US: Intercompany Profit Transactions—Plant Assets

Intercompany Profit Transactions—Plant Assets

1. What is the objective of eliminating the effects of intercompany sales of plant assets in preparing consolidated financial statements?

The objective of eliminating the effects of intercompany sales of plant assets is to reflect plant assets and related depreciation amounts in the consolidated financial statements at cost to the consolidated entity.

2. In accounting for unrealized profits and losses from intercompany sales of plant assets, does it make any difference if the parent is the purchaser or the seller? Would your answer be different if the subsidiary were 100 percent owned?

Consolidation procedures for eliminating unrealized profit on plant assets are affected by the direction of the sale. The full amount of unrealized profit or loss on downstream sales (parent to subsidiary) is charged or credited to the controlling interest. In the case of upstream sales, however, unrealized profit or loss is allocated between controlling and noncontrolling interests. Because there is no allocation to noncontrolling interests in the case of a 100 percent owned subsidiary, consolidation procedures are the same for upstream sales as for downstream sales.

3. When are unrealized gains and losses from intercompany sales of land realized from the viewpoint of the selling affiliate?

Unrealized gains and losses from intercompany sales of land are realized from the viewpoint of the selling affiliate when the purchasing affiliate resells the land to parties outside the consolidated entity. This is also the point at which the consolidated entity recognizes gain or loss on the difference between the selling price to outside parties and the cost to the consolidated entity.

4. How is the computation of noncontrolling interest share affected by downstream sales of land? By upstream sales of land?

Noncontrolling interest share is not affected by downstream sales of land because the realized income of the subsidiary is not affected by downstream sales. In the case of upstream sales of land, the reported income of the subsidiary is adjusted downward for unrealized profits and upward for unrealized losses to determine realized income. Since noncontrolling interest share is computed on the basis of realized subsidiary income, the computation of noncontrolling interest share is affected by upstream sales of land.

5. Consolidation workpaper entries are made to eliminate 100 percent of the unrealized profit from the land account in downstream sales of land. Is 100 percent also eliminated for upstream sales of land?

Consolidation procedures are designed to eliminate 100 percent of all unrealized profit or loss on all intercompany transactions. The issue is not whether 100 percent of the unrealized profit or loss is eliminated, but if the amount eliminated is allocated between controlling and noncontrolling interests. In the case of an upstream sale of land, 100 percent of the unrealized profit from the sale is eliminated, but the amount is allocated between controlling and noncontrolling interests in relation to their ownership holdings.

6. How are unrealized gains and losses from intercompany transactions involving depreciable assets eventually realized?

Unrealized gains and losses from intercompany sales of depreciable assets are realized through use if the assets are held within the consolidated entity and through sale if the assets are sold to outside parties. The process of recognizing previously unrealized gains and losses through use is a piecemeal recognition over the remaining useful life of the depreciable asset.

7. Describe the computation of noncontrolling interest share in the year of an upstream sale of depreciable plant assets.

8. How does a parent eliminate the effects of unrealized gains on intercompany sales of plant assets under the equity method?

The effects of unrealized gains on intercompany sales of plant assets are charged against the parent’s income from subsidiary account in the year of the intercompany sale, with equal amounts being deducted from the investment in subsidiary account. In subsequent years, the income from subsidiary and investment in subsidiary accounts are increased for depreciation on the unrealized gain that is recorded on the subsidiary books for downstream sales or for the parent’s proportionate share for upstream sales. If the unrealized gain relates to land, no entries are needed until the land is sold to entities outside of the affiliation structure.

9. What is the effect of intercompany sales of plant assets on the parent and consolidated net income in years subsequent to the year of sale?

Accounting procedures are designed to eliminate the effects of intercompany sales of plant assets on both parent income and consolidated net income until the gains and losses on such sales are realized through use or through sale to outside parties. In years subsequent to intercompany sales of depreciable plant assets, the effect on parent income is eliminated by adjusting depreciation expense to a cost basis for the consolidated entity.

10. Explain the sequence of workpaper adjustments and eliminations for unrealized gains and losses on depreciable plant assets. Is your answer affected by whether the intercompany transaction occurred in the current year or in prior years?