Chapter 5: Intercompany Profit

Transactions Inventories
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany
Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn

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Intercompany Profits
Inventories: Objectives
1. Understand the impact of intercompany profit
for inventories on preparation of consolidation
working papers.
2. Apply the concepts of upstream versus
downstream inventory transfers.
3. Defer unrealized inventory profits remaining
in ending inventory of either the parent or
subsidiary.

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Objectives (cont.)
4. Recognize realized, previously deferred inventory
profits in the beginning inventory of either the
parent or subsidiary.
5. Adjust the calculations of noncontrolling
interest amounts in the presence of
intercompany inventory profits.

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Intercompany Profit Transactions Inventories

1: Intercompany Inventory Profits

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Intercompany Transactions
For consolidated financial statements, ARB No.
51 (as amended by FASB Statement No. 160)
states:
"intercompany balances and transactions
shall be eliminated."
Show income and financial position as if the
intercompany transactions had never taken
place.

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Intercompany Sales of Inventory

Profits on intercompany sales of inventory
All recognized if goods have been resold to
outsiders
Deferred if the goods are still held in
inventory
Previously deferred profits in beginning
inventory are recognized
Consider a FIFO inventory system
Beginning inventories are sold
Ending inventories are from current period
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No Intercompany Profits in
Inventories

During 2009, Pretty sold goods costing $1,000 to its subsidiary, Simple, at a gross profit of 30%. Simple had none of this
inventory on hand at the end of 2009. Worksheet entry for 2009:

All intercompany sales of inventories have been resold to outside parties, so remove the full sales price from both sales and
cost of sales.
Pretty's sales are reduced $1,429.
Simple's cost of sales are reduced $1,429.
The same entry is used if Simple sells to Pretty.

Sales

Cost of sales

1,429

1,429

Sales = $1,000 / (1-30%) = $1,429

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Intercompany Profits Only in

Ending Inventories

Last year, 2009, Paul sold goods costing $500 to its

subsidiary, Sal, at a gross profit of 25%. Sal had none
of this inventory on hand at the end of 2009.
During 2010, Paul sold additional goods costing
$900 to Sal at a gross profit of 40%. Sal has $200 of
these goods on hand at 12/31/2010. Worksheet
entries for 2010:
Sales

1,500

Cost of sales

1,500

Sales = $900 / (1-40%) = $1,500

Cost of sales
Inventory
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Ending inventory profit = $200 x 40%

80
80
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Intercompany Profits Beginning

and Ending Inventories

Last year, 2009, Pam sold goods costing $300 to its

subsidiary, Sir, at mark-up of 25%. Sir had $120 of this
inventory on hand at the end of 2009.
During 2010, Pam sold additional goods costing $500 to Sir
at a 30% mark-up. Sir has $260 of these goods on hand
at 12/31/2010. Worksheet entries for 2010:
Sales
650

Cost of sales

650

Sales = $500 + 30%($500) = $650

Cost of sales

60

Inventory

60

Ending inv. profits = $260 x 30%/130%

Investment in Subsidiary
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24
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Intercompany Profit Transactions Inventories

2: Upstream & Downstream

Inventory Sales
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Upstream and Downstream Sales

Downstream
Sales
Parent
Subsidiary sells
to parent

Parent sells to
subsidiary
Subsidiary 1

Subsidiary 2

Subsidiary 3
Upstream Sales

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Intercompany Inventory Sales

The worksheet entries for eliminating intercompany profits for downstream sales

Sales

XXX

Cost of sales

XXX

For upstream sales, the last entry would also include a debit to noncontrolling interest, splitting the profit to be realized between controlling and noncontrolling
interests.

For the intercompany sales price

Cost of sales

XX

Inventory

XX

For the profits in ending inventory

Investment in Subsidiary
Cost of sales

XX
XX

For the profits in beginning inventory

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Data for Example

For the year ended 12/31/2011:
Subsidiary income is $5,200
Subsidiary dividends are $3,000
Current amortization of acquisition price is
$450
Intercompany (IC) sales information:
IC sales during 2011 were $650
IC profits in ending inventory $60
IC profit in beginning inventory $24
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Income Sharing with Downstream

Sales PARENT Makes Sale
Subsidiary net income

$5,200

Current amortizations

(450)

Adjusted income

$4,750

CI 80% share
$3,800
(60)
24

Defer profits in EI
Recognize profits in BI

Income recognized

(60)

$3,764

24

$4,714

Income from subsidiary

$2,400

NCI 20% share

$950

When parent
makes the
IC
Subsidiary
dividends
$3,000
sale, the impact of deferring
and recognizing profits falls all
to the parent.
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$600

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Income Sharing with Upstream

Sales SUBSIDIARY Makes Sale
Subsidiary net income

$5,200

CI 80% share

Current amortizations

(450)

$3,800

$4,750

(48)

Adjusted income

19.2
Defer profits in EI
Recognize profits in BI
Income recognized

(60)

$3,771.2

24
$4,714

Income from subsidiary

$2,400

When subsidiary
the IC sale,
Subsidiary
dividendsmakes
$3,000
the impact of deferring and
recognizing profits is split among
controlling and noncontrolling
interests.
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NCI 20% share

$950.0
(12.0)
4.8
$942.8
$600

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Intercompany Profit Transactions Inventories

3: Unrealized Profits in Ending

Inventories
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Ending Inventory on Hand

Intercompany profits in ending inventory
Eliminate at year end
Working paper entry
Cost of sales
XXX
Inventories
XXX
For the unrealized profit

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Parent Accounting
Porter owns 90% of Sorter acquired at book value (no
amortizations). During the current year, Sorter reported
$10,000 income. Porter sold goods to Sorter during the
year for $15,000 including a profit of $6,250. Sorter still
holds 40% of these goods at the end of the year.
Unrealized profit in ending inventory
40%(6,250) = $2,500
Porter's Income from Sorter
90%(10,000) 2,500 unreal. Profits = $6,500
Noncontrolling interest share
10%(10,000) = $1,000
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Entries
Porter's journal entry to record income
Investment in Sorter

6,500

Income from Sorter

6,500

Worksheet entries to eliminate intercompany

sale and unrealized profits
Sales

15,000

Cost of sales
Cost of sales
Inventory
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15,000
2,500
2,500
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Worksheet Income Statement

Porter Sorter
Sales
Income from Sorter

$100.0

$50.0

6.5

Cost of sales

(60.0)

(35.0)

Expenses

(15.0)

(5.0)

Noncontrolling interest share

Controlling interest share

DR

$7.5

Consol

15.0

$135.0

6.5

0.0

2.5 15.0

(82.5)
(20.0)

1.0
$31.5

CR

(1.0)
$31.5

There would be a credit adjustment to Inventory for 2.5 on the

balance sheet portion of the worksheet.

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What if?
If the sales had been upstream, by Sorter to
Porter:
Unrealized profits in ending inventory
40%(6,250) = $2,500
Porter's Income from Sorter
90%(10,000 2,500) = $6,750
Noncontrolling interest share
10%(10,000 2,500) = $750
Upstream profits impact both
Controlling interest share
Noncontrolling interest share
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Intercompany Profit Transactions Inventories

4: Recognizing Profits from

Beginning Inventories
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Intercompany Profits in Beginning

Inventory
Unrealized profits in
ending inventory one year

Become

Profits to be recognized in the beginning

inventory of the next year!
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Intercompany Profit Transactions Inventories

5: Impact on Noncontrolling Interest

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Direction of Sale and NCI

The impact of unrealized profits in ending
inventory and realizing profits in beginning
inventory depends on the direction
Downstream sales
Full impact on parent
Upstream sales
Share impact between parent and
noncontrolling interest

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Calculating Income and NCI

Downstream sales:
Income from sub
= CI%(Sub's NI) Profits in EI + Profits in BI
Noncontrolling interest share
= NCI%(Sub's NI)
Upstream sales:
Income from sub
= CI%(Sub's NI Profits in EI + Profits in BI)
Noncontrolling interest share
= NCI%(Sub's NI Profits in EI + Profits in BI)
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Upstream Example with

Amortization

Perry acquired 70% of Salt on 1/1/2009 for $420 when Salt's

equity consisted of $200 capital stock and $200 retained
earnings. Salt's inventory was understated by $50 and
building, with a 20 year life, was understated by $100. Any
excess is goodwill.

2009
Perry

2010
Salt Perry

Salt

Separate income
$1,250 $705 $1,500 $745
During 2009, Salt sold goods costing $700 to Perry at a 20%
markup.
$240 of these goods
in Perry's
ending
inventory.
Dividends
$600were$280
$600
$300
In 2010, Salt sold goods costing $900 to Perry at a 25% markup
and Perry still had $100 on hand at the end of the year.

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Analysis and Amortization

Cost of 70% of Salt

$420

Implied value of Salt 420/.70

$600

Book value 200 + 200

400

Excess

$200
Unamort Amort

Allocated to:

Unamort Amort

Unamort

1/1/09

2009

1/1/10

2010

12/31/10

Inventory

50

(50)

Building

100

(5)

95

(5)

90

Goodwill

50

50

50

200

(55)

145

(5)

140

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2009 Income Sharing (Upstream)

Salt's net income
Current amortizations
Adjusted income

$705

CI 70% share

(55)

$455

$650

($28)

Income from Salt

$427
Defer profits in EI

(40)

Income recognized

$610

$196
NCI 30% share
$195

Subsidiary dividends

$280

($12)
$183

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$84

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Perry's 2009 Equity Entries

Investment in Salt

420

Cash

420

For acquisition of 70% of Salt

Cash

196

Investment in Salt

196

For dividends received

Investment in Salt
Income from Salt

427
427

For share of income

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2009 Worksheet Entries

1. Adjust for errors & omissions - none
2. Eliminate intercompany profits and losses
Sales
700
Cost of sales
Cost of Sales

700
40

Inventory

40

3.

Eliminate income & dividends from sub. and bring

Investment account to its beginning balance
Income from Salt
427
Dividends

196

Investment in Salt

231

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2009 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share

183

Dividends

84

Noncontrolling interest

99

5. Eliminate reciprocal Investment & sub's equity

balances
Capital stock

200

Retained earnings

200

Inventory

50

Building

100

Goodwill

50

Investment in Salt

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420

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2009 Entries (3 of 3)
6. Amortize fair value/book value differentials
Cost of sales

50

Inventory
Depreciation expense

50
5

Building

7. Eliminate other reciprocal balances none

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2010 Income Sharing (Upstream)

Salt's net income
Current amortizations
Adjusted income

$745

CI 70% share

(5)

$518

$740

($14)
$28

Defer profits in EI
Realize profits from BI
Income recognized
Subsidiary dividends

(20)

$532

40
$760

$210

$300

Income from Salt

NCI 30% share

$222
($6)
$12
$228

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$90

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Perry's 2010 Equity Entries

Cash

210

Investment in Salt

210

For dividends received

Investment in Salt
Income from Salt

532
532

For share of income

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2010 Worksheet Entries

1.
2.

Adjust for errors & omissions - none

Eliminate intercompany profits and losses

Sales

900

Cost of sales
Cost of Sales

900
20

Inventory

20

Investment in Salt

28

Noncontrolling interest

12

3.

Eliminate
income & dividends from sub. and bring 40
Cost of sales
Investment account to its beginning balance

Income from Salt

532

Dividends

210

Investment in Salt

322

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2010 Entries (2 of 3)
4. Record noncontrolling interest in sub's earnings &
dividends
Noncontrolling interest share

228

Dividends

90

Noncontrolling interest

5. Eliminate reciprocal Investment & sub's equity

balances
Capital stock

200

Retained earnings

625

Inventory

Building

95

Goodwill

50

Investment in Salt

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138

679

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2010 Entries (3 of 3)
6. Amortize fair value/book value differentials
Depreciation expense

Building

7. Eliminate other reciprocal balances none

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