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I did not understand the adjusting entries for this note, specially for the inventory part. Unrealised profits have to be considered in here?
(vii) Ribby is considering selling its subsidiary, Hall. Just prior to the year end, Hall sold inventory to Ribby at a price
of $6 million. The carrying value of the inventory in the financial records of Hall was $2 million. The cash was
received before the year end, and as a result the bank overdraft of Hall was virtually eliminated at 31 May 2008.
After the year end the transaction was reversed and it was agreed that this type of transaction would be carried
out again when the interim financial statements were produced for Hall, if the company had not been sold by
that date.Solution for this note in the paper (taken from ACCA website – same reasoning given in Kaplan)
The transaction should not be shown as a sale. Inventory should be reinstated at $2 million instead of $6 million and
a decrease in retained earnings of $4 million should occur in the accounting records of Hall.CR Inventory $4 million
DR Retained earnings of Hall $4 millionThe cash position should be reversed also by increasing cash by $6 million and the current liabilities by $6 million.
Ask yourself – “Is this a genuine transaction – is the inventory genuinely sold – or is this a window-dressing transaction?”
I don’t know abut you but, to me, it stinks. This is NOT a sale of inventory and therefore it needs to be brought back into inventory by way of complete reversal of the original double entry and the bank figure will therefore also be affected.
So, given that, why / how do you not understand the reduction in value of the inventory on the balance sheet and the reduction of the retained earnings by way of cancellation of revenue and reintroduction of 2m inventory
If you still don’t understand, tell me again but with more specific detail of the particular problems which you face
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