Will total earnings of an entity be affected by intercompany sales profits?

Question

Consolidated income statements report the earnings of a single economic entity. Will the total reported earnings of this entity, measured at the end of a period of time greater than one year, be affected by the fact that intercompany sales of assets at a profit occurred during this period of time? Explain

Answer 1

Actual EBIT won't change.. (although, as suggested in your Question, it IS possible to change the accounting period when profits arise / earnings are reported) but FOR SURE profit AFTER Taxes will be changed (typically, improved).

Multi-nationals do this all the time (so that profits arises in the Country with the lowest taxes) ... and each Countries Revenue office tries to maximise the 'profit' that arrises in their own Country ...

Take the example of 'Bed & Breakfasting' between couples .. the Share Holder would sell near the end of the Tax year (thus realising a CGT gain of less than their annual allowance) and have the spouse buy back the (same) shares a few days later (in the next tax year).

This was done each year to minimise the final CGT liability when the shares were eventually sold 'for good' ..

Answer 2

I agree with the answer that BAL gave, but I'm a little concerned that you mention an "asset" sale. Certainly if two parts of a consolicated company do business with each other, the profits don't flow to the intercompany profits, but I'm thinking that an asset that is sold for more than book value might be a different matter.

Answer 3

On a consolidated basis, all intercompany sales and expenses are eliminated so that the whole entity has not increased sales or profits from intercompany sales (assuming 100% ownership and consolidation).

Selling products to yourself isn't a sale that results in economic gain to the enterprise -- that is the theory of eliminating the intercompany sales and profits.

In simple terms, imagine you and your wife owned a house (free and clear) worth $100,000 and she had $100,000 in savings. You then sell the house to your wife - she pays you $100,000 from the savings and you give her the house. If you "consolidate" your assets, between you, the two of you still own one house worth $100,000 and still have $100,000 in cash. No increase in net worth.