Parrot Corporation holds a 42 percent ownership of Sunrise, Inc. The equity method is being applied. Parrot assigned the entire original excess purchase price over book value to goodwill. During 2012, the two companies made intra-entity inventory transfers. A portion of this mer- chandise was not resold until 2013. During 2013, additional transfers were made.
- What is the difference between upstream transfers and downstream transfers?
- How does the direction of an intra-entity transfer (upstream versus downstream) affect the application of the equity method?
- How is the intra-entity unrealized gross profit computed in applying the equity method?
- How should Parrot compute the amount of equity income to be recognized in 2012? What entry is made to record this income?
- How should Parrot compute the amount of equity income to be recognized in 2013?
- If none of the transferred inventory had remained at the end of 2012, how would these transfers have affected the application of the equity method?
- How do these intra-entity transfers affect Sunrise’s financial reporting?
Solution
- a) Upward transaction represent sale by investee and purchase by investor while downward transaction represent sale by investor and purchase by investee.
- b) Under upstream transaction, whole profit on unsold goods is reduced from investment account balance while under downstream transaction only share of investor in unrealized profit is reduced from investment account balance.
- c) Profit is computed as: Unsold goods at year end * Profit margin %
- d) Equity income will be = Share in net income of sunrise 2012 – profit on downward transacted unsold inventory – Share in profit on upward transacted unsold inventory
Journal entry:
| Date | Particulars | Amount (Dr) | Amount (Cr) |
| xx | Investment in sunrise | xx | |
| Income share from Sunrise | xx |
- e) Equity income to be recognized in 2013 =Share in net income of sunrise 2013+Profit on downward transacted unsold inventory +Share in profit on upward transacted unsold inventory
- f) Then these transactions will nothave any impact on equity method investment acounting.
- g) It will not have any acounting impact but in its fianncial statements it should report about tranactions with Parrot corporation.
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