[My Cousin Vinny]

I know this is a very vague question, but I am hoping someone can just give me a very high level answer as Becker does not mention GPM whatsoever in its textbook section on inventory inter company transactions. Why is it necessary? I keep seeing it being used in several of the MC questions Becker offers. Also, how does it relate to it Ending Inventory and COGS, I feel like I should remember this from BEC but i don’t, sigh 🙁

Thank you!

[RB]

Gross profit margin is sales less COGS, or as a percentage its (Sales – COGS) / (Sales). If I remember back to FAR, the gross profit margin has to be eliminated when you consolidate a subsidiary, as part of the steps of removing intercompany transactions.
So if you know sales to subsidiary and GP% you can figure out sales to eliminate, then COGS to eliminate, inventory to change, etc.

[My Cousin Vinny]

Thank you so much Justin, that makes a lot of sense! I hate to be a pest, but would you mind providing a quick example of this?

[RB]

that… is going to take too much thought at the moment. I'm cramming for BEC tomorrow, kinda crunch time. Just checking the forums when I need a break from main problems.
If I can I'll check my old notes this weekend… but I'll be celebrating finishing exam 4 for a while so, no promises.

[Anonymous]

You need to account for it for two reasons.

1. Business units need to be measured based on their performance, and the best way to display that is to treat most inter-company transactions as if they were “arms-length” transactions. No business unit or division would choose to sell internally if they knew they wouldn't get the proper credit (profit margin) for it. Think about it…if I have a limited amount of production time, I am going to choose the most profitable product to add to my portfolio.

2. Multinational companies deal with transfer pricing on a regular basis. If you don't know what that is, look it up because its key to understand. Arms-length transactions once again become critical due to the international tax laws. It is too time consuming to balance a different internal price and external price and if you are being honest about your transfer pricing then they shouldn't differ greatly anyways.

[D.O.]

Good responses everyone. I'd like to add on to what Justin mentioned. Gross profit margin (GP%) is useful although one must be skeptical of blindly applying it without having an understanding of the company's overall structure and operations.

For instance, a U.S. corporation based in CA that has has subsidiaries operating both domestically and abroad would still have to take into account diferences in applicable financial reporting standards (AFRS). This would mean that the timing of the recognition of revenues and associated expenses relating to a domestic subsidiary's production of a product (COGS) in U.S. states' would be recognized in accordance with U.S. GAAP. Intercompany loans, rents, etc. would be eliminated in preparing consolidated financial statements.

A year over year variance analysis of GP% would be a good place to start. However, determining how 263A UNICAP rules have been administered in establishing capitalization policies and procedures and determing materiality thresholds would be even more useful when defining audit risk.

The existence of other internal controls and well established policies and procedures could lower control risk as well (ie. Segregation of duties from acceptance, recording, custody and confirmation.) Inherent risk stemming from the company's operating environment exclusive of internal controls would play a factor in defining detection risk as well.

[Author]

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