Ali Ltd sold an item of plant to its subsidiary Baba Ltd on 1 January 2017 for $100 000. The asset had cost Ali Ltd $120 000 when acquired on 1 January 2015. At that time the remaining useful life of the plant was assessed at 5 years. The adjustment necessary on consolidation as at 30 June 2018 in relation to the sale of plant will result in:
A) an increase in retained earnings and a decrease in current year profit.
B) a decrease in retained earnings and an increase in current year profit.
C) an increase in retained earnings and an increase in current year profit.
D) a decrease in retained earnings and a decrease in current year profit.

Question

Quizplus · Accepted Answer

The sale of the plant from Ali Ltd to Baba Ltd resulted in a profit of $20,000 ($100,000 sale price - $80,000 carrying amount at the time of sale, given the original cost of $120,000 and two years of depreciation over a 5-year useful life). This intra-group profit needs to be eliminated on consolidation. As of 30 June 2018, 1.5 years have passed since the sale, so some of the profit would have been realized through depreciation. However, the adjustment would decrease retained earnings (eliminating the unrealized profit) and increase the current year profit (by reducing the excess depreciation charged on the inflated sale price).

Ali Ltd Sold an Item of Plant to Its Subsidiary