 Hello, and welcome to this session in which we will discuss eliminating entries that deals with income statement account. In the prior session, we looked at eliminating entries that deals with the balance sheet. As always, I would like to remind you this lecture is for my CPA candidate. So this is my CPA review course. You can go to Farhat Lectures and obviously download it. If you are a subscriber, if not, go ahead and subscribe. If you want more in detailed explanation about these topics, please go to my advanced accounting, which you should have access to if you are a member, if you are a subscriber. So income statement elimination are a bit more complicated, relatively speaking, than the balance sheet. Nevertheless, I'm going to simplify them. They consist of eliminating the transactions that are simultaneously reported as expenses in one entity and revenues in the other one. And revenues and expenses, they associate with them gains and losses. So you sold something to another party, a parent sold something to a subsidiary at a gain, the parent sold something at a loss, or vice versa, the sub sells it. So we have sales and we have, which is sales revenues and we have gains and losses. Usually the CPA exam cover four topics when it comes to eliminating income statement entries. The appreciable fixed asset transaction. And here we're talking about usually land focusing on intercompany gains and losses. Usually they give you gains, but they could give you losses, the appreciable fixed assets. So I'm going to start with the easy, easy when we have non depreciable asset and we're going to take the non depreciable asset and use a depreciable asset and see how it works. Basically selling fixed asset that are subject to depreciation that we're going to look at a sale of intercompany inventory where we have to deal with sales, cost of good goods sold with the focus on markup. And we looked at investment in bonds when, when a subsidiary or the parent company sells a bond or issue a bond, then the other company buys it basically retired the bond, how to, how to account for that. Again I will start with the easiest one, which is non depreciable fixed asset. It's important to understand the concept. Then we can build on the depreciable asset. Now it's important to know that any gains or losses resulting from the intercompany sale transaction is not realized from the perspective of the consolidated financial statement unless that transaction is executed with an outsider. I always give you that box. We have the parent and we have the sub. Any transaction between the parent and the sub will needs to be eliminated. The only transaction we count are the transaction outside. Any gains and losses that are generated or incurred outside the box, outside the consolidated financial statement. One thing we need to know before we start this session or chapter four is upstream versus downstream. Again, back to my box. We have parent and we have a sub. When the parent sells to the sub, we say it's a downstream sale. When the sub sells to the parent, we say it's an upstream sale. When dealing with intercompany transaction, it's important to differentiate between upstream and downstream transfer to understand the mechanism of the transaction and assess the potential effect on the NCI non-controlling interest in cases where the parent company owns less than 100 percent of the own 100 percent. It doesn't really make a difference. What's an upstream refer to the transaction in which the subsidiary company is transferring an asset to the parent company, therefore the sub being the seller would report the result of the transfer as a gain or a loss so that the sub is selling, therefore they will have a gain or a loss on their books. Remember, each company will keep their books separately. If the sub is not wholly owned subsidiary by the parent company, portion of the result of this transaction is attributed to the NCI. If the parent company don't own you 100 percent, then part of the gain and the loss will need to go to NCI. Hopefully, this makes sense. If they own 100 percent of you, then you'll absorb 100 percent of the gain or the loss. On the other hand, a downstream transfer referred to a mechanism in which the parent transferring an asset to the subsidiary, from the parent down to the subsidiary. Well, under those circumstances, it's easier in a sense that there's no, we don't have to worry about the NCI because we are the parent company, therefore the total gain or the total loss is attributed to the company. The sub has nothing to do with this transaction. So let's go ahead and get started and I will work an example with both. So this way you see the difference. Starting with the non-depreciable fixed asset again, usually we're talking about land. The intercompany sale of non-depreciable fixed asset is obviously easier to eliminate than the intercompany sale of the depreciable fixed asset and you will see why in the next session. When selling a non-depreciable asset, the seller would report a gain, most of the time a gain could be a loss, that it's unrealized from a consolidated financial statement perspective. Well, the parent sold it to the sub. Yes, the parent made the gain, but when the sub and the parent combined, that gain has to be gone. On the other hand, the buyer would report an inflated asset or an overvalued asset. So if, and we'll see an example. So if I have a piece of land that's worth $100,000, that's the cost. I sold it for 120. This is how much I sold it for. Well, I'm going to report a gain of 20 and the sub would report it at 120. So we have two problems. I have a gain that needs to be eliminated and the sub will have an additional 20,000 in the land cost because the land is really owned by both the sub and the parent. Therefore, the true cost would still need to be 100,000. And we'll see this in an example. Therefore, the eliminating journal entry consists of simply eliminating the intercompany gain recorded by the seller by restating the asset at its original value. So we would remove the gain and we deflate or reduce the asset back to its original value. We'll work an example and it's very easy to follow. Okay? The only case when the gain on a sale on an undepreciable asset appears on the consolidated, obviously, is when the buyer of the asset sold it to a third outside party. If they sold it to another sub of the same group, then we still cannot recognize the gain. Let's take a look at an example. That's the best way to do this. During year one, company X owned 85% of company Y. So X is the parent. Sold the land initially bought for 210 to Y for 300,000. So let's take a look at the journal entry from X and Y's perspective. X is the parent. X sold the company. They will credit the land, debit cash for 300,000, and they have a gain of 90,000. Pretty straightforward. Y bought the land. The land is recorded on Y's books for 300,000. And they have a cash. They paid cash of 300,000 to company Y. So this is the books for each separate company. And each company will keep their books separately. At the end of the year, they're going to have to combine. When they have to combine, we have two problems here. We have a gain that we need to take out, because that gain is an intercompany gain, because we're not told that Y sold it to an outside party. And we have a land listed at 300,000, but it should be listed at 210. So we also have to reduce the land by 90,000. I just gave you the eliminating entry. Debit the gain, credit the land. Debit the gain, credit the land. And by doing so, we fixed the problem. We eliminated the intercompany gain by crediting, by debiting the gain, and we reduced the land by 90,000, thus restating the land. Now, this transaction is a downstream transfer of an undepreciable asset, because X is the seller and Y is the buyer. This transaction has no impact on NCI, because NCI is when the subsidiary sells it to the parent and the parent owns less than 100% of the subsidiary. That's not the case here. Now, we have to be aware what's gonna happen in subsequent year, because remember, this entry here, this entry here, this is a consolidated entry. It does not go on X's books, it doesn't go on Y's books. So every year, as long as company Y keeps the asset, we're gonna have to eliminate that gain. So let's go to the subsequent year. At the end of the year, at the end of the year of sale, the gain reported on the sale of the land is close to retained earnings. Once year end has done, that gain on the subs books goes to the retained earnings. Therefore, in years following the year of sale, until the land is sold to an external party, the eliminating entry would be debited to retained earnings account and credited to the land for the amount previously recognized. So simply put, this is what we did in year one. This is year one. Now, if we did not sell the land by year two, well, we still have the overstated land on the buyer's book. Why? And we still have a gain that's now reported in retained earnings. So what do we have to do in subsequent year? Well, we have to debit retained earnings, reduce retained earnings, because we cannot debit gain. The gain is sitting here. The gain is sitting in retained earnings in future years. We have to debit retained earnings and credit the land. We keep doing so until the land is actually, is actually sold, is actually sold. Now let's take a look at an upstream sale. Now assume company Y is the seller and company X is the buyer, upstream sale. Prepare the eliminating entries by the end of year one and year two. The cost of the land, again, 210 and the subsidiary sold at 4,300,000. Now we're gonna do the opposite. I hope you remember the original entry, how X, how Y would record the sale and how X would record the buy, which is the exact opposite as we saw earlier. Now the eliminating journal entry at the end of year one would include the debit to revenue for the parent share of 85% and a debit to non-controlling interest for the remaining 15% attributed to the non-controlling interest. So when we credit the land, we have to reduce the land. Okay, I'm not gonna show you the original entry because you should know the original entry. We're gonna debit the gain on the sale of the land. We're gonna reduce the gain of the sale of the land by 76,500 and we're gonna debit non-controlling interest by 13,500, why? Because we own 85%, simply put, what's gonna happen is this. We're gonna have to allocate the gain, which is 90,015% and 85%. 15% is 13,500 is allocated, is reducing the NCI. In year two, again, we're gonna have to do the same thing except in year two, the gain will be gone. We no longer have the gain. So what happened to the gain? The gain becomes retained earnings. The gain becomes retained earnings and NCI and crediting land. Again, this is the eliminating entry because every year we have to do so until the land is sold to an outsider, okay? It's important to know that the parent company would continue to report the land for 300,000. Remember, the parent company bought it for 300,000 and it's a standalone balance sheet. The consolidated balance sheet would show the land at its original cost of 210. So keep that in mind. What should you do now? Go to farhatlectures.com, work multiple choice questions. If there's an exercise, work the exercise. Eliminating entries are easy, peasy once you understand the easy point on the exam. They don't test you as much as I would do it in an advanced accounting course. Now, if you want to be more confident and just like, you know what? I wanna really have, leave no rock unturned, go to my advanced accounting and learn about this topic because I go much, much more in depth in that course. Good luck, study hard. I'm always here to help you and stay safe.