[Anonymous]

Hi everyone,

I am really confused on understanding intercompany transactions (and eliminating them).

I’m not understanding the logic behind the unrealized and realized profits.

For example, Company A owns 100% of Company B. Company A sells company B with a markup of 25% over its cost. Company A made a total of intercompany sales of 500,000. In year end, company B has 100,000 in their ending inventory from the purchases of company A.

How would you determine the unrealized profit and realized profit?

The eliminating entry would be to first reverse the 500,000 of intercompany sales (debit) and 500,000 intercompany COGS (500,000).

But after that, I am having trouble understanding the logic of how to calculate realized/unrealized profit.

[Topsya]

I am actually having trouble with that topic myself.

Here is how I would solve this (I might be wrong though)

1. Reverse the sale.

Dr Sale – $500,000

Cr COGS – $500,000

We reversing it because this Sale should never been recorded in the first place. It is simply a transfer of assets within a company.

2. Since you recorded a sale originally, COGS has changed (increased). When the item was in the possession of the parent, its COGS was 100%, and now it's 125%. Same item though. So you need to bring it back to what it was originally.

Dr. COGS – $80,000

Cr. EI – $80,000

Do you know the answer? Please let me know.

Thanks,

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Topsya]

I am actually having trouble with that topic myself.

Here is how I would solve this (I might be wrong though)

1. Reverse the sale.

Dr Sale – $500,000

Cr COGS – $500,000

We reversing it because this Sale should never been recorded in the first place. It is simply a transfer of assets within a company.

2. Since you recorded a sale originally, COGS has changed (increased). When the item was in the possession of the parent, its COGS was 100%, and now it's 125%. Same item though. So you need to bring it back to what it was originally.

Dr. COGS – $80,000

Cr. EI – $80,000

Do you know the answer? Please let me know.

Thanks,

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Anonymous]

Hmm, I believe #1 is correct but I am not sure about #2.

I'm having trouble with the logic but from my notes, it seems like Cost markup x Cost = Sale price.

So it may be 1.25 x Cost = 500,000. Cost = 400,000.

So #2 is:

Dr COGS 100,000

Cr. Ending inv 100,000

(not sure if this is correct either), and then I have no clue on how to find the additional entries for removing unrealized profits.

[Anonymous]

Hmm, I believe #1 is correct but I am not sure about #2.

I'm having trouble with the logic but from my notes, it seems like Cost markup x Cost = Sale price.

So it may be 1.25 x Cost = 500,000. Cost = 400,000.

So #2 is:

Dr COGS 100,000

Cr. Ending inv 100,000

(not sure if this is correct either), and then I have no clue on how to find the additional entries for removing unrealized profits.

[lleon]

As I understand it (hopefully someone else can confirm):

The profit that would need to be eliminated is the profit recognized by the parent on its sale to the subsidiary since they sold the goods at a markup. However, you only need to eliminate the profit of the inventory still on hand.

So, on the sale of 500k, company A recorded:

Dr. Cash 500k

Cr. Sales 500k

Dr. COGS 400k

Cr. Inventory 400k

Company B recorded:

Dr. Inventory 500k

Cr. Cash 500k.

Therefore, company A has gross profit of 100k on their books. Upon consolidation, company B has 100k in ending inventory. That represents 20% of the inventory company B originally recorded (100/500). Therefore, as part of your eliminating entries, you would have to eliminate 20% of the 100k profit originally recognized by company A.

Eliminating entry to remove sale:

Dr. Sales 500k

Cr. COGS 500k

Entry to remove gross profit:

Dr. COGS 20k

Cr. Inventory 20k

Both entries can be combined into one as follows:

Dr. Sales 500k

Cr. COGS 480k

Cr. Inventory 20k

Can someone else confirm? Thanks!

Licensed in Arizona

[lleon]

As I understand it (hopefully someone else can confirm):

The profit that would need to be eliminated is the profit recognized by the parent on its sale to the subsidiary since they sold the goods at a markup. However, you only need to eliminate the profit of the inventory still on hand.

So, on the sale of 500k, company A recorded:

Dr. Cash 500k

Cr. Sales 500k

Dr. COGS 400k

Cr. Inventory 400k

Company B recorded:

Dr. Inventory 500k

Cr. Cash 500k.

Therefore, company A has gross profit of 100k on their books. Upon consolidation, company B has 100k in ending inventory. That represents 20% of the inventory company B originally recorded (100/500). Therefore, as part of your eliminating entries, you would have to eliminate 20% of the 100k profit originally recognized by company A.

Eliminating entry to remove sale:

Dr. Sales 500k

Cr. COGS 500k

Entry to remove gross profit:

Dr. COGS 20k

Cr. Inventory 20k

Both entries can be combined into one as follows:

Dr. Sales 500k

Cr. COGS 480k

Cr. Inventory 20k

Can someone else confirm? Thanks!

Licensed in Arizona

[lleon]

Per my post above and to more directly answer the original question, the profit would be 100k (inter-company). 80k has been realized and 20k is unrealized and must be removed, per my understanding.

I arrived at the 20% unrealized because of the ending inventory on company B's books, which is 100k. They recorded the inventory at 500k, so 100k/500k = 20% still on the books, which would mean 20% of the inter-company profit is included in that inventory. The rest of the inventory has presumably been sold, thus realizing the profit from the inter-company sale.

Licensed in Arizona

[lleon]

Per my post above and to more directly answer the original question, the profit would be 100k (inter-company). 80k has been realized and 20k is unrealized and must be removed, per my understanding.

I arrived at the 20% unrealized because of the ending inventory on company B's books, which is 100k. They recorded the inventory at 500k, so 100k/500k = 20% still on the books, which would mean 20% of the inter-company profit is included in that inventory. The rest of the inventory has presumably been sold, thus realizing the profit from the inter-company sale.

Licensed in Arizona

[Topsya]

@lleon Thank you!

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Topsya]

@lleon Thank you!

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Anonymous]

Thanks to both of you!

That explanation is perfect.

[Anonymous]

Thanks to both of you!

That explanation is perfect.

[Author]

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