Question

How do unrealized intercompany inventory profits from a prior period affect the computation of consolidated net income when the inventory is resold in the current period? Is it important to know if the sale was upstream or downstream? Why or why not?

Answer 1

When the inventory arising from inter company transactions is sold in the current year, the unrealised profits, which would have been reduced from the previous year inventory and P&L, gets added back to the profits of the year in which the inventory is sold, as the profits previously unrealised, now gets realised.

Therefore, unrealised profits get realised when inventory is sold and therefore, increase income of that particular year.

It is important to know whether the transaction is upstream or downstream. In case of downstream transaction, the entire profit lies in parent books and therefore, the entire unrealised profit is eliminated from parent share of profit. However, in case of upstream transaction, the unrealised profit element is split between NCI and parent. Therefore, for elimination and subsequent adding back of profits, it is important to know whether the sale was upstream or downstream as it impact the split of unrealised profit at the time of elimination and also the adding back of profit when the inventory is finally sold.

Pleaes comment for any further clarifiations