Hi, I was wondering if someone could clarify a couple things for me on the logic of upstream/downstream transactions. 1) How does this make sense? If a parent sells $10 of widgets to a sub, and it makes a $1 profit, it would recognize the $1 profit. Lets say the sub sells 50% of what it bought for $1 profit, and has remaining has $5 of the inventory left. In this case, the parent sees the profit from the sale to sub, and the profit from the sub’s final sale. The profit would be $1 + (% ownership)($1)…which is what it would be if you think of these companies as one entity i think. The sale is final to the sub right? Any inventory write downs will flow back through to the parent. So what exactly are we adjusting? 2) Is this logic correct?: Until the whole process is 100% complete (meaning parent sale to sub and then subsequent sub sale is fully complete), we back out all the profit on the transaction by ownership %? Thats the way it looks from the CFAI text examples on page 23 of book2. 3). Process is same for upstream and downstream in that you back out whatever profit was made on the sale by ownership %. Thanks for any help you can shed on this for me.
Running to a meeting but I’ll take a quick crack at this… I think you are focusing on inventory, when this is more about profit recognition. If the firms were one entity, would you recognize profit because you moved one piece of inventory to another wing of your factory? No, so you don’t do so here either. Full profit recognition does not come until the inventory is sold to an unrelated 3rd party. Otherwise, parent and sub could continually sell the same inventory back and forth, recognizing and increasing “profit” with each transaction.
ok, that makes sense that if the firm was a single entity that you wouldnt recognize the profit. But if the subsidiary (or parent) only sold 50% of the goods it purchased, then are you still backing out 100% of the sale X ownership %? It would seem more logical to subtract out like this: Profit from sale X (1- % sold by subsidiary) X % ownership