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 machinery between a parent and a
sub.
Sale of machinery for a gain
Assume that Sturdy Denim sells a $1,000 piece of machinery to
Parent Jeans. The book value of the machinery on Sturdy’s books is $800. So,
here’s Sturdy’s profit:
Sale
proceeds $1,000
Less:
Book value $800
Gain
on sale $200
Finally, assume that Sturdy’s annual depreciation was
$100/year. 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 machinery is overstated by $200. In other
words, the value of the machinery 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
Machinery (Parent) $200
(To eliminate the intercompany sale of machinery)
Upstream vs. downstream
If the sale of machinery 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 machinery (to eliminate the
higher machinery cost).
Differences in depreciation
There’s
another issue when the intercompany transaction involves machinery You just
saw above that the asset on the Parent’s books was overstated. If the asset
is overstated, then the depreciation is overstated.
In this
case, the Parent was depreciating the asset based on their cost ($1,000).
Sturdy’s book value at the time of the sale is $800. The amount of
depreiciation depends on the depreciation method used (ie- straight line,
accelerated method, etc.). To keep it simple, assume that the Parent’s
depreciation for the year is $50 higher than the subsidiary:
Debit Credit
Accumulated Depreciation $50
Depreciation Expense $50
(To eliminate the machinery’s excess depreciation)
This entry adjusts the depreciation to the amount recognized by Sturdy
(the sub). You have removed any impact of the sale of machinery from the sub to
the parent. You eliminated three things:
1. Sturdy’s gain of $200
2. Parent’s excess cost in machinery $200
3. Parent’s excess depreciation $50
This video will also help:
Your comments are welcome! Visit my website for
online classes on the toughest accounting topics.
Thanks!
Ken Boyd
St. Louis Test Preparation
(cell) (314) 913-6529
(you
tube channel) kenboydstl
(blog) http://accountingaccidentally.blogspot.com/
(twitter)
@StLouisTestPrep
Author/ Cost Accounting for Dummies (John Wiley and Sons) March 2013
No comments:
Post a Comment