What does G* do?

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.

Intra-Entity Inventory Transfers Example Three entries require attention in the calculation of noncontrolling interest in the sub's net income December 31, 2013: Entry S

Entry S eliminates a portion of the parent's investment account and provides the initial noncontrolling interest balance. The entry also removes stockholders' equity accounts of the subsidiary as of the beginning of the current year. DR CS DR RE CR Investment in S CR Non-controlling interest

Intra-entity Transactions - Upstream Inventory Transfer - ENTRY S

Entry S eliminates a portion of the parent's investment account and provides the initial noncontrolling interest balance. The entry also removes stockholders' equity accounts of the subsidiary as of the beginning of the current year. DR CS DR RE CR Investment CR NCI

Intra-Entity Inventory Transfers Example Three entries require attention in the calculation of noncontrolling interest in the sub's net income December 31, 2013: Consolidating TI entry:

Entry TI eliminates the intra-entity sales/purchases for 2013. DR Sales CR COGs

Entry G* - what is it?

From a consolidated view, the buyer's Cost of Goods Sold (the beginning inventory component) and the seller's 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.

Intra-Entity Inventory Transfers Example Three entries require attention in the calculation of noncontrolling interest in the sub's net income December 31, 2013: Entry G

G defers the unrealized gross profit (30% rate) of $6,000remaining at the end of 2013. DR COGs CR inventory Entry G eliminates the overstatement of Inventory as well as the ending component of Cost of Goods Sold which decreases consolidated income.

Intra-entity Transactions - Land Transfer Entry TL - if transferred at gain.

If land is transferred between the parent and sub at a gain, the gain is considered unrealized and must be eliminated DR Gain on sale of Land CR Land By crediting land for the same amount, this effectively returns the land to its carrying value on the date of transfer.

Intra-entity Transactions -- Depreciable Asset Transfers - ENTRY ED

In addition, the buyer's depreciation is based on the inflated transfer price. The excess depreciation expense must be eliminated - DR Accum. Dep. - CR Dep. Exp. to eliminate overstatement of depreciation expense caused by inflated transfer price (ED for excess deprec.)

Intra-entity Transactions -- Depreciable Asset Transfers - example - Able purchased equipment for $100,000 and has recorded $40,000 of depreciation since that time. - Baker buys equipment from Able for $90,000 on 1/1/12. Remaining life=10 years. Entry ED

In addition, the buyer's depreciation is based on the inflated transfer price. The excess depreciation expense must be eliminated. DR Accum Deprec - 3,000 CR Depr Exp - 3,000 To eliminate overstatement of deprec. exp. caused by inflated transfer price. Must be repeated for all 10 years

Intra-entity Land TransfersEliminating Unrealized Gains - Entry GL* (year of sale) ??? ask about this

In the period the land is sold to a third party, the unrealized gain must be eliminated one more time, and also finally recognized as a REALIZED gain in the current period's consolidated financial statements. DR RE (beg. bal. of seller) CR Gain on Sale of Land Modify the entry to credit the Gain account instead of land

Intra-entity Transactions -- Depreciable Asset Transfers Entry TA

In the year of transfer, the unrealized gain must be eliminated and the assets restated to original historical cost. DR Gain on Sale of Equipment DR Equipment CR Accumulated Depreciation To remove unrealized gain and return equipment accounts to balances based on original historical costs (labeled TA in reference to transferred asset