Intercompany Profit

Transactions—Plant Assets

Transactions between affiliates for sales and purchases of plant assets create unrealized
profits and losses to the consolidated entity. The consolidated entity eliminates (defers)
such profits and losses in reporting the results of operations and its financial position. We
also
eliminate these in reporting the financial position and results of operations of a parent under
the
equity method. The adjustments to eliminate the effects of intercompany profits on plant
assets
are similar to, but not identical with, those for unrealized inventory profits. Unrealized
inventory
profits self-correct over any two accounting periods, but unrealized profits or losses on plant
assets
affect the financial statements until the related assets are sold outside the consolidated
entity or are
exhausted through use by the purchasing affiliate. This chapter covers concepts and
procedures for
eliminating unrealized profits on plant assets in one-line consolidations under the equity
method
and in consolidated statements.

Downstream Sale of Land

San Corporation is a 90 percent-owned subsidiary of Pak Corporation, acquired for
$270,000 on
January 1, 2011. Investment cost was equal to book value and fair value of the interest
acquired.
San’s net income for 2011 was $70,000, and Pak’s income, excluding its income from San,
was
$90,000. Pak’s income includes a $10,000 unrealized gain on land that cost $40,000 and
was sold
to San for $50,000. Accordingly, Pak makes the following entries in accounting for its
investment
in San at December 31, 2011:
Investment in San (
+
A)
63,000
Income from San (R,
+
SE)
63,000
To record 90% of San’s $70,000 reported income.
Income from San (
-
R,
-
SE)
10,000
Investment in San (
-
A)
10,000
To eliminate unrealized profit on land sold to San.
Exhibit 6-1 presents a consolidation workpaper for Pak and Subsidiary for 2011.
Separate
summary financial statements for Pak and San appear in the first two columns.
Gain on the sale of land should not appear in the consolidated income statement, and the
land
should be included in the consolidated balance sheet at its cost of $40,000. Entry a
eliminates the
gain on sale of land and reduces the land account to $40,000—its cost to the consolidated
entity.
This is the only entry that is significantly different from adjustments and eliminations
illustrated in
previous chapters.

The overvalued land will continue to appear in the separate balance sheet of San in
subsequent
years until it is sold outside of the consolidated entity, but the gain on land does not appear
in the
separate income statements of Pak in subsequent years. Therefore, entry a as shown in
Exhibit 6-1
applies only in the year of the intercompany sale.
Y
EARS
S
UBSEQUENT
TO
I
NTERCOMPANY
S
ALE
Here is the adjustment to reduce land to its cost to the
consolidated entity in years subsequent to the year of the intercompany downstream sale:

The debit to the investment account adjusts its balance to establish reciprocity with the
subsidiary equity accounts at the beginning of each subsequent period in which the land is
held.
For example, the investment account balance at December 31, 2011, is $323,000. This is
$10,000
less than Pak’s underlying equity in San of $333,000 on that date ($370,000
*
90%). The differ-
ence arises from the entry on the parent’s books to reduce investment income and the
investment
account for the intercompany profit in the year of sale.