A simple way to look at it is – company A sells company B sneakers for 5,000. Now, we know the 5,000 includes a markup, which represents the profit on the sale for company A. Let's say the sneakers cost company A 3k, so gross profit on sale for company A is 2,000. Journal entries below for both entities – assuming inventory was bought on credit.
Debit – COGS – 3,000
Credit – sales – 5,000
credit – inventory – 3,000
Debit – Accounts receivable – 5,000
This is the entry for company A.
Company B records this entry:
Debit – Inventory – 5,000
Credit – Accounts payable -5,000
Now lets assume the company B still has the inventory on hand as of year end, we know for consolidation purposes, you can't owe your self money, and you there can no inter company gains on transactions or else companies will be pumping revenue numbers at year end on sales to themselves.
So we need to eliminate the payable and receivable, so we just offset them against each other:
Debit – Accounts payable – 5,000
Credit – Accounts receivable – 5,000
This eliminates the amount the company owes to itself.
Then we need to eliminate the gain on the transaction that company A recorded as result of he sale. We do this by basically eliminating the original transaction as if it never happened:
debit- sales – 5,000
credit- cogs – 3,000
debit- inventory – 3,000
credit – inventory- 5,000
This is one way of doing it and basically eliminates the 2k increase in inventory and 2k gross profit the company would have shown on the year end balance sheet.
Now where it gets tricky is when company B sales some of the inventory to a third party, which is ok. Same rules apply.
We know the gross margin on the sale is 40% (2,000 gross profit/$5,000 sales price), which means the original cost of the inventory is 60% of the sales price (3,000/5,000), so lets say company B has 2,000 in inventory left from the original sale from company A, 40% of this represents inter company gain, which needs to be eliminated. An easy way to do is to just combine all sales, cogs and then figure it out from there. So lets say company b sells 3,000 worth of inventory for 4,000, we know that 3,000 includes profit from company a which needs to be eliminated (40%), and this would mean company B has inventory left on hand of 2,000, which also contains profit from company A (40%) which needs to be eliminated. So add the total cogs from both entities (3,000 from company A, 3,000 from company B for a total of 6,000). Now add the total sales from both companies, 5,000 for company A and 4,000 for company B for a total of 9,000). Now we know that COGS is wrong because it includes a gross profit from company A which needs to be eliminated, since company B sold 60% of the inventory it bought (3,000/5,000), we know the cost of sales should be 60% of the original value from company A (3,000*60%=1,800). Again total cogs added up is 6,000, so we must post a credit of 4,200 to correct it. Of the 2,000 left in inventory for company B, we need to eliminate the gross profit (40%, so 40%*2,000=800). And now we look at total sales, which is 9k (4k plus 5k), well only 4k is real and came from a third party, so 5k must be eliminated. So the entry to fix the entire is below:
Debit – Sales – 5,000
Credit – Cogs – 4,200
Credit Inventory – 800
Basically, of the 3,000 in originally inventory, 40% should be left (2,000-800=1,200), since you company B sold 60%. It comes down to removing the gross profit between the sale between company A and company B, so that the inventory is properly valued at year end.
FAR - 93
REG - 87
BEC - 84!!!!
AUD - 99!!!!!! CPA exam complete.
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