On February 1, 2013 Smith Company sold inventory to its wholly owned subsidiary Orchid Ltd. for $10,000. These goods had previously cost $7,500. 75% of these goods were then sold by Orchid Ltd. for $15,000 by the February 28, 2013 year-end. What adjustments are required for the preparation of the consolidated financial statements? Ignore the effects of income taxes.

Question

Quizplus · Accepted Answer

Since the goods were sold from Orchid Ltd. to an external party, the intercompany profit needs to be eliminated. The original sale was for $10,000, which means an intercompany profit of $2,500 ($10,000 - $7,500). Therefore, sales must be decreased by $10,000, and cost of goods sold must be decreased by $9,375 ($7,500 cost of goods + $1,875 intercompany profit). Additionally, Orchid Ltd.'s ending inventory needs to be adjusted by the remaining 25% of the goods that were not sold externally, which is $625 ($2,500 total inventory - $1,875 intercompany profit).

On February 1, 2013 Smith Company Sold Inventory to Its