Chapter 8
This presentation is the property of its rightful owner.
Sponsored Links
1 / 41

CHAPTER 8 PowerPoint PPT Presentation


  • 90 Views
  • Uploaded on
  • Presentation posted in: General

CHAPTER 8. INTRODUCTION TO INTERCOMPANY TRANSACTIONS. FOCUS OF CHAPTER 8. Intercompany Transactions: Operational Importance Nature and Variety The Importance of Using Supportable (fair) Transfer Prices Basic Conceptual Issues Minimizing the Consolidation Effort

Download Presentation

CHAPTER 8

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


CHAPTER 8

INTRODUCTION TO INTERCOMPANY TRANSACTIONS


FOCUS OF CHAPTER 8

  • Intercompany Transactions:

    • Operational Importance

    • Nature and Variety

    • The Importance of Using Supportable (fair) Transfer Prices

    • Basic Conceptual Issues

  • Minimizing the Consolidation Effort

  • Realized and Unrealized Profit Situations


Operational Importance of Intercompany Transactions

  • Extent of Vertical Integration:

    • Nearly 40% of world trade constitutes intercompany transactions.


Operational Importance of Intercompany Transactions

  • Assessing Performance for Each Entity Within the Consolidated Group:

    • Meaningful assessment would be impossible without intercompany transactions.


Arm’s-Length Transactions: A Short Explanation

  • Defined:

    • “Transactions that take place between completely independent parties.”


Categories of Transactions

  • Arm’s Length Transactions:

    • Are the ONLY transactions that can be reported in the consolidated statements.

  • Non-Arm’s Length Transactions:

    • Are usually referred to as “related party transactions.”

    • Include ALL intercompany transactions.


Types of Related Party Transactions

  • Involving only Individuals:

    • Transactions among family members.

  • Involving Corporations:

    • With management and other employees.

    • With directors and stockholders.

    • With affiliates (controlled entities).

      • Probably constitutes at least 99% of all corporate related-party transactions.


Necessity of Eliminating Intercompany Transactions

  • Eliminate ALL intercompany transactionsin consolidation:

    • Because they are internal transactions from a consolidated perspective.

    • Not because they are related-party transactions.

    • Only transactions with outside unrelated parties can be reported in the consolidated statements.


Intercompany Transactions:Additional Opportunities for Fraud

  • Intercompany transactions sometimesoccur to:

    • Conceal embezzlements.

    • Overstate reported profits.

2 + 2 = 5


Nature and Varietyof Intercompany Transactions

  • Type 1—Dividend payments:

    • Parents often need cash from subsidiaries:

      • To pay dividends.

      • To pay their own expenses.

    • Reasons why parents cannot get cash from subsidiaries (a “blocked funds” problem):

      • Regulatory restrictions.

      • Governmental restrictions.


Nature and Varietyof Intercompany Transactions

  • Type 2—Loans:

    • Parents often centralize treasury functions at the parent level. Thus:

      • Subsidiaries are unable to borrow from outside lenders.

      • Subsidiaries usually borrow from their parents.

        • Interest may or may not be charged.


Nature and Varietyof Intercompany Transactions

  • Type 3—Reimbursements for Directly Traceable Costs:

    • Parents often arrange and pay for external services that benefit a subsidiaryONLY.

    • Charging the subsidiary merely results in recording expenses in the proper income statement.


Nature and Varietyof Intercompany Transactions

  • Type 4—Corporate Headquarters Services and Expense Allocations:

    • Handle one or two ways:

      • BILLING from a profit center:

        • Parent credits a Revenues account.

      • ALLOCATION from a cost center :

        • Parent credits an O/H Allocation acct.

        • Use either incremental or proportional allocation methods.


Nature and Varietyof Intercompany Transactions

  • Type 5—Income Tax Expense Allocations:

    • Occurs ONLY when a parent & subsidiary file a consolidated tax return:

      • Use method consistent with FAS 109 “Accounting for Income Taxes”:

        • Pro forma separate return method complies.

        • Formula driven allocation method may or may not comply.


Nature and Varietyof Intercompany Transactions

  • Type 6—Intangibles:

    • Parents often transfer technology and other intangibles to subsidiaries: Two ways to do so are:

      • Sell It: The transfer of a “right to” an item. (Recorded as a sale.)

      • Grant a License: The transfer of a “right to use” an item. (Recorded as licenseincome.)


Nature and Varietyof Intercompany Transaction

  • Type 7—Inventory Transfers:

    • Virtually all occur in vertically integrated entities.

    • Classified as:

      • Downstream sales (parent to subsidiary)

      • Upstream sales (subsidiary to parent)

      • Lateral sales (subsidiary to subsidiary)


Nature and Varietyof Intercompany Transactions

  • Type 8—Fixed Asset Transfers:

    • Far less common than inventory transfers.

    • Most likely to occur when one entity has surplus machinery or surplus office equipment.


Nature and Varietyof Intercompany Transactions

  • Type 9—Investments in Bonds of a Member of the Consolidated Group:

    • Found infrequently in practice.

    • Much more involved to account for than intercompany loans because of premiums and discounts.


Importance of Using Supportable (Fair) Transfer Prices

  • Transfer prices may be:

    • Negotiated between the entities.

    • Set by the parent company.


Importance of Using Supportable (Fair) Transfer Prices

  • Actual transfer prices used are:

    • RelevantONLY from each individual entity’s perspective—impacts each entity’s reported net income.

    • Irrelevant from a consolidated perspective

      • Because they are undone in consolidation—exactly as if the transactions had NEVER occurred.


Importance of Using Supportable (Fair) Transfer Prices: Tax Rules

  • From An Income Tax Reporting Perspective:

    • Transfer prices used have enormous implications.

    • Because of the potential to arbitrarily shift profits between entities.

    • And thereby lower the consolidated income tax expense.

    • Especially on an international scale.


Importance of Using Supportable (Fair) Transfer Prices:Tax Rules

  • Tax Rules Concerning Transfer Prices:

    • Section 482 of Internal Revenue Code requires that:

      • Transfer prices be at an arm’s length basis. Thus:

        • Must charge a related party the same price as an unrelated party.


Importance of Using Supportable(Fair) Transfer Prices: Tax Rules

  • Section 482 applies to ALL transfers:

    • Inventory.

    • Fixed assets.

    • Services.

    • Technology, patents, trademarks, and other intangibles (whether by sale or granting of a license).

    • Interest rates on loans & prices on leases.


Importance of Using Supportable(Fair) Transfer Prices: Tax Rules

  • Consequences of Insupportable Transfer Prices:

    • Substantial tax penalties and fines.

    • Adjustment to financial statements for underreporting of consolidated income tax expense and payable.

  • Transfer prices are irrelevant for tax purposes:

    • When a worldwide reporting system is used (as used by six states).


A Billion Here, A Billion There!Pretty Soon We’re Talking “Real Money”

  • BAD NEWS:

    • The IRS loses between $20-$40 billion of tax revenues each year because of transfer pricing shenanigans.


The Complexity of Determining Supportable Transfer Prices: Winners

  • GOOD NEWS:

    • Tax accountant advisors to the multinational firms earn big fees (as high as $500 per hour) giving advice on how to “MINIMIZE” consolidated income taxes.


GAAP Requirements Concerning Intercompany Transactions

  • GAAP requires the following to be eliminated for consolidated reporting:

    • All intercompany revenues, expenses, gains, and losses.

    • All open account balances (intercompany receivables and payables).

    • All unrealized intercompany profits and losses.

      • Use GROSS PROFIT OR LOSS.


The Consolidation Effort:Keep It Simple

  • Use SEPARATE intercompany accountsin the income statement (for eachtransaction type).

  • Use a single Intercompany Receivable/ Payable account on each set of books.

  • Reconcile ALLintercompany accounts prior to consolidation.

  • Use the “elimination by rearrangement” technique on the consolidation worksheet.


What’s Unrealized and What’s NOT?

  • The unrealized profit issue does not occur when:

    • Transfers are made at cost.

    • Transfers are made at above cost AND

      • The profit reported by the one entity is FULLY OFFSET by additional costs and expenses reported in the income statement by the other entity.


Issuing Parent-Company-Only (PCO) Statements

  • Ye All Shall Know This:

    • A parent company’s PCO statementsmust report the samenet income and retained earnings amounts as appear in the consolidated statements.


Review Question #1

Intercompany income statement accounts are eliminated in consolidation because they are deemed as being:A. Artificial transactions. B. Potentially manipulative transactions. C. Internal transactions. D. At amounts that are not determined onarms-length basis. E. None of the above.


Review Question #1With Answer

Intercompany income statement accounts are eliminated in consolidation because they are deemed as being:A. Artificial transactions. B. Potentially manipulative transactions. C. Internal transactions. D. At amounts that are not determined onarms-length basis. E. None of the above.


Review Question #2

Which of the following account types need not be eliminated in consolidation? A. Intercompany assets & intercompany liabilities. B. Intercompany revenues & intercompany expenses. C. Intercompany overhead allocations.D. Long-term intercompany receivables.E. None of the above.


Review Question #2With Answer

Which of the following account types need not be eliminated in consolidation? A. Intercompany assets & intercompany liabilities. B. Intercompany revenues & intercompany expenses. C. Intercompany overhead allocation amounts.D. Long-term intercompany receivables.E. None of the above.


Review Question #3

An intercompany account balance that would not need to be reconciled prior to consolidation is Intercompany:A. Dividends Payable.B. Interest Receivable.C. Management Fees Payable.D. Overhead Allocation Receivable.E. None of the above.


Review Question #3With Answer

An intercompany account balance that would not need to be reconciled prior to consolidation is Intercompany:A. Dividends Payable.B. Interest Receivable.C. Management Fees Payable.D. Overhead Allocation Receivable.E. None of the above.


Review Question #4

An account balance that would not need to be reconciled prior to consolidation is:A. Intercompany Sales.B. Intercompany Interest Expense.C. Intercompany Management Fee Income.D. Intercompany Overhead Allocation Out.E. None of the above.


Review Question #4With Answer

An account balance that would not need to be reconciled prior to consolidation is:A. Intercompany Sales.B. Intercompany Interest Expense.C. Intercompany Management Fee Income.D. Intercompany Overhead Allocation Out.E. None of the above.


Review Question #5

In 2006, Saxco incurred $75,000 of inter-company interest charges. Of this amount, Saxco paid $50,000 cash to its parent and capitalized $30,000 to a discrete construction project. The unrealized intercompany profit at 12/31/06 is: A. $ -0- B. $5,000C. $20,000D. $25,000E. $30,000


Review Question #5With Answer

In 2006, Saxco incurred $75,000 of inter-company interest charges. Of this amount, Saxco paid $50,000 cash to its parent and capitalized $30,000 to a discrete construction project. The unrealized intercompany profit at 12/31/06 is: A. $ -0- B. $5,000C. $20,000D. $25,000E. $30,000


End of Chapter 8

  • Time to Clear Things Up—Any Questions?


  • Login