SUBJECT: Accounting 15

DESCIPTIVE TITLE: Accounting for Business Combination

This course covers essential issues on financial accounting and reporting in Business
Combinations. It covers accounting on Mergers and Consolidation.

The materials in this learning module are from the following:

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1. Main reference Textbook: Advanced Financial Accounting: 2021 edition by
Antonio Dayag.
2. Other references:
 Advanced Financial Accounting Volume 2: by Pedro Guerrero & Jose
Peralta
 CPA Reviewer in Practical Accounting 2: by Antonio Dayag
 CPA Reviewer in Practical Accounting 2: by Pedro Guerrero & Jose Peralta

Lesson No. 5: Intercompany Gain Transactions-Plant Assets

Learning Objectives:
The students should be able:
 To understand the accounting for investment in subsidiaries using the cost model and
the equity method
 To understand the procedures in computing consolidated sales, cost of goods sold,
gross profit, in addition to the procedures discussed in the previous lessons.
 To understand the procedures in determining and computing intercompany gains on
transactions involving sale of plant assets
 To prepare separate and consolidated financial statement subsequent to date of
acquisition

Intercompany sales of plant assets differ from intercompany sales of merchandise in two aspects. First,
intercompany sales of plant assets between affiliated companies are unusual transactions. While
intercompany sales of merchandise occur frequently. Second, the relatively long useful lives of plant
assets require the passage of many accounting periods before intercompany gains or losses on sales of
these assets are realized in transactions with outsiders. In contrast, intercompany profits in inventories
at the end of one accounting period usually are realized through sale of the merchandise to outsiders
during the following period.

Intercompany gains and losses resulting from intercompany sales of plant assets are to be eliminated
(deferred) in preparing consolidated financial statements. The working paper elimination entries to
eliminate the effects of intercompany gains on plant assets are similar to, but not identical with, those
for unrealized inventory profits. Unrealized profit in inventories are self-correcting over any two
accounting periods, while unrealized gains or losses on plant assets affect the financial statements until
the related plant assets are sold to outsiders or are exhausted through use by the purchasing affiliate.

Intercompany Gain on sale of Non-Depreciable Assets

When intercompany sale of non-depreciable plant assets occur, eliminations often are needed in the
preparation of consolidated financial statements for as long as the assets are held by the acquiring
company. The simplest example is the intercompany sale of land.

Overview of Profit Elimination Process

When land is sold between affiliated companies at book value, no special adjustments or eliminations
are needed in preparing the consolidated statement. If, for example, a company sells to a subsidiary
land costing P100,000 for also P100,000, the land continues to be valued at the P100,000 original cost to
the consolidated entity:
Parent Subsidiary
Cash P100,000 Land 100,000
Land 100,000 Cash 100,000
 Both the income and assets are stated correctly from a consolidated viewpoint.
Intercompany sale of land at a gain requires adjustments or eliminations in the consolidation process.
The selling entity’s gain must be eliminated because the land is still held by the consolidated entity, and
no gain may be reported in the consolidated financial statements until the land is sold to outsiders. Also
the land must be reported at the original cost in the consolidated financial statements as long as it is
held within the consolidated entity, regardless of which affiliate holds the land.
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Illustration
Assume that on July 1, 2019 Parent Corporation sold land costing P100,000 to its subsidiary, Sub
Company for P175,000.
Parent Corp Sub Company
Cash P175,000 Land 175,000
Land 100,000 Cash 175,000
Gain on sale of land 75,000

The gain must be eliminated in the preparation of consolidated financial statements and the land
restated to its original cost of P100,000.
Eliminating Entry:
Gain on sale of land 75,000
Land 75,000

Assignment of Unrealized Profit Eliminations

A gain or loss on an intercompany sale is recognized by the selling affiliate and ultimately accrues to the
stockholders of that affiliate. When a sale is from a parent to a subsidiary, referred to as downstream
sale, any gain or loss on the sale accrues to the parent company’s stockholders. When the sale is from a
subsidiary to its parent, an upstream sale, any gain or loss accrues to the subsidiary’s stockholders. If
the subsidiary is wholly owned, all gain or loss ultimately accrues to the parent company as the sole
stockholders. If, however, the selling affiliate is not wholly owned, the gain or loss on the upstream sale
is apportioned between the parent company and the non-controlling shareholders.

Unrealized intercompany gains and losses are eliminated in the following ways:
Sale Elimination
Downstream Against controlling interest
Upstream:
Wholly owned subsidiary Against controlling interest
Partially owned subsidiary Proportionately against controlling and non-
controlling interest

Subsequent Disposition of Asset

Unrealized intercompany gain on sale of assets is viewed as being realized at the time the assets are
resold to outsiders. For consolidation purposes, the gain or loss recognized by the affiliate to outsiders
must be adjusted for the previously unrealized intercompany gain or loss.

Illustration:
Continuing our example of Par Corporation and Suba Company, assume that Suba Company sold the
land that it purchased from Par to outsiders for P225,000 on March 1, 2020. Suba Company recognizes
a gain of P50,000 (P225,000-175,000). From a consolidated viewpoint, however, the gain is P125,000
(P225,000-100,000).
Elimination Entry on Dec. 31, 2020:
Retained Earnings, Jan. 1 75,000
Gain on sale of land 75,000
 INTERCOMPANY SALE INVOLVING DEPRECIABLE ASSETS

Unrealized intercompany gains on a depreciable assets 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.
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The amount of depreciation recognized each period on an asset purchased from an affiliate is based on
the intercompany selling price. From a consolidated viewpoint, however, depreciation must be based
on the cost of the asset to the consolidated entity. Eliminating entries are needed to restate the asset,
the related accumulated depreciation, and depreciation expense to the amounts that would appear in
the consolidated financial statements if there had been no intercompany sale. Consolidated statements
must appear as if the intercompany sale had never occurred.

Downstream Sale
Assume that Parent Corporation sells equipment to Sub Company on December 31, 2019, for P70,000.
The equipment originally cost Parent P90,000 when purchased three (3) years before December 31,
2019, and is being depreciated over a useful life of 10 years using the straight-line method with no
residual value. The book value of the equipment immediately before the sale by Parent is computed
below:
Original cost to Parent P90,000
Accumulated depreciation on Dec. 31, 2019:
Annual depreciation ((P90,000 /10 yrs) P9,000
No. of years x 3 27,000
Book value, December 31, 2019 P63,000

The gain recognized by Parent on the intercompany sale of the equipment is:
Sales price of the equipment P70,000
Book Value 63,000
Gain on sale of the equipment P 7,000

Separate Company Entries:

Books of Sub Company Books of Parent Corp.
Dec. 31, 2019: Dec. 31, 2019
Equipment 70,000 Depreciation 9,000
Cash 70,000 Accumulated Depreciation 9,000

Cash 70,000
Accumulated Depreciation 27,000
Equipment 90,000
Gain on sale of equipment 7,000

Consolidation working paper

Amounts from Consolidated
Trial Balance Elimination Amounts

Machinery and 70,000 20,000 90,000

equipment
Accumulated Depr. 0 (27,000) (27,000)
Gain on sale (7,000) 7,000 0

Elimination entry:
Machinery and equipment 20,000
Gain on sale of equipment 7,000
Accumulated depreciation 27,000
 UPSTREAM SALE
Assume that Sub Company sells equipment to Parent Corporation for P70,000 on December 31, 2019.
The book value of the equipment at the time of sale is P63,000. (same computation in the previous
illustration)
Separate Company Entries:
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4 of Sub Company Books of Parent Corporation
Dec. 31, 2019:
Depreciation expense 9,000
Accumulated depreciation 9,000
Dec. 31, 2019:
Cash 70,000 Equipment 70,000
Accumulated depreciation 27,000 Cash 70,000
Equipment 90,000
Gain on sale of equipment 7,000

Elimination Entry:
Machinery and equipment 20,000
Gain on sale of equipment 7,000
Accumulated Depreciation 27,000

Comprehensive Illustration
To illustrate the above topic, solutions to comprehensive problem no. 1 found in chapter 5 of your
textbook: Advanced Financial Accounting 2021 Edition by: Antonio Dayag is attached for your further
study.

MULTIPLE CHOICE PROBLEMS

For your activities, you are instructed to answer the multiple choice problems on chapter 5 of said
textbook.

GOOD LUCK!!!
 Computation of consolidated sales, cost of sales and Gross profit (Amounts are assumed)
Sales Cost of Sales Gross Profit
Parent P540,000 P216,000 P324,000
Subsidiary 360,000 192,000 168,000
Sub-Total P900,000 P408,000 P492,000
Intercompany sales-DS (120,000) (120,000)
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Intercompany sales-US (75,000) (75,000)
RGPBI-DS (18,000) 18,000
RGPBI-US (12,000) 12,000
UGPEI-DS 24,000 (24,000)
UGPEI-US 6,000 (6,000)
Consolidated P705,000 P213,000 P492,000