Intercompany Profit Transactions

—Plant Assets
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

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-1
Hall
INTERCOMPANY PROFITS ON
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. 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:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-2
Hall
INTERCOMPANY PROFITS ON
Downstream Sale of Land

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-3
Hall
INTERCOMPANY PROFITS ON
Downstream Sale of Land
Adjustment entry during the year

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-4
Hall
INTERCOMPANY PROFITS ON
Downstream Sale of Land

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-5
Hall
INTERCOMPANY PROFITS ON
Downstream Sale of Land

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-6
Hall
INTERCOMPANY PROFITS ON
Downstream Sale of Land
YEARS SUBSEQUENT TO INTERCOMPANY
SALE

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-7
Hall
INTERCOMPANY PROFITS ON
DEPRECIABLE PLANT ASSETS
Assume that Per Corporation sells machinery to its 80
percent-owned subsidiary, Sop Corporation, on
December 31, 2011. The machinery has an
undepreciated cost of $50,000 on this date (cost,
$90,000, and accumulated depreciation $40,000), and
it is sold to Sop for $80,000. Journal entries to record
the sale and purchase on Per’s and Sop’s books are as
follows:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-8
Hall
INTERCOMPANY PROFITS ON
DEPRECIABLE PLANT ASSETS

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-9
Hall
INTERCOMPANY PROFITS ON
DEPRECIABLE PLANT ASSETS
There is an unrealized gain on Per’s books at
December 31, 2011, and, accordingly, Per adjusts its
investment income for 2011 under the equity method
for the full amount of the unrealized gain:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-10
Hall
INTERCOMPANY PROFITS ON
DEPRECIABLE PLANT ASSETS
The gain on machinery should not appear in the
consolidated income statement for 2011, and Per
should include the machinery in the consolidated
balance sheet at $50,000, its depreciated cost to the
consolidated entity. A consolidation adjustment
accomplishes this effect:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-11
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
If the sale from Per to Sop had occurred on January 1,
2011, the machinery would have been depreciated by
Sop during 2011, and any depreciation on the unrealized
gain would be considered a piecemeal recognition of the
gain during 2011. Assume that on January 1, 2011, the
date of the intercompany sale, the machinery has a five-
year remaining useful life and no expected residual value
at December 31, 2015. Straight-line depreciation is used.

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-12
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
The entries to record the sale and purchase are the same
as for the December 31 sale; however, Sop also records
depreciation expense of $16,000 for 2011 ($80,000 , 5
years). Of this $16,000 depreciation, $10,000 is based on
cost to the consolidated entity ($50,000 cost , 5 years),
and $6,000 is based on the $30,000 unrealized gain
($30,000 , 5 years).

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-13
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-14
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
In eliminating the effect of the intercompany sale from
its Investment in Sop account for 2011, Per Corporation
makes the following entries:

30,000 for unrealized on sale of machinary

6,000 for realized of depreciable expenses

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-15
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
Adjusting entry during the year:
To eliminate gain on sale
Gain on sale of Machinary 30,000
Machinary 30,000

To adjust depretitaion expenses

Accumulated Depretiation 6,000
Depretiation expnenses 6,000

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-16
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
In each of the years 2012 through 2015, Per adjusts its
investment income for the piecemeal recognition of the
previously unrecognized gain on the machinery with the
following entry:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-17
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
Accordingly, by December 31, 2015, the end of the
useful life of the machinery, Per will have recognized the
full $30,000 gain as investment income. Its investment
account balance will reflect the elimination and
piecemeal recognition of the unrealized gain as follows:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-18
Hall
DOWNSTREAM SALE AT THE
BEGINNING OF A YEAR
In a consolidation workpaper, it is necessary to establish
reciprocity between the investment and subsidiary equity
accounts at the beginning of the period before
eliminating reciprocal balances. Thus, we eliminate the
effect of the unrealized gain on the December 31, 2011,
investment account in the 2012 consolidation workpaper
with the following entry:

© Pearson Education, Inc. publishing as Prentice Hall© Pearson Education, Inc. publishing as Prentice 2-19
Hall