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Dear sir,
I’ve learned that the unrealized profit should be added to the consolidated COGS. What I understand about the reason for doing this is to reduce consolidated gross profit so as to account for the unrealized portion. Would there be other explanations for this, from the perspective of cost of goods sold?
thanksLiming
The reason for doing it is, as you say, to reduce the total profit by the unrealised amount.
(It does make sense because on the Statement of financial position we reduce the total inventory by the unrealised profit. Since the cost of goods sold is opening inventory + purchases – closing inventory, then if the value of the closing inventory is reduced it makes the cost of goods sold to be higher.)
Hi John
Two questions. The working of the one seems straight forward:
PCo acqd 75% ord. shares of Sco on that company’s Incorp’n in 20×3. Summarized stmt of P/L are set out below(cutting to the relevant part):
PCo profit for the year: 21000
SCo “”. “”. : 8000.
SCo had recorded sales of 5000 at gross marg.of 40%. 50% remained unsold on 31 Dec 20×3.Group profit for the yr was calc.to be 28000, after taking into account intra group “adjustments”
Workings for profit attrib.to NCI was:GP was 5000*40%=2000. Unrealized profit then=2000*50%=1000.Portion of unrealized profit attrib.to NCI=25%*1000=250.
Therefore profit attrib to NCI IS (8000*25%)-250=1750. This I understand.A second Q read:
Pumpkin Co has 90% equity share Cap of Squash Co.C of Sales were: Pumpkin co: 100k, Squash Co: 80k at year end 31/12/x3. During the yr squash sold goods costing 5k for 8k to Pumpkin. At yr end ALL OF the goods remained unsold.
I understand the consolidated COS to be 100k+80k-8k+3k=175k. Problem is,if Squash profit for the yr was 16k, what is the profit attrib to NCI(non-controlling interest):
BPP’working was: (16k-3k)*10%=1.3k. When I apply this same “technique” to the eg above I get a difft answer.
Could you kindly unpack this for me. I’ll provide more details if these prove to be inadequate.
RegardsIt is just that the workings have been written differently.
If you apply the same technique to the first question, where the unrealised profit was 1,000, then you get (8,000 – 1,000) x 25% = 1,750
Alternatively if you apply the technique in the first question to the second question, then unrealised profit is 3,000. NIC’s share is 10% x 3,000 = 300.
Therefore profit attributable to NCI is (16,000 x 10%) – 300 = 1,300Both ways give the same answer in both cases – it doesn’t matter which way you do the workings.
16,000 is given in the question, 3,000 is the unrealized profit on the inventory, 8,000 are the inter company transfers which need removing from the sales and from the cost of sales.
I do suggest that you watch the free lectures on consolidations.
I have a question. When a parent sells goods to a subsidiary we get unrealized profit. If then the subsidiary sells it to a third party we realize the profit. The question is why realize it? Because still the profit that was made by the parent was by selling to the subsidiary. It just does not seem logical. What I think is irrespective of the fact that the subsidiary has sold it to a third party or not it should still be unrealized. Clarify please.
Thanks.I guess that you have not watched my free lectures!!
The consolidated accounts are treating the two companies as though they were just one big company. Therefore profit for the consolidated accounts is only realised when the goods are sold outside of the ‘big’ company. If one of the companies sells to the other, but the goods are still in inventory, then the ‘big’ company has not really sold them and therefore the profit on them is unrealised.
I do suggest that you watch my lectures – they are a complete free course for Paper F3 and cover everything needed to be able to pass the exam well.
My confusion is even if the subsidiary sells the goods purchased from the parent outside the group how can the parent realize that profit after all that profit was made by selling to the subsidiary? For example if the parent sells goods to the subsidiary at a profit of $500 and the subsidiary sells them ahead at a profit of $700. How can the parent realize that 500 profit made as it was from selling to the subsidiary?
Suppose goods cost the parent 500. Suppose they sell them to the subsidiary for 800 and then the subsidiary sells the externally for 1,000.
The parent records the sale of 800 and the cost and therefore has a profit of 300.
The subsidiary records the sale of 1,000 and the cost to them of 800, and therefore a profit of 200.
When we consolidate we show the total sales externally which is 1,000 and the total cost externally which is 500. So a total profit for the group of 500.
If the subsidiary had not sold the goods, and they were still in inventory, then the group has made no profit because they were not sold externally. There would therefore be a provision for unrealised profit of the 300 that the holding company had recorded.
Hi John,
Would you be able to explain to me the concept of adding the unrealised profit to the COGS using the below example?
If A owns 70% of B. B sold $1,000 worth of product to A. Cost of B was $500. At the end of the financial year, A had 25% of the good lefts unsold. Adjustments for the consolidated statement would be as follows:
– 1000 to Revenue (To reflect adjustment to B’s revenue), -1000 to COGS (To reflect adjustment to A’s Costs)
+ 125 to COGS, -125 to inventory
As mentioned above, this is to reduce consolidated gross profit (as well as its the formula when you decrease inventory). But what is the logic of this?
I would think that you have to reduce COGS by 125 instead, as this was extra cost booked into B’s accounts, which was the amount not actually sold.
Thank you!
We add 125 to the cost of goods sold, which reduces the profit by 125. The purpose is to remove from the profit the profit on goods that have not been sold outside the group.
(Removing 1,000 from the COGS and from the revenue is for the reasons you stated, and this 1,000 includes the goods still in inventory. Removing the 1,000 does not in itself affect the total profit.)
All of this is explained in my free lectures. The lectures are a complete free course for Paper F3 and cover everything needed to be able to pass the exam well.
Hi john, I’ve a problem in the question…
P Co. acquired 75% of the shares in S Co. on 1 jan, 2000 when the retained earning of S Co. stood at $10000. During the year to 31 dec, 2002 S Co. sold good to P Co. for $10000 at a mark-up of 25%.
“Extract from SOFP at 31 dec, 2002:- it includes Retained Earning of P Co. $45000 and Retained Earning of S Co. $22000”
— Now I was successful in carrying out the unrealized profit which was $2000 in which unrealized profit attributable to Group was $1500 (2000*75%) and unrealized profit attributable to NCI was 500 (2000*25%)
SIR my question starts from here that what will be the ‘Group Retained Earnings’ and as in this question S Co. sold good to P Co. which means unrealized profit will be deducted from the S Co. reserves the how we will account for this adjustment while calculating ‘Group Retained Earning’?
Kindly SIR can you unpack this question, I’ll be thankful.You have not typed out the whole question, because there is only unrealised profit if any of the goods that S sold to P are still in P’s inventory. There is no reason why any or all of them will still be in inventory – the question will have to say if they are. (And even if they are, the unrealised profit all affects P’s SOPL because it is P who will have recorded the profit when they were sold to S – it is not attributed to S).
If it is a question in the BPP Revision Kit then say which one and then I can see the whole questions.
Have you watched my free lectures on consolidations?
(I am surprised that you do not have an answer in the same book in which you found the question. You should be using a Revision Kit from one of the ACCA approved publishers – they contain answers and explanations.)
I’m sorry I forgot to write the remaining entry held in inventory plus I’ve re-watched your lecture again & it helped me grasp the knowledge, thank you for the concern!
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