Inter-company Profits: (Analysis Based Case Study)
Many organizations are expanding their operations to international levels by either growing organically or through mergers and acquisitions. Because of the expansion, changes and additional financial reporting procedures have to be apparent in the companies (Carrington, 2008). More intently, a company’s accounting practices are crucial. Some organizations do not attach value to inter-company accounting because of other pressing matters in the organization. Nevertheless, companies are beginning to understand the importance of inter-company accounting.
Organizations realize that complex and inefficient inter-company procedures can be catastrophic to the company (Fischer, Tayler & Cheng, 2007). The study shall analyze how Verizon Wireless and Harley-Davidson address the matters that pertain to inter-company transactions. More precisely, the dissection shall scrutinize the elimination of the effects of inter-company transactions in Harley-Davidson. Moreover, the dissection shall examine the effects of inter-company transactions on the consolidated net income of the company. The streamlining of inter-company transactions enables a company to evade mistakes and reporting complications, and in the end, the company realizes a diversified range of benefits.
How Verizon Wireless Treats Inter-Company Profits For Consolidation
The company has two reportable segments, and these are the domestic wireless segment and the domestic wire line segment (Verizon, 2013). The income that pertains to the Verizon Wireless Partnership incorporates the income that is attributable to Vodafone Group Plc. non-controllable interest. In the recent past, the domestic wireless total operating revenues appreciated because of the inclusion of the operating revenues of Alltel (Verizon, 2013). More precisely, Verizon’s profits increased due to the inclusion of Alltel’s operating results and the appreciation in the cost recovery rate. The company’s comprehensive income incorporates net income and other profits and losses that have an effect on equity (Verizon, 2013). Nevertheless, the generally accepted accounting principles (GAAP) dictate that these entries should be non-existent in the net income. Verizon Communications Inc. bases its financial reporting procedures on the provisions of the US generally accepted accounting principles (Carrington, 2008).
Verizon’s consolidated financial statements incorporate the entries in the controlled subsidiaries. In addition, the net income in Verizon’s consolidated financial statements also incorporates the non-controlling interests of controlled subsidiaries whose ownership is not completely under Verizon (Verizon, 2013). In instances whereby Verizon does not possess a 100% of the shares in a controlled subsidiary company, the non-controlling interest constitutes the net income and total equity. In cases whereby the investments that Verizon does not control affect the company’s operational and financial frameworks, the equity method becomes applicable in handling these particular investments (Verizon, 2013).
The company’s consolidated balance sheet encompasses the equity and cost method investments although Verizon classifies them as investments in unconsolidated businesses. However, the company eliminates all substantial intercompany accounts and transactions. In instances whereby, the intercompany profits not yet realized, Verizon eliminates these profits when preparing the consolidated financial statements (Verizon, 2013). The intercompany profits are only included in the consolidated financial statements of the company when they are realized.
Whether Harley-Davidson Eliminates All Inter-Company Transactions When Preparing Consolidated Financial Statements
Harley-Davidson’s condensed financial statements incorporate the accounting records of Harley-Davidson Inc. and of the subsidiaries that are 100% owned by the company. Moreover, the accounts also included attribute to the two business segments that are operational in the company (Harley-Davidson, 2013). More precisely, Harley-Davidson consolidates variable interest entries identified with secured financing this is because the company is the main beneficiary. The elimination of intercompany accounts and substantial intercompany transactions is evident in Harley-Davidson’s financial reporting framework (Harley-Davidson, 2013). The company incorporates two business functions namely motorcycles and associated products and financial services. The preparation of Harley-Davidson’s financial statements is in line with the provisions of US generally accepted accounting principles. According to the US GAAP, the Harley-Davidson management has to create estimates and assumptions that influence the sum reported in the financial statements and the notes associated with them (Harley-Davidson, 2013).
The elimination of intercompany accounts and substantial intercompany transactions is necessary, and at Harley-Davidson, this is the case (Harley-Davidson, 2013). The company ensures that it confines itself to the provisions of US GAAP, and the requirement in the standards requires the elimination of accounts attributed to intercompany transactions and all significant intercompany transactions. It is necessary to eliminate the intercompany transactions at Harley-Davidson because of various reasons. Firstly, inefficient intercompany processes may lead to increased costs (Carrington, 2013). In cases whereby, the intercompany accounts exhibit increased inefficiencies and they are existent in the company’s accounts, the effects become catastrophic to the organization. The levels of revenue drastically lower and the company may perform inadequately. Hence, the Harley-Davidson management finds it necessary to eliminate all intercompany accounts and substantial intercompany transactions.
Secondly, complex intercompany processes can cause internal control and reporting issues (Fischer, Tayler & Cheng, 2007). In cases whereby the company experiences internal control challenges, the results become adverse to the organization. The capability of the company to detect and prevent fraud becomes limited. In the end, the company’s financial statements might not exhibit a correct and fair perspective of the financial status of the company (Carrington, 2008). The credibility of the company’s financial statements might be in doubt if this is the case. It is necessary for the Harley-Davidson management to eliminate the intercompany accounts and significant intercompany transactions to avoid the menace of tampering with the company’s internal control structures.
Effects of the Treatment of Intercompany Transactions on Consolidated Net Income
An inefficient intercompany structure may lead to misstatements and significant write offs (Fischer, Tayler & Cheng, 2007). Therefore, the consolidated net income of the company either lowers or rises depending on the nature of the error. Significant write-offs will lower the consolidated net income of the business whereas misstatements may either increase or decrease the consolidated net income. Overstatements will raise the consolidated net income, and understatements will lower the consolidated net income of the company (Carrington, 2008).
Secondly, if the sale of an intercompany asset is not eliminated it will affect the consolidated net income. For instance, a parent company possesses an asset, and the asset’s buying price was $200000. The parent company sells the asset to one of its subsidiaries at $300000. If there is no elimination of the transaction, it will raise the profits of the parent company by $100000. Moreover, if the subsidiary does not eliminate the transaction, the asset will reflect in the balance sheet of the subsidiary company (Fischer, Tayler & Cheng, 2007). In the end, the amounts of consolidated net income will lack accuracy.
The treatment of intercompany revenues and expenses will affect the company’s consolidated net income (Carrington, 2008). For instance, a subsidiary company records an increase in revenue in its financial statements, and the parent company records an expense in its accounts. In the event of consolidation, the two amounts will cancel each other. More precisely, there may be an overstatement or an understatement of revenues and expenses in the consolidated financial statements. As a result, the consolidated net income becomes affected.
Intercompany transactions encompass upstream and downstream transactions. Upstream transactions occur when a subsidiary company sells to the parent company, and downstream transactions occur when a parent company sells to the subsidiary company (Fischer, Tayler & Cheng, 2007). The treatment of upstream and downstream transactions will affect the consolidated net income. For example, in downstream transactions the charge is on the parent company if the elimination of profits occurs. The exclusion of unrealized profits from the consolidated net income has to be apparent. However, if there is no elimination of the unrealized profit, the figure of consolidated net income becomes inaccurate (Carrington, 2008). In upstream transactions, the charge of the eliminated profit is on the subsidiary company. More precisely, non-controllable interest comes into play because the non-controllable interest shares in the profits of the subsidiary (Fischer, Tayler & Cheng, 2007). The consolidated net income incorporates the non-controllable interest, and if the treatment of non-controllable interest is incorrect, the consolidated net income becomes inaccurate.
In conclusion, it is crucial to eliminate intercompany accounts and significant transactions. Verizon Communications Inc. incorporates the amount of non-controllable interest in the consolidated net income. However, only the confirmed intercompany profits constitute the final figure of the consolidated net income (Verizon, 2013). Harley-Davidson eliminates intercompany accounts and substantial transactions between the parent company and subsidiary companies (Harley-Davidson, 2013). The treatment of intercompany transactions affects the accuracy of the consolidated net income. The management has to act in line with the provisions of the US generally accepted accounting principles. More intently, the company must ensure that the elimination of intercompany transactions is successful in all scenarios. Such procedures will guarantee the successful operation of the company, and the company’s credibility becomes evident.
Carrington, G. R. (2008). Tax accounting in mergers and acquisitions. New York: Random House.
Fischer, P., Tayler, W., & Cheng, R. (2007). Fundamentals of advanced accounting. Cengage Learning.
Harley-Davidson. (2013). Harley-Davidson, Inc. Retrieved from http://ar.harley-davidson.com/pdfs/HarleyDavidson_10K_2013.pdf
Verizon. (2013). View PDF. Retrieved from http://www.verizon.com/about/sites/default/files/2013_vz_annual_report.pdf