Question

Explain the consolidation adjustment needed for unrealised profit arisen from trading of goods.

Answer 1

When an entity sold goods to another entity it includes certain profit percentage in the cost of goods while selling.

When this two entities are consolidated, then this two seprate entity becomes one single entity. The sale of one entity becomes the purchase of other and its consolidation will lead to profit for one entity and hike in Inventory cost towards other.

Profit is only realised when the inventory is sold outside the group.

Hence on consolidation the unrealised gain on closing inventories will be eliminated from groups profit and closing inventory will be recorded at cost of the groups.

Example:

Let A & B are two entities , A is holding 60% in B, Here B sold inventories of $20000 to A for $35000, making a profit of $15000. The inventory is still with A on consolidation date,

Hence here profit of $15000 is to be removed and for inventory is to be stated at $20000 ,

Hence journal entry will be consolidate revenue ----Dr , with $35000 and cost to sales credit to $20000 , inventory to be credited by $15000.

The reduction of group profit of $15000 will be allocated in A and B in ratio of 60% and 40%.