Chapter 8 Consolidated Financial statements: Intercompany Transactions Objectives of the Chapter



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Rendering of Services

  • One affiliate may render services to another and result in intercompany fee revenue and expense (i.e., management fee charged to subsidiaries by a parent company).

Rendering of Services (Contd.)

  • The intercompany fee revenue and expense are offset in the working paper.
  • Both the parent company and the subsidiary should record the fee billing in the same accounting period.

Income Texas Applicable to Intercompany Transactions

  • No income tax effects associated with the elimination of the intercompany revenue or expenses since no profit or loss involved in these intercompany transactions.
  • It does not matter whether the parent company and its subsidiaries file separate income tax returns or a consolidated tax return.

II. Accounting for Intercompany Transactions Involving Profit (Gain) or Loss

  • For intercompany transactions involving profit or loss, the unrealized profits or losses must be eliminated in the preparation of consolidated financial statements until they are realized.

The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses

  • Failure to eliminate unrealized profits and losses would result in consolidated income statements that report not only results of transactions with outsiders but also the results of related party activities within the affiliated group.

The Importance of Eliminating or Including Intercompany Profits (Gains) and Losses (Contd.)

  • Similarly, no recognition of realized gains (losses) would misstate the consolidated net income.
  • The management can manipulate consolidated net income if unrealized intercompany profits and losses were not eliminated.

Intercompany Sales of Merchandise

Intercompany Sales of Merchandise (Contd.)

  • a. Intercompany Sales at Cost
  • Example 8.3: Intercompany sale at cost
    • Assume that Palm sold merchandise costing $150,000 to Starr during the year ended 12/31/2001 at a selling price equals to Palm’s cost.
    • The ending inventories of Starr on 12/31/2001 included $25,000 of merchandise obtained form Palm.

Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)

    • By 12/31/2001, Starr still owed Palm $15,000 for merchandise purchased during 12/31/2001.
    • Assuming perpetual inventory system for both companies, the following aggregate entries would be prepared by both companies for the foregoing transactions:

Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)

  • Palm Corporation Journal Entries
  • 150,000
  • 150,000
  • To record sales to Starr Company
  • 150,000
  • Inventories
  • 150,000
  • To record cost of goods sold to Satrr Company.
  • Cash
  • 135,000
  • 135,000

Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)

  • Starr Company Journal Entries
  • Inventories
  • 150,000
  • Intercompany Accounts
  • Payable
  • 150,000
  • To record purchases from Palm Corporation.
  • 135,000
  • Cash
  • 135,000
  • To record payments made to Palm Corporation.
  • Trade Accounts Receivable
  • 160,000
  • Sales
  • 160,000
  • To record sales.
  • Cost of Goods Sold
  • 125,000
  • Inventories
  • 125,000
  • To record cost of goods sold.

Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)

  • The following is a partial working paper for consolidated financial statements of Palm and subsidiary (include only the data related to this intercompany sale of merchandise at cost):

Intercompany Sales of Merchandise (Contd.) Example 8.3 : (Contd.)

  • Starr Company
  • Eliminations Inc. (Dec.)
  • Consolidated
  • Income Statement
  • Intercompany
  • rev. (exp.)
  • *
  • Balance Sheet
  • Intercompany
  • rec. (pay.)
  • 15,000
  • (15,000)
  • *Palm Corporation’s $15,000 intercompany sales and intercompany cost of goods sold are offset in Palm’s separate income statement in the working paper.
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