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Chapter 7 – Intercompany Transfers of Services and Noncurrent Assets
CHAPTER 7
INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT
ASSETS
OVERVIEW OF CHAPTER
Chapter 7 focuses on the elimination of the effects of transfers of services and noncurrent
assets between companies included in a consolidated entity. The initial portion of the chapter
presents the rationale for eliminating unrealized profits and an overview of the profit
consolidation process in a transfer of services setting.
The chapter then goes on to present transfers of long term assets. The illustrations in the
chapter present the journal entries recorded by the purchaser and seller as a result of the
intercorporate transfer, along with the journal entries recorded by the parent under the fully
adjusted equity method of accounting for its investment in the subsidiary and the elimination
entries needed to complete the consolidation worksheet. Where appropriate, we include an
analysis of the balance in the investment account and a separate computation of consolidated net
income/retained earnings and noncontrolling interest.
The chapter uses a sale of land from parent to subsidiary (downstream sale) to introduce
the consolidation procedures required when unrealized profits have been recorded. The land
transfer is then assumed to be an upstream transfer, permitting an easy transition into a
discussion of the impact of unrealized profits recorded on the subsidiary's books on the
computation of income and net assets assigned to the noncontrolling interest.
The chapter than gives a similar presentation for a transfer of a depreciable asset.
Because of the systematic realization of unrealized gains and losses over the remaining life of the
asset, consolidation worksheets are illustrated for the year of transfer and the year following. It
illustrates both an upstream and downstream transfer.
Appendix 7A illustrates the consolidation procedures followed when the parent accounts
for its investment in the subsidiary under the modified equity method and the cost method.
Chapter 7 - INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS
7-2
LEARNING OBJECTIVES
When students finish studying this chapter, they should be able to:
LO 7-1 Understand and explain concepts associated with transfers of services and long-
term assets.
LO 7-2 Prepare simple equity-method journal entries related to an intercompany land
transfer.
LO 7-3 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following a downstream land transfer.
LO 7-4 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following an upstream land transfer.
LO 7-5 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following a downstream depreciable asset transfer.
LO 7-6 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following an upstream depreciable asset transfer.
SYNOPSIS OF CHAPTER 6
Intercompany Transfers of Services and Noncurrent Assets
Micron’s Intercompany Fixed Asset Sale
LO 7-1 Understand and explain concepts associated with transfers of services and long-
term assets.
Intercompany Transfers of Services
Intercompany Long-Term Asset Transfers
LO 7-2 Prepare simple equity-method journal entries related to an intercompany land
transfer.
Intercompany Land Transfers
Overview of the Profit Elimination Process
Assignment of Unrealized Profit Elimination
LO 7-3 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following a downstream land transfer.
Downstream Sale of Land (Year of Sale)
LO 7-4 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following an upstream land transfer.
Chapter 7 - INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS
7-3
Upstream Sale of Land (Year of Sale)
LO 7-5 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following a downstream depreciable asset transfer.
Intercompany Transfers of Depreciable Assets
Downstream Sale
Change in Estimated Life of Asset upon Transfer
LO 7-6 Prepare equity-method journal entries and consolidation entries for the
consolidation of a subsidiary following an upstream depreciable asset transfer.
Upstream Sale
Asset Transfers before Year-End
Intercompany Transfers of Amortizable Assets
Appendix 7A:
Intercompany Noncurrent Asset Transactions - Modified Equity Method
and Cost Method
Modified Equity Method
Cost Method
Chapter 7 - INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS
7-4
NOTES ON POWERPOINT SLIDES
We have attempted to provide PowerPoint slides that will be useful to a broad set of users. Since
instructors often have different styles and preferences, we have attempted to include slides that
will accommodate different approaches and that can be adapted to classes with different levels of
preparation. For example, some instructors prefer to introduce the material before students have
read the chapter. We have tried to facilitate these types of introductory discussions by including
slides that replicate key points from the chapter. Other instructors expect students to have read
the chapter and attempted homework problems before coming to class. As a result, they may not
find it useful to review all of the topics in the chapter or to include slides that simply review
many of the details they expect students to study before class. However, instructors following
this approach often like to use sample exercises and problems built into the slides that allow
them to have extended discussions or to facilitate group interaction in class.
If instructors elect to spend two class periods on the same subject, they might find a combination
of both styles to be useful by first introducing foundational material before students have read
the chapter and studied the topic, followed by an extended discussion the next class period after
students have read the chapter and attempted homework problems.
We have tried to develop slides that can facilitate a flexible approach to allow instructors to
select the slides that best match their objectives and style for class discussions. This is the reason
we are including over 100 slides for some chapters in the text. We do not expect all instructors
to use all slides, but the slide files should help support different teaching approaches and allow
instructors to select the subset of slides that best matches their specific discussion objectives.
The slides are organized by learning objective. We have included a slide at the beginning of
each learning objective to show where the new material begins. Instructors may or may not want
to use these learning objective slides in class. We provide them primarily as a way of organizing
the material. We also include short multiple choice questions at the end of most learning
objectives. Some instructors find it useful to pause periodically during class to assess students’
level of understanding. For this reason, we include several “practice quiz questions” that can be
used throughout class discussions to engage students, help them focus on key points, or to
facilitate group interaction. Finally, we provide longer exercises and problems that many
instructors find useful in assessing understanding and encouraging group learning.
LO 7-1 Understand and explain concepts associated with transfers of services and long-term
assets.
• Slides 3-7 summarize basic concepts related about the transfer of services and non-
current assets.
LO 7-2 Prepare simple equity-method journal entries related to an intercompany land
transfer.
• Slides 11-16 introduce the concepts in LO2.
• Slides 17-25 present a very simple example to illustrate the problems associated with
unrealized gains on the sale of long term assets. To keep it simple, this example does
not defer the unrealized gain in the parent’s books as would be required under the
Chapter 7 - INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS
7-5
fully adjusted equity method to simply illustrate concepts. Thus, it follows the
modified equity method. Some instructors may want to simply skip this example and
start with the next.
• Slides 26-35 repeats the same example based on the fully adjusted equity method.
Students sometimes have a hard time visualizing how the deferral of unrealized gains
in the parent’s equity method accounts solves the problems associated with
intercompany non-current asset transfers. We provide simple diagrams to illustrate
how the balance sheets of each company are affected by inter-company asset transfers
and equity method deferral entries. We also provide partial worksheets to illustrate
how equity method entries on the parent’s books and worksheet elimination entries
resolve problems associated with intercompany asset transfers.
LO 7-3 Prepare equity-method journal entries and consolidation entries for the consolidation
of a subsidiary following a downstream land transfer.
• Slides 39-44 introduce the concepts in LO3.
• Slides 45-50 present a partially owned downstream land transfer. Instructors can use
this as a group exercise to allow students to think about equity method entries on the
parent’s books as well as worksheet elimination entries. The example also provides
partial worksheets to illustrate how the equity method and worksheet entries correct
both the income statement and balance sheet problems associated with non-current
asset transfers.
LO 7-4 Prepare equity-method journal entries and consolidation entries for the consolidation
of a subsidiary following an upstream land transfer.
• Slides 52-56 introduce the concepts in LO3.
• Slides 57-63 convert the same group exercise into an upstream land transfer. In
particular, slide 40 explains the differences between a downstream and an upstream
asset transfer. In a downstream transfer situation with a partially owned subsidiary,
the ownership percentage doesn’t matter for the gain deferral. Since the gain resides
on the income statement of the parent company (and since the NCI shareholders are
assumed to not own parent company stock), the NCI shareholders do not share in the
gain deferral. However, in an upstream asset transfer situation, since the unrealized
gain resides on the income statement of the subsidiary, the NCI shareholders share in
the deferral.
LO 7-5 Prepare equity-method journal entries and consolidation entries for the consolidation
of a subsidiary following a downstream depreciable asset transfer.
• Slides 65-74 introduce important concepts about the transfer of depreciable assets.
• Slides 75-78 introduce a simple example in which a depreciable asset is transferred
on the last day of the year. This example illustrates how the elimination entry
removes the gain and adjusts the consolidated financial statements so that it appears
as if the asset had stayed on the parent’s books (i.e., as if the transfer hadn’t taken
place).
• Slides 79-83 modify the same example to assume that the depreciable asset transfer
takes place on the first day of the year. In this way, a new elimination entry becomes
Chapter 7 - INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS
7-6
necessary to adjust the depreciation expense to what it would have been if the parent
had not transferred the asset and had merely changed its estimate of useful life.
• Slides 89-91 provide a detailed downstream depreciable asset is transfer that takes
place on the last day of the year. This example could be used as a group exercise to
allow students to practice preparing the equity method adjustment on the parent’s
books to defer an unrealized gain on a depreciable asset transfer.
• Slides 92-105 modify the same example to assume that the depreciable asset transfer
takes place on the first day of the year. This comprehensive example again could be
used as a group exercise. The solution is very detailed showing how the worksheet
elimination entries are prepared each year. Finally, we provide partial worksheets to
show how the equity method and worksheet elimination entries effectively remove
the effects of depreciable asset transfers.
LO 7-6 Prepare equity-method journal entries and consolidation entries for the consolidation
of a subsidiary following an upstream depreciable asset transfer.
• Slides 107-111 introduce the concepts in LO6.
• Slides 112-126 provide a comprehensive, upstream depreciable asset transfer
example. This example provides very detailed illustrations of how to calculate the
equity method adjustments on the parent’s books as well as the worksheet
consolidation entries
• Slide 127 provides a brief summary the accounting for the transfer of amortizable
assets.
TEACHING IDEAS
1. Instructors could invite a manager of a local company that has a parent-subsidiary
affiliation with another company to the class to discuss the types and magnitude of
intercompany transactions and transfers that occur in the local company. Students will
also be interested in a presentation of the separate accounting that is necessary for the
intercompany transactions and transfers. Students then could be required to prepare a
concise report outlining what they learned about the entity.
2. Students could be asked to determine the method(s) of depreciation of fixed assets that
are used by their Fortune 100 Company by analyzing the company’s disclosure of
accounting policies. Then, they could be asked to determine the methods of depreciation
used by the companies in the Accounting Trends & Techniques sample of firms. This
information is available in "Section 3: Income Statement Depreciation Expense." The
straight-line method is the dominant method in use, although some firms use more than
one method. The following question could be raised: What implications does the method
of depreciation used have on subsequent consolidation entries after an intercorporate
transfer of a fixed asset?
Chapter 7 - INTERCOMPANY TRANSFERS OF SERVICES AND NONCURRENT ASSETS
3. Students could be asked to investigate how common intercompany transfers of non-
current assets and services were. They could be instructed to review the most current
edition of Accounting Trends & Techniques to find out how many of the survey
companies report these types of transactions. This information can be found in “Section
1: General,” under “Related Party Transactions.” In addition, students should review the
financial statement notes of four consolidated entities and briefly describe what type of
intercompany transactions (if any) were disclosed by those entities.
DESCRIPTIONS OF CASES, EXERCISES, AND PROBLEMS
C7-1
LO 7-6
20 min.
M
Correction of Elimination Procedures
Students must place themselves in the role of an audit team member and develop
a memorandum detailing necessary intercompany work paper consolidation
entries relating to intercompany equipment sales. Supportive cites from the
authoritative literature are required.
C7-2
LO 7-1,
LO 7-2
20 min
M
Consolidation of Intercompany Services
Students must place themselves in the role of an audit team member and develop
a memorandum detailing necessary intercompany work paper consolidation
entries relating to intercompany services. Supportive cites from the authoritative
literature are required.
C7-3
LO 7-2,
LO 7-5
20 min.
M
Noncontrolling Interest
This case gives specific consideration to the way in which a determination is
made of the amount of income and net assets assigned to the noncontrolling
interest in the consolidated statements. The usefulness of this information to the
noncontrolling shareholders is also questioned.
C7-4
LO 7-1,
LO 7-4
30 min.
M
Intercompany Sale of Services
The issue of the parent company purchasing services from its subsidiary and the
effect of this intercompany transaction on the consolidated statements are
explored. Students must identify the balances relating to intercompany services
that must be eliminated in consolidation and identify the timing of recognition of
profit.
C7-5
LO 7-1
30 min.
M
Intercompany Profits
Students must access 10-K filings with the SEC or other databases in providing
answers to questions relating to intercompany sales of Century Telephone
Enterprises, Inc., Verizon Communications, and Harley-Davidson. Internet
addresses for the companies are provided in the solutions manual.
