Question

How the 30% is derived, and what are the numbers that calculate the intra-entity deferred gross profit?  I am looking for a professional memo addressed to me stating your response!

Example Problem Journal Entries: Intra Entity Asset Transactions

INTRA-ENTITY GROSS PROFIT, 12/31/17 Intra-entity gross profit ($200,000 – $160,000) ................................ $40,000

Inventory remaining at year's end ...................................................... 18%

Intra-entity intra-entity gross profit, 12/31/17 .................................. $ 7,200

INTRA-ENTITY GROSS PROFIT, 12/31/18 Intra-entity gross profit ($350,000 – $297,500) ................................ $52,500

Inventory remaining at year's end ...................................................... 30%

Intra-entity gross profit in inventory, 12/31/18 ................................ $15,750

CONSOLIDATED COST OF GOODS SOLD

Parent balance ................................................................................... $607,500

Subsidiary balance ........................................................................... 450,000

Remove intra-entity transfer .......................................................... (350,000)

Recognize 2017 deferred gross profit ......................................... (7,200)

Defer 2018 intra-entity gross profit .............................................. 15,750

Cost of goods sold .................................................................................. $716,050

Answer 1

Inventory remaining at year end 30% means out of inventory bought during the year 30% is still in hand.

In the given example this means during 2018 one company bought 350,000 from another company and at year 30% (105,000 =350,000*30%) of such bought inventory is unsold.

Following is detail calculation which throws more lights :

Selling price (a)	350,000
Cost (b)	297,500
Gross Profit (c=a-b)	52,500
Profit ratio to selling price (d=c/a)	15%
Inventory at year end '(e )	30%
Inventory at year end value (f=a*e)	105,000
Gross profit unrealized on ending Inventory (g=f*d)	15,750

One of the important principle of consolidation is to remove unrealized profit generated for the transaction between companies which are consolidated.

Taking example of above, out of $ 350,000 inventory at cost only 105,000 is unsold while balance 245,000 is sold to third party. The first entity while selling goods at $350,000 have made profit of 15% as calculated above, however to the extent of $15,750 (105,000*30%) is unrealized for the dealing between two related party.

For removing unrealized profit Cost of goods sold is increased. Further the unrealized profit which was added in 2017 would be realized during 2018 since such inventory would have been sold hence such profit is recognized and hence cost of goods sold is reduced for that.