Question

Which accounts might be misstated on a consolidated financial statement level and why, when an intergroup transaction consisted of a sale of inventory?

Answer 1

When one group sells an inventory to another group who are required to prepare the Consolidated Financial statements the following implications can be seen -

We will understand the above situation with the help of an example -

Let X corp. holds 100% of Y corp

COGS be $100

Now X sold 100 units to Y at cost plus 20% margin i.e. at $120 and Y sold 50 units from those 100 units at $150 to an unrelated third party

• When Inventory is sold by X to Y at a profit entry passed will be

In the books of X,

Particulars	Debit	Credit
Y Corp	$12,000
Sales		$12,000
COGS	$10,000
Inventory		$10,000

In the books of Y,

Inventory	$12,000
X corp		$12,000
Third party	$7,500
Sales		$7,500
COGS	$6,000
Inventory		$6,000

As Y corp is 100% subsidiary of X corp, the X corp is required to prepare consolidated worksheet.When two groups are consolidated single economic entity approach is followed and both the entities are treated as one entity and one cannot make sales to themselves which otherwise results in -

• Unrealized profits

• Overstated inventory as it includes unrealized profit

• Overstated COGS

• Sale which one cannot make to themselves

If X corp would have made direct sale to third party entries would have been -

Third party	$7500
Sales		$7,500
COGS (50 units x $100)	$5,000
Inventory		$5,000

At the time of consolidation following accounts will be misstated due to transaction made by an entity with itself;

• Sales A/C as it have the entry of sales made by X corp to Y corp, which is not allowed

• Inventory A/C for remaining 50 units in the books of Y corp as it contains unrealized profit portion of Cost + 20%

• COGS for units sold by Y corp to third party i.e. for 50 units as it is overstated due to unrealized profit charged by X corp.