Understand your T - Accounting

Understand Your T-Accounts

In developing automated processes, one should always remember the core of what needs to be accomplished.   In sales between related companies for inventory to be sold to outside customers, there are some specific rules to follow. 

Figure 1.  Initial general accounting after sale of inventory from seller company to buyer company

The intercompany sale and cost of sale is eliminated from the seller company profit and loss statement.  In addition, the resulting account receivable is also eliminated.

The inventory is off the books of the selling company and is transferred to the buyer company at a higher carrying value equal to the sales amount.  The buyer company also has an account payable to the seller company.  The account payable is eliminated from the books of the buyer company.

Figure 2.  X indicates amounts to eliminate

In this way it is as if the sale had never occurred and nothing was either to be received or paid for such sale.  This leaves us with the inventory.

The inventory carrying value on the buyer’s books now has an embedded profit.  The difference between the sale price and the cost of the sale at the seller company is passed to the buyer company in the inventory value.  For reporting purposes, the profit has not yet been earned and thus the profit in the inventory must be eliminated at month end.

Ultimately either in the current period of transfer or in subsequent period, the buyer company will sell the inventory to outside companies.  The result is a series of calculations to determine how much of the profit in inventory can be recognized by reducing cost of sales, and how much the remaining inventory carrying value must be adjusted for the remaining profit in inventory.  In BPC we will automate these processes using automatic adjustment rules and prepare for the next period.

Figure 3.  Month End if 50% sold