Intra-entity Inventory Transactions

You are a CPA with Ikra and Umaynah working with your client Chestnut Productions. On January 1, Chestnut Productions acquired all voting stocks of Mapletainment.

Assume in one year, Mapletainment had an inventory with cost of $60,000 and sold it to Chestnut Productions for $96,000. Chestnut Productions sold 70% of this inventory to an unrelated party for $100,000. Both Mapletainment and Chestnut use the perpetual inventory system.

Chestnut asks you to help record entries on the books of the financial statement and to show how they should apply FASB ASC 810-10-45-1 (PDF). FASB ASC 810-10-45-1 states that consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity and that such statements shall not include gain or loss on transactions among the entities in the consolidated group. Accordingly, any intra-entity profits or loss on assets remaining within the consolidated group shall be eliminated until the goods are ultimately sold to an unrelated party or consumed in the production process.

Step 1: Journal Entries

Your first step is to make the journal entries that should be recorded by each entity.

warningNote: After two incorrect attempts, the correct answer will be shown.

Mapletainment

Accounts	Debit	Credit
Cash
Sales revenue
Cost of goods sold
Inventory

Chestnut Productions

Accounts	Debit	Credit
Inventory
Cash
Cash
Sales revenue
Cost of goods sold
Inventory

Explanation:

Mapletainment

$96,000 is cash received from selling inventory to Chestnut.
$60,000 is the cost of inventory sold to Chestnut. This was inventory that was previously purchased from an unrelated party by Mapletainment.

Chestnut

$96,000 is cash paid to buy inventory from Mapletainment.
$100,000 is cash received from selling 70% of its inventory to an unrelated party.
$67,200 is the cost of 70% inventory sold to an unrelated party (equals 70% x 96,000).

Step 2: Apply FASB ASC 810-10-45-1

Next, you look at how to apply FASB ASC 810-10-45-1. What should the balance be for the following accounts in the consolidated financial statement?

Cash: $
Sales revenue: $
Cost of goods sold: $
Gross profit: $
Ending Inventory: $

Explanation:

Given
Given
Cost of goods sold: $42,000 = 70% *$60,000
Gross profit: $58,000 = $100,000 - $42,000
Ending Inventory: $18,000 = 30% * $60,000 or = $60,000 - $42,000

Step 3: Compare Balances

Compare the balances of these accounts when you combine the information from both entities and the amounts that should be reported on consolidated financial statements.

Account	Combined Information from Both Entities (From Step 1)	Consolidated Amounts (From Step 2)
Cash		$100,000
Sales Revenue		$100,000
Cost Of Goods Sold		$42,000
Gross Profit		$58,000
Ending Inventory		$18,000

Explanation:

This step summarizes the original accounts from Step 1.

Cash: $100,000
Sales Revenue: $196,000
Cost Of Goods Sold: $127,200
Gross Profit: $68,800
Ending Inventory: $28,800

Step 4: Fix Accounts

Is each account over stated, understated, or neither? By how much?

Account	Over-or Understated?	How Much?
Cash
Sales Revenue
Cost Of Goods Sold
Gross Profit
Ending Inventory

Explanation:

Use the table in Step 3 to compare the Combined Information from both entities and the Consolidated Amounts. If the amounts are equal, the account is neither over- nor understated (Cash). If the Combined amount is smaller, it is understated (no accounts). If the Combined amount is larger, it is overstated (the other four accounts).

How can you fix these four accounts?

Consolidation Entry	Accounts	Debit	Credit
TI	Sales revenue
	Cost of goods sold
G	Cost of goods sold
	Inventory

Explanation:

The first entry is used to remove the $96,000 sale recorded by Mapletainment and the $96,000 purchase recorded by Chestnut. A TI entry removes the transfer price recorded by the related parties (parent and subsidiary).

The second entry is used to defer the intra-entity gross profit remaining with the unsold or ending inventory from the intra-entity sale/purchase of the inventory. This must be recognized in the following accounting period when inventory is sold to an unrelated party. A G entry defers the gross profit remaining in the ending inventory until the inventory is sold/consumed in the following year.

Summary

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