Elimination of Unrealized Gains or Losses on
Intercompany Sales of Property and Equipment
I. Overview
In consolidated financial statements, intercompany sales
of property and equipment (PPE) must be eliminated
because the group is treated as a single economic
entity.
When one affiliate sells equipment to another affiliate:
The gain or loss recognized by the seller is
unrealized from the perspective of the consolidated
entity.
The equipment is still owned within the group.
Therefore:
1. Unrealized gain or loss must be eliminated.
2. Depreciation must be adjusted based on the
asset’s original carrying amount.
II. Key Concept
Suppose:
Parent sells equipment to Subsidiary
Equipment remains within the consolidated group
Any gain or loss is:
Unrealized Gain or Loss=Transfer Price−Book Value
This must be eliminated in consolidation.
III. Types of Intercompany PPE Transfers
Type Description
Downstream Parent →
Sale Subsidiary
Subsidiary →
Upstream Sale
Parent
Important Difference
Downstre Upstre
Item
am am
Affects NCI? No Yes
Gain elimination allocated
No Yes
to NCI?
IV. Basic Consolidation Objective
The consolidated statements should reflect:
Asset at original historical cost to the group
Correct depreciation
No artificial gain or loss
V. Illustration 1 — Downstream Sale (Parent to
Subsidiary)
Problem. On January 1, 20X5, Parent Company sold
equipment to Subsidiary Company for ₱500,000.
Equipment’s book value = ₱350,000
Remaining useful life = 5 years
Straight-line depreciation
No residual value
Parent Subsidiary
Debit Credit Debit Credit
Cash 500,000 Equipme 350,000
nt
A/D- 150,000 Cash 350,000
Deprn
Equipme 500,000
nt
GSE 150,000
Prepare consolidation adjustments for 20X5.
Step 1 — Compute Unrealized Gain
Gain=₱ 500,000−₱ 350,000=₱ 150,000 The
gain is unrealized in
consolidation.
Step 2 — Compute Excess Depreciation
Subsidiary records depreciation based on transfer price:
₱ 500,000÷ 5=₱ 100,000 Correct
depreciation based on original
book value:
₱ 350,000 ÷5=₱ 70,000Excess depreciation: ₱ 100,000−₱ 70,000 = P30,000
Step 3 — Consolidation Entry (Year of Transfer)
Entry TI — Eliminate Gain
Dr Gain on Sale of Equipment .............. 150,000
Cr Equipment ....................................
150,000
Purpose: Remove unrealized gain and Restore equipment
to original carrying amount
Entry ED — Adjust Depreciation
Dr Accumulated Depreciation ............... 30,000
Cr Depreciation Expense .....................
30,000
Purpose: Reduce excess depreciation and reflect correct
group depreciation
VI. Effect on Consolidated Statements
Consolidated Equipment
Item Amount
Transfer Price ₱500,000
Less: Unrealized Gain (150,000)
Consolidated Carrying
₱350,000
Amount
Consolidated Depreciation
Item Amount
Recorded by Subsidiary ₱100,000
Less Excess (30,000)
Correct Consolidated
₱70,000
Depreciation
VII. Illustration 2 — Upstream Sale (Subsidiary to
Parent)
Problem. Subsidiary sold machinery to Parent for
₱420,000 . Book value = ₱300,000 and the remaining life
= 4 years. Parent owns 80% of Subsidiary.
Parent Subsidiary
Debit Credit Debit Credit
Equipme 300,000 Cash 420,000
nt
Cash 300,000 A/D 120,000
Equipme 420,000
nt
GSE 120,000
Step 1 — Compute Gain: ₱ 420,000−₱ 300,000=₱ 120,000
Step 2 — Compute Excess Depreciation
Depreciation recorded: ₱ 420,000 ÷ 4=₱ 105,000
Correct depreciation: ₱ 300,000 ÷ 4=₱ 75,000
Excess: ₱ 105,000−₱ 75,000=₱ 30,000
Step 3 — Consolidation Entries
Entry TI
Dr Gain on Sale of Machinery ............. 120,000
Cr Machinery .................................. 120,000
Entry ED
Dr Accumulated Depreciation .............. 30,000
Cr Depreciation Expense .................... 30,000
VIII. Important NCI Effect (Upstream Only)
Because the seller is the subsidiary:
Gain elimination reduces subsidiary income.
Therefore, NCI share is affected.
Adjustment to NCI
₱ 120,000× 20 %=₱ 24,000NCI income decreases by ₱24,000.
IX. Subsequent Years
After the year of transfer:
Unrealized gain remains partially embedded in the
asset.
Continue adjusting depreciation until asset is fully
depreciated or sold externally.
X. Illustration — Subsequent Year Adjustment
Using Illustration 1: Unrealized gain = ₱150,000 Useful
life = 5 years
Annual excess depreciation: ₱ 150,000÷ 5=₱ 30,000
In each subsequent year:
Dr Accumulated Depreciation .............. 30,000
Cr Depreciation Expense .................... 30,000
No additional gain elimination entry is needed after the
first year.
XI. Intercompany Losses
Losses are also eliminated because they may be artificial.
Example
Parent sells equipment to Subsidiary
Book value = ₱500,000
Selling price = ₱420,000
Loss: ₱ 420,000−₱ 500,000=(₱ 80,000)
Consolidation Entry
Dr Equipment ..................................... 80,000
Cr Loss on Sale of Equipment ............. 80,000
Purpose: Restore asset to proper carrying value
XII. Conceptual Summary
Issue Treatment
Unrealized gain Eliminate
Unrealized loss Eliminate
Excess depreciation Adjust
Downstream
No NCI effect
transfer
Upstream transfer NCI affected
Asset reported at original
Goal
group cost
XIII. Comprehensive Illustration
Problem. On January 1, 20X5:
Parent sold equipment to Subsidiary for ₱900,000
Book value = ₱600,000
Remaining life = 6 years
Straight-line depreciation
Parent owns 75% of Subsidiary
Required:
1. Compute unrealized gain
2. Compute excess depreciation
3. Prepare consolidation entries
4. Determine effect on NCI
Solution
Step 1 — Unrealized Gain: ₱ 900,000−₱ 600,000=₱ 300,000
Step 2 — Excess Depreciation
Recorded depreciation: ₱ 900,000 ÷ 6=₱ 150,000
Correct depreciation: ₱ 600,000 ÷6=₱ 100,000
Excess: ₱ 150,000−₱ 100,000=₱ 50,000
Consolidation Entries
Entry TI
Dr Gain on Sale of Equipment ............ 300,000
Cr Equipment ................................
300,000
Entry ED
Dr Accumulated Depreciation ............. 50,000
Cr Depreciation Expense ................... 50,000
Effect on NCI
This is downstream (Parent → Subsidiary).
Therefore: No effect on NCI
XIV. Quick Formula Guide
Unrealized Gain Transfer Price −Book Value
Unrealized Gain
Excess Depreciation Remaining Useful Life
XV. Common Errors of Students
Error Correction
Forgetting depreciation Always compute excess
adjustment depreciation
Gain eliminated only in year
Eliminating gain every year
of transfer
Ignoring NCI effect Upstream sales affect NCI
Using transfer price in Use original group carrying
consolidation amount
XVI. Board-Type Practice Problem
Practice Problem
On January 1, 20X6:
Subsidiary sold equipment to Parent for ₱750,000
Book value = ₱510,000
Remaining useful life = 8 years
Parent owns 85% of Subsidiary
Required
1. Compute unrealized gain
2. Compute excess depreciation
3. Prepare consolidation entries
4. Determine NCI adjustment
Answer
Unrealized Gain ₱ 750,000−₱ 510,000=₱ 240,000
Excess Depreciation ₱ 240,000 ÷ 8=₱ 30,000
Entry TI
Dr Gain on Sale of Equipment ............ 240,000
Cr Equipment ................................
240,000
Entry ED
Dr Accumulated Depreciation ............. 30,000
Cr Depreciation Expense ................... 30,000
NCI Adjustment
NCI percentage:100 %−85 %=15 %
NCI reduction: ₱ 240,000 ×15 %=₱ 36,000