Helly Company purchased 100% of the outstanding common shares of Cobra Company on December 31, 2012 for $170,000. At that date, Cobra had $100,000 of outstanding common stock and retained earnings of $30,000. It was agreed that the net assets were fairly valued except that the fair value of the capital assets exceeded their net book value by $20,000 and the carrying value of the inventory exceeded its fair value by $10,000. The capital assets had a remaining useful life of eight years as of the acquisition date and have no salvage value. Inventory turns over four times a year. Both companies pay tax at a rate of 30%. What adjustment should be made to the consolidated financial statements for the year ended December 31, 2013 for the difference in inventory valuation?

Question

Quizplus · Accepted Answer

Since the inventory was overvalued by $10,000, the cost of goods sold for the year ended December 31, 2013 would have been overstated by that amount. Therefore, to correct the overstatement, the cost of goods sold for 2013 should be decreased by $10,000. This adjustment will decrease the expenses, which will in turn increase the net income, and ultimately result in an increase in retained earnings at the end of the year. Thus, option A is the correct choice.

Helly Company Purchased 100% of the Outstanding Common Shares of Cobra