Intercompany Transactions: Inventory Transactions. CPA Exam

Summary

This session provides a detailed explanation of intercompany transactions related to inventory, focusing on eliminations required for consolidation in CPA exam reviews. The instructor covers the process of eliminating intercompany sales, cost of goods sold, and profits when consolidating the financial statements of a parent company and its subsidiary. Key journal entries are demonstrated for both the parent and the subsidiary, and the necessary adjustments to inventory and cost of goods sold are explained. The session ensures clarity on how intercompany profit is handled and provides students with practical insights for successful consolidation and accurate financial reporting.

Takeaways

• 😀 Intercompany transactions involving inventory require careful elimination in consolidated financial statements.
• 😀 Elimination involves removing intercompany sales, cost of goods sold (COGS), and any intercompany profit.
• 😀 The intercompany profit on inventory held by the subsidiary must be eliminated if it hasn't been sold to an external party.
• 😀 Gross profit percentage is crucial in calculating the embedded profit in inventory during intercompany transactions.
• 😀 When preparing consolidation entries, first eliminate the intercompany sales and COGS.
• 😀 After eliminating sales and COGS, eliminate the profit embedded in the unsold inventory by adjusting the inventory value.
• 😀 In the provided example, Company A sold inventory for $160,000 with a profit of $35,000, and Company B resold 70% to external customers.
• 😀 The elimination entries for consolidation involve debiting intercompany sales and COGS, and adjusting the inventory for profit.
• 😀 Consolidated ending inventory and COGS should reflect the actual values, adjusted for intercompany transactions and profit.
• 😀 The goal of these adjustments is to ensure that the consolidated financial statements represent the combined companies as if they are one entity, with no inflated intercompany figures.

Q & A

What is the main topic of this session?

The main topic is intercompany inventory transactions and the elimination of these transactions in consolidated financial statements, specifically for CPA review students.

What is the basic concept behind intercompany inventory transactions?

Intercompany inventory transactions involve a parent company selling inventory to a subsidiary (or vice versa). When preparing consolidated financial statements, these transactions need to be eliminated to avoid inflating sales, COGS, and inventory.

Why do intercompany inventory transactions need to be eliminated?

These transactions need to be eliminated to ensure that the consolidated financial statements reflect only external sales and costs, not internal transfers that do not affect the overall group financials.

What happens to the profit from an intercompany sale if the inventory is still in stock at the subsidiary?

The profit from the intercompany sale is eliminated if the inventory is still in stock at the subsidiary, adjusting the ending inventory to reflect the cost of the inventory rather than the inflated intercompany selling price.

What journal entries are made when Company A sells merchandise to Company B?

Company A would debit accounts receivable (sub) for $160,000, credit sales (sub) for $160,000, debit cost of goods sold for $125,000, and credit inventory for $125,000.

What is the significance of the 25% profit margin in this scenario?

The 25% profit margin represents the profit that Company B makes when selling the inventory to an external party. This profit margin is used to adjust the cost of goods sold and inventory in the consolidated statements.

How is the sales amount of Company B to external parties calculated?

The sales amount of Company B to external parties is calculated by solving for 'x' where sales minus COGS equals the profit, and the profit equals 25% of sales. In this case, the sales amount is $149,333.

What adjustments are made when consolidating the intercompany transactions?

The intercompany sales and COGS are eliminated, and the intercompany profit embedded in the inventory is also eliminated. Adjustments are made to both cost of goods sold and inventory to reflect only external transactions.

What is the formula to calculate the gross profit percentage in this scenario?

The gross profit percentage is calculated by dividing the profit ($35,000) by the sales amount ($160,000), resulting in a percentage of 21.875%.

What is the final consolidated ending inventory and cost of goods sold after the eliminations?

The consolidated ending inventory is $37,500, and the consolidated cost of goods sold is $87,500, reflecting the adjustments for intercompany transactions and profits.