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PURP on NCA
Suppose Holding co.sell NCA to subsidiary with profit margin. Which of the following treatment is more fair presention?
Option 1
carrying value with transfer price – carrying without transfer price = purp
journal
Dr Holding Retained earning
Cr Subsidiary NCAOption 2
journal 1 (purp)
Dr Holding co. R.E
Cr Subsidiary NCAjournal 2 (Depreciation)
Dr Subsidiary NCA
Cr Subsidiary Post acquisition R.EOption 1 is more fair…
This is because once the parent co. has sold goods to subsidiary, it means the parent will have unrealized profit on NCA still held at year end….hence we need to remove this…
Again, the subsidiary will have already charged the depreciation on that NCA based on the transfer price and hence overcharged that asset, and therefore we will need to add it back to retained earnings of the Subsidiary………..
The overall net impact of this is that, in the group financial statements (consolidated), the unrealized profit to be debited by parents in its retained earnings will be added with the additional depreciation to be credited to subsidiary’s retained earnings, and the overall impact will be a NET UNREALIZED PROFIT, which is something like -ve plus +ve………….Hi
Good effort Gaudiano – and it would have been perfect 18 months ago.
However …… the current position is that the NET profit ie profit on the transfer LESS the excess depreciation should be deducted from the retained earnings of the selling company.
the rationale is that of the profit recognised on transfer, part of that profit becomes realised with the passing of each successive year. The extent to which that profit is realised is measured by the amount of the “excess” depreciation which the buying company is charging.
So, in summary, the adjusting journal entry would be effected entirely in the records of the selling company – in the example above, in the parent company and the accounting entries would be:-
Dr Parent Retained Earnings and
Credit combined TNCA (it doesn’t make any difference to the TNCA figure if you put the credit against the TNCA of the buying company because all we are going to do with the TNCA line is add it across. However, it is important to put the adjustment to the retained earnings in the correct company and, as stated, the NET figure is debited in the seller’s retained earningsHope that helps (I’ve not got round to re-recording that lecture but the course notes are correct)
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