1) Pop Corporation sold land that cost $80,000 to its 90% owned subsidiary Son Corporation for $100,000, resulting in an unrealized $20,000 gain.
2) To eliminate this unrealized intercompany gain in consolidation, Pop reduces its investment in Son by $20,000 and eliminates the $20,000 gain from income.
3) In subsequent years, Son's balance sheet will continue to show the overvalued land until it is sold outside the group. But the consolidated financial statements will adjust Son's land account to $80,000 to match the original cost to the consolidated entity.
1) Pop Corporation sold land that cost $80,000 to its 90% owned subsidiary Son Corporation for $100,000, resulting in an unrealized $20,000 gain.
2) To eliminate this unrealized intercompany gain in consolidation, Pop reduces its investment in Son by $20,000 and eliminates the $20,000 gain from income.
3) In subsequent years, Son's balance sheet will continue to show the overvalued land until it is sold outside the group. But the consolidated financial statements will adjust Son's land account to $80,000 to match the original cost to the consolidated entity.
1) Pop Corporation sold land that cost $80,000 to its 90% owned subsidiary Son Corporation for $100,000, resulting in an unrealized $20,000 gain.
2) To eliminate this unrealized intercompany gain in consolidation, Pop reduces its investment in Son by $20,000 and eliminates the $20,000 gain from income.
3) In subsequent years, Son's balance sheet will continue to show the overvalued land until it is sold outside the group. But the consolidated financial statements will adjust Son's land account to $80,000 to match the original cost to the consolidated entity.
1) Pop Corporation sold land that cost $80,000 to its 90% owned subsidiary Son Corporation for $100,000, resulting in an unrealized $20,000 gain.
2) To eliminate this unrealized intercompany gain in consolidation, Pop reduces its investment in Son by $20,000 and eliminates the $20,000 gain from income.
3) In subsequent years, Son's balance sheet will continue to show the overvalued land until it is sold outside the group. But the consolidated financial statements will adjust Son's land account to $80,000 to match the original cost to the consolidated entity.
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BAB 6 INTERCOMPANY PROFIT TRANSACTIONS-PLANT ASSETS
1.1. INTERCOMPANY PROFITS ON NONDEPRECIABLE PLANT ASSETS
The transfer of nondepreciable plant assets between affiliates at a price other than book value gives rise to unrealized profit or loss to the consolidated entity. These transactions might include intercompany sales of land or of intangible assets that have an indefinite life, and are therefore not amortized. An intercompany gain or loss appears in the income statement of the selling affiliate in the year of sale. However, such gain or loss is unrealized and must be eliminated from investment income in a one-line consolidation by the parent. We also eliminate its effects in preparing consolidated financial statements. Intercompany transfers of plant assets are much less frequent than intercompany inventory transfers. They most likely occur when mergers are completed, as a part of a reorganization of the combined companies. The direction of intercompany sales of plant assets, like intercompany sales of inventory items, is important in evaluating the effect of unrealized profit on parent and consolidated financial statements. A gain or loss on sales downstream from parent to subsidiary is initially included in parent income and must be eliminated. The amount of elimination is 100 percent, regardless of the noncontrolling interest percentage. Subsidiary accounts include any profit or loss from upstream sales from subsidiary to parent. The parent recognizes only its share of the subsidiary’s income, so only the parent’s proportionate share of unrealized profits should be eliminated. The effect on consolidated net income is the same as for the parent.This section of the chapter discusses and illustrates accounting practices for intercompany sales of land, covering both downstream and upstream sales. Accounting for intercompany sales of any non-amortizable asset will receive similar treatment.
Downstream Sale of Land
Son Corporation is a 90 percent–owned subsidiary of Pop Corporation, acquired for $540,000 on January 1, 2016. Investment cost was equal to book value and fair value of the interest acquired. Son’s net income for 2016 was $140,000, and Pop’s income, excluding income from Son, was $180,000. Pop’s income includes a $20,000 unrealized gain on land that cost $80,000 and was sold to Son for $100,000. Accordingly, Pop makes the following entries in accounting for its investment in Son at December 31, 2016: Investment in Son ( + A) 126,000 Income from Son (R, + SE) 126,000 ( To record 90% of Son’s $140,000 reported income.) Income from Son ( - R, - SE) 20,000 Investment in Son ( - A) 20,000 (To eliminate unrealized profit on land sold to Son.) The overvalued land will continue to appear in the separate balance sheet of Son in subsequent years until it is sold outside of the consolidated entity, but the gain on land does not appear in the separate income statements of Pop in subsequent years. Therefore, entry a as shown in Exhibit 6-1 applies only in the year of the intercompany sale. YEARSSUBSEQUENT TOINTERCOMPANYSALE Here is the adjustment to reduce land to its cost to the consolidated entity in years subsequent to the year of the intercompany downstream sale: Investment in Son ( + A) 20,000 Land ( − A) 20,000 To reduce land to its cost basis and adjust the investment account to establish reciprocity with Son’s equity accounts at the beginning of the period. The debit to the investment account adjusts its balance to establish reciprocity with the subsidiary equity accounts at the beginning of each subsequent period in which the land is held. For example, the investment account balance at December 31, 2016, is $646,000. This is $20,000 less than Pop’s underlying equity in Son of $666,000 on that date ($740,000 * 90%)The difference arises from the entry on Pop’s books to reduce investment income and the investment account for the intercompany profit in the year of sale. Exhibit 6-1 presents a consolidation workpaper for Pop and Subsidiary for 2016. Separate summary financial statements for Pop and Son appear in the first three columns. Gain on the sale of land should not appear in the consolidated income statement, and the land should be included in the consolidated balance sheet at its original cost of $80,000. Entry a eliminates the gain on sale of land and reduces the land account to $80,000—its cost to the consolidated entity. This is the only entry that is significantly different from previous chapters.