X Inc. owns 80% of Y Inc. During 2012, X Inc. sold inventory to Y for $10,000. Half of this inventory remained in Y's warehouse at year end. Y Inc. sold Inventory to X Inc. for $5,000. 40% of this inventory remained in X's warehouse at year end. Both companies are subject to a tax rate of 40%. The gross profit percentage on sales is 20% for both companies. Unless otherwise stated, assume X Inc. uses the cost method to account for its Investment in Y Inc. Assuming that X Inc. used the equity method, what adjustment would have to be made to the investment in Y account to adjust for any unrealized profits on Y's sales to X?

Question

Quizplus · Accepted Answer

The unrealized profit on Y's sales to X is calculated as 40% of $5,000 (inventory remaining) multiplied by the gross profit percentage of 20%, which equals $400. The tax effect is 40% of $400, which is $160. Therefore, the adjustment to the investment in Y account is $400 - $160 = $240. However, since the question asks for the adjustment to the investment account, the tax effect is not considered, so the adjustment is $400. But since the question asks for the adjustment to the investment in Y account, the correct adjustment is $192, which is the after-tax effect of the unrealized profit.

X Inc Owns 80% of Y Inc