Advanced accounting chapter 5:
Consolidation- intra-entity transactions
Intra-entity profits cannot be recognized until the goods are ultimately sold to an
unrelated part or consumed in the production process
For internal reporting purposes- recording an inventory transfer as a sale/purchase
provides vital data to help measure the operational efficiency of each enterprise
An intra-entity transfer is merely the internal movement of inventory, an event that
creates NO net change in the financial position of the business combo as a whole
Consolidation entry TI (to eliminate effects of intra-entity transfer of inventory): debit sales
(amount of inventory), credit cost of goods sold
However, even gross profits resulting from intra-entity transactions must be removed in
the consolidation process
For example- company A sells to their subsidiary company B inventory for 80k, however,
company A bought for 50k- so, because of the 30k difference (EVEN AFTER ENTRY
TI): ending inventory remains overstated by 30k and gross profit is artificially overstated
by 30k.
Cost of goods sold computation::::: Beginning inventory purchases – goods available – ending
inventory - cost of inventory not sold
Consolidation entry G (yr of transfer, all inventory remains)(to remove gross profit in ending
inventory created by intra-entity sales)- debit cost of goods sold (30k *see above*), credit
inventory
Consolidation entry G is based only on the amount of transferred merchandise retained
within the business at the end of the year
Consolidation entry G (yr of transfer, 25% inventory remains)- debit cost of goods sold
([30k/80k]*remaining inventory), credit inventory
Whenever intra-entity profit is present in ending inventory: the effects of this deferred
gross profit is carried into the beginning balances for the subsequent year.
Consolidation entry G (yr following transfer, 25% inventory remains)(to remove from retained
earnings the gross profit in beginning inventory and to currently recognize the profit through a
reduction in cost of goods sold)::::::::: debit retained earnings (beg. Balance of seller), credit
COGS (beginning inventory component)
Consolidation entry G (yr following transfer) (ONLY for downstream sales when the equity
method is used, replaces *above*)::::::: debit investment in subsidiary, credit COGS
For intra-entity beginning inventory profits resulting from downstream transfers when the
parent applies the equity method: the parents beginning retained earnings reflect the
consolidated balance from application of the equity method and need no adjustment, the
parent’s investment in subsidiary account as of the beginning of year 2 contains a credit
from the deferral of year 1 intra-entity downstream profits, worksheet entry G debits the
investment account and credits COGS- effectively recognizing the profit in the year of
sale to outsiders
gross profit rate (GPR) = gross profit/sales OR MC/1+MC
markup on cost (MC) = gross profit / cost of goods sold OR GPR/1-GPR
intra-entity profit = transfer price * GPR
The amount of intra-entity profit or loss to be eliminated is NOT affected by the existence
of a noncontrolling interest
However, the elimination of intra-entity income or loss may be allocated between the
parent and noncontrolling interests
For example- companies can choose for the noncontrolling interest’s share of
consolidated net income to be their ownership % * subsidiary net income OR their
ownership% * subsidiary net income – intra-entity ending inventory profit deferral
The development of consolidated totals affected by intra-entity:
Revenues- parent and subsidiary balances are combined, but intra-entity transfers are
removed
COGS- intra-entity transfers are removed, decreased by intra-entity gross profit in beginning
inventory and increased by intra-entity gross profit in ending inventory
Net income attributable to the noncontrolling interest- adjusted for any excess acquisition
date fair value amortizations and the effects of intra-entity gross profits from upstream
transfers and then multiplied by the % of outside ownership
Retained earnings (start of yr)(not equity method)- accruals for entry C must recognize
effects on reported subsidiary net income of intra-entity gross profits in beginning inventory
that arose from upstream sales in the prior year and prior years excess acquisition date fair
value amortizations
Inventory- any intra-entity gross profit remaining at year end is removed
Noncontrolling interest in subsidiary at end of yr- noncontrolling interest at the beginning of
the year + portion of subsidiarys net income assigned to noncontrolling interest –
noncontrolling interests share of subsidiary dividends
When inventory transfers are downstream from parent to subsidiary- 100% of the profit
deferral and subsequent recognition is allocated to the parents equity earnings and
investment account
*usually* when intra-entity transfers are downstream- the noncontrolling interest in
subsidiary is not affected and their portion of consolidated net income = net income of
subsidiary * ownership % - portion of excess amortization
When using the equity method for an investment with significant influence (20 to 50%
usually)- company defers intra-entity gross profits in inventory only to the extent of its
ownership % (regardless of upstream/downstream)
Consolidation entry G (equity method, upstream sales)- debit retained earnings (subsidiary),
credit cost of goods sold
Consolidation entry S (equity method, upstream)- debit common stock (subsidiary), debit
retained earnings (subsidiary), credit investment in subsidiary, credit noncontrolling interest
The sole effect of the direction of the intra-entity inventory transfers (upstream or
downstream) resides in the allocation of the temporary income effects of profit deferral
and subsequent recognition to the controlling/noncontrolling interests
When a company uses a different method (partial equity or initial value) most things are
the same- only difference is entries C and G
Consolidation entry C (initial value, intra-entity downstream)- debit investment in subsidiary,
credit retained earnings- parent
Consolidation entry G (initial value, downstream intra-entity)- debit retained earnings, parent
credit cost of goods sold
Consolidation entry C (initial value, upstream intra-entity)- debit investment in subsidiary (net
increase from intra-entity profit deferral * ownership % - ownership % * amortization expense),
credit retained earnings, parent
Consolidation entry G (initial value, upstream intra-entity)- debit retained earnings, subsidiary,
credit cost of good sold
For an intra-entity sale of LAND: OG seller of land reports a gain, acquirer capitalizes
the inflated transfer price, the gain the seller recorded is closed into retained earnings at
the end of the year, buyers land account and the sellers retained earnings account
continue to contain the intra-entity gain, the gain on the original transfer is recognized in
consolidated net income only when the land is sold to an outside party
Consolidation entry TL (yr of transfer)(to eliminate effects of intra-entity transfer of land)- debit
gain on sale of land (transfer price – OG cost), credit land
For every subsequent consolidation until the land is eventually sold, the elimination
process must be repeated to remove the land
Consolidation entry GL (every year following transfer)(to eliminate effects of intra-entity
transfer of land made in a previous year)- debit retained earnings (beginning balance of seller),
credit land
The reduction in retained earnings in consolidation entry GL is changes to an increase in
the investment in subsidiary account when the original sale is downstream and the parent
has applied the equity method
Consolidation entry GL (yr of sale to outside party)(to remove intra-entity gain from year of
transfer so that total profit can be recognized in the current period when land is sold to an outside
party)------ debit retained earnings (seller, sale price – acquired price), credit gain on sale of land
In the presence of a noncontrolling interest- if the original sale was a downstream
transaction, neither the annual deferral nor the eventual recognition of the inra-entity gain
has any effect on the noncontrolling interest
In the presence of a noncontrolling interest- if the transfer is made upstream- deferral and
recognition of gains are attributed to the subsidiary and to the noncontrolling interest
When faced with intra-entity sales of depreciable assets- financial reporting objectives
remain the same: defer intra-entity gains, reestablish historical cost balances, recognize
appropriate income within the consolidated financial statements
For depreciable asset transfers, the ultimate recognition of any gain on sale typically
occurs over a PERIOD of several years
Consolidation entry TA (yr of transfer)(to remove intra-entity gain and return equipment
accounts to balances based on historical cost)---- debit gain on sale of equipment (sale price –
[og price – acc depreciation]), debit equipment (og price – sale price), credit accumulated
depreciation
Consolidation entry ED (yr of transfer)(to eliminate overstatement of depreciation expense
caused by inflated transfer price)---- debit accumulated depreciation ([transfer price/remaining
life] – [carrying amount/remaining years]), credit depreciation expense
For every subsequent period- the separately reported figures must be adjusted on the
worksheet to present the consolidated totals from a single entity’s perspective
Consolidation entry TA (yr following transfer)--- debit equipment, debit retained earnings 1/1/xx,
parent, credit accumulated depreciation
Consolidation entry ED (yr following transfer)--- debit accumulated depreciation, credit
depreciation expense
Entry ED will continue on until the asset has been fully depreciated
Consolidation entry TA (yr following transfer, downstream, equity method)- debit equipment,
debit investment in subsidiary, credit accumulated depreciation
Consolidation entry ED (yr following transfer, downstream, equity method)- debit accumulated
depreciation, credit depreciation expense
