Chapter Five
Consolidated
Financial
Statements –
Intra-Entity
Asset
Transactions
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Learning Objective 5-1
Understand why intra-entity
asset transfers create accounting
effects within the financial
records of affiliated companies
that must be eliminated or
adjusted in preparing consolidated
financial statements.
5-2
Intra-entity Transactions
 Companies that make up a business combination
frequently retain their legal identities as separate
operating centers and maintain their own recordkeeping.
 Inventory sales between the companies must be recorded.
The seller records revenue, and the buyer enters the
purchase into its accounts.
 For internal reporting purposes, recording an inventory
transfer as a sale/purchase provides vital data to help
measure the operational efficiency of each enterprise.
5-3
Intra-entity Transactions
 From a consolidated perspective neither a sale nor a purchase
has occurred. An intra-entity transfer is merely the internal
movement of inventory that creates no net change in the
financial position of the business combination taken as a
whole.
 In the consolidated financial statements, the transfers are
eliminated.
 The consolidated statements reflect only transactions with
outside parties.
 Worksheet entries report the perspective of the consolidated
enterprise.
5-4
Learning Objective 5-2
Demonstrate the consolidation
procedures to eliminate intra-entity
sales and purchases balances.
5-5
Sales and PurchasesIntra-entity
ENTRY TI (Transferred Inventory)
In a business combination, both parties record the transfer in their
internal records as a normal sale/purchase. This consolidation
worksheet entry is necessary to remove the resulting balances from the
externally reported figures. Cost of Goods Sold is reduced here under
the assumption that the Purchases account usually is closed out prior
to the consolidation process.
5-6
Learning Objective 5-3
Explain why consolidated
entities defer intra-entity gross
profit in ending inventory and
the consolidation procedures
required to recognize profits
when actually earned.
5-7
Unrealized Gross Profit –
Intra-entity
Despite Entry TI, the inflated ending inventory figure causes
cost of goods sold to be too low and profits to be too high . For
consolidation purposes, the expense is increased by this amount
through a worksheet adjustment that properly removes the
unrealized gross profit from consolidated net income.
If all of the transferred inventory is retained by the business
combination at the end of the year, entry G eliminates the
effects of the seller’s gross profit that remains unrealized within
the buyer’s ending inventory in year 1.
5-8
Unrealized Gross Profit –
Intra-entity
Consoliation ENTRY G Year of Transfer (Year 1)
Because the gross profit rate was 37½ percent ($30,000 gross
profit/$80,000 transfer price), this retained inventory is stated at
a value $7,500 more than its original cost ($20,000 X 37½%).
The required reduction (Entry G ) is not the entire $30,000
shown previously but only the $7,500 unrealized gross profit
that remains in ending inventory.
5-9
Learning Objective 5-4
Understand that the consolidation
process for inventory transfers is
designed to defer the unrealized
portion of an intra- entity gross
profit from the year of transfer into
the year of disposal or consumption.
5-10
Unrealized Gross Profit –
Intra-entity
In year 2, the overstatement is removed within the consolidation process
but this time from the beginning inventory balance (which appears in the
financial statements only as a positive component of cost of goods sold).
This elimination is termed Entry *G. The asterisk indicates that a
previous year transfer created the intra-entity gross profits.
Entry *G removes unrealized gross profit from beginning figures so
that it is recognized in the consolidated income in the period in which
it is earned.
5-11
Intra-entity Transactions –
Downstream Transfers
Entry *G if the transfer of inventory is downstream AND the
parent uses the equity method, the following entry is used to
recognize the remaining unrealized profit left at the end of the
previous year.
Investment in Subsidiary account replaces the Retained
Earnings account used for upstream sales.
5-12
Unrealized Inventory Gain –
Downstream Transfers
Worksheet entries to eliminate sales/purchases balances
(Entry TI) and to remove unrealized gross profit from ending
Inventory in Year 1 (Entry G) are standard, regardless of the
circumstances of the consolidation.
BUT the procedure to eliminate intra-entity gross profit from
Year 2’s beginning account balances differs from the Entry *G
just presented IF:
(1) the original transfer is downstream (parent’s) and
(2) the parent applies the equity method for internal
accounting purposes.
5-13
Unrealized Inventory Gain Downstream Transfers
For intra-entity beginning inventory profits resulting from
downstream transfers when the parent applies the equity
method:
a. Parent’s retained earnings are appropriately stated due
to intra-entity profit deferrals and recognition.
b. The subsidiary retained earnings reflect none of the
intra-entity profit and require no adjustment.
c. The parent’s investment account at beginning of Year 2
contains a credit from the deferral of Year 1
downstream profits.
d. Worksheet Entry *G transfers the Year 1 Investment
account credit to a Year 2 earnings credit via COGS to
recognize the profit in the year of sale to outsiders.
5-14
Learning Objective 5-5
Explain the difference between
upstream and downstream
intra-entity transfers and how
each affects the computation
of noncontrolling interest
balances.
5-15
Unrealized Gross Profits –
Effect on Noncontrolling Interest
According to FASB ASC paragraph 810-10-45-6:
The amount of intra-entity profit or loss to be eliminated is not
affected by the existence of a noncontrolling interest.
The complete elimination of the intra-entity profit or loss is
consistent with the underlying assumption that consolidated
financial statements represent the financial position and
operating results of a single economic entity.
The elimination of the intra-entity profit or loss may be
allocated proportionately between the parent and
noncontrolling interest.
5-16
Unrealized Gross Profits –
Effect on Noncontrolling Interest
Accounts affected by intra-entity transactions:
 Revenues
 Cost of Goods Sold
 Expenses
 Noncontrolling Interest in Subsidiary’s Net Income
 Retained Earnings at the Beginning of the Year
 Inventory
 Land, Buildings, and Equipment
 Noncontrolling Interest in Subsidiary at End of Year.
5-17
Intra-Entity Inventory Downstream Transfer Example
Top Company acquires 80 percent of the voting
stock of Bottom Company on January 1, 2012.
Top pays $400,000.
Acquisition-date fair value of noncontrolling
interest is $100,000.
Top allocates the entire $50,000 excess fair value
over book value to adjust a database owned by
Bottom to fair value.
The database has an estimated remaining life of
20 years.
5-18
Intra-Entity Inventory Downstream Transfer Example
The subsidiary reports net income of $30,000 in 2014 and $70,000 in 2015, the
current year.
Dividends declared are $20,000 in the first year and $50,000 in the second.
A $10,000 intra-entity receivable and payable exists as of December 31, 2015.
Intra-entity inventory transfers between the two companies:
2014
2015
Transfer prices . . . . . . . . . . . . . . . . . . . . . . . . $80,000 $100,000
Historical cost . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
70,000
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000 $ 30,000
Year-end Inventory balance (transfer price) $16,000 $ 20,000
Gross profit percentage . . . . . . . . . . . . . . . . . . . .X 25% X30%
Gross profit remaining in year-end inventory$ 4,000
$ 6,000
5-19
Intra-Entity Inventory Transfers Example
Three entries require attention in the calculation of noncontrolling interest
in the sub’s net income December 31, 2015.
Entry *G removes unrealized gross profits (25% rate) carried over from the
previous period intra-entity downstream sales. Entry *G reduces Cost of
Goods Sold (or beginning inventory component) which creates an increase
in current year income. Gross profit is correctly recognized in 2015 when
inventory is sold to an outside party. The debit to the Investment in Bottom
account brings that account to a zero balance in consolidation.
5-20
Intra-Entity Inventory Downstream
Transfer - Example
Entry TI eliminates the intra-entity sales/purchases for 2015.
Entry G defers the unrealized gross profit (30% rate) of $6,000remaining
at the end of 2015.
Entry G eliminates the overstatement of Inventory as well as the ending
component of Cost of Goods Sold which decreases consolidated income.
5-21
Intra-entity Transactions –
Upstream Inventory Transfer
A different set of consolidation procedures is necessary if the
intra-entity transfers are upstream.
Upstream gross profits are attributed to the subsidiary, Bottom,
not the parent, Top.
Because inventory transfers are upstream from Bottom to Top,
only 80% of the profit deferral and subsequent recognition is
allocated to the parent’s equity earnings and investment
account.
Intra-entity profit reallocation across time affects both the
subsidiary’s reported income and the noncontrolling interest.
5-22
Intra-entity Transactions –
Upstream Inventory Transfer
The records of the two companies change to reflect the
parent’s application of the equity method for
upstream sales.
(Entry *G) reduces Bottom’s beginning 2015 Retained
Earnings balance, and decreases Cost of Goods Sold
which increases consolidated net income to recognize
profit earned in 2015 by sales to outsiders.
5-23
Intra-entity Transactions –
Upstream Inventory Transfer
As of January 1, 2015, $16,000 of transfers remain in
Top’s inventory, and $4,000 of gross profit (25%) is unearned
from a consolidated perspective. Also, Bottom’s beginning
Retained Earnings are overstated by $4,000, the gross profit
from 2014 intra-entity transfers.
A credit to Cost of Goods Sold increases consolidated net
income to recognize that the profit has been earned in 2015 by
sales to outsiders.
5-24
Intra-entity Transactions –
Upstream Inventory Transfer
Entry S eliminates a portion of the parent’s investment account
and provides the initial noncontrolling interest balance.
The entry also removes stockholders’ equity accounts of the
subsidiary as of the beginning of the current year.
5-25
Intra-entity Transactions –
Upstream vs. Downstream transfers
Compare the Entry *G for the downstream and upstream
transfers to see the difference in the transactions.
The effect of downstream and upstream transfers when
the parent uses the equity method are compared in more
detail.
5-26
Intra-entity Transactions –
Upstream vs. Downstream transfers
5-27
Learning Objective 5-6
Prepare the consolidation entry
to remove any unrealized
gain created by the intra-entity
transfer of land from the accounting
records of the year of transfer and
subsequent years.
5-28
Intra-entity Transactions –
Land Transfer
ENTRY TL
If land is transferred between the parent and sub at a gain, the
gain is considered unrealized and must be eliminated.
By crediting land for the same amount, this effectively returns
the land to its carrying value on the date of transfer.
5-29
Intra-entity Transactions -Land Transfer
ENTRY *GL
As long as the land remains on the books of the buyer, the
unrealized gain must be eliminated at the end of each fiscal
period.
The original gain was closed to R/E at the end of that period. To
eliminate the gain in subsequent years, it must come from R/E.
5-30
Intra-entity Land Transfers
Eliminating Unrealized Gains
ENTRY *GL (Year of sale)
In the period the land is sold to a third party, the unrealized gain
must be eliminated one more time, and also finally recognized as
a REALIZED gain in the current period’s consolidated financial
statements.
5-31
The Effect of Land Transfers on
Noncontrolling Interests
DOWNSTREAM
transfers have no
effect on
noncontrolling
interest.
UPSTREAM transfers
have a gain on the
SUBSIDIARY books!
All noncontrolling
interest balances are
based on the sub’s net
income EXCLUDING
the intra-entity gain.
5-32
Learning Objective 5-7
Prepare the consolidation
entries to remove the effects
of upstream and downstream
intra-entity fixed asset transfers
across affiliated entities.
5-33
Intra-entity Transactions -Depreciable Asset Transfers
Example

Able Co and Baker Co are related parties.
 Able purchased equipment for $100,000 several years
ago, and has recorded $40,000 of depreciation since
that time.
 Baker buys the equipment from Able for $90,000 on
1/1/14.
 Equipment has a remaining useful life of 10 years.
5-34
Intra-entity Transactions -- Depreciable
Asset Transfers
On the Buyer’s (Baker) Books:
Equipment. . . . . . . . . . . . . . . . . . . . . $90,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000
NOTE: The buyer WILL record $9,000 per year in depreciation based on
the remaining life.
On the Seller’s (Able) Books:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . $90,000
Accumulated Depreciation . . . . . . . . .40,000
Equipment . . . . . . . . . . . . . . . . . . . . . $100,000
Gain on Sale of Equipment . . . . . . . . . . 30,000
NOTE: The seller WOULD record depreciation expense at $6,000 / year if
they had not sold the equipment.
5-35
Intra-entity Transactions -Depreciable Asset Transfers
ENTRY TA
In the year of transfer, the unrealized gain must be
eliminated and the assets restated to original historical cost.
5-36
Intra-entity Transactions -- Depreciable
Asset Transfers
ENTRY ED
In addition, the buyer’s depreciation is based on the inflated
transfer price. The excess depreciation expense must be
eliminated.
5-37
Intra-entity Transactions -Depreciable Asset Transfers
In Years Following the Year of Transfer
Equipment is carried on the individual books at a
different amount than on the consolidated books.
The amounts change each year as depreciation is
computed.
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.
5-38
Intra-entity Transactions -Depreciable Asset Transfers
On Baker’s (buyer’s) books, the annual depreciation = $90,000 ÷
10 yrs. = $9,000 per year.
The 1/1/15 R/E effect = the original gain of $30,000 on Able’s
(seller’s) books less $9,000, one year of depreciation.
5-39
Intra-entity Transactions -Depreciable Asset Transfers
ENTRY *TA (Subsequent Years)
The adjustment to fixed assets and depreciation expense must
be made in each succeeding period. The entry for
Consolidation is:
5-40
Intra-entity Transactions -Depreciable Asset Transfers
ENTRY ED (Subsequent Years)
In addition, the Depreciation Expense and Accumulated
Depreciation accounts must be adjusted.
5-41
Intra-entity Transactions -Depreciable Asset Transfers
If the transfer is downstream and the parent uses the equity
method, then their Retained Earnings balance has already
been reduced for the gain, and we adjust the Investment
account instead.
5-42