CCFC 513 Lecture Notes - Lecture 7: Income Statement, Retained Earnings
25 Jun 2018
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Review Chapter 6
Eliminate all intercompany transactions as if they never happened
There are intercompany transactions in:
- Inventory
- Land
- PPE
Intercompany transactions in inventory
- Step 1: Look at sales and COGS
- Step 2: Identify if there are any unrealized profit
• Problem: When inventory goes from S (subsidiary) to P (parent) and remain on
hand in the consolidated entity at year end, it is not reasonable for S to record a
profit because the asset never left the entity
• Consequence: There will be overstatement of COGS for buyer and
overstatement of profit for seller
- Step 3: When inventory is sold to outsider, the profit is realized. We will then recognize
the unrealized profit
In the current year intercompany, verify if there are any unrealized profit in the PREVIOUS
YEAR
Intercompany transactions in land
S sells land to P
- Land is overstated on balance sheet and S recorded a gain on the sale (there is no gain
there)
- By the end of the year, land is still there we must eliminate the gain on the year the
sale took place
- In Year 1, there is unrealized profit, which is waiting to be realized until land is sold to
outsiders
- At end of Year 2, if we still have a land, it remains unrealized
- At end of Year 3, if land is sold, it becomes realized profit
The unrealized/realized profits depends on timing of the moving of the assets
Intercompany transactions in property, plant and equipment (PPE)
S sold a depreciable asset to P
- S sells equipment to P, probably because P wants to use it, not because P will sell it to
outsider
- With depreciable asset, it stays in the entity until it gets used up by P. When the asset is
used up, it will never leave the company, it will be at NBV = 0
- It is not a reasonable expectation for PPE that the asset will leave the company
Document Summary
Eliminate all intercompany transactions as if they never happened. Step 1: look at sales and cogs. Step 3: when inventory is sold to outsider, the profit is realized. In the current year intercompany, verify if there are any unrealized profit in the previous. Land is overstated on balance sheet and s recorded a gain on the sale (there is no gain there) By the end of the year, land is still there we must eliminate the gain on the year the sale took place. In year 1, there is unrealized profit, which is waiting to be realized until land is sold to outsiders. At end of year 2, if we still have a land, it remains unrealized. At end of year 3, if land is sold, it becomes realized profit. The unrealized/realized profits depends on timing of the moving of the assets. Intercompany transactions in property, plant and equipment (ppe)
