Question

"Consolidated Financial Statements – Intra-Entity Asset Transactions"

• The consolidation process required for the intra-entity transfer of depreciable assets is different from the requirements for inventory and land. Analyze the current consolidation process for intra-entity transfer of depreciable assets and suggest at least one (1) improvement to the process. Provide an example to support your recommendation.     
• Assume that company P (parent) uses the equity method to account for its investment in company S (subsidiary). Company P purchases inventory items from company S. According to FASB’s guidance, the accountant must remove the inter-company profit from Company S’s net income. Evaluate the consolidation process for inventory transfers between the parent and subsidiary and describe the process for eliminating profit from the non-controlling interest. Determine if the process permanently eliminates the profit from the non-controlling interest or merely shifts the profit from one period to the next. Provide support for your rationale.
• Copying will be marked as unhelpful

Answer 1

Transactions between parent & subsidiary are considered "internal transactions" of a single economic entity.

The effects of of these transactions are eliminated during the consolidation of financial statements.

Hence, consolidated financial statements reflect transactions only with third parties.

Elimination of Intra-Entity sale/purchases of inventory

Firstly, the entries are eliminated by debiting sales and crediting cost of goods sold

Sales A/c Dr.

To Cost of Goods Sold A/c

Next, to eliminate the unrealized gain due to margin in the sales amount, following entry is passed

Cost of Goods Sold A/c Dr.

To Inventory A/c

Once, the inventory is subsequently sold to a third party, the intercompany gain is in the beginning of Retained Earnings on the seller's books, and must be moved to Consolidated Income.

Retained Earnings

To Cost of Goods Sold A/c

Treatment of Upstream Sale (Subsidiary to Parent) - The unrealized gains belong to the subsidiary. We'll reduce the subsidiary's net income by the unrealized gain prior to calculating the noncontrolling interest's share.

Treatment of Downstream Sale (Parent to Subsidiary) - The unrealized gains belong to the Parent.

Accounting Treatment for Transfer of Land

If land is transferred between the Parent & Subsidiary at a gain, the gain is considered unrealized and needs to be eliminated during consolidation.

Gain on Sale of Land A/c Dr.

To Land A/c

As long as the land remains in the books of the buyer, every year the unrealized gain needs to be eliminated during consolidation process.

Retained Earnings A/c Dr.

To Land A/c

Since original gain was transferred to Retained Earnings, we must eliminate the same from Retained Earnings.

Once the land is sold a third party, the unrealized gain must be transferred to realized gain by passing following entry

Retained Earnings A/c Dr.

To Gain on Sale of Land A/c

Treatment of Upstream Sale (Subsidiary to Parent) - The unrealized gains belong to the subsidiary. We'll reduce the subsidiary's net income by the unrealized gain prior to calculating the noncontrolling interest's share.

Treatment of Downstream Sale (Parent to Subsidiary) - The unrealized gains belong to the Parent with no impact on noncontrolling interest

Accounting Treatment for Transfer of Depreciable Assets

If a depreciable asset is transferred,following treatment is given:

• In Buyer's books - the buyer will record depreciation based on the amount paid and the future life of the asset
• In Seller's books - the seller will record depreciation as of carrying value as if they'd not sold the asset.
• In the year of transfer, the unrealized gain must be eliminated and the asset be restated to it's original historical cost.
• Additionally, buyer's depreciation is based on inflated selling price. The excess depreciation expense is eliminated.
• The adjustment to fixed assets and depreciation need to be made at the end of each accounting period

Suggestion for Improvement

There're no formal accounting guidelines to to address valuation of noncontrolling interests in intra-entity gains.

Historically, only the deferral of gains from upstream sales is presumed to affect the noncontrolling interest while the downstream sales doesn't.

Treatment of sale of Inventory by Subsidiary S to Parent Company P (Upstream Sales)

Cash A/c Dr.

To Sales A/c

(Being sales recorded in S's books)

Sales A/c Dr.

To Cost of Goods Sold A/c

(Gain is eliminated from S's books during consolidation process)

Cost of Goods Sold A/c Dr.

To Inventory A/c

(Unrealized gain in the inventory is eliminated)

Once, the inventory is subsequently sold to a third party:

Retained Earnings

To Cost of Goods Sold A/c

(Being intercompany gain in the beginning of Retained Earnings on the seller's books now moved to Consolidated Income once sold to third party)