 Hello and welcome to the session in which you would look at how to handle intercompany, the third gross profit on non-controlling interest. What is the effect on non-controlling interest? Well, there are two terms in the title that you need to be familiar with. One is what is the third gross profit? Well, the third gross profit arises when we have intercompany transaction, when one company sells inventory to another company. If the second company sold it to an outsider, we don't have any gross profit to defer. If we have any inventory left on the books, then we have a certain amount of the third profit that we have to take care of, handled. The question is, how does the third gross profit affect non-controlling interest? The non-controlling interest is the minority interest. It's the interest of the shareholders that don't own the majority of the company. So, make sure you are comfortable with those two terms before we discuss the topic here, because the topic is specifically about the third gross profit. How does it affect non-controlling interest? Well, how does it affect non-controlling interest? It all depends whether the transaction is a downstream transaction. It means the parent selling inventory to the subsidiaries or the subsidiary selling inventory to the parent, which is called an upstream. So, this is a downstream. A downstream means the parent is selling down to the subsidiary. Well, if it's a downstream, any intercompany ending inventory gross profit deferral is all attributed to the parent company. Pretty straightforward. If it's an upstream sale, intercompany ending inventory gross profit deferral is attributed to the non-controlling interest. Now, we have to split it a little bit between the non-controlling interest. The best way to illustrate this is to actually look at an example and see how it works. We have a parent company that acquired 80% of the outstanding stock of a sub on January 1, X1. No difference between book value and fair value to keep this example simple. In 20 X1 in the first year, intercompany sales of 90,000, the original cost was 54. And at the end of the year, 20% of those were remained unsold. In 20 X2, sales of intercompany sales was 120,000. The cost is 66,000. Of this amount, of this amount of sales, 30% remained unsold. Now, I did not tell you whether we sold from the parent to the subsidiary or from subsidiary to the parent because we have to learn both. I have to show you how to deal with both. The parent company X2 reported net income was 300,000. The subsidiary's X2 reported net income was 100,000. Well, the first thing we want to know is how much of gross profit do we have deferred from X1 to X2? And how much gross profit do we have deferred from X2 to X3? Because we're going to be dealing with X2. Well, here's how it goes. In X1, sales, intercompany sales was 90,000. The cost of the sale was 54. The gross profit for X1 was 36,000. We are told 20% remained. It means we still have 20% of the 36,000, which is called the third gross profit. Gross profit that we did not realize. Why? Because we did not sell all the 90,000 that we sold to the other company. Therefore, within that remaining inventory, we have 7,200 of the third gross profit. What's going to happen to this? This is the third gross profit. It's going to be deferred to X2. It's going to be counted to X2. In X2, we have sales, intercompany sales of 120 intercompany inventory sales. The original cost for the seller was 90. Therefore, the profit was 54,000. The gross profit of this amount was 30% remained unsold. 30% of 54,000 is 6,200. This amount will be deferred because it was not sold to 20X3. Now, we just want to take a look at the journal entries just to kind of show you how do we deal with this and the following year. So in X2, what we do is this 7,200 that we deferred to X1, we deferred to X2. If it's an upstream sale, we need to have retained earning, which is beginning retained earning from the prior year and reduce cost of goods sold to increase the profit in X1. And we talked about this in the prior session. If it's a downstream sale, we debit investment in sub and we credit cost of goods sold. And I talked about these journal entries just as this is a review. And if you want to see more journal entries, please look at the prior recording, because in this session, I'm focusing specifically on the non-controlling interests. Now, before we discuss non-controlling interests, most likely you are either an accounting student or a CPA candidate. Well, the reason you are looking for help, that's why you end up here. I can help you, farhatlectures.com. Please visit my website, whether you are an accounting student or a CPA candidate, I can help you. This is a partial list of my accounting courses. I have lectures, multiple choice, true, false and resources that's going to help you with your courses. My courses are aligned with your courses as well, and everything is broken down by chapter. My CPA material is aligned with your Becker, Roger, Wiley, Gleam, or any other CPA review course. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording, share it with other. If you find it helpful, obviously you're watching, share it with other. Put a like, press on the like button, subscribe. Connect with me on Instagram, Facebook, Twitter and Reddit. And I started a CPA group me account. So if you would like to join a CPA exam support group. So now what we're going to do, we're going to look at how do we compute the non-controlling interest and how much is the consolidated net income. First, we're going to start with a downstream sale. The subsidiary had income of 110,000. Now, remember downstream sale is when the parent sold to the subsidiary. So we have parent selling to the sub. This is what a downstream sale. Well, remember we own 80% of this company. Therefore the sub 20% is the minority shareholders or the non-controlling interest. So of the 110, 22 goes to the minority or the NCI interest. Well, to compute the consolidated net income for this company, what we're going to do, we're going to look at, look at the parent net income, which is 300,000. At the parent, the 80% of 80% of the sub, sub reported net income. Then we are going to add 7,200 of inter company gross profit. Remember, we're dealing here with X2. So the amount that was deferred from X1 was realized in X2. Realized means we assume it's sold because we assume we're using FIFO. The amount from X2 will be realized in X3. We'll need, we'll need to be deferred. Therefore we'll add 7,200. This is the 7,200. Then we deduct 16,200 to defer this profit to X3. Therefore consolidated net income is 379,000. Now if we are dealing with a, with an upstream sale, with an upstream sale, the sub has net income of 110,000. Now the sub made the sale. Therefore the sub has the deferred profit from X1. They will need to add this profit because this profit was realized in X2. Then the sub will have to remove or defer this 16,200 to X3, 20 X3. Therefore the sub adjusted net income is 101. Notice the non-controlling interest now is 20% of the 101. Therefore the non-controlling interest will absorb that deferral. This is what we're trying to say here. Therefore the NCI interest of the consolidated net income is 22,200. Now let's compute the consolidated net income starting with 300,000. Then we're going to take 101 times 80%, which is 80,800. Therefore consolidated net income is 380,800 dollars, the consolidated net income. So this is basically just to show you the difference. Most likely this topic is not on the CPA exam, but I don't want you to take any chances, but it's definitely part of your advanced accounting course. What should you do now? Go to farhatlectures.com and work MCQs. Invest in yourself. Subscribe. Don't shortchange yourself. I can help you. My resources can help you clarify certain topics, which will help you with your courses, which will help you with your CPA preparation, which will help you with your career. Good luck, study hard, and of course, stay safe.