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“One line of Madrid Co’s inventory had a fair value of $8m above its carrying amount. This inventory had all been sold by 30 September 20X6.”
This is Q9 in practice question bank from BPP Study Text.
I don’t understand how to treat the inventory. Are the following double entries correct? Why retained earnings need to be adjusted?
Dr Inventory $8m
Cr Goodwill $8mDr Retained Earnings $8m
Cr Inventory $8mBoth the entries are correct.
The fair value adjustment for the inventory means that the net assets of subsidiary at acquisition would be $8m higher, which reduces the excess of consideration paid over net assets i.e. goodwill.
As the inventory has been sold by the year end, it must have been included in cost of sales for the year. However, this addition would have been at cost. So, in order to reflect fair value of inventory, we’ll have to add a further $8m to the cost of sales, which in turn, would reduce the profit by $8m. This is reflected by debiting retained earnings.
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