Task: Intercompany Profit Elimination Alternatives:
Rockness Corporation purchased much of its inventory from its 90 percent owned subsidiary, Mauch Company. Mauch price its sales to Rockness to earn a 40 percent gross profit on the sales. During 20x4, Rockness purchased $400,000 of inventory from Mauch and resells all f the inventory to unrelated parties, except for $40,000 left in ending inventory.
In reviewing the preparation of consolidated financial statements for the year, Rockness's controller, Liz Weber, notes that all unrealized intercompany profit remaining in ending inventory is eliminated proportionally against the controlling and noncontrolling interests. This proportionate elimination is reflected in the amounts reported for consolidated net income and the income assigned to the noncontrolling interest. Liz recalls that several alternatives exist when preparing consolidated financial statements for dealing with unrealized intercompany profits on transfer from less-than-wholly owned subsidiaries to the parent, but not all are considered currently accepted. She remembered, for example, that proportionate elimination has been suggested when only parent's proportionate share (based on the extend to which the parent shares in the subsidiary's profit) would be eliminated. Also, she has heard that some companies eliminate all unrealized intercompany profit against the controlling interest.
Having been impressed previously with your knowledge of accounting theory, Liz asks you to provide her with some additional information about different approaches to the elimination of unrealized intercompany profit on upstream sales.
Required:
Q1. Compute the amount at which Rockness's inventory purchased from Mauch would be reported in the consolidated balance sheet at December 31, 20x4, under each of the following three approaches to the elimination of unrealized intercompany profits:
a. Proportionate or pro rata (90 percent) elimination.
b. Full elimination against the controlling interest.
c. Full elimination, with proportionate allocation against the controlling and noncontrolling interests.
Q2. What amount of unrealized intercompany profit would be eliminated from consolidated net income and from the income assigned to the noncontrolling interest for 20x4 under each of the three approaches listed in part a?
Q3. Provide supporting arguments for each of the three methods listed in part a, and indicate which are acceptable in practice based on current authoritative standards.
Intercompany Debt
Intercompany Debt, both long-term and short-term, arise frequently. In some case, intercorporate borrowings may arise because one affiliate can borrow at a cheaper rate than other, and lending to other affiliates may reduce the overall cost of borrowing. In other cases, intercompany receivables/payables arise because of intercompany sales of goods or service or other types of intercompany transactions.
Required
a. What major problem might arise with intercompany debt between a domestic parent and foreign subsidiaries in different countries? How has Hershey Foods dealt with this problem?
b. Did Hershey Foods' intercompany loans arise because of direct loans or because of intercompany sales of goods and service on credit?