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Chapter 4. INTERCOMPANY TRANSACTIONS. 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

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chapter 4

Chapter 4

INTERCOMPANY TRANSACTIONS

recap of chapter 1
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.
recap of chapter 13
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.
recap of chapter 2
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.
recap of chapter 25
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
chapter 3
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
chapter 37
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
ch 4 eliminate intercompany transactions
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
direction labels
Direction labels
  • Downstream: from parent to subsidiary
  • Upstream: from subsidiary to parent
  • Lateral: from one subsidiary to another subsidiary
treat as if never happened
Treat as if never happened
  • Recognized on p’s and s’ book
  • Eliminate to undo
downstream plant asset year of intercompany transaction
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
downstream inventory year of intercompany transaction
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
intercompany debt transactions
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
direct intercompany debt
Direct Intercompany Debt
  • Worksheet elimination includes offsetting amounts for:
    • Notes payable and notes receivable
    • Interest expense and interest revenue
indirect debt year of intercompany transaction
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
comparison of intercompany plant asset inventory and debt transactions
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
downstream plant asset year after intercompany transaction
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
downstream plant asset year after intercompany transaction18
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
relationship between depreciation expense and accumulated depreciation worksheet eliminations
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.
relationship between depreciation expense and accumulated depreciation worksheet eliminations20
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

relationship between income statement and retained earnings worksheet eliminations
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
downstream inventory year after intercompany transaction
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
cost of goods sold adjustment
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
cost of goods sold adjustment24
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)
similarities between plant asset and inventory worksheet eliminations
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
indirect debt year after intercompany transaction
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
relationship between income statement and retained earnings worksheet eliminations over time
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

upstream intercompany transactions contrast to downstream year of transaction
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
income to noncontrolling interest adjustment
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
income to noncontrolling interest adjustment cont d
Income to Noncontrolling Interest Adjustment (cont’d)
  • Example 5a (plant asset)
    • Gain on Sale ($3,000 debit)
    • Depreciation Expense ($150 credit)
income to noncontrolling interest adjustment cont d31
Income to Noncontrolling Interest Adjustment (cont’d)
  • Example 5b (inventory)
    • Sales ($64,000 debit)
    • Cost of Goods Sold ($51,000 credit)
income to noncontrolling interest adjustment cont d32
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)
income to noncontrolling interest adjustment cont d33
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
intercompany transactions upstream and downstream period after transaction
Intercompany Transactions (Upstream and Downstream) – Period After Transaction
  • Worksheet Elimination 4
    • Downstream - no Income to Noncontrolling Interest adjustment
    • Upstream - Income to Noncontrolling Interest adjustment
intercompany transactions upstream and downstream period after transaction cont d
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