When you finish studying this article, you should be able to understand and explain concepts associated with transfers of long-term assets.
The following illustrations provide an overview of the intercompany sale process using land as an example. Figure below presents a series of transactions involving a parent company and its subsidiary. First, Parent Company purchases land from an unrelated party. Then Parent Company sells the land to a subsidiary. Finally, the subsidiary sells the land to an unrelated party. The three transactions, and the amounts, are as follows:
T1—Purchase by Parent Company from an outsider for $10,000.
T2—Sale from Parent Company to Subsidiary Corporation for $15,000.
T3—Sale from Subsidiary Corporation to an outsider for $25,000.
As shown in the following cases, the amount of gain reported by each of the individual companies and by the consolidated entity in each accounting period depends on which transactions occur during that period.
All three transactions are completed in the same accounting period. The gain amounts reported on the transactions are:
The gain reported by each of the entities is considered to be realized because the land is resold to an unrelated party during the period. The total gain that the consolidated entity reported is the difference between the $10,000 price it paid to an unaffiliated seller and the $25,000 price at which it sold the land to an unaffiliated buyer. This $15,000 gain is reported in the consolidated income statement. From a consolidated viewpoint, the sale from Parent Company to Subsidiary Corporation, transaction T2, is an internal transaction and is not reported in the consolidated financial statements.
Only transaction T1 is completed during the current period. The gain amounts reported on the transactions are:
Neither of the affiliated companies has made a sale, and no gains are reported or realized. The land is reported both in Parent Company’s balance sheet and in the consolidated balance sheet at its cost to Parent, which also is the cost to the consolidated entity.
Only transactions T1 and T2 are completed during the current period. The gain amounts reported on the transactions are:
The $5,000 gain reported by Parent Company is considered unrealized from a consolidated point of view and is not reported in the consolidated income statement because the land has not been resold to a party outside the consolidated entity. Subsidiary Corporation’s books carry the land at $15,000, the cost to Subsidiary. From a consolidated viewpoint, the land is overvalued by $5,000 and must be reported at its $10,000 cost to the consolidated entity.
Only transaction T3 is completed during the current period; those of T1 and T2 occurred in a prior period. The gain amounts reported on the transactions in the current period are:
Subsidiary recognizes a gain equal to the difference between its selling price, $25,000, and cost, $15,000, and the consolidated entity reports a gain equal to the difference between its selling price of $25,000 and the cost to the consolidated entity from an outsider of $10,000.
From a consolidated viewpoint, the sale of an asset wholly within the consolidated entity involves only a change in the technical owner of the asset and possibly its location and does not represent the culmination of the earning process. To culminate the earning process with respect to the consolidated entity, it must make a sale to a party external to the consolidated entity. The key to deciding when to report a transaction in the consolidated financial statements is to visualize the consolidated entity and determine whether a particular transaction (1) occurs totally within the consolidated entity, in which case its effects must be excluded from the consolidated statements or (2) involves outsiders and thus constitutes a transaction of the consolidated entity.