Question

Understand how an intercompany sale; where the book value exceeds the transfer price of a depreciable asset is handled.

Answer 1

When faced with intercompany sales of depreciable assets, the accountant’s basic objective remains unchanged: to defer unrealized gains to establish both historical cost balances and rec­ognize appropriate income within the consolidated statements. More specifically, accountants defer gains created by these transfers until such time as the subsequent use or resale of the asset consummates the original transaction. For inventory sales, the culminating disposal normally occurs currently or in the year following the transfer. In contrast, transferred land is quite often never resold thus permanently deferring the recognition of the intercompany profit.

For depreciable asset transfers, the ultimate realization of the gain normally occurs in a dif­ferent manner; the property’s use within the buyer’s operations is reflected through deprecia­tion. Recognition of this expense reduces the asset’s book value every year and hence, the overvaluation within that balance.

The depreciation systematically eliminates the unrealized gain not only from the asset account but also from Retained Earnings. For the buyer, excess expense results each year because the computation is based on the inflated transfer cost. This depreciation is then closed annually into Retained Earnings. From a consolidated perspective, the extra expense gradually offsets the unrealized gain within this equity account. In fact, over the life of the asset, the depreciation process eliminates all effects of the transfer from both the asset balance and the Retained Earnings account.