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Sir when a non current asset is sold from parent to subsidiary I understand that unrealized profit is to be deducted from retained earnings of the company selling it but as the asset is already sold to subsidiary and it is depreciation more based on the price it paid then why is the excess depreciation netted off against the company selling it. It is actually buying company that has depreciated asset more therefore will it not increase the retained earning of buyer company.
I am bit confused here because if buyer company depreciated more than what should be then adjustment should be in its retained earning ( should go up by excess amount depreciated)
Why adjustment is done in retained earning of the selling company ?
Please help !Hmm, this is an awkward one, indeed!
For many years I agreed with you but I’ve had to change (relatively) recently
The reasoning is this … (incidentally, it makes no difference whether it’s the parent or the subsidiary that’s doing the selling – the adjustments for pup AND for excess depreciation go through the seller’s records) … when the asset is sold for an amount in excess of carrying value, thus creating the need for a pup, that unrealised profit becomes realised over the life of the asset
As each year goes by (say there was a four year remaining useful life at the time of transfer) one quarter of that profit is realised so that, over the entire four year period, the entire profit is realised
If we had started at date of transfer with an unrealised profit of $600 then after one year the pup to carry forward would be only $450 because the asset has been used for that one year and thus one quarter of the profit has been realised.
Same for years two, three and four so that, at the end of its life, the profit on the transfer of that asset is fully realised
If it makes it any easier, think about it this way … we started off needing a pup of $600 but after one year we now need a pup of only $450
After another year, we need a pup of just $300 and so on
If we had made only the pup (and not the depreciation) adjustment in the seller’s records we would be left with a $600 pup in the seller’s records for ever more!
10, 20, 30 years into the future there would be that pup. And generations of auditors would ask each year and say “What’s this pup?” to which you, as an old man now, would have to say:-
“Way back in the early part of the century we sold an asset to a subsidiary at a profit and this is that profit figure. I wish we had sold it at its carrying value and then we wouldn’t have this white elephant hanging around in our financial statements”
Does that make sense for you?
Thank you sir for the detailed explanation. You make students life so much easy.
Many thanks once again !
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