What is Intercompany - Example of Fixed Assets Elimination with Journal Entries

Interpreting the impact of intercompany transactions on the financial records of the units involved begins with understanding how the transactions are initially recognized on each unit’s financial records. It is also important to understand how each intercompany transaction impacts the income statement and balance sheet of the units involved in the period of the intercompany transaction as well as in subsequent periods. From this understanding it is possible to determine how to adjust the consolidated financial statements for intercompany transactions using worksheet eliminations. This section presents the journal entries that would be recorded by each entity when selected intercompany transactions occur. Accompanying the journal entries are the worksheet eliminations that are necessary to prepare the consolidated financial statements. Fixed Asset Transaction at the End of the Period The following data pertain to the sale of a machine from Pratt to Sterling.

Example :- Assume a machine was purchased by Pratt on January 1, 2001, for $9,000. The machine is being depreciated using the straight-line method assuming a 10-year life with no salvage value. The machine is sold to Sterling for $6,000 on December 31, 2006. Pratt records its 2006 depreciation expense prior to the sale. At the date of the sale, six years have passed since the purchase of the machine. Thus, the accumulated depreciation is $5,400 ($900 × 6). The remaining useful life of the asset to Sterling is four years.

At the date of the intercompany sale of the machine, Pratt and Sterling record the following entries:

Journal Entry—Pratt Corporation Books

Cash                                                                                                               6,000     DR.
Accumulated Depreciation ($900 × 6)                                                     5,400     DR.
Gain on Sale of Machine [$6,000 – ($9,000 – $5,400)]                                                      2,400     CR.
Machine                                                                                                                                      9,000     CR.

 To record sale of machine to Sterling

Journal Entry—Sterling Products Books

Machine               6,000                     DR.
Cash                                      6,000                     CR.

To record purchase of machine from Pratt.

After completing this transaction, the recognized historical cost of the machine is $6,000 and the accumulated depreciation is $0. In addition, a gain of $2,400 has been recognized on Pratt’s income statement. From the consolidated entity’s perspective, this transaction never occurred because it did not involve an unrelated party. The December 31, 2006, worksheet elimination must return the Machine account to its original historical cost, $9,000, because this amount is the historical cost to the consolidated entity. The worksheet elimination must also reestablish the $5,400 balance in the Accumulated Depreciation account. In addition, the $2,400 gain on Pratt’s financial records must be eliminated because the transaction is viewed as having not occurred.

The T-account format presented below is used throughout the remainder of the chapter to calculate the dollar amounts necessary for the worksheet eliminations. The T-account format does not specifically represent a ledger account on either company’s accounting records. Rather, it is a tool used to calculate the adjustment necessary for the appropriate presentation of the consolidated financial statements. The first entry of each balance sheet T-account is the beginning of year balance (or date of original purchase) on the books where the account was recorded prior to the intercompany transaction. Income statement accounts are presumed to have a zero beginning balance; therefore, the beginning balance is not shown in the T-account. Entries made during the year, on both unit’s books, are then displayed below the beginning balance. The consolidated balance for the account is shown as the required ending balance.

 The amount shaded is the dollar amount of the worksheet elimination needed to convert the existing balance to the correct consolidated balance. Pratt’s machine had a $9,000 historical cost on its financial records at January 1, 2001. The historical cost of the machine was removed from Pratt’s financial records on December 31, 2006, and is presented as a $9,000 credit in the T-account. Sterling’s recording of the machine purchase appears as a $6,000 debit in the T-account. Because the consolidated financial statements must disclose the original historical cost ($9,000), a debit worksheet elimination of $3,000 is required.

The January 1, 2006, balance in Accumulated Depreciation was reported as $4,500 on Pratt’s books. A $900 increase in Accumulated Depreciation was posted in 2006 to reflect the current year depreciation expense recorded by Pratt. The December 31 balance of $5,400 ($4,500+$900) was debited by Pratt at the date of sale. Because the consolidated balance at December 31, 2006, should be $5,400, the worksheet elimination must include a $5,400 credit to restore the balance.

                

 The T-account analysis indicates the amounts needed in the Example 4-1a worksheet elimination presented to remove the impact of the intercompany machine sale. Preparing this worksheet elimination will return the balances in the Machine, Accumulated Depreciation, and Gain on Sale of Machine accounts to the amounts that would have existed had the intercompany transaction never occurred (i.e., the amounts relevant for the consolidated financial statements).

Worksheet Elimination —Journal Entry Form

December 31, 2006

Machine                                               3,000     DR.

Gain on Sale of Machine                   2,400    DR.

Accumulated Depreciation                                           5,400    CR.