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Chapter 4
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Chapter 4

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  1. Chapter 4 INTERCOMPANY TRANSACTIONS

  2. Recap of Chapter 1 • Business combinations can come in many forms • If the assets of a business are acquired, they are booked at their fmv. • If this is less than the purchase price, the difference is booked as good will and tested for impairment • If the fmv of the assets is more than the purchase price, the excess is an extraordinary gain.

  3. Recap of Chapter 1 • If the fmv of the assets is more than the purchase price, allocate the cost to fmv of current assets, financial assets, assets held for sale, prepaids related to post retirement costs, and deferred tax assets • If the price is less that the fmv of these assets, the difference is an extraordinary gain • If not, allocate the remaining cost to other assets in proportion to their relative FMV.

  4. Recap of Chapter 2 • Parent uses historical cost to account for investment in another entity, unless • If “parent” has “significant influence” over operating and financial policies (normally 20-50% of voting shares outstanding) , use equity method • If parent has “control” (normally over 50%), directly or indirectly, consolidate.

  5. Recap of Chapter 2 • Parent books subs activities on the equity method: credits income at subs year end = % owned * sub’s income and debits investment • At year end, makes worksheet entries to consolidate • First entry removes parent’s investment in sub, and subs’ owner’s equity (including pre-acquisition income) at acquisition and allocates purchase price differential from subs net book value

  6. Chapter 3 • If owns less than 100%, impute subs total value by purchase price/% acquired, and use this to allocate assets. • % * impute value = equity account called Noncontrolling interest

  7. Chapter 3 • Next entry removes subs post-acquisition income/loss (net of amortization of purchase differential) after considering and dividends to parent, and also its effect in the parent’s investment in sub • Unless 100% owned, Income is %, with the rest affecting . Noncontrolling interest

  8. Ch 4: Eliminate Intercompany Transactions • One unit of an entity is involved in a transaction with another unit of the same entity • Examples: • Parent and subsidiary • Two subsidiaries • Two divisions • Two departments

  9. Direction labels • Downstream: from parent to subsidiary • Upstream: from subsidiary to parent • Lateral: from one subsidiary to another subsidiary

  10. Treat as if never happened • Recognized on p’s and s’ book • Eliminate to undo

  11. Downstream Plant Asset – Year of Intercompany Transaction • Restate asset to original historical cost • Adjust depreciation expense to reflect original historical cost and estimated life • Adjust accumulated depreciation to reflect cost allocation of original historical cost • Eliminate recognized gain or loss on sale of plant asset

  12. Downstream Inventory – Year of Intercompany Transaction • Restate remaining inventory to original historical cost • Eliminate intercompany sales • Adjust cost of goods sold to reflect allocation of original historical cost

  13. Intercompany Debt Transactions • Direct: when one unit of an entity makes a loan directly to another unit of the same entity • Indirect: when one unit of an entity acquires, from an unrelated party, debt previously issued by another unit of the same entity

  14. Direct Intercompany Debt • Worksheet elimination includes offsetting amounts for: • Notes payable and notes receivable • Interest expense and interest revenue

  15. Indirect Debt - Year of Intercompany Transaction • Eliminate retired portion of Bonds Payable, related proportionate discount or premium, and interest expense on retired debt • Eliminate Investment in Bonds and interest revenue • Create extraordinary gain or loss on early debt retirement for difference

  16. Comparison of intercompany plant asset, inventory, and debt transactions • Plant asset and inventory worksheet elimination removes from the consolidated income statement the gain or loss or gross profit recognized by selling affiliate • Debt worksheet elimination creates the gain or loss resulting from the effective debt retirement

  17. Downstream Plant Asset – Year After Intercompany Transaction • Restate asset to original historical cost (same dollar amount as in period of intercompany transaction) • Adjust depreciation expense to reflect allocation of original historical cost based on new owner’s estimated remaining life

  18. Downstream Plant Asset – Year After Intercompany Transaction • Adjust accumulated depreciation to reflect cost allocation based on original historical cost • Adjust Retained Earnings for prior year income statement account adjustments

  19. Relationship between Depreciation Expense and Accumulated Depreciation Worksheet Eliminations End of year sale of plant asset Example Facts: • Parent sells asset to Subsidiary on 12/31/02. • Selling price - $12,000 • Historical cost - $15,000 • Accumulated depreciation - $6,000. • Three years useful life remain.

  20. Relationship between Depreciation Expense and Accumulated Depreciation Worksheet Eliminations End of year sale of plant asset example Depr. ExpenseAccum. Depr. 2002 $6,000 2003 $1,000 $5,000 2004 $1,000 $4,000

  21. Relationship between Income Statement and Retained Earnings Worksheet Eliminations End of year sale of plant asset example Ending Gain on SaleDepr. Exp.Ret. Earnings 2002 $3,000 $3,000 • $1,000 $2,000 • $1,000 $1,000

  22. Downstream Inventory – Year After Intercompany Transaction • Restate remaining inventory to original historical cost • Eliminate any additional intercompany sales • Adjust cost of goods sold to reflect allocation of original historical cost • Adjust Retained Earnings for prior year income statement account adjustments

  23. Cost of Goods Sold Adjustment • Three component parts (Example 2b) • Current period intercompany cost of sales = $108,000 • Markup on beginning inventory sold to unrelated parties = $16,000 • Markup on current period intercompany sales sold to unrelated parties = $42,000

  24. Cost of Goods Sold Adjustment • Three component parts (Example 2b) • Total Cost of Goods Sold Adjustment (cr.) = $166,000 ($108,000 + $16,000 + $42,000)

  25. Similarities between Plant Asset and Inventory Worksheet Eliminations • Asset account: returned to cost basis value from original owner’s financial records • Cost allocation: reflects allocation of original owner’s historical cost • Retained earnings: reflects adjustments to income statement accounts in previous periods

  26. Indirect Debt - Year After Intercompany Transaction • Eliminate retired portion of Bonds Payable, related proportionate discount or premium, and interest expense on retired debt • Eliminate investment in bonds and interest revenue • Adjust Retained Earnings for prior year income statement account adjustments

  27. Relationship between Income Statement and Retained Earnings Worksheet Eliminations Over Time Indirect Debt (Example 1c) Ext LossInt RevInt ExpR/E 2002 $12,040 2003 $17,000 $18,720 $12,040 2004 $17,000 $18,720 $10,320

  28. Upstream Intercompany Transactions – Contrast to Downstream, Year of Transaction • Worksheet elimination (5) is the same for upstream and downstream • Worksheet elimination (4) Income to Noncontrolling Interest must be adjusted in upstream transactions

  29. Income to Noncontrolling Interest Adjustment • Income statement accounts included in Worksheet elimination (5) provide the dollar amount of adjustment to subsidiary net income for computing Income to Noncontrolling Interest

  30. Income to Noncontrolling Interest Adjustment (cont’d) • Example 5a (plant asset) • Gain on Sale ($3,000 debit) • Depreciation Expense ($150 credit)

  31. Income to Noncontrolling Interest Adjustment (cont’d) • Example 5b (inventory) • Sales ($64,000 debit) • Cost of Goods Sold ($51,000 credit)

  32. Income to Noncontrolling Interest Adjustment (cont’d) • Example 5c (debt) • Extraordinary Loss ($7,750 debit) • Interest Revenue ($13.290 debit) • Interest Expense ($14,040 credit)

  33. Income to Noncontrolling Interest Adjustment (cont’d) • Income to Noncontrolling Interest ($18,335) • Sterling net income net of upstream intercompany transaction adjustments x noncontrolling interest percentage • ($205,000 - $1,800 + $150 - $16,000 + $3,000 + $7,750 - $13,290 + $14,040) x .10

  34. Intercompany Transactions (Upstream and Downstream) – Period After Transaction • Worksheet Elimination 4 • Downstream - no Income to Noncontrolling Interest adjustment • Upstream - Income to Noncontrolling Interest adjustment

  35. Intercompany Transactions (Upstream and Downstream) – Period After Transaction (cont’d) • Worksheet Elimination (5) • Downstream – previous years’ income statement accounts allocated to Retained Earnings • Upstream – previous years’ income statement accounts allocated to Retained Earnings and Noncontrolling Interest