To consolidate affiliated companies, intercompany sales must be eliminated.Assume that Company P sold merchandise costing $5,000 to a subsidiary Company S, for $5,200.Company S then sells the merchandise to an outside company for $5,600.If the affiliated companies do not eliminate the intercompany sale, the following would occur:

Question

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CB) The gross profit of $600 is correct because it represents the difference between the final sale price ($5,600) and the original cost ($5,000). However, without eliminating the intercompany sale, both sales and cost of goods sold are inflated because the intercompany transaction ($5,200 sale from P to S) is counted twice: once in P's records and once in S's records when it should only impact the consolidated entity once.C) The gross profit percentage would be overstated because the sales figure includes the intercompany sale, artificially inflating the sales total without a corresponding increase in actual profit. This makes the profit margin appear higher than it truly is when considering the consolidated entity's performance.

To Consolidate Affiliated Companies, Intercompany Sales Must Be Eliminated