Question

Issue 2:

Our Parent company often sells inventory to the Subsidiary company at a profit. I do not understand why we sometimes reduce the inventory account but at other times we credit and reduce Cost of Goods sold account. What is the reason for both? (3 marks)

Answer 1

Parent company and subsidiary company are one and the same though they have separate legal name and presence. In simple words, parent and subsidiary companies are like two wheels for a motocycle. It means that though they are existing differently, any transaction takes place betweeen them is like interchanging front and back wheel in the same motor cycle. Transfer of inventory from a parent company to a subsidiary company is like moving stocks within the same company itself. So, this transaction will decrease parent company's stock but at the same time will increase subsidiary company's inventory for the same amount. It will lead to nill effect on company's consolidated inventory balance. As a result, there should not be any profit loaded in the inventory transferred between parent and subsidiary company. When inventory is transferred from parent company to a subsidiary company, parent company must record it as a decrease in inventory only. If parent company has accounting policy to record all inventory transfers as cost of goods sold, parent company must consolidate inventory transfers made to subsidiary company at regular interval and reduce cost of goods sold figure accordingly. Therefore, parent company sometimes reduce the inventory account but at other times it credits and reduce Cost of Goods sold account.