A consolidation means that you combine the financial results of a
parent company with a subsidiary company. A parent company buys a percentage of
a subsidiary’s equity. At the end of a month or year, all parties would like to
see the combined results of the parent and the “sub”.
To prevent double-counting, you need to eliminate the financial
impact of transactions between a parent and a sub. Important: Most of the
transactions are treated in the same way, whether they are upstream
or downstream transactions. Consider a sale of inventory between a parent and a
sub.
Parent buys sub
Assume that Parent Jeans buys 80% of Sturdy Denim. Sturdy happens
to supply denim material for Parent Jeans’ blue jean manufacturing. Companies
may take an ownership interest in a supplier. It’s important to Parent Jeans to
have a reliable denim supplier. So, why not invest in the supplier to help them
raise more capital to operate?
Non-controlling interest
If
Parent Jeans buys 80% of Sturdy Denim, someone else owns 20%. You refer to
that other owner as the non-controlling interest (NCI). You'll see the impact of the non-controlling interests in other blog posts.
Sale of inventory for a gain
Assume that Sturdy Denim sells $1,000 in denim to Parent Jeans.
Sturdy’s profit is 20%, or $200. Consider what needs to be eliminated if you
consolidate the financials of Sturdy Denim and Parent Jeans.
Sturdy’s gain on sale
In
consolidation, Sturdy and Parent are considered the same company. So, you
would want to eliminate any profit on transactions between the two companies.
Said another way, you want to include only the transactions with third parties.
In
this case, Sturdy’s profit is overstated by $200 (due to the sale to Parent).
There’s another issue: Parent’s inventory is overstated by $200. In other
words, the value of the inventory on Parent’s books is $200 too high. Here’s
the journal entry to eliminate these two issues in consolidation:
Debit Credit
Net Income (Sturdy- Sub) $200
Inventory (Parent) $200
(To eliminate the intercompany sale of inventory)
Upstream vs. downstream
If the sale of inventory went from Sturdy (the sub) to the parent, the
elimination entry would be the same. By that I mean the you would debit
net income (to eliminate the profit) and credit inventory (to eliminate the
higher inventory cost).
Your comments are welcome! Visit my website for
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Thanks!
Ken Boyd
St. Louis Test Preparation
(cell) (314) 913-6529
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Author/ Cost Accounting for Dummies (John Wiley and Sons) March 2013
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