From a combined point of view, these transactions result merely in a shift of assets from one department or branch to another department or branch of the same entity. The elimination of intercompany markups in assets should be complete, irrespective of the presence or absence of an' outside (minority) interest.
Whether individual affiliates pay or do not pay intercompany debts has no effect on consolidated income or net assets.V/hen bonds are not bought or sold at par the intercompany accounts may not be reciprocal.When this condition exists, reciprocity must be established before eliminating the asset account against the liability account.If the unrealized profit remaining in the ending inventory is not eliminated the consolidated cost of goods sold will be under- stated and profits overstated. 19 Each year the carrjinj: value of the fixea assets nust be ad- justed iron the net figure v./nich equals cost to the vendor less accumulated depreciation thereon. year, since the •vvorking ;oapers are not automatically continuous, fixed assets must be credited on the working papers for the initial unreal- ised r^rofit aarrin, the allowance for de-c^re elation must be debited for the difference between depreciation on cost and per the vendee's books accumulated to the first of the year, 8nd consolidated retain .u earnings must be debited for the balsjice. During the service life of the fixed asset, the vendee will usually include in its income statement a charge for depreciation expense based on the purchas© priot. The credit lost may be all or a portion because Section 48 (c) of the Internal Revenue Code makes it clear that the property transferred to the acquiring corporation does not qualify as used property iinder "Section 58' property," The property must be purchased as defined in Section 179 (a-)(2).Therefore, the computation of consolidated cost of goods sold and of consolidated gross profit is closely related to the problem of inventory valuation. 586, 16 Tiiere are other situations that might arise '.'ith inter- com-nany sales of merchandise. The profit element in the year of sale must also be n • • -- ^ 20 eliminated. 3inoe an int©roomnany profit was in- eluded in the purchase price, the depreciation figure will be too hish for use in a consolidated statement. This section specifically excludes property 8cq.uired from within the affiliation.The consolidated cost of goods sold is computed by taking the com- bined cost as shown by the books of the constituent companies less intercompany purchases plus or minus adjustments of inven- tory figures. 10,000 Cost of Goods Sold ^10,000 To eliminate intercompany profits in beginning inventory Kracke, op. One situation occurs with raarket write-downs arid intercojnpany profit deductions. The second metnpd assiuaes that the cost to the consoli- dated entity is the cost to the vendor plus the profit of the vendor applicable to its minority. Consequently, depreciation will have to be recomputed on a basis of cost to the entire group and an entry made debiting allowance for depreciation and crediting depreciation expense. "Preparing Consolidated Statements for Majaagement . The problem of inter- company transfers of "Section 58 property" will affect groups where there is a common parent corporation.The consolidated v/orking paper should reflect the following entries w^hen there is intercompany profit in merchan- dise in the beginning and ending inventories: Cost of Goods Sold - ' . If the inven- tory valuation of merchandise acquired from an affiliated company has been reduced from cost to market and the amount of the reduction is the same or greater than the reduction that would have been Laade for intercompany x^rofit then no further reduction in the inventory valuation need be made. Only the parent company's share of the intercompejiy profit is eliminated from consoli- dated profits. Thus, when fixed assets are transferred between comoanies at a profit, the depreciation expense, from the consolidation viewpoint, will have to be reduced; and if transferred at a loss, will have to be increased, since for consolidation purposes depreciation is based on cost to the original purchaser.'' In the writer's opinion intercompany sales between affili- ated companies in reality are intercompany transfers which are made for the convenience of the consolidation. Where there is a group of brother-sister relationship, in an early transfer be- tween them a loss of credit to the selling corporation may result. "Special Supplement, 1965 Federal Tax Course, The Revenue Act of 1962, pp. 22 however the acquiring corporation would be entitled to the credit based on "Used Section 58 property." Used property is subject to the limitation of 1150,000 per year.If any such affiliate is a subsidiary with a minority interest, the per share equity of that interest is thus reduced, in the consolidated statements, in the same manner and in the same proportionate amount as the controlling interest.The practice of reflecting a minority interest's share of unrealized intercompany profit as if realized, while widely accepted, conflicts with the underlying purpose of consolidated finan- cial statements as herein contemplated, namely, to reflect the activities of a group of companies as though they constituted a single unit. Accounting and Reporting Standards for Corporate Financial St atements and Preceding Statements an.d Supplements , p. 1^ In the preceding quotation, the American Accounting Associ- ation describes the way intercompany profits in assets should be handled.2,500 •To reflect sain from reacquisition o^ The consolidated v/orking paper should reflect the entries as follov/s: Co. Adjustment & Consolidated P S ' Elimination Financial Debits Dr. Statement Bonds of S 1549,000 5U,000 A ;,000 Credits Bonds Payable 0,000 100,000 Premium on Bonds 5,000 1,500A P.etained Earnings: Co.P ^' ,500 A Assuming that the 100 per cent elimination is to be snared between, the consolidated retained earnings and a minority interest. The elimination would be as in the preceding illustration except a minority interest of 20 per cent should be reflected as shovm in the following entry.