Park Corp. recorded sales of inventory costing $500,000 to Small Co., its wholly owned subsidiary, on the same terms as sales made to third parties. At December 31, 20X3, Small held one-fifth of these goods in its inventory. The following information pertains to Park and Small's sales for 20X3.
…………………………Park…………Small
Sales…………… $2,000,000…..$1,400,000
Cost of sales…..$800,000……..$700,000
……………………$1,200,000….$700,000
In its 20X3 consolidated income statement, what amount should Park report as cost of sales?
a$1,060,000
b$1,100,000
c$1,260,000
d$1,500,000
The intercompany sales of $500,000 must be eliminated when calculating sales for consolidated financial statement purposes. In addition, since Small has sold 4/5 of the goods purchased from Park, Small's cost of sales includes $400,000 as the cost of those goods, which must also be eliminated. Included in Park's cost of sales is the cost related to the entire $500,000 of sales to Small. Since only 4/5 of those goods have actually been sold to third parties, the remaining 1/5 must be eliminated, at 40% of sales price, or $40,000. Finally, the remaining 1/5 is in Small's inventory at the amount paid to Park. The intercompany profit of 60% or $60,000 must also be eliminated from inventory.
The resulting entry would appear as follows:
Sales 500,000
Inventory 60,000
Cost of sales 440,000
As a result, consolidated cost of sales would be $800,000 + $700,000 – $440,000 or $1,060,000.
Totally confused. Why is intercompany profit 60%, how is it calculated? Why sales debited by 500000 if it's a cost of inventory?