Prepared by: HAZEL JADE E.

VILLAMAR__
E-mail Address: _hazeljade.villamar@clsu2.edu.ph________

Central Luzon State University

Science City of Muñoz 3120
Nueva Ecija, Philippines

Instructional Module for the Course

ACCTG 2215 / Accounting for Business Combinations

Module 2
Topic 5 (Intercompany Profit in Beginning
and Ending Inventories)

Overview

This course covers the concepts and application of the different standards
related to accounting for business combination. It involves techniques and
methodologies on how to deal properly with issues and problems involving
business combination that are likely to be encountered in practice and in the
National CPA Licensure Examination.

I. Objectives
At the end of the module, the following are expected to:

A. To understand the concept of intercompany transactions;

B. Identify the effect of intercompany transactions to financial statements; and

C. Compute the effect of intercompany sales.

 ACCTG 2215 / Accounting for Business Combinations

UPSTREAM SALE OF INVENTORY

Intercompany Profit in Beginning and Ending Inventories

Assume that on March 1, 2020, Sub Company (an 80% owned subsidiary) sold
merchandise to Parent Company costing P7,500 for P10,000 or at a gross profit of 25%, out
of which P5,000 remained unsold by Parent Company on December 31, 2020. The
inventories sold to outsiders by Parent Company were marked up at 20% on cost. (based
on preceding module)
Additionally, on January 7, 2021, Sub sold again merchandise to Parent for P15,000.
Of this, merchandise worth P4,000 remains in the ending inventories of Parent on December
31, 2021. The following entries were recorded by each company on 2021:

Books of Sub Company:

01/07/2021 Cash 15,000
Sales 15,000
To record the sale to Parent Company.

Cost of goods sold 11,250

Inventory 11.250*
To record the cost of inventory sold.
* (15000 x 75%)

Books of Parent Company:

01/07/2021 Inventory 15,000
Cash 15,000
To record the purchase from Parent.

12/31/2020 Cash 19,200

Sales 19,200*
To record the sale to outsiders.
* ((5000 + 15000 – 4000) x 120%)

Cost of goods sold 16,000

Inventory 16,000*
To record the cost of goods sold.
*(5000 + 15000 – 4000)

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 ACCTG 2215 / Accounting for Business Combinations

Selling Price Cost Gross Profit (25%)

Beginning Inventory P 5,000 P 3,750 P 1,250**
Add: Sales P 15,000 P 11,250 P 3,750
Totals P 20,000 P 15,000 P 5,000
Less: Ending Inventory 4,000 3,000 *1,000
Cost of goods sold P 16,000 P 12,000 P 4,000
*The unrealized profit on ending inventory if P1,000.

Based on the foregoing analysis, the working paper elimination entries are required
for Sub’s intercompany sales of merchandise to Parent for the year ended December 31,
2020:
EE 1 Sales 15,000
Cost of goods sold 15,000
To eliminate intercompany sale of inventory.

EE 2 Cost of goods sold 1,000

Inventory 1,000
To eliminate unrealized inventory profit.

EE 3 Retained earnings, 1/1/21 – Parent 1,000

NCI 250
Cost of goods sold 1,250**
To eliminate realized inventory profit.

Sub’s intercompany sales and cost of goods sold in prior year, 2020, had been closed
with other income accounts to Sub’s Retained Earnings account on December 31, 2020.
Therefore, from a consolidated point of view, Sub’s December 31, 2020 retained earnings
was overstated by P1,250 unrealized intercompany profit in Parent’s inventories on
December 31, 2020. Since NCI is considered to be a part of consolidated stockholders’
equity, then they are considered as part owners of consolidated assets. As such, their share
in intercompany profits in inventories were considered not realized.
Also, the unrealized profit included in Parent’s beginning inventories was charged to
cost of goods sold when Parent sold the inventory during the period. Thus, overstating the
cost of goods sold for 2021. EE 3 results in the reporting of beginning consolidated retained

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 ACCTG 2215 / Accounting for Business Combinations

earnings and cost of goods sold for the year as if there had been no unrealized intercompany
profit at the beginning of the year.

NCI in Net Income of Subsidiary

The computation of NCI in net income of subsidiary and the allocation of consolidated
net income on December 31, 2021 are as follows:

Sub’s net income from own operations (assumed) 20,000

Realized profit in beginning inventory 1,250
Unrealized profit on ending inventory ( 1,000)
Sub’s realized net income 20,250

NCI in net income of subsidiary (20,250 x 20%) 4,050

Consolidated Net Income

Consolidated net income on December 31, 2021 may be computed and allocated as
follows:

Parent’s net income from own operations (assumed) 60,000

Sub’s realized net income 20,250
Consolidated net income 80,250
Attributable to NCI 4,050
Attributable to parent shareholders 76,200

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 ACCTG 2215 / Accounting for Business Combinations

REFERENCES:

Advanced Accounting Principles and Procedural Applications Volume 2 by Pedro P. Guerrero

and Jose F. Peralta

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