Question

Answer the following questions:

- The effect of unrealized profits and losses on sales between affiliated companies is eliminated in preparing consolidated financial statements. When are profits and losses on such sales realized for consolidated statement purposes?

- What effect does the elimination of intercompany sales and cost of goods sold have on consolidated net income?

- Would failure to eliminate unrealized profit in inventories at December 31, 2016, have any effect on consolidated net income in 2017? 2018?

Answer 1

Q.1

Profit or Losses on the sales between the affiliated companies is realized when the purchasing company resells the goods purchased from the affiliated company to the external parties.

When all the goods purchased from affiliated company is completely resold to the external parties outside the consolidated entity in the same accounting period, then no unreliazed profit or loss are to be eliminatied while preparing consolidated financial statements.

Q.2

While preparing consolidated financial statements, an equivalent amount are deducted from Intercompany Sales and Cost of Goods sold and therefore the net effect on the consolidated net income in Nil. Hence, there is no effect on consolidated net income when the intercompany sales and cost of goods sold is eliminated.

Q.3

When the unrealized profit are not eliminated at the end of the year 2016, then there will be a overstatement in Consolidated Net Income. There will also be effect on Closing Stock for the year 2016 due to which it also effects the consolidated net income in 2017 as the closing inventory of 2016 is the opening inventory of 2017 and the unrealized profit on the opening inventory will have a understatement in consolidated net income. Hence, elimination error of unrealized profits can be corrected for any two accounting periods. If the Correcting the elimination of unrealized profit of 2016 in the year 2017, will not have effect on consolidated net income in the year 2018.