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Redline intercompany agreement

to the session and if you look at the elimination of unrealized profit on intercompany sales off inventory let's go ahead and start the process let's go ahead and define some terms we need to be aware of one of the terms that we need to be aware of is consolidated entity what do we mean by the consolidated entity basically consolidated entity is when we have the parent company and it has subsidiaries like subsidy s1 and s2 and all this group the company s1 s2 maybe could be as s3 s4 all of those who are called the consolidated entity when we talk about the consolidated entity this is what we are discussing now why does that why is this concept important here because we're only going to recognize the profit that's on the outside of the consolidated entities when we when we generate a profit outside the entity that's the profit that we're going to be recognizing okay so that's that's why we need to know this now what else do we have to be aware of well we have to be aware of certain terms such as downstream sales and upstream sales so what is it downstream sales well we have the parent company that's up top so think of the company the parent on the top then the parent sells goods and services to the subsidiary so it's going from the top down its downstream sale in this session specifically we're going to look at the down streams downstream sales in the next session we look at the opposite of an upstream sale and what is an upstream sale the opposite when the subsidiary sells to the company to the parent company now what happened if subsidiary one sells the subsidiary - this is called horizontal sale s1 and s2 they're called brother-sister company and basically what they have they have a common Oller their brother-sister they have a common owner okay also just FYI another term for consolidated entity another another term for kin consolidated entity is affiliated group this is called affiliated group so P s1 and s2 that's the affiliated group so profit that has not been realized through subsequent sales the third party is defined as unrealized intercompany profit and must be eliminated in the preparation of the consolidated financial statement so any profit between P and s 1 P and s 2 s 2 and P s 1 and P n e profit that has not left the consolidated entity is not it'll have to be will have to be eliminated and the same thing applied for the loss of we have a loss between the parent and the subsidiary or the subsidiary and the parent well it's also needs to be eliminated and this is what we need to know so on P pick the parent sells to the sub the sub sells to the parent and there's the profit and loss that's it and that's setting on the books between them we need to eliminate that profit and loss so what is the financial reporting objective basically if you like if you wanna summarize this chapter okay so we're gonna looking at intercompany sales of merchandise on the determination of the consolidated balances well here's what we do know consolidated sales so the total sales for the whole entity will only include sales would third party I said I'm gonna use the term third party but basically it's not between the parent and the sub cells with parties outside the affiliated group outside the consolidated entity that's the only sales that will appear in the consolidated financial statements okay and we'll look at an example consolidated cost of sales so cost of goods sold include only the cost of the affiliated group of the goods that have been sold to parties outside the affiliation outside the affiliated group so the cost of goods sold in other words the cost of goods sold is the cost of goods sold of the original purchaser of the affiliated group so if the sub one purchased the asset at $500 sold the pea company for seven hundred and P companies sold it for a thousand so let's assume s1 this is a quick quick example that we're going to work more examples of this s1 purchased something for five hundred dollars s1 sold it to p1 for seven hundred for the parent company now the parent company costs is seven hundred because the parent company bought it at seven hundred now the parent company sold to XYZ company an outside third party sold it for nine hundred and fifty dollars so the question is what is the profit is the profit 250 what is the profit for 50 well we're going to use the cost of s1 the cost for the affiliated group is five hundred okay so this is a quick example we'll look at more examples later on also consolidated inventory and the balance sheet is recorded and its cost to the affiliated group so again we look at the affiliated group overall and we're going to go back and record it at the original cost at the original cost of whoever bought this asset this is what's going to happen if you really want to summarize it in one statement the objective is to eliminate the effect of intercompany sales as if they never have occurred so basically we have to go back then bottom-line us to remove the sales the intercompany sales as if they never ever occurred and we will do this we will do this when we look at an example so that's that's a good idea to do this so let's take a look at the first example actually this is a downstream say a downstream sale means what it means the parent selling to the sub so the parent on the top selling to the sound okay so take a minute and read this example so we have Perkins company owns 85% of sheraton company Perkins company sells merchandise to Sheridan add a twenty percent above cost now we need to talk about this term when we say twenty percent above cost because you need to understand how how this what does that mean how does how this is how does this affect you what do mean by twenty percent of of course think about it this way so basically the company that sells you something 20% above course that means they took your cost whatever the cost of the item they multiplied by 1 point to zero so they took their cost multiplied by 1 which is the original cost plus point 2 so that's how what's the selling price okay so let's go ahead and apply this just to make sure we understand how does how does this how does this formula work so for this example did in two thousand eleven and two thousand twelve such and such sales amounted to 450 so here we are saying the sales amount is 450 and cost which is we don't know what causes times 1.2 equal to 450 well if we simplify for cost we'll take 450 divided by one point one point two dividing both sides by one point two we figure out that the cost is three hundred and seventy five thousand so this is the cost for the parent company three hundred and seventy-five thousand this is the cost of goods sold cost of goods sold now this is important because you need to know if the information is given to you in this matter in this manner you need to know how do we translate this information okay now but basically the shortcut really that the formula the shortcut for and for for this formula is basically taking sales basically so if we take sales divided by one plus the mark-up gives us cost it's what we did here so this is the formula we'll take four hundred and fifty thousand divided by one point two gives us the cost three hundred and seventy five thousand so this is basically the formula if we now go back and figure out what your cost is but here you are giving sales and you want to find your cost we're not getting cost so make sure you understand how you can do it both ways but simply put if you start with this formula you know cost times one point two equal to the selling I'm sorry this here cost times 1.2 equal to the selling price then you'll be able to find out what is your cost but this is the formula this is the formula let's go back to the let's go back let's go back let's go back to the example and in this example the sale is 450,000 for 2011 the sale for 2012 is four hundred and eighty six thousand respectively and important for this example that Sheraton the subsidiary has sold all the inventory purchase from Perkins to a third party so that's what we have no inventory that's left on the subsidiaries box so prepared the word paper entries to loan eight the effect of intercompany sales for 2011 so they want us to to remove the intercompany sales of 2011 well what's what's what's a good what's a good the practice is to actually see the journal entries see the journal entries as they happen so I believe that's a good practice and this way you see what's happening so the parent company so the parent company sold sold four hundred and fifty thousand worth of goods to the subsidiary so what would the parent company what entry with the parent company make let's do it on the note it's much easier so we have the parent company and we have the sub ok so the parent company let's assume they they sold it on account so they will debit account receivable four hundred and fifty thousand credit sales to sub intercompany sales that's a good practice if they have this this way they know they need to eliminate the sale then they will debit cost of goods sold and cost of goods sold is 375 which is 450 450 divided by one point two three seventy-five one point two and they will credit inventory 375 now while with the sub do the sub they purchase the inventory for 450 therefore under books they will debit purchases if they're using periodic inventory system or they will debit inventory okay or since they already sold the merchandise we're going to debit purchases cost of goods sold 450 okay so they made a purchase let me just make sure this is smaller this way it will fit better so they will debit purchases which is part of and we're going to look at this shortly cost of goods sold 450 and since they owe the money and since they owe the money to the to the parent company they will have an AP AP parent and this is AR sub okay four hundred and fifty thousand now would not give an additional information that's as soon they sold it for some other party for 10 million dollars it doesn't matter so they again they will debit account receivable for 10 million they will credit sales for 10 million it doesn't matter okay we don't care about the sales and refer to the third party so what's going to happen is this we have to eliminate the intercompany sales so what is the intercompany sales well right here this is the intercompany sales and we only have to account for the intercompany cost of goods sold well we have to eliminate the intercompany cost of goods sold what's the intercompany cost of goods sold as this amount here so let's actually let's make the example more realistic let's assume they sold it for six hundred and seventy five thousand to XYZ company so debit accounts receivable credit sales 675 okay no problem now if I ask you before we proceed into consolidation what is the profit what is the total profit for the consolidated entity what is the profit for the consolidated entity now if you look at the sub if you look at the sub specifically if you see if you looking at the sub alone you'll take 675 which isn't 675 - 450 because that was the cost for the sub 675 - 450 and you may say the profit is 225 no this is the profit for the sub what we need to do we need to take 265 and subtract the original cost 375 so 675 - 675 - 375 is 300,000 therefore the total profit is 300,000 this is the total profit okay so what does that mean that means I need to get rid of this cost of goods sold because it should not be there because the cost of goods sold is right here so I need to get rid of this 450 and I need to get rid of the intercompany sales because the only sales is 675 not 450 okay so how do I do this let me just kind of I did it but let me do it if I have I have to credit sale if I credit up sales I will debit sale so I'm going to debit sales this is the elimination in three debit sales for the sub 450 and credit cost of goods sold purchases cost of goods sold 450 I'm done basically eliminated the sale the intercompany sales and vasive and remember the accounts receivable and the accounts payable those two cancel each other so it doesn't matter if we paid cash let's assume they paid us cash well it will be debit cash credit cash for 50 so they'll also eliminate each other so it doesn't matter how we made the purchase those two entries with eliminate each other okay so notice what what's really what survived because cash is gone or accounts payable accounts receivable are gone cost of goods sold of the sub is cancelled against the sales of the sales of the parent company so what's left is the sales entry for 675 which as I make I made up this number the original cost of goods sold and the original inventory cost pretty straightforward as if this basically basically we just this entry here it never happened what happened is we bought it at 375 sold it we bought it at 375 sold it at 675 this is basically what happened okay and this is basically a simple example but we're going to be adding to it it's basically a simple example to eliminate the intercompany downstream sales or you could use this 3-carbon the three column method to summarize the 2011 intercompany sales you have the total the intercompany sales total is 450 the intercompany cost of goods sold is 375 this is the total column represents sales and cost of goods sold booked by the parent company to record the sale to Sheraton the sales amount also represent the cost of the inventory recorded by Sheraton of course then three sold column we go back the result column represent the intercompany inventory that was resold to third party so this column here it's the end represent the intercompany inventory that was resolved to third parties portions resold are recorded in cost of goods sold so whatever we sold this become this becomes cost of goods sold because when the subsidiary bought it it becomes their cost okay and on-hand represent intercompany inventory still on hand in the affiliated group and this example is simple we assume we have no inventory on hand we have no inventory on hand which is pretty pretty easy example to deal with when it comes to this so basically in a situation like this we need one single entry and the entry is to debit sales credit cost of goods purchase because what happened is the goods sold resold becomes the cost of goods purchased so that's good it's done this is a downstream sail one example one entry to eliminate intercompany sales of merchandise now in this example we're going to keep some inventory on hand so in the next example I'm going to keep this as a separate this is yeah let let's keep this as a separate example so this is one simple example straightforward you know only we made the sale and nothing left on hand in the next example that we're going to work with it's the same numbers but one-third of the inventory that the sub purchase is still on here so we need to know how to deal with those type of situations all do I will keep this as a separate recording I want to walk you through this step by step if you have any questions any comments about this recording please email me or see me in class