Advanced Accounting Jeter ● Chaney Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment Prepared by Sheila Ammons, Austin Community College Learning Objectives • Understand the financial reporting objectives in accounting for intercompany sales of nondepreciable assets on the consolidated financial statements • State the additional financial reporting objectives in accounting for intercompany sales of depreciable assets on the consolidated financial statements • Explain when gains or losses on intercompany sales of depreciable assets should be recognized on a consolidated basis • Explain the term “realized through usage” • Describe the differences between upstream and downstream sales in determining consolidated net income and the controlling and noncontrolling interests in consolidated income Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives • Compare the eliminating entries when the selling affiliate is a subsidiary (less than wholly owned) versus when the selling affiliate is the parent company • Compute the noncontrolling interest in consolidated net income when the selling affiliate is a subsidiary • Compute consolidated net income considering the effects of intercompany sales of depreciable assets • Describe the eliminating entry needed to adjust the consolidated financial statements when the purchasing affiliate sells a depreciable asset that was acquired from another affiliate • Explain the basic principles used to record or eliminate intercompany interest, rent, and service fees Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property • When there have been intercompany sales of nondepreciable property, workpaper entries are necessary to: – Include gains or losses on the sale in consolidated net income only at the time such property is sold to parties outside the affiliated group and in an amount equal to the difference between the cost of the property to the affiliated group and the proceeds received from outsiders – Present nondepreciable property in the consolidated balance sheet at its cost to the affiliated group LO Financial reporting objectives – nondepreciable property Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property Upstream Sale • E7-4 (variation): Procter Company owns 90% of the outstanding stock of Silex Company On January 1, 2014, Silex Company sold land to Procter Company for $350,000 Silex had originally purchased the land on June 30, 2010, for $200,000 • Procter Company plans to construct a building on the land bought from Silex in which it will house new production machinery The estimated useful life of the building and the new machinery is 15 years LO Financial reporting objectives – nondepreciable property Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property E7-4 (variation): Entries made on the books of each affiliate to record this intercompany sale in 2014 Entry on Books of Silex Cash Entry on Books of Procter 350,000 Land Land Cash 350,000 350,000 200,000 Gain on sale Note: No further entries are recorded 150,000 on the books of Procter until the land is sold to outsiders Additional Entry for Complete Equity Method: Proctor Only Equity in income 135,000 Investment in Silex 135,000 To reduce its income from subsidiary by its share of the intercompany gain ($150,000 x LO Financial reporting objectives – nondepreciable property 90%) Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property E7-4: B(1) Prepare the workpaper entries necessary because of the intercompany sale of land for the year ended December 31, 2014 Gain on Sale of Land 150,000 Land ($350,000 - $200,000) To eliminate the $150,000 gain reported by Silex Company and to reduce the land balance from the $350,000 recorded on the books of Procter to its 150,000 $200,000 cost to the affiliated group LO Financial reporting objectives – nondepreciable property Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property E7-4: B(2) Prepare the workpaper entries for the year ended December 31, 2015 Upstream Sale Cost Method and Partial Equity Method Beg Retained Earnings – Procter (90%) Beg Noncontrolling Interest (10%) Land 150,000 Complete Equity Method Investment in Silex Company (90%) Beg/ Noncontrolling Interest (10%) Land 150,000 135,000 15,000 135,000 15,000 LO Financial reporting objectives – nondepreciable property Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property E7-4: Summary Points – Proctor (parent) continues to report the land on their statements at the intercompany selling price of $350,000 However, in the consolidated balance sheet, the land is reported at its cost to the affiliated group of $200,000 – If the intercompany seller had been the parent (downstream sale), the entire $150,000 would go to the controlling interest, resulting in a $150,000 debit to the beginning retained earnings of the parent company LO Financial reporting objectives – nondepreciable property Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Nondepreciable Property Sales to Outsiders Upstream Sale E7-6: P Company owns 90% of the outstanding common stock of S Company On January 1, 2015, S Company sold land to P Company for $600,000 S Company originally purchased the land for $400,000 – On January 1, 2016, P Company sold the land purchased from S Company to a company outside the affiliated group for $700,000 LO Financial reporting objectives – nondepreciable property Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property P7-12: Worksheet entries for Dec 31, 2015 Equity In Subsidiary Income Dividends Declared ($75,000 x 80%) 60,000 Investment in Stone Company 180,000 240,000 To reverse the effect of parent company entries during the year for subsidiary dividends and income Upstream Sale Partial Equity LO Workpaper entries-upstream sales Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property Upstream Sale P7-12: Worksheet entries for Dec 31, 2015 Plant and Equipment Retained Earnings – Prather ($150,000 x 80%) Noncontrolling Interest ($150,000 x 20%) Accumulated Depreciation 540,000 Partial Equity 390,000 120,000 30,000 To reduce controlling and noncontrolling interests for their shares of unrealized intercompany profit at beg of year, to restore fixed assets to its book value to the selling affiliate on the date of the intercompany sale LO Workpaper entries-upstream sales Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property Upstream Sale P7-12: Worksheet entries for Dec 31, 2015 Accumulated Depreciation Other Expenses (Depreciation Expense) 15,000 Retained Earnings – Prather ($15,000 x 80%) 12,000 Noncontrolling Interest ($15,000 x 20%) 3,000 Partial Equity 30,000 LO year Workpaper To reverse amount of excess depreciation recorded during and toentries-upstream recognize an sales Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property P7-12: Worksheet entries for Dec 31, 2015 Upstream Sale Partial Equity Beg Retained Earnings - Stone Common Stock - Stone 1,038,000 525,000 Investment* in Stone ** Noncontrolling Interest To eliminate investment account and create NCI account * 1,250,400 312,600 (($1,263,000 - $675,000) x 80%) - $180,000 = $290,400 + $960,000 = $1,250,400 ** [$240,000 + ($1,038,000 - $675,000) x 20%] = $312,600 LO Workpaper entries-upstream sales Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property Year Subsequent to Intercompany Sale Upstream Sale P7-16 (Complete Equity Method): Prather Company owns 80% of the common stock of Stone Company The stock was purchased for $960,000 on January 1, 2012, when Stone Company’s retained earnings were $675,000 On January 1, 2014, Stone Company sold fixed assets to Prather Company for $960,000; Stone Company had purchased these assets for $1,350,000 on January 1, 2004, at which time their estimated useful life was 25 years The estimated remaining useful life to Prather Company on 1/1/14 is 10 years Both companies employ the straight-line method of depreciation Required: Prepare a consolidated statements workpaper for the year ended December 31, 2015 LO Upstream sales- complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property Upstream Sale P7-16 (Complete Equity Method): (1) (3) (5) (1) NCI in Consolidated Income = 20% x ($300,000 + $15,000) = $63,000 LO Upstream sales- complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property Upstream Sale P7-16 (Complete Equity Method): (2) (1) (3) (2) (3) (4) (2) (4) (2) (5) (3) LO Upstream sales- complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property P7-16: Prepare the worksheet entries for Dec 31, 2015 Equity in Subsidiary Income Dividends Declared ($75,000 x 80%) 60,000 Investment in Stone Company 192,000 252,000 To reverse the effect of parent company entries during the year for subsidiary dividends and income Upstream Sale LO Upstream sales- complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property Upstream Sale P7-16: Worksheet entries for Dec 31, 2015 Plant and Equipment Investment in Stone ($150,000 x 80%) Noncontrolling Interest ($150,000 x 20%) Accumulated Depreciation 540,000 390,000 120,000 30,000 To reduce controlling and noncontrolling interests for their shares of unrealized intercompany profit at beg of year, to restore the carrying value of equipment to its book value on the date of the intercompany sale LO Upstream sales- complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property P7-16: Worksheet entries for Dec 31, 2015 Accumulated Depreciation Other Expenses (Depreciation Expense) 15,000 Investment in Stone Company ($15,000 x 80%) 12,000 Noncontrolling Interest ($15,000 x 20%) 3,000 Upstream Sale 30,000 LO Upstream equity method To reverse amount of excess depreciation recorded duringsalesyear complete and to recognize an Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Sales of Depreciable Property P7-16: Worksheet entries for Dec 31, 2015 Beg Retained Earnings - Stone Common Stock - Stone Upstream Sale 1,038,000 525,000 Investment* in Stone ** Noncontrolling Interest To eliminate investment account and create NCI account * 1,250,400 312,600 (($1,263,000 - $675,000) x 8)%) - $180,000 = $290,400 + $960,000 = $1,250,400 ** [$240,000 + ($1,038,000 - $675,000) x 20%] = $312,600 LO Upstream sales- complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Calculation And Allocation Of Consolidated Net Income; Consolidated Retained Earnings: Complete Equity Method • Under the complete equity method: – Controlling interest in consolidated net income will always equal the net income reported by the parent – Consolidated retained earnings will equal the retained earnings reported by the parent at any point, assuming the parent has correctly adjusted for any and all unrealized (and subsequently realized) intercompany profit LO Consolidated net income – complete equity method Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Interest, Rents, and Service Fees Income and expenses relating to interest, fees, and rents should be reported in consolidation only when they arise from transactions with parties outside the affiliated group Workpaper entry to eliminate intercompany interest: Interest Income Interest Expense XXX XXX Workpaper entry to eliminate intercompany payables and receivables: Notes Payable Notes Receivable XXX Interest Payable Interest Receivable XXX XXX XXX LO 10 Intercompany interest, rents, service fees Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Interest, Rents, and Service Fees Workpaper entry to eliminate intercompany rent: Rent Income Rent Expense XXX XXX Intercompany Service Fees When one affiliate charges fees to another, the form of the eliminating entry is determined by how the transaction is recorded by the affiliates LO 10 Intercompany interest, rents, service fees Copyright © 2015 John Wiley & Sons, Inc All rights reserved Intercompany Interest, Rents, and Service Fees • Eliminating entries relating to intercompany transactions depend on how these transactions are recorded on the books of the affiliates In all cases the financial reporting objectives are: – To include in revenue only the amounts that result from transactions with parties outside the affiliated group – To present property in the consolidated balance sheet at its cost to the affiliated group – To present accumulated depreciation in the consolidated balance sheet based on the cost to the affiliated group – To present depreciation expense in the consolidated income statement based on the cost to the affiliated group LO 10 Intercompany interest, rents, service fees Copyright © 2015 John Wiley & Sons, Inc All rights reserved ... reporting objectives in accounting for intercompany sales of nondepreciable assets on the consolidated financial statements • State the additional financial reporting objectives in accounting for intercompany... Only Equity in income 135,000 Investment in Silex 135,000 To reduce its income from subsidiary by its share of the intercompany gain ($150,000 x LO Financial reporting objectives – nondepreciable... Gain on Sale of Land 150,000 Land ($350,000 - $200,000) To eliminate the $150,000 gain reported by Silex Company and to reduce the land balance from the $350,000 recorded on the books of Procter