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Extracted from Kaplan Text Example 2 Associates in CIS (Page 116)
During the year, Parent sold goods to the Associate for $ 1 million at a mark-up of 25%. At the year end A still held one quarter of these goods in inventory.
Parent holds 30% of the equity share capital of the Associate.
Unrealized profit = $15000 (I understand how this is calculated)
In the consolidated income statement, this amount ($15000) will be added (increase) to the cost of sales.
I cannot understand (the logic behind it) why the unrealised profit is added to the cost of sales?
Further, am I correct to state that the inventory was sold by the parent to the associate, so the unrealized profit should be included in the inventory of the entity which made the purchase (the associate in here) instead of the parent company which made the sale?
Thanks.
If I add to cost of sales, does that not reduce gross profit, and isn’t that what we’re trying to achieve?
It’s not the valuation of inventory which is important – that’s simply a cross-add ( where intra-group sale is between parent and subsidiary – and the same principles apply if it’s an associate involved ). The crux is which company has recognised the profit which is unrealised. So the adjustment is in the records of the selling company.
Now, MY way of dealing with pups where an associate is involved is ALWAYS to adjust in the associate, even though it may be the parent doing the selling. That way automatically reduces the retained earnings by the amount of the parent’s share of the unrealised profit in the sale to the associate.
However, this does throw up a difference in the answer when compared with printed solutions which do it the other way ( the way you have identified in using 15,000 ) but still balances overall – it’s a matter of where the 15,000 gets adjusted, but it still gets adjusted whichever way you do it.
Hope that helps
Pleases help me on the following:
When changing from proportionate consolidation to equity method, do we need to bring in the con controlling interest?
E.g. Parent – Company A owns 50% of JV B. JV B has a subsidiary (Sub C) with an ownership of 65%.
In consolidated financials of A(proportionate consolidation), NCI pertaining to Sub C was identified. However when changing from proportionate consolidation to equity method do we have to still show NCI? or can we only take what is relevant to Com A & disregard NCI?
Please let me know what materials I can refer to.
Thanks.
Hi Mel
Well! You certainly cannot refer to any materials relevant to F7! This is a P2 level situation.
And if we are a 50% joint venturer and the venture holds a 65% interest in another company, please tell me where the non-controlling interest comes in!
Maybe the P2 material would help you here but, even then, I cannot remember any element of the P2 course notes nor past exam questions that has such a situation
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