[Broag]

I feel like this is one of those subjects that once you get “it” you will be able to do any problem. However, I’m struggling pretty hard with the inventory and bond aspects of intercompany transactions. The problem below is really confusing to me.

Ahm Corp. owns 90% of Bee Corp.’s common stock and 80% of Cee Corp.’s common stock. The remaining common shares of Bee and Cee are owned by their respective employees. Bee sells exclusively to Cee, Cee buys exclusively from Bee, and Cee sells exclusively to unrelated companies. Selected Year 1 information for Bee and Cee follows:

Bee Corp. Cee Corp.

Sales $ 130,000 $ 91,000

Cost of sales 100,000 65,000

Beginning inventory None None

Ending inventory None 65,000

What amount should be reported as gross profit in Bee and Cee’s combined income statement for the year ended December 31, Year 1?

a.

$47,800

b.

$41,000

c.

$56,000

d.

$26,000

Explanation

Choice “b” is correct, $41,000 gross profit in combined income statement.

Rule: “Combined financial statements” do not eliminate “equity” accounts (they are all added across); however, all other intercompany “transactions” and “balances” are eliminated in combined financial statements just as they are in consolidated financial statements.

Eliminating Entry:

Debit (Dr) Credit (Cr)

Interco. sales – Bee $ 130,000

Interco. COGS – Bee $ 100,000

COGS – Cee 15,000

Inventory – Cee 15,000

Intercompany profit on the sale of inventory by Bee to Cee is $30,000 ($130,000 interco. sales − $100,000 interco. COGS). At year end, 50% of Cee’s inventory purchased from Bee remains in ending inventory and 50% has been sold. Therefore, intercompany profit is eliminated from Cee’s inventory and COGS as follows:

50% × $30,000 = $15,000 eliminated from inventory

50% × $30,000 = $15,000 eliminated from COGS

Why 50% here? Wouldn’t it be 80%? Very confused.

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[Anonymous]

The 50% is the percentage of ending inventory left. They (Cee corp) purchased $130,000 of goods and they have $65,000 left in ending inventory.

The sales and COGS booked by Bee corp should be completely eliminated.

Dr — Sales 130,000

Cr — COGS 100,000

The remaining 30,000, which is the gross profit from the original sale, must also be eliminated, and is allocated between further decreasing COGS and decreasing inventory. If the merchandise was sold, then it needs to be removed from COGS. If it's still in ending inventory, it needs to be removed from inventory. In most cases it's probably a mixture of the two, like this scenario where 50% was sold and 50% is still in inventory, thus $15,000 goes to further crediting COGS and $15,000 goes to crediting inventory.

Dr — Sales 130,000

Cr — Bee COGS 100,000

Cr — Cee COGS 15,000

Cr — C Inventory 15,000

Ultimately, you've eliminated $130,000 in sales and $115,000 in COGS. So sales are $91,000 and COGS are $50,000 which gives you your gross profit of $41,000.

[Author]

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