CHAPTER 9 INTERCOMPANY INVENTORY TRANSFERS FOCUS OF CHAPTER 9 • Conceptual Issues • Procedures for Calculating Unrealized Profit • Procedures for Deferring Unrealized Profit by fsq79985

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									CHAPTER
   9
INTERCOMPANY
   INVENTORY
   TRANSFERS
   FOCUS OF CHAPTER 9

• Conceptual Issues
• Procedures for Calculating Unrealized Profit
• Procedures for Deferring Unrealized Profit:
  – The Complete Equity Method
  – The Partial Equity Method
  – The Cost Method
Conceptual Issues: Issue #1
 Should We or Shouldn’t We?
• Whether to Eliminate Intercompany
  Transactions in Consolidation:
  – No controversy—they must be
    eliminated.
  – Not eliminating causes two problems:
      • Meaningless double-counting of
        (1) sales and (2) cost and expenses.
      • Potential to manipulate income.
     The Substance of
    Inventory Transfers
• The CONSOLIDATED Perspective:
   – Merely the physical movement of
     inventory from one location to another
     location.
   – Similar to the movement of inventory
     from one division to another division.
   – NOT a bona fide transaction.
• The SEPARATE COMPANY Perspective:
   – A bona fide transaction.
 Conceptual Issues: Issue #2
 Which Measure of Profit To Use?
• Possible Theoretical Profit Measures:
  – Gross profit.
  – Operating profit.
  – Net income.
• Profit Measure Required To Be Used
  By GAAP:
  – GROSS PROFIT             Sales.................... $1,000
    (of the selling entity). Cost of sales....... (600)
                                   GROSS profit. $ 400
Conceptual Issues: Issue #3
Whether To Eliminate Income Tax Effects ?

• Income taxes on the selling entity’s
  UNREALIZED gross profit must also be
  eliminated.
• In this chapter :
   – No income tax entries are required.
   – Because we assume that the tax effects
     have already been recorded in the
     parent’s or the subsidiary’s general
     ledger.
      • DONE FOR SIMPLICITY ONLY.
Conceptual Issues: Issue #4
  Whether To Eliminate All or Some?
• DOWNSTREAM Sales to a Partially Owned
  Subsidiary:
  – Eliminate 100% of unrealized profit.
  – Fractional elimination is prohibited.
• UPSTREAM Sales from a Partially
  Owned Subsidiary:
  – Eliminate 100% of unrealized profit.
  – Fractional elimination is prohibited.
Conceptual Issues: Issue #5
Whether To Share the Deferral?
• DOWNSTREAM Sales to a Partially
  Owned Subsidiary:
  – Entire profit accrues to the parent—thus
    sharing is not appropriate.
• UPSTREAM Sales from a Partially
  Owned Subsidiary:
  – Must share deferral with the NCI
    shareholders (if amount is material).
Inventory Transfers: A Whole
 New Slant on “Realization”

 • REALIZATION—What to focus on for
   consolidated reporting purposes:
    – Not on whether the SELLER has—
       • Delivered the product,
       • Collected on the sale, or
       • Reduced to an acceptable level
         the uncertainty about the net cash
         flow effect of an earnings activity.
 Inventory Transfers: A Whole
   New Slant on “Realization”

• REALIZATION—What to focus on for
  consolidated reporting purposes:
   – But on whether the BUYER has:
      • Resold the inventory to an outside
        unaffiliated customer.
Inventory Transfers: Unrealized
Profit—Searching for that Old Basis
 • The Objective:
    – To change the inventory’s carrying value
      from the NEW basis of accounting to
      the OLD basis of accounting.
     Inventory Transfers: Calculating
     Unrealized Gross Profit—The Analysis
Amounts That Will ALWAYS Be Known (Given):
                                                         Re-  On
                                                  Total Sold Hand
Interco. sales (NEW basis)............. $1,000               $200
Interco. cost of sales (OLD basis).. (600) ____ ____
  Gross Profit.................................... $ 400
  Gross Profit Percentage............... 40%

CRITICAL ASSUMPTION:
   The gross profit percentage derivable from the total
column applies to both (1) the inventory that has been
resold AND (2) the inventory that is still on hand.
         Inventory Transfers:        Calculating
           Unrealized Gross Profit—The Analysis
Completed Analysis:
                                                            Re-  On
                                                   Total   Sold Hand
Interco. sales (NEW basis).............. $1,000            $800 $200
Interco. cost of sales (OLD basis).. (600)                 (480) (120)
  Gross Profit.................................... $ 400   $320 $ 80

                          REALIZED
                          UNREALIZED
The Inventory/COS Change in Basis Elimination Entry
is derived from this analysis.
   Inventory Transfers:
  A Point to Remember
• Intercompany Sales and Intercompany
  Cost of Sales accounts are eliminated
  only in years in which intercompany
  sales occur.
    Inventory Transfers:
 The Two Procedural Methods
• MODULE 1: The Complete Equity
  Method:
  – Unrealized profit is deferred in the
    selling entity’s general ledger.
• MODULE 2: The Partial Equity Method:
  – Unrealized profit is deferred in the
    consolidation process.
         Miscellaneous:
Lower-of-Cost-or-Market Adjustments

 •    For consolidated reporting purposes,
      the appropriate valuation of
      intercompany- acquired inventory is:
     – The lower of:
        (1) the selling entity’s cost or
        (2) the market value.
      Miscellaneous: Partial
Ownerships—Reporting to the NCI
             Shareholders
• Under existing GAAP, a partially owned
  subsidiary:
   – Need not defer any of its unrealized
     intercompany gross profit in reporting
     to its NCI shareholders.
      Review Question #1
For 2006, Paxco reported $60,000 of
intercompany sales (25% markup on cost
and fully paid for by Y/E) to Saxco, which
reported $20,000 of intercompany acquired
inventory at 12/31/06. The unrealized profit
at 12/31/06 is:
A. $ -0-
B. $4,000
C. $5,000
D. $20,000
E. None of the above.
         Review Question #1
                 With Answer
For 2006, Paxco reported $60,000 of
intercompany sales (25% markup on cost and
fully paid for by Y/E) to Saxco, which reported
$20,000 of intercompany acquired inventory at
12/31/06. The unrealized profit at 12/31/06 is:
A. $ -0-
B. $4,000 (20% of $20,000 Y/E inventory)
C. $5,000
D. $20,000
E. None of the above.
        Review Question #2
For 2006, Punco reported intercompany cost of
sales of $1,600,000 (markup is 20% of transfer
price) to Sunco, which reported $600,000 of
intercompany acquired inventory at 12/31/06.
The unrealized profit at 12/31/06 is:
A. $80,000
B. $96,000
C. $120,000
D. $150,000
E. None of the above.
         Review Question #2
                 With Answer
For 2006, Punco reported intercompany cost
of sales of $1,600,000 (markup is 20% of
transfer price) to Sunco, which reported
$600,000 of intercompany acquired inventory
at 12/31/06. The unrealized profit at 12/31/06
is:
A. $80,000
B. $96,000
C. $120,000 (20% of $600,000 Y/E inventory)
D. $150,000
E. None of the above.
      Review Question #3
For 2006, Salco (80% owned by Palco)
reported $800,000 of intercompany sales
(1/3 markup on cost) to Palco, which resold
$700,000 of this inventory by 12/31/06. The
unrealized profit at 12/31/06 is:
A. $20,000
B. $25,000
C. $26,667
D. $33,333
E. None of the above.
        Review Question #3
               With Answer
For 2006, Salco (80% owned by Palco)
reported $800,000 of intercompany sales (1/3
markup on cost) to Palco, which resold
$700,000 of this inventory by 12/31/06. The
unrealized profit at 12/31/06 is:
A. $20,000
B. $25,000 (25% x $100,000 inventory on hand)
C. $26,667
D. $33,333
E. None of the above.
    End of Chapter 9
Time to Clear Things Up—Any
  Questions?

								
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