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Suppose :
S Co. had recorded sale of $5000 to P Co.
S had purchased these goods from outside supplier at cost of $3000, and half of them still remains in P Co. inventory at the end of yead.
We also have Cost of sale for both company as P : $30m and S: $ 20mIn solution: Consolidated statement of P/L
COS = 30+20-5+1 =46I dont get why it has ( -5+1 ) ???
Anyone can explain it. plzThe 5 deduction is simply to eliminate the intra-group transaction (also cancelled from combined revenue)
The addition of 1 is to eliminate the unrealised profit which S Co has recognised when it made the sale to P Co. Without the adjustment, S’s profits include the 2 profit which it recognised when it made the sale to P Co. But you cannot make a profit by selling to “yourself” (in a group situation, we treat the companies within the group as though they were a single combined entity)
Because P Co has sold half the goods to the outside World, so far as the group is concerned, the profit on the half of the goods sold outside HAS been achieved. But the goods remaining in P’s inventory (at cost to P of $2,500) INCLUDE the profit element charged by S on sale to P and it’s that profit element which we need to adjust for.
IF your question is “Why do we ADD the 1 to cost of sales?” it’s because, by adding to cost of sales, we are reducing the gross profit – costs are being increased by the 1 so profit is therefore reduced by 1
Is that clear?
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