 Hello and welcome to the session in which we would look at intercompany transfer of depreciable asset. Well in the prior recordings we looked at the intercompany transfer of inventory, the intercompany transfer of land. And if you remember inventory was a little bit more complicated than land, land was the easiest because we don't have to deal with depreciation. Well, depreciable asset, guess what? By its nature they have depreciation like equipment, truck, building and any long-lived asset. And here when we say depreciable asset you can include also intangibles which are amortized but nevertheless they are treated the same. And the concept is the same whether we are transferring intercompany inventory or inventory land there are few things that we have to be aware of. This one it's going to be a little bit different but basically the same idea we have to defer any intercompany gain. If there's any intercompany gain we're going to have to defer it. We're going to have to re-establish historical cost. So when we sell an asset to another entity that is that is related to us it's which is part of the consolidated financial statement. We have to report everything at historical cost. We have to re-establish historical cost and we have to recognize the appropriate gain in the consolidated financial statement. And specifically here what's going to happen with depreciable asset which you will see which is something little different than inventory and land is you're going to recognize the gain in piecemeal. It means a gradually through depreciation and we'll see this. So this point here is a little bit different and we'll see it when we work the example in a journal entry. But deferring the gain deferring the intercompany gain and re-establishing historical cost this applied to inventory this applied also to land. So that's always the case when we have a consolidated entity. Now the best way to illustrate this concept is to start to look to take a look at an example. Let's assume on January 1st year one Adam company sells an equipment to Ryan company. Now I'm not going to specify whether Adam is the parent or Ryan is the subsidiary. I'll tell you the difference at the end. The selling price is 90,000 so Adam sold it for 90,000. Adam purchased the equipment for 100,000. This is the historical cost and the equipment has accumulated depreciation of 40,000. What does that mean? It means if we have a historical cost of 100,000 minus 40 that's correct. We have a book value of 60,000 that's the book value. Now we sold this asset it has a book value of 60 sold for 90. It means from Adam's perspective on Adam's record Adam will record a gain of $30,000 and this is an intercompany gain. Now this is what we're going to be journalizing and after we journalize we have to see what's going to happen after year one and after year two. 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Share it with other connect with me on Instagram, Facebook, Twitter, Reddit and I started a CPA exam group me account you can join there as well. So let's start to take a look at the journal entries starting with the seller's record which is Adam so let's take a look at the journal entry sold the equipment receive cash from Ryan for 90,000 this is the selling price we remove the equipment for 100,000 we remove we remove accumulated depreciation for 40 and we book again on Adam's book so this is Adam the seller. Now the buyer's record which is Ryan Ryan will debit the equipment that's how much they paid for it 90,000 and they will credit cash 90,000 now from an inter entity perspective hopefully you know that we need to remove the gain we need to remove we need to re establish the equipment at historical cost which will deal with this in a moment however what I need to tell you is this asset has a remaining life of 10 years so from Adam's perspective since it has a remaining life of 10 years the book value is 60,000 computed on the prior slide book value divided by 10 Adam takes 6,000 of depreciation per year now on Ryan's book Ryan's going to debit this debit depreciation expense 9,000 because as far as Ryan's is concerned that's his cost which is also you can say his book value which is 90 minus 0 his book value divided by 10 years remaining Ryan will take 9,000 for the same depreciation for the same asset well what we can say is from a consolidated perspective hopefully you see that we have 3,000 more in depreciation and we'll deal with that shortly now let's go ahead and prepare the consolidated entry in the year of transfer in the year of transfer we need to get rid of the gain because this is an inter company gain we need to put the asset back to 100,000 so we need to add 10,000 here we need to remove the gain and we need to re establish accumulated depreciation because we removed accumulated depreciation therefore we debited the gain so simply put let me show you what we just did so let me just show you the whole thing cash 90 cash 90 is gone we credited the gain here we're going to debit the gain so we debited the gain we reduced the gain this gain is gone debit equipment debit equipment 90 credit equipment 100 were missing 90,000 if we debit equipment 10 10,000 this is the equipment is gone so basically we debited equipment 9,000 10,000 and we need to remove accumulated depreciation we credit accumulated depreciation so this entry in the year of transfer we we did is we remove the inter company gain the 30,000 and what we did also is re-established the asset at 100,000 and we re-established the accumulated depreciation as we mentioned earlier that we have a 3,000 of overstatement of depreciation here we're going to have to do on a consolidated basis depreciation expense is overstated so this is not on the buyer's record this is a consolidated statement so based on this is a consolidated entry so basically we're going to reduce depreciation expense by 3,000 and debit accumulated depreciation by 3,000 so here's what I want you to see here so we have accumulated depreciation was credited 40,000 to be re-established now we debited this 3,000 on a consolidated we are looking at 37,000 and what we did by reducing depreciation expense remember when you reduce your depreciation expense it means you increased your net income when you increase your net income it means you are increasing your retained earnings what does that mean it means you are starting to recognize some of that gain because you reduced your reduced your expenses increase your net income and increase your retained earning and this entry would repeat itself would repeat for the next 10 years why the next 10 years because we have a gain of 30,000 this gain this gain of 30,000 if we divided by 10 we're going to start to recognize 3,000 of it and this is what I said earlier we're going to be recognizing the gain in piecemeal and this is what I meant by piecemeal for depreciable asset let's take a look at year two maybe it will clarify the point a little bit further and year two we're going to have to do the same thing we're going to have to re-establish the asset at 100,000 debit the equipment 10,000 we're going to have to debit retained earnings of the seller 27 hold on a second we so at the beginning we debit at gain 30,000 remember the gains goes into retained earnings so in year two we no longer have a gain we now it's it's setting in retained earnings also remember that from a consolidated perspective we increase this retained earning by 3,000 in other words we increase it by increasing that income so in year two in year two what's going to happen is we're going to have to debit retained earning only 27 because we recognize on a consolidated basis 3,000 of the gain why did we recognize 3,000 of the gain because the the buyer used that equipment to generate revenue now the the asset being consumed so whether the asset being consumed or sold to an outsider it's the same effect once it's consumed it's consumed for the purpose of servicing the outsider therefore we recognize 3,000 of profit that's why in year two we're going to debit retained earnings only 27 credit accumulated depreciation only 37 and I showed you why 37 because accumulated depreciation was 37 we need to be re-established at 37 now for looking at year three well we're going to debit equipment 10,000 we're going to debit retained earnings well let's let's do the second entry first then we again will do the second entry and then this is a consolidated not the buyer's record but the buyer's record has 3,000 of overstatement of expense so in year two we also remember we repeat this entry four ten times we credit depreciation expense debit accumulated depreciation now if we're looking at year three now I can show you year three better year three we're going to debit equipment 10,000 we're going to debit retained earning 24 because we recognize another 3,000 of the gain and accumulated depreciation for this will be for year three year four year five year six until we use up all the gain or we sell or we resell the asset on outside party but this is what we have to do so hopefully you see how we are chipping away that 30,000 now at the beginning I told you whether this is an upstream or a downstream it doesn't really matter but I was this was an upstream sale we assume it's an upstream sale this is what how we do an upstream sale if this was a downstream sale downstream it means from the parent to the subsidiary rather than using the retained earnings we use the account called investment in sub investment and sub so that's the difference that you need to know whether it's an upstream or a downstream so at the beginning I did an upstream which is we use retained earning and these the reason I say retained earnings because it's harder to explain the retained earnings and that's why I use the retained earnings what should you do now go to farhatlectures.com work mcqs that covers this topic that's going to reinforce what you just learned okay you learned it you understand it test yourself so this way you are ready for your exam you're ready for your CPA and this way you know that you know the material don't shortchange yourself invest in yourself invest in your accounting career good luck study hard and of course stay safe