INTERCOMPANY SALE OF PROPERTY, PLANT AND EQUIPMENT

Intercompany sales of property, plant, and equipment are also identified as either downstream or
upstream because only upstream sales affect non-controlling interests.

Accounting procedures:
A. Any gain or loss is deferred and
a. Amortized over the asset’s remaining life, if the asset is depreciable.
b. Recognized only when the asset is sold to an unrelated party or otherwise derecognized, if the
asset is non-depreciable:
B. If the asset is subsequently sold to an unrelated party, the unamortized balance of the deferred gain
or loss is recognized in profit or loss.
C. In a downstream sale, the gain or loss is adjusted to the controlling interest only. Therefore, NCI is not
affected.
D. In an upstream sale, the adjustments for gain or loss are shared between the controlling interest and
NCI. Therefore, NCI is affected.
E. In any case, the unamortized balance of the deferred gain or loss is eliminated when the consolidated
financial statements are prepared.

Illustration: Consolidation - Intercompany PPE transaction

On January 1, 20x1, ABC Co. acquired 80% interest in XYZ, Inc. The business combination resulted to
goodwill of P3,000. On this date, XYZ’s equity comprised of P50,000 share capital and P24,000 retained
earnings. NCI was measured at its proportionate share in XYZ’s net identifiable assets.

XYZ’s assets and liabilities on January 1, 20x1 approximately their fair values except for the following:

XYZ, Inc Carrying Fair Fair value

amounts values adjustments (FVA)
Inventory 23,000 31,000 8,000
Equipment (4yrs. remaining life) 50,000 60,000 10,000
Accumulated depreciation (10,000) (12,000) (2,000)
Totals 63,000 79,000 16,000

On January 1, 20x1, ABC Co. sells equipment with a historical cost of P10,000 and accumulated
depreciation of P2,000 to XYZ, Inc. for P12,000, on cash basis. The equipment has a remaining useful life 4
years.

The year-end individual financial statements are shown below:

Statement of financial position
As at December 31, 20x1
ABC Co. XYZ, Inc
ASSETS
Cash 35,000 45,000
Accounts receivable 75,000 22,000
Inventory 105,000 15,000
Investment in subsidiary (at cost) 75,000
Equipment 190,000 62,000
Accumulated depreciation (56,000) (23,000)
TOTAL ASSETS 424,000 121,000

LIABILITIES AND EQUITY

Accounts payable 43,000 30,000
Bonds payable 30,000 -
Total liabilities 73,000 30,000
Share capital 170,000 50,000
Share premium 65,000 -
Retained earnings 116,000 41,000
Total equity 351,000 91,000
TOTAL LIABILITIES AND EQUITY 424,000 121,000
Statements of profit or loss
For the year ended December 31, 20x1

ABC Co. XYZ, Inc

Sales 300,000 120,000
Costs of goods sold (165,000) ( 72,000)
Gross profit 135,000 48,000
Depreciation exp. ( 38,000) ( 13,000)
Distribution costs ( 32,000) ( 18,000)
Interest expense ( 3,000) -
Gain on sale of equipment 4,000 -
Profit for the year 66,000 17,000

Requirements: Prepare the December 31, 20x1 consolidated financial statements:

Solutions:
Step 1: Analysis of effects of intercompany transaction
The intercompany sale is downstream because the seller is the parent (ABC Co.)

Let us analyze the effects of the intercompany sale having in mind the concept that it is as if the
intercompany sale never occurred:
Because of the sale Had there been no sale Effect on combined financial
statements before adjustments
a. ABC Co. recognized gain on a. No gain should have been a. Profit is overstated by
sale of P4,000 [P12,000 - recognized. P4,000.
P10,000 - P2,000)]
b. The equipment’s new cost b. The equipment’s historical b. The equipment’s cost is
is P12,000 the purchase cost is P10,000 overstated by P2,000.
price
c. The equipment’s c. The equipment’s c. Accumulated depreciation
accumulated depreciation accumulated depreciation on Jan. 1, 20x1 is
on Jan. 1,20x1 is zero on Jan. 1, 20x1 is P2,000 understated by P2,000.
because it has been
derecognized.
d. XYZ recognized d. ABC should have recognized d. Depreciation is overstated
depreciation of P3,000 in depreciation of P2,000 in by P1,000. Therefore, profit
20x1 (P12,000 purchase 20x1 (P8,000 carrying is understated by P1,000.
price ÷ 4yrs.). amount ÷ 4yrs.).
e. The equipment ‘s e. The equipment’s e. Accumulated depreciation
accumulated depreciation accumulated depreciation on Dec. 31, 20x1 is
on Dec. 31, 20x1 is P3,000 on Dec. 31, 20x1 should understated by P1,000.
(P0 beg. + P3,000 have been P4,000 (P2,000
depreciation). beg. + P2,000 depreciation).

CJE #1: To eliminate the gain on the intercompany sale

Dec. 31, Gain on sale of equipment (a)* 4,000
20x1 Equipment (b) 2,000
Accumulated depreciation- Jan. 1 (c) 2,000
*The letters are references to the analyses above.

CJE #2: To eliminate the overstatement in depreciation

Dec. 31, Accumulated depreciation (e) 1,000
20x1 Depreciation expense (d) 1,000

As stated earlier, the gain or loss on an intercompany sale of depreciable asset is initially deferred and
subsequently amortized over the remaining life of the asset. The amortization is done by eliminating
only the unamortized balance of the deferred gain as of the consolidation date. The amortized portion
remains.

The unamortized balance of the deferred gain is computed as follows:

Deferred gain on sale - Jan 1, 20x1 4,000
Multiply by: (3 yrs. remaining as of Dec. 31, 20x1 over 4 yrs.) 3/4
Deferred gain on sale - Dec. 31, 20x1 3,000
Notice from analysis (a) and (d) above that the net effect of the transaction is an overstatement in profit
for P3,000 (P4,000 overstatement - P1,000 understatement), equal to the unamortized balance of the
deferred gain. Only this amount should be eliminated. That is why the net effect of CJE’s #1 and #2 is a
decrease in profit for P3,000 (i.e., Dr. to gain of P4,000 and Cr. to depreciation expense of P1,000). The
P1,000 amortized portion remains in the accounts.

By year-end, the gain would have been closed to the seller’s retained earnings. Therefore, ABC’s retained
earnings shall be adjusted for the unamortized balance of the deferred gain.

CJE #3: To adjust the year-end retained earnings of the seller:

Dec. 31, Retained earnings - ABC Co. (downstream) 3,000
20x1 Income summary - working paper 3,000

Step 2: Analysis of net assets

XYZ, Inc. Acquisition Consolidation Net
date date change
Share capital 50,000 50,000
Retained earnings 24,000 41,000
Other components of equity - -
Totals at carrying amounts 74,000 91,000
Fair value adjustments at acquisition date 16,000 16,000
Subsequent depreciation of FVA NIL (10,000)*
Unrealized profits (upstream only) NIL -
Subsidiary’s net assets at fair value 90,000 97,000 7,000

*P8,000 dep’n. of FVA on inventory + P2,000 [(P10,000 - P2,000) ÷ 4 yrs.] dep’n. of FVA on equipment =
P10,000

Notice that the intercompany sales does not affect XYZ’s equity (and consequently NCI) because the sale
is downstream.

Step 3: Goodwill computation

The problem states that goodwill on acquisition date was P3,000. This is also the amount at year-end
because there is no impairment of goodwill during the year.

CJE #4: To eliminate investment in subsidiary and recognize goodwill

Dec.31, Inventory 8,000
20x1 Equipment 10,000
Share capital -XYZ, Inc. 50,000
Retained earnings - XYZ, Inc. 24,000
Goodwill 3,000
Investment in subsidiary 75,000
Accumulated depreciation 2,000
NCI at acquisition date (90K x 20%) 18,000

CJE #5: To recognized the depreciation of FVA during the year:

Dec. 31, Cost of sales (dep’n of FVA on inventory) 8,000
20x1 Depreciation expense* 2,000
Inventory 8,000
Accumulated depreciation 2,000
*(P10,000 - P2,000= P8,000 net FVA on equipment ÷ 4yrs. = P2,000)

CJE #6: To adjust the retained earnings accounts for FVA depreciation:
Dec. 31, Retained earnings - ABC [(8K + 2K) x80%] 8,000
20x1 Retained earnings -XYZ [(8K + 2K) x 20%] 2,000
Income summary - working paper 10,000

Step 4: Non-controlling interest in net assets

XYZ’s net assets at fair value - Dec. 31,20x1 (step 2) 97,000
Multiply by: NCI percentage 20%
Total 19,400
Add: Goodwill to NCI net of accumulated impairment losses -*
Non-controlling interest in net assets - Dec. 31,20x1 19,400
*No goodwill is attributed to NCI is measured at proportionate share.
Step 5: Consolidated retained earnings
ABC’s retained earnings - Dec. 31, 20x1 116,000
Consolidation adjustments:
ABC’s share in the net change in XYZ’s net assets 5,600
Unamortized deferred gain (downstream only) - (step 1) (3,000)
Gain or loss on extinguishment on bonds -
Impairment loss on goodwill attributable to Parent -
Net consolidation adjustments 2,600
Consolidated retained earnings - Dec. 31, 20x1 118,600

Net change in XYZ’s net assets (step 2) of P7,000 x 80% = P5,600

Step 6: Consolidated profit or loss

Parent Subsidiary Consolidated
Profits before adjustments 66,000 17,000 83,000
Consolidation adjustments:
Unamortized def. gain - (step 1) (3,000) ( - ) (3,000)
Dividend income from subsidiary ( - ) N/A ( - )
Gain or loss on extinguishment of bonds ( - ) ( - ) ( - )
Net consolidated adjustments (3,000) ( - ) (3,000)
Profits before FVA 63,000 17,000 80,000
Depreciation of FVA (8,000) (2,000) (10,000)
Impairment loss on goodwill ( - ) ( - ) ( - )
Consolidated profit 55,000 15,000 70,000

Shares in the depreciation of FVA: (10,000 x 80%); (10,000 x 20%)

Step 7: Profit or loss attributable to owners of parent and NCI

Owners NCI Consolidated
ABC’s profit before FVA (step 6) 63,000 N/A 63,000
Share in XYZ’s profit before FVA 13,600 3,400 17,000
Depreciation of FVA (step 6) (8,000) (2,000) (10,000)
Share in impairment loss on goodwill ( - ) ( - ) ( - )
Totals 68,600 1,400 70,000

Shares in XYZ’s profit before FVA (step 6): (17,000 x 80%); (17,000 x 20%)

CJE #7: To eliminate the post- acquisition change in XYZ’s net assets and to recognized NCI in
post-acquisition change in net assets

Dec. 31, Retained earnings - XYZ (squeeze) 15,000

20x1 Retained earnings - ABC 13,600
NCI ( post- acquisition) 1,400
This is the parent’s share in XYZ’s profit before FVA (step 7)
This is the profit attributable to NCI (step 7)
 ABC Co. XYZ, Inc CJE ref.# Consolidation adjustments CJE ref. # Consolidated
ASSET Dr. Cr.
Cash 35,000 45,000 80,000
Accounts
receivable 75,000 22,000 97,000
Inventory 105,000 15,000 4 8,000 8,000 5 120,000
Investment in
subsidiary 75,000 - 75,000 4 -
Equipment 190,000 62,000 4 10,000 2,000 1 260,000
Accumulated
depreciation (56,000) (23,000) 2 1,000 6,000 1,4,&5 (84,000)
Goodwill - - 4 3,000 3,000
TOTAL ASSETS 424,000 121,000 476,000
LIABILITIES & EQUITY
Accounts
Payable 43,000 30,000 73,000
Bonds pay. 30,000 - 30,000
Total liab. 73,000 30,000 103,000
Share capital 170,000 50,000 4 50,000 170,000
Share premium 65,000 - 65,000
Retained earnings 116,000 41,000 3,4,6,6,&7 52,000 13,600 7 118,600
Non-controlling
interest - - 19,400 4&7 19,400
Total equity 351,000 91,000 373,000
TOTAL LIAB & EQTY 424,000 121,000 124,000 124,000 476,000
Sales 300,000 120,000 420,000
Cost of goods sold (165,000) (72,000) 5 8,000 (245,000)
Gross profit 135,000 48,000 175,000
Depreciation exp. (38,000) (13,000) 5 2,000 1,000 2 (52,000)
Distribution cost (32,000) (18,000) (50,000)
Interest exp. ( 3,000) - (3,000)
Gain on saleof equip. 4,000 1 4,000 -
Profit for the year 66,000 17,000 70,000

The consolidated statement of financial position is shown below:

ABC Group
Consolidated statement of financial position
As of December 31, 20x1
ASSETS
Cash 80,000
Accounts receivable 97,000
Inventory 120,000
Equipment 260,000
Accumulated depreciation (84,000)
Goodwill 3,000
TOTAL ASSETS 476,000
LIABILITIES AND EQUITY
Accounts payable 73,000
Bonds payable 30,000
Total liabilities 103,000
Share capital 170,000
Share premium 65,000
Retained earnings 118,000
Owners of parent 353,600
Non-controlling interest 19,400
Total equity 373,000
TOTAL LIABILITIES AND EQUITY 476,000
The consolidated statement of profit or loss is shown below:
ABC Group
Statement of profit or loss
For the year ended December 31, 20x1
Sales 420,000
Cost of goods sold (245,000)
Gross profit 175,000
Depreciation expense (52,000)
Distribution cost (50,000)
Interest expense (3,000)
Profit for the year 70,000
Profit attributable to:
Owners of the parent 68,600
Non-controlling interests 1,400
70,000

Reconciliation using formulas:

Total assets of ABC Co. 424,000
Total assets of XYZ, Inc. 121,000
Investment in subsidiary (72,000)
Fair value adjustments - net (16K - 10K) 6,000
Goodwill -net 3,000
Effect of interco. transaction - unamortized deferred gain (3,000)
Consolidated total assets 476,000

Total liabilities of ABC Co. 73,000

Total liabilities of XYZ, Inc 30,000
Fair value adjustments - net -
Effect of intercompany transactions -
Consolidated total liabilities 103,000

Share capital of ABC Co. 170,000

Share premium of ABC Co. 65,000
Consolidated retained earnings 118,000
Equity attributable to owners of the parent 353,600
Non-controlling interests 19,400
Consolidated total equity 373,000