RSM321H1 Chapter Notes - Chapter 7: Equity Method, Income Statement, Financial Statement
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Chapter 7 (A)
(A) Intercompany Profits in Depreciable Assets
Part (A) looks at the elimination and realization of intercompany profits (losses) in depreciable
assets. The concepts involved in the holdback of profits (losses) are similar to those examined
previously with regard to intercompany land profits (losses), but the realization concepts are
different because they are based on consumption rather than a sale. This chapter completed the
illustrations of the holdback and realization of intercompany profits and gains in assets by
examining the consolidation procedures involved when the profit is in an asset subject to
amortization. The gain is held back in order to state the depreciable asset at its undepreciated
historical cost from a consolidated perspective. The intercompany profit is subsequently realized
as the assets are used or consumed in generating revenues over the remaining life of the assets.
Because there are differences between the periods in which the tax is paid and the periods in
which the gains are realized in the consolidated statements, income tax must be allocated.
Some general tips to remember when consolidating intercompany profits in depreciable assets:
• Recall that profit is recognized when the goods are sold to outsiders when accounting for
intercompany profits in inventory and land.
• When accounting for intercompany exchanges in depreciable assets, the purchasing entity’s
depreciation expense is based on the parent’s cost.
• The gain (loss) on sale is recorded on the separate-entity books of the selling entity at the time
of the sale.
• On consolidation, the depreciation expense is adjusted to what the depreciation would have
been if the intercompany exchange had not taken place and an intercompany gain (loss) had not
arisen on the separate-entity financial statement of the seller.
• For intercompany profits in depreciable assets, the entity purchasing the depreciable asset uses
the depreciable asset to carry out its business of selling goods or providing services to its
customers. Even though the depreciable asset is not sold to outsiders, the products or services
are sold to outsiders. Therefore, the gain from the intercompany sale of the depreciable asset is
realized over the life of the depreciable asset as the purchasing entity uses the depreciable asset to
produce goods or provide services for outsiders. This concept bases the realization of the gain on
the consumption (by depreciation) of the asset that contains the unrealized gain.
• When the subsidiary is the selling company, increase or reduction in net income (to adjust for
(1) the unrealized gain or loss, and (2) the realization of the gain or loss through depreciation) is
allocated to both the non-controlling and controlling interests in the same manner as was
illustrated in Chapter 6. When the parent is the selling company, there is no need to allocate
between the non-controlling and controlling interests.
• Non-controlling interest is affected by unrealized profits on upstream transactions.
• The tax paid on the unrealized profits represents a prepayment from a consolidated viewpoint.
Income tax expense is matched to the income of the consolidated entity.
• Accumulated depreciation is based on the original cost to the consolidated entity.
• As with chapter 6, when the parent uses the equity method to account for it investment in the
subsidiary, the equity method captures the net effect of all consolidation entries. The investment
account is a balance sheet account at the end of the year, whereas investment income is an
income statement account for one period of time. The parent’s income under the equity method
should be equal to consolidated net income attributable to the parent.
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