Capitalization of intercompany expense

[Buki]

Hi all,

I would need an advice on the following. When software development costs are incurred by a sub, but the parent will enjoy the future economic benefits and the sub charges the cost plus through to the parent, parent capitalizes the expense, how should the entries and elimination look like?

It should be assumed that capitalization criteria is achieved on the parent level and the question is only about how to book both the interco (eliminating) entries for interco income for the cost plus on the sub side and interco expense on the parent side, at the same time capitalize the interco expense and be whole on the side of elimination.

I hope the question was clear, if not, I will be happy to try to explain better. Thank you in advance.

[JRSB]

capitalise on consol too.

sub Cr bank Dr interco
parent Dr asset cr interco

you say 'cost plus' so sounds like profit to remove on consol too so group development asset may be less than parent's own books

[Marek Muc]

On the consolidated level, you should capitalise only external expenses, as if the parent contracted the suppliers directly, anything else must be recognised directly in group P/L. So I would focus on actual expenses incurred by the sub and not on the profit margin, as the margin may include allocation of sub's overheads that wouldn't be allowed to be capitalised.
Did the sub capitalise the software in its separate financial statements.

[JRSB]

why only capitalise expenses external to the group? the costs might be salaries of employees of the sub as part of an internally generated development asset?

[Marek Muc]

Sure, employees aren't part of the group

[Buki]

Thank you both JRSB and Marek.

It was concluded that the margin in the cost plus cannot be capitalized, so that part follows simple elimination and there are no further concerns. There was nothing capitalized for this expense on sub's books and it was concluded that there cannot be. Our understanding is also that both external and internal expense incurred for the internally generated intangible can be capitalized.

I would think that where we ultimately should land is:

Sub: Dr Interco receivable for the full cost plus, Cr Interco income for the cost plus
Parent: Dr Interco expense for the cost plus, Cr Interco payable for the cost plus

When payment happens that's clear. Can we then only on the elim level Dr Capitalized SW expense, Cr Expense? Why I'm thinking Cr Interco expense and Dr Capitalized SW expense on parent level would not work is because interco accounts would then not net to zero, so would a solution of booking this only on the elim level work?

[Marek Muc]

it's best to prepare a simple illustrative example with numbers if you want to discuss debits and credits

[JRSB]

I wouldn't describe employees of the subsidiary as being expenses external to the group but probably a terminology point

[Buki]

Here it goes. Total cost plus charged from sub to parent is say at 10% margin 1,100.00

Interco billing:
Sub: Dr Interco receivable 1,100.00 Cr Interco income 1,100.00
Parent: Dr Interco expense 1,100.00 Cr Interco payable 1,100.00

Interco payment:
Sub: Dr Bank 1,100.00 Cr Interco receivable 1,100.00
Parent: Dr Interco payable 1,100.00 Cr Bank 1,100.00

Capex:
Elim: Dr Capitalized SW expense 1,000.00 Cr Expense 1,000.00

[Marek Muc]

I don't see expenses incurred by sub (split them between eligible for capitalisation and not).
I also don't see intangible assets recognised by parent