ExpertHard1 markMultiple Choice
CPA · Question 5 · Area 1: Financial Reporting
Parent Co. owns 80% of Sub Co. During Year 1, Parent sold inventory to Sub for $500,000. The cost of the inventory to Parent was $350,000. At December 31, Year 1, Sub had sold 60% of this inventory to outside parties. The tax rate is 25%. In the consolidated balance sheet at December 31, Year 1, by what amount should the inventory be reduced to eliminate the intercompany profit?
Parent Co. owns 80% of Sub Co. During Year 1, Parent sold inventory to Sub for $500,000. The cost of the inventory to Parent was $350,000. At December 31, Year 1, Sub had sold 60% of this inventory to outside parties. The tax rate is 25%. In the consolidated balance sheet at December 31, Year 1, by what amount should the inventory be reduced to eliminate the intercompany profit?
Answer options:
A.
$150,000
B.
$60,000
C.
$90,000
D.
$45,000
How to approach this question
1. Calculate total intercompany gross profit. 2. Determine the % of inventory remaining. 3. Multiply total profit by remaining % to find unrealized profit. 4. Reduce inventory by this amount.
Full Answer
B.$60,000✓ Correct
Total intercompany profit = $500,000 (Sales) - $350,000 (Cost) = $150,000. Since 60% was sold, 40% remains in ending inventory. Unrealized profit to eliminate = $150,000 * 40% = $60,000. The inventory on the consolidated balance sheet must be reduced to its original cost to the consolidated entity.
Common mistakes
Eliminating the entire profit ($150k) instead of just the unsold portion; applying the tax rate to the inventory reduction.
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