Intercompany Transcations
Eliminate 100% of Intercompany Transactions (even when noncontrolling interest exists)
Intercompany transactions must be eliminated because they lack the criteria of being "arm's length."
1. Balance Sheet—Eliminate 100%
a. Eliminate 100% of all intercompany payables and receivables.
Accounts payable $xxx
Accounts receivable $xxx
Bonds payable (intercompany portion only) $xxx
Bonds investment (in affiliate) $xxx
Accrued bond interest payable $xxx
Accrued bond interest receivable $xxx
Dividends payable (affiliate portion only) $xxx
Dividends receivable (from affiliate) $xxx
b. Eliminate 100% of intercompany gross profit in ending inventory and fixed assets of parent or subsidiary.
2. Income Statement—Eliminate 100%
a. Interest expense / Interest income (bonds)B. Not Consolidated = Not Eliminated
Do not eliminate intercompany accounts if you do NOT consolidate.C. Intercompany Inventory/Merchandise Transactions
It is common for affiliated companies to sell inventory/merchandise to one another. Often this inventory/merchandise is sold at a profit. The total amount of this intercompany sale and cost of goods sold should be eliminated prior to preparing consolidated financial statements. In addition, the intercompany profit must be eliminated from the ending inventory and the cost of goods sold of the purchasing affiliate. 100% of the profit should be eliminated even if the parent's ownership interest is less than 100%. The intercompany profit in beginning inventory that was recognized by the selling affiliate in the previous year must be eliminated by an adjustment (debit) to retained earnings.
Workpaper Elimination - Intercompany Merchandise Transactions
DR-Intercompany sales $XXXPass Key
When inventory has been sold intercompany and the CPA Examination requires you to correct the accounts, remember to reverse the original intercompany transaction (sale and cost of goods sold, internally) and:
Inventory sold to outsiders
Inventory still on hand
Correct cost of goods sold
Correct ending inventor
Example -Intercompany Profit in Inventories
Gearty Corporation owns 100% of the common stock of Olinto Corporation. Gearty sold inventory with a cost of $1,000,000 to Olinto for $1,100,000 during Year 1. The Year 1 ending inventory of Olinto included goods purchased from Gearty for $660,000. Olinto had a remaining account payable balance to Gearty of $200,000 on December 31, Year 1.
Journal entry to record the sale by Gearty:Year 1 Workpaper Elimination Entry: The intercompany sales and intercompany cost of goods sold must be eliminated from Gearty's books and the intercompany profit on the sale of inventory must be eliminated from Olinto's books. The intercompany accounts payable and accounts receivable must also be eliminated.
Step 1—Calculate intercompany profit on sale of inventory:
Intercompany profit on sale of inventory = $1,100,000 sales price – $1,000,000 cost = $100,000
Step 2—Allocate intercompany profit between purchaser's ending inventory and cost of goods sold
Beginning inventory $0
Purchases $1,1000,000
Cost of goods available $1,1000,000
Ending inventory 660,000 (60%)
Cost of goods sold 440,000 (40%)
Intercompany profit in Olinto's cost of goods sold ($100,000 x 40%) 40,000
Intercompany profit in Olinto's ending inventory ($100,000 x 60%) 60,000
DR-Intercompany sales – Gearty $1,100,0
CR-Intercompany cost of goods sold – Gearty $1,000,000
CR-Cost of goods sold – Olinto 40,000
CR-Inventory – Olinto 60,000
DR-Accounts payable $200,000
CR-Accounts receivable $200,000
D. Intercompany Bond Transactions
If one member of the consolidated group acquires an affiliate's debt from an outsider, the debt is considered to be retired and a gain/loss is recognized on the consolidated income statement. This gain/loss on extinguishment of debt is calculated as the difference between the price paid to acquire the debt and the book value of the debt. This gain/loss is not reported on either company's books, but is recorded through an elimination entry. All intercompany account balances are also eliminated.
Example - Intercompany Bond Transactions
On December 31, Year 1, Gearty Corporation issued bonds with a carrying value of $300,000, and a face value of $250,000. The premium on bonds payable was recorded as $50,000.
Journal entry to record the sale of the bonds on Gearty's books:
DR-Cash $300,000
CR-Bonds payable $250,000
CR-Premium on bonds payable 50,000
On December 31, Year 1, before any portion of the premium was amortized, Olinto Corporation acquired all the outstanding bonds from the original purchasers at a price of $275,000.
Journal entry to record the purchase of the bonds on Olinto's books:
DR-Investment in Gearty bonds $275,000
CR-Cash $275,000
Workpaper elimination entry—Eliminated intercompany balances and recognizes the gain on extinguishment of debt:
DR-Bonds payable $250,000
DR-Premium 50,000
CR-Investment in Gearty bonds $275,000
CR-Gain on extinguishment of bonds 25,000
1. Intercompany Interest
Eliminate intercompany accounts such as interest expense, interest income, interest payable, and interest receivable.
2. Amortization of Discount or Premium
Eliminate amortization of the discount or premium, which serves as an increase, or decrease in the amount of interest expense/revenue that is recorded. The unamortized discount or premium on the intercompany bond is eliminated.
3. Subsequent Years
The elimination for realized but unrecorded gain/loss on extinguishment of bonds in subsequent years would be adjusted to retained earnings. Noncontrolling interest would be adjusted if the bonds were originally issued by the subsidiary.
E. Intercompany Sale of Land
The intercompany gain/loss on the sale of land remains unrealized until the land is sold to an outsider. A workpaper elimination entry in the period of sale eliminates the intercompany gain/loss and adjusts the land to its original cost.
On July 1, Year 1, Gearty Corporation sold land to Olinto Corporation for $200,000. The initial cost of the land to Gearty was $175,000.
Journal entry to record the sale on Gearty's books:
DR-Cash $200,000
CR-Land $175,000
CR-Intercompany gain on sale of land 25,000
Journal entry to record the purchase on Olinto's books:
DR-Land $200,000
CR-Cash $200,000
Workpaper elimination entry—Elimination of the intercompany gain and adjustment of land to its original cost:
DR-Intercompany gain on sale of land $25,000
CR-Land ($200,000 – $175,000) $25,000
In the subsequent year and every year thereafter until the land is sold to a third party, retained earnings (Gearty) would be debited and land would be credited to eliminate the intercompany profit. Retained earnings are debited in subsequent years because the gain would have been closed to this account. Since Gearty (parent) was the seller of the land and Olinto (subsidiary) was the purchaser, there is no need to divide the intercompany gain between retained earnings and noncontrolling interest.
F. Intercompany Profit on Sale of Depreciable Fixed Assets
The gain or loss on the intercompany sale of a depreciable asset is unrealized from a consolidated financial statement perspective until the asset is sold to an outsider. A working paper elimination entry in the period of sale eliminates the intercompany gain/loss and adjusts the asset and accumulated depreciation to their original balance on the date of sale.
Example
Facts: Olinto Corporation (subsidiary) sold equipment on January 1, Year 1 to Gearty Corporation (parent) for $100,000. The equipment had a net book value of $70,000 (cost of $90,000 and accumulated depreciation of $20,000), and a remaining life of ten years.
January 1, Year 1 journal entry to record the sale on Olinto's books:
DR-Cash $100,000
CR-Accumulated depreciation 20,000
DR-Machinery (original cost) $90,000
CR-Intercompany gain on sale of machinery 30,000
January 1, Year 1 journal entry to record the purchase on Gearty's books:
DR-Machinery $100,000
CR-Cash $100,000
December 31, Year 1 journal entry to record the depreciation on Gearty's books:
DR-Depreciation expense ($100,000 ÷ 10) $10,000
CR-Accumulated depreciation $10,000
December 31, Year 1 workpaper elimination entry—Elimination of intercompany gain and adjustment of the machine and accumulated depreciation accounts to their original balance:
DR-Intercompany gain on sale of machinery $30,000
CR-Machinery ($100,000 – $90,000) $10,000
CR-Accumulated depreciation 20,000
The depreciation expense recorded by Gearty is overstated by the intercompany profit included in the cost of the machinery. NBV
| GAAP Original | Non-GAAP Intercompany | Difference | |
| NBV | $70,000 | $100,000 | $30,000 |
| Depreciation years | ÷ 10 Yrs | ÷ 10 Yrs | ÷ 10 Yrs |
| Depreciation | $7,000 | $10,000 | $3,000 |
Workpaper elimination entry—Elimination of excess depreciation:
DR-Accumulated depreciation $3,000
CR-Depreciation expense $3,000
Example-Subsequent Year Workerpaper Elimination Journal Entry
In the subsequent years the intercompany gain/loss on the sale of the asset and the excess depreciation has been closed to retained earnings. The elimination entries in subsequent years therefore adjust retained earnings, and if appropriate, noncontrolling interest for the original gain or loss less the excess depreciation previously recorded (unrealized gain/loss at the beginning of the year). Continuing with the previous example, in Year 2, the workpaper elimination entries would be:
Journal entry to adjust fixed assets:
DR-Retained Earnings $27,000*
CR-Machinery $10,000
CR-Accumulated depreciation 17,000**
Journal entry to adjust depreciation:
DR-Accumulated depreciation $3,000
CR-Depreciation expense $3,000
* Original gain – Excess depreciation previously recorded = Unrealized gain at the beginning of the year. $30,000 – $3,000 = $27,000.
** Original accumulated depreciation difference of $20,000 less excess depreciation of $3,000 previously recorded.
Consolidate D Financial Statements
The December 31, Year 1 financial statements of Gearty Corporation and Olinto Corporation are consolidated as follows using the Concept Exercise on pages 36–37 and the intercompany transactions on pages 46-51:
| Gearty Dr(Cr) | Olinto Dr (Cr) | Elimination Debits | Elimination Credits | Adjusted Balance | |
| Income Statement | |||||
| Sales | $18,4000,000 | 6,000,000 | 1,100,000 | 23,300,000 | |
| Cost of goods sold | 11,480,000 | 4,210,000 | 1,000,000 | 14,650,000 | |
| 40,000 | |||||
| Operating expensense | 5,505,000 | 1,330,000 | 12,500 | 3,000 | 6,844,500 |
| Equity earnings | 350,000 | 0 | 350,000 | ||
| Investment income | 1000,000 | 0 | 100,000 | ||
| Investment expense | 80,000 | 140,000 | 220,000 | ||
| Gain on fixed assets sales | 25,000 | 30,000 | 25,000 | ||
| 30,000 | |||||
| Gain on debt | 0 | 0 | 25,000 | 25,000 | |
| Net income | 1,810,000 | 350,000 | 1,517,500 | 1,068,000 | 1,710,500 |
| Gearty Dr(Cr) | Olinto Dr(Cr) | Elimination Debits | Elimination Credits | Adjusted Balance | |
| Statement of Retained Earnings | |||||
| RE, 1/1/Year 1 | 1,190,000 | 300,000 | 300,000 | 1,190,000 | |
| Net income | 1,810,000 | 350,000 | 1,517,500 | 1,068,000 | 1,710,500 |
| Dividends | 0 | 150,000 | 150,000 | 0 | |
| RE,12/31/Year 1 | 3,000,0000 | 500,000 | 1,817,500 | 1,218,000 | 2,900,500 |
| Gearty Dr(Cr) | Olinto Dr(Cr) | Elimination Debits | Elimination Credits | Adjusted Balance | |
| Balance Sheet | |||||
| Cash | 1,120,000 | 520,000 | 1,640,000 | ||
| AR | 2,075,000 | 1,605,000 | 200,000 | 3,480,000 | |
| Inventory | 2,000,000 | 1,000,000 | 60,000 | 2,940,000 | |
| Marketable Securities | 1,225,000 | 275,000 | 275,000 | 1,225,000 | |
| Fixed Assets | 3,470,000 | 1,5000,000 | 200,000 | 25,000 | 5,118,000 |
| 3,000 | 10,000 | ||||
| In-process R&D | 0 | 0 | 100,000 | 12,500 | 87,500 |
| Goodwill | 0 | 0 | 100,000 | 12,500 | 87,500 |
| Inventment in Sub | 2,700,000 | 0 | 2,700,000 | 0 | |
| Total Assets | 12,590,000 | 4,900,000 | 803,000 | 3,302,500 | 14,990,500 |
| AP | 2,290,000 | 1,250,000 | 200,000 | 3,340,000 | |
| Bonds payable(net) | 1,300,000 | 1,750,000 | 250,00 | 3,340,000 | |
| 50,000 | |||||
| Common stock | 5,000,000 | 1,000,000 | 1,000,000 | 5,000,000 | |
| A.P.I.C. | 1,000,000 | 400,000 | 400,000 | 1,000,000 | |
| RE | 3,000,000 | 500,000 | 1,817,500 | 1,2185,000 | 2,900,500 |
| Liabilities & Equity | 12,590,000 | 4,900,000 | 3,717,500 | 1,218,000 | 14,990,500 |
Explanation of consolidation adjustments:
1. Elimination of the intercompany sale of inventory (see page 47):2. Amortization of in-process R&D over 8 years ($100,000/8 = $12,500
DR-Amortization expense $12,500Elimination of excess depreciation resulting from the intercompany sale of machinery (see page 50):
DR-Amortization depreciation $3,0004.Elimination of Olinto's equity and Gearty's investment in Olinto and the recognition of the land fair value adjustment, in-process R&D, and goodwill on December 31, Year 1 (see page 37):
DR-Common stock – subsidiary $1,000,0005.Elimination of intercompany land transaction (see page 49):
DR-Intercompany gain on sale of land $25,0006.Elimination of intercompany sales of equipment (see page 50):
DR-Intercompany gain on sale of machinery $30,0007.Record the retirement of intercompany bonds (see page 48):
DR-Bonds payable $250,0008. Elimination of intercompany AR and AP resulting from intercompany sale of inventory (see page 47):
DR-Accounts payable $200,000Total of net income adjustments carried down to the statement of retained earnings. b. Total of retained earnings adjustments carried down to the balance sheet.
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