INTERCOMPANY TRANSACTIONS WITH DEPRECIABLE ASSETS

Many business transactions between a parent company and its subsidiary involve a profit (gain) or loss.
Among these transactions are intercompany sales of merchandise and intercompany sales of plant assets.
This paper will focus on the discussion and illustration involving intercompany transactions with
depreciable assets.

 Intercompany Sales of Property Plant and Equipment

Intercompany sales of property, plant and equipment differ from intercompany sales of merchandise
in two aspects.

1. Intercompany sales of PPE between affiliated companies are unusual transactions, while
intercompany sales of merchandise occur frequently.
2. The relatively long useful lives of PPE require the passage of many accounting periods
before intercompany gains or losses on sales of these assets are realized in transactions
with outsiders.

Unrealized intercompany gains on a depreciable PPE are viewed as being realized gradually over
the remaining life of the asset as it is used by the purchasing affiliate. In effect, a portion of the
unrealized gain is realized each period as benefits are derived from the asset.

ILLUSTRATION: Downstream Sale

Assume that P Corp. sells equipment to S Co. on January 01, 2020, for 77,000.00. The equipment originally
cost P Corp. 100,000.00 when purchased three years ago, and is being depreciated over total life of 10 years
using the straight-line method with no residual value. After the acquisition, S Co. depreciated the equipment
over its remaining useful life using the same method. The book value of the equipment immediately before
the sale by P Corp. is computed below:
Original Cost to P Corp. 100,000
Accumulated Depreciation on Dec. 31, 2020: (30,000)
100,000/10) x 3
Book Value, 12/31/2020 70, 000

Sales Price 77,000

Book Value (70,000)
Gain on Sale of Equipment 7,000

12/31/2020- P Corp.
ACCOUNT Debit Credit
Cash 77,000
Equipment- cost 90,000
Accumulated Depreciation 30,000
Gain on Sale 7,000
Table 1: Summary of transactions in the books of P Corp.

12/31/2020- S Co.
ACCOUNT Debit Credit
Cash 77,000
Equipment 77,000
Table 2: Summary of transactions in the books of S Co.

The consolidation adjustments for this intercompany sale are as follows:

1. No gain or loss in the intercompany sale is recognized.
2. Depreciation expense should be reported as if the equipment was depreciated by
the seller.
3. The carrying amount of the equipment should be reported at the amounts that were
supposed to be reported in the seller’s books as if the transaction had never
happened.
CONSOLIDATION ADJUSTMENTS

Balances from Separate F/S ADJUSTMENTS CONSOLIDATED

F/S
12/31/2020 P Corp. S Co. DEBIT CREDIT 12/31/2020
Gain on Sale 7,000 - 7,000* -
Depreciation - 11,000 1,000** 10,000
Expense
Equipment- - 77,000 23,000*** 100,000
Cost
Accumulated - (11,000) 29,000 (40,000)
Depreciation
Equipment- 66,000 60,000
net

* Since it was stated that no gain or loss in the intercompany sale is recognized, the gain on sale of 7,000
shall be eliminated in the Consolidation adjustments.

** Since it was stated that depreciation expense should be reported as if no intercompany sale had
happened, the depreciation expense of 11,000 shall be reduced to 10,000, which was the same
depreciation expense reported by the seller.

*** Since it was stated that the carrying amount of the equipment should be reported at the amounts
that were supposed to be reported in the sellers book without any sale has been made, the equipment
cost shall be increased by 23,000 to arrive at the original cost of the equipment which was 100,000.