Question

Green Ltd owns 100% of Arrow Ltd.During the financial year ending 30 June 2016, Green Ltd sold inventory, originally costing $98 000, to Arrow Ltd for $180 000. Arrow Ltd sold inventory, originally costing $120 000, to Green Ltd for $160,000. At year end 30 June 2016, Green Ltd has sold 40% of the inventory it purchased from Arrow Ltd outside the group, while Arrow Ltd still has 25% of the inventory it purchased from Green Ltd on hand. Tax rate is 30%.

(a)  Why does this information create a elimination entry for consolidation purposes at year end?

(b)  What is the consolidation/elimination entry at 30 June 2016?

(c)  What is the consolidation/elimination entry for the item shown above at 30 June 2017?

Answer 1

(a) As during consolidation we combine the financial statements of both the parties, that results in the intercompany transaction between the two parties being recorded twice, once in each of there books and so thats why we have to eliminate the effects of thos transactions from the financial statements.

(b)

Date	Account	Debit	Credit
30-Jun-16	Sales a/c	340000
	To COGS a/c		295500
	To inventory a/c		44500
30-Jun-16	Deffered tax asset	13350
	To tax expense		13350
(c)
30-Jun-17	COGS a/c	44500
	To retained earnings a/c		44500
30-Jun-17	Tax expense a/c	13350
	To deferred tax asset a/c		13350

During consolidation we have to eliminate all inter company transactions as during consolidation we treat all the companies as well and it would mean the company dealing with itself.

So as we have credited the sales earlier when selling goods from Green to Arrow and from Arrow to Green, we have to debit while consolidation to remove its effects.

The total sales to be credited = 180000 + 160000 = 340000

We also have to reduce the extra COGS expense shown and bring it down to the percent of inventory actually sold outside the company and with the original cost the goods were brought into the company(when they were bought from outside the company)

We also have to eliminate the unrealized profit on the inventory still remaining inside the company, which means the inventory is overvalued by  the percentage of gross profit first realized by the company when selling the good to the associate company x the inventory that is still unsold.

So when we debit the sale we have to credit the excess cogs and the unrealized profit(as inventory as it is overvalued)

As we realized the profit of the unsold inventory we would have paid more taxes for the unsold inventory as well and now we would have to create a deferred tax asset to eliminate that and reduce our tax expense for the year.

As next year we sell the remaining inventory we recognize the profit by crediting retained earnings and also reverse the DTA created last year.

Please like the solution if satisfied and drop a comment in case of any doubt,

Thankyou