Acker Inc. bought 40% of Howell Co. on January 1, 2010 for $576,000. The equity method of accounting was used. The book value and fair value of the net assets of Howell on that date were $1,440,000. Acker began supplying inventory to Howell as follows:

Howell reported net income of $100,000 in 2010 and $120,000 in 2011 while paying $40,000 in dividends each year.
What is the amount of unrealized intra-entity inventory profit to be deferred on December 31, 2011?

Question

Acker Inc. bought 40% of Howell Co. on January 1, 2010 for $576,000. The equity method of accounting was used. The book value and fair value of the net assets of Howell on that date were $1,440,000. Acker began supplying inventory to Howell as follows:

Howell reported net income of $100,000 in 2010 and $120,000 in 2011 while paying $40,000 in dividends each year.
What is the amount of unrealized intra-entity inventory profit to be deferred on December 31, 2011?

Quizplus · Accepted Answer

To calculate the unrealized intra-entity inventory profit on December 31, 2011, we need to compare the cost of inventory transferred from Acker to Howell with the selling price of Howell.

We don't have the selling price of inventory of Howell, but we can calculate it using the gross profit percentage of Howell, which is (120,000 - 40,000) / ? = 50%. Solving for the missing amount, we get the selling price of inventory of Howell as $160,000.

The cost of inventory transferred from Acker to Howell would be the cost of goods sold of Howell minus its gross profit, which is $80,000 (120,000 x (1 - 50%)). Therefore, the unrealized profit on intra-entity inventory transfers is $80,000 - $72,000 (40% x $80,000) = $8,000.

Hence, the correct answer is B.

Acker Inc Bought 40% of Howell Co