On January 1,2014,Plastam Industries acquired an 80% interest in Sparta Company to assure a steady supply of Sparta's inventory that Plastam uses in its own manufacturing businesses.Sparta sold 100% of its output to Plastam during 2014 and 2015 at a markup of 125% of Sparta's cost.Plastam had $12,000 of these items remaining in its inventory at December 31,2015.If Plastam neglected to eliminate unrealized profits from all intercompany sales from Sparta,the inventory on the consolidated balance sheet at December 31,2015 was
A)overstated by $1,920.
B)understated by $1,920.
C)overstated by $2,400.
D)understated by $2,400.

Question

Quizplus · Accepted Answer

Since Sparta sold 100% of its output to Plastam at a markup of 125% of Sparta's cost, Plastam's cost for the inventory is only 80% of the selling price. Therefore, Plastam's inventory at December 31, 2015 should have been $10,000 (80% of $12,500) without considering unrealized profits. However, Plastam neglected to eliminate unrealized profits of $2,400 ($12,000 x 20%) from the intercompany sales with Sparta, causing the inventory to be overstated by the same amount. Thus, the inventory on the consolidated balance sheet at December 31, 2015 was overstated by $2,400.

On January 1,2014,Plastam Industries Acquired an 80% Interest in Sparta