Question

Case facts:

Agua Fixtures Corporation has been supplying high-quality kitchen fixtures to its customers for several decades and uses a LIFO inventory system. Rapid increases in the cost of fixtures have resulted in inventory values substantially below current replacement cost. To bring its inventory carrying costs up to more reasonable levels, Agua Fixtures sold its entire inventory to Chandler Corporation and purchased an entirely new supply of inventory items from Persimmon Manufacturing. Aqua Fixtures owns common stock of both Persimmon and Chandler.

Agua Fixtures' external auditor immediately pointed out that under some ownership levels of these two companies, Agua Fixtures could accomplish its goal of bringing its inventory carrying costs closer to current replacement cost and under other levels it could not.

Requirements:

In the form of an interoffice memorandum, you are to prepare responses to Agua Fixtures’ president addressing the following issues.

1. Based upon your research using the Accounting Standards Codification (ASC), describe the effects of intercompany transfers on the valuation of inventories. Include summarized citations from the ASC to support your statements. Wherever possible, you are to specifically connect the standards to the case facts.

2. Based upon your research using the ASC, discuss the effects that different ownership levels of Persimmon and Chandler would have on the success of Agua Fixtures’ plan. Include summarized citations from the ASC to support your statements. Wherever possible, you are to specifically connect the standards to the case facts.

Answer 1

ANS-(1) As per given case, this transaction between Agua Fixtures corporation , Chandler Corporation & Persimmon Manufacturing is a related party transaction.

So, As per ASC, at transaction between related party are eleminate at the time of preparing consolidated Balance Sheet and also for Tax purpose it should be always on the basis of Arm Length .

As per given Refefence of ASC 606 Like ...

A transfer price is the price charged between related parties (e.g., a parent company and its controlled foreign corporation) in an intercompany transaction. Although intercompany transactions are eliminated when consolidating the financial results of controlled foreign corporations and their domestic parents, for tax purposes such entities are not consolidated (Sec. 1504(b)(3)), and the transactions are therefore not eliminated. Transfer prices directly affect the allocation of groupwide taxable income across national tax jurisdictions. Hence, a company’s transfer-pricing policies can directly affect its after-tax income to the extent that tax rates differ across national jurisdictions.

Sec. 482 gives the IRS the authority to adjust taxable income between two related parties to more accurately reflect the income earned by each party. As detailed in Regs. Sec. 1.482-1(b), the standard to be applied to determine the true taxable income of a controlled taxpayer is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. Generally, a controlled transaction meets the arm’s-length standard if the income from the transaction is consistent with the income that would have been realized if unrelated taxpayers had engaged in a comparable transaction under comparable circumstances.

ANS-2 IF Agua fixture not effect the management control and ownership level of Persimmon and chandler is different level than transaction between these party are normal transaction and elimination not required for preparing of consolidated balance sheet and and for tax purpose we consider it arm length transaction.

For Reference you can consider ASC 606 and ASC 810.