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Chapter 6: Intercompany Profit Transactions – Plant Assets

by Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompany

Advanced Accounting, 10th editionby Floyd A. Beams, Robin P. Clement,

Joseph H. Anthony, and Suzanne Lowensohn

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Intercompany Profits – Plant Assets: Objectives1. 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.

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1: Transfers of Plant Assets1: Transfers of Plant AssetsIntercompany Profit Transactions – Plant Assets

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Intercompany Fixed Asset SalesIntercompany 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

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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.

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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) = $7Elimination entry for 2009 Worksheet

Gain on sale of land 10

Land 10

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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) = $8Elimination entry for Worksheets in 2010 to 2012

Investment in Stan 10

Land 10

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2013 Calculations

Recognize the previously deferred gain, with full effect to Park

• Park's Income from Stan90%(90) + 10 = $91

• Noncontrolling interest share10%(90) = $9

Elimination entry for 2013 Worksheet

Investment in Stan 10

Gain on sale of land 10

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2: Deferring Unrealized Profits2: Deferring Unrealized ProfitsIntercompany Profit Transactions – Plant Assets

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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

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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

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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.

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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) = $14Elimination entry for 2009 Worksheet

Gain on sale of equipment 30 Equipment 30

Accumulated depreciation 6

Depreciation expense 6

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3: Recognizing Realized, Previously 3: Recognizing Realized, Previously Deferred ProfitsDeferred Profits

Intercompany Profit Transactions – Plant Assets

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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

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2010 to 2012 CalculationsContinue 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) = $16Elimination entry for Worksheets in 2010Investment in Soper 24 Accumulated depreciation 6

Equipment 30

Accumulated depreciation 6

Depreciation expense 6

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Entries (cont.)Worksheet entries for 2011

Worksheet entries for 2012

Investment in Soper 18 Accumulated depreciation 12

Equipment 30

Accumulated depreciation 6

Depreciation expense 6

Investment in Soper 12 Accumulated depreciation 18

Equipment 30

Accumulated depreciation 6

Depreciation expense 6

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2013 CalculationsRecognize the remaining deferred gain, with full

effect to Perry• Perry's Income from Soper

80%(90) + 6 = $78• Noncontrolling interest share

20%(90) = $18Elimination entries for 2013 Worksheet

Investment in Soper 6 Accumulated depreciation 24

Equipment 30

Accumulated depreciation 6

Depreciation expense 6

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4: Impact on Noncontrolling Interest4: Impact on Noncontrolling InterestIntercompany Profit Transactions – Plant Assets

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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 interestsUpstream sales impact noncontrolling interests!

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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.

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2009 CalculationsDefer the unrealized gain and amortize it over 5

years sharing the gain40 gain / 5 years = $8

• Pail's Income from Shovel70%(70 – 40 + 8) = $26.6

• Noncontrolling interest share30%(70 – 40 + 8) = $11.4

Elimination entry for 2009 WorksheetGain on sale of equipment 40

Equipment 40

Accumulated depreciation 8

Depreciation expense 8

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2010 to 2012 Calculations

Continue to recognize part of the gain, sharing its effect between the controlling and noncontrolling interests

• Pail's Income from Shovel70%(80 + 8) = $61.6

• Noncontrolling interest share30%(80 + 8) = $26.4

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2010 Worksheet Entries

Elimination entry for Worksheets in 2010

Investment in Shovel 22.4

Noncontrolling interest 9.6

Accumulated depreciation 8.0

Equipment 40.0

Accumulated depreciation 8.0

Depreciation expense 8.0

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2011 Worksheet Entries

Worksheet entries for 2011

Investment in Shovel 16.8

Noncontrolling interests 7.2

Accumulated depreciation 16.0

Equipment 40

Accumulated depreciation 8.0

Depreciation expense 8.0

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2012 Worksheet Entries

Worksheet entries for 2012

Investment in Shovel 11.2

Noncontrolling interest 4.8

Accumulated depreciation 24.0

Equipment 40.0

Accumulated depreciation 8.0

Depreciation expense 8.0

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2013 CalculationsRecognize 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) = $29.4Elimination entries for 2013 WorksheetInvestment 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

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Sale at Other Than Fair ValueIntercompany 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

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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 XXX

Equipment XXX

Accumulated depreciation X

Depreciation expense X

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