Consolidation of Associate – Unrealized profit in the stock

Sales between associates and parent in a group accounts situation is not adjusted, as would be the case between a parent and a subsidiary. The group inventory however will need adjusting, hence answer C.

Normally sales between subs and parent get adjusted for sales, cost of sales, PURP and inventory (if items remain in inventory). For the parent and associate scenario the sales figure, purp and cost of sales normally would not be affected as an associate is considered to be outside of the group. Inventory however is always adjusted.

Satheesh, have you watched the video lectures on this site?

The adjustment for pups when dealing with associates is clearly explained

There is NO cancellation of revenue and cost of sales because the associate is not a group entity

First, calculate the pup

In your example it’s 40% of $2,000,000 = $800,000 x 25/125 mark up = $160,000

This is adjusted by reducing the associate’s retained earnings and the resultant reduced earnings are the basis of the calculation ‘H’s share of A’s post-acquisition retained earnings’ so that figure will fall by 30% of $160,000 = $48,000

The effect of this adjustment is a reduction in the consolidated retained earnings (debit $48,000) and a reduction in the figure ‘Investment in Associate’ (credit $48,000)

OK?

The problem is, where DO you deduct the $48,000

My entry that says reduce (debit) consolidated retained earnings effectively hides the issue

To reduce retained earnings you either have to increase the expenses (eg cost of sales) or you have to reduce the incomes

The only place for such an adjustment to be included is as an addition to cost of sales thus reducing gross profit

But where in cost of sales? There’s only one place available and that is as a deduction from the closing inventory – cost of sales increase and retained earnings decrease

A bit better?

You’re welcome

This is an F3 question!

The question tells us that “McLintock applies a mark-up of 25% on all goods sold”

Mark up is a profit percentage based on cost and …

… cost + profit = selling price

So if mark up percentage is 25 and cost is 100, then …

… 100 + 25 = 125

Therefore the profit element of $125 sales value is 25/125

This is clearly explained in John Moffat’s F3 lectures and again in the F7 notes and lectures

OK?

“If we CR inventory 48,000, then will this make the Balance sheet un balanced? Because now, all Group retained earning, investment in associate, inventory are reduced by 48,000″

Inventory is a strange animal

In those days long gone when I used to teach double entry bookkeeping to fresh faced students on their first day of a course, it was one of my favourite quotations to say”Stock (ie inventory) is its own double entry” much to their consternation!

When you increase the value of closing inventory, that has the affect of decreasing cost of sales and that, in turn, leads to an increase in profits

But if you increase closing inventory like that, then the same figure in current assets on the statement of financial position also increases.

That means that for every $ increase in closing inventory reducing cost of sales and increasing profits, the current assets increase by the same $

In the example that started this thread, the elimination of a pup arising from a transaction with an associate reduces the associate’s retained earnings (in the associate’s records inventory will decrease, therefore cost of sales will increase and profits will decrease)

That reduction in the retained earnings of the associate itself has a dual effect:

Our share of the associate’s retained earnings will fall by the amount of our percentage holding as applied to the pup

Additionally, our share of those retained earnings of the associate – a figure that we use in working W5A to calculate the Investment in Associate for the statement of financial position – will fall by the same amount

The real issue is … should the credit go against group inventory or against the Investment in Associate

BPP and Kaplan take it to group inventory

The way I deal with it (and it’s much quicker and easier) is to take the entire pup off the associate’s profits and then take out percentage share of those reduced profits.

That has the effect of automatically eliminating the group’s share of that pup that arose from a trade with an associate

OK?