Question

12. Bugs Bunny Ltd owns 92% of Road Runner Ltd. During 2019 Bugs Bunny Ltd sells inventory for $470,000 to Road Runner Ltd at a mark-up of 25% above cost. At the end of the financial year 50% of the inventory was unsold. What is the work paper journal entry to eliminate the effects of the intercompany sale?

please help

Answer 1

When a group entity sells goods to another, the selling entity as a seperate legal entity , records profit made on those sales , If these goods are still held in inventory by the buying entity at the year end , however the profit recorded by the selling entity , when viewed from the standpoint of the group as a whole, has not yet been earned, and will not be earned until the goods are eventually sold outside the group. On the consolidation , the unrealised profit on the closing inventory will be eliminated from the group's profit and the closing inventory of the group will be recorded at cost to the group.

In the given question Bugs Bunny Ltd as a holding company sold some goods for $4,70,000 to the Road runner Ltd at 25% above the cost which is its subsidiary company as Bugs Bunny ltd holds 92.5% share of road runner ltd.

Inventory unsold = 50% of $4,70,000 i.e. $2,35,000 (Transfer price)
Mark up = 25%
Unrealised profit = ( $2,35,000 / 125% ) X 25% = $47,000

The double entry on consolidation is as follows:
Consolidated revenue dr. $ 2,35,000
To cost of sales A/c $ 1,88,000
  To Inventory A/c $ 47,000

In this case , since it is the parent that has made the sales , the reduction in profit of $47,000 is allocated entirely to parent company i.e Buggs Bunny Ltd.

Buggs bunny ltd shall reduce the inventory of road runner ltd in consolidated financila statements by $47,000