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110 Basil acquired 60% of Parsley on 1 March 20X9. In September 20X9 Basil sold $46,000 worth of goods to Parsley. Basil applies a 30% mark-up to all its sales. 25% of these goods were still held in inventory by Parsley at the end of the year.
An extract from the draft statements of profit or loss of Basil and Parsley at 31 December 20X9 is:
Basil Parsley
Revenue 955,000 421,500
Cost of sales (407,300) (214,600)
Gross profit 547,700 206,900All revenue and costs arise evenly throughout the year.
What will be shown as gross profit in the consolidated statement of profit or loss of Basil for the year ended 31 December 20X9?The answer is:
Basil 547,700
Parsley (206,900 × 10/12) 172,417
PURP ((46,000 × 30 / 130) × 25%) (2,654)
717,463Can you please clarify why are not we eliminating the whole intra group profit (profit from the transaction when 46,000 worth of goods were sold to the subsidiary) from the consolidated figures? Why are we eliminating mark up only on the left goods?
Hmmm Elene!
Have you watched the related video about the treatment of unrealised profits?
Apparently not 🙁
If I sell to you at a profit and you sell to the outside world at a profit, so far as our group of entities is concerned, the profit is made (some by me and some by you, but it is realised)
If I sell to you at a profit and you still have those goods in inventory, even though I have made a profit, so far as the group is concerned those goods are still in inventory so the profit that I have recognised is unrealised so far as our group of entities is concerned
So we have to eliminate ONLY the unrealised profits in the closing inventory of intra-group traded goods
OK?
Watch the lecture!
Consider this
I buy goods 300
I sell to you for 350
You sell to the outside world for 375
300 + 50 = 350 + 25 = 375
Between us we have made 75 profit
But if you still have those goods in inventory, the line becomes:
300 + 50 = 350
That 350 is the value of the intra-group traded goods held by you in inventory and that 50 that I have recognised is unrealised so far as the group is concerned
OK?
I understand that we have to eliminated ONLY the unrealized profits (not profits earned from the transaction when goods were resold to the other world), but the way how unrealized profit is calculated still does not make sense for me.
Imagine we have goods sold by parent to the subsidiary after acquisition:
Parent:
Revenues 100
COS (80)
Profit 2060% of these goods were resold by the subsidiary to the other world at a sales price of 80.
Subsidiary:
Revenues 80
COS (100*60%) = (60)
Profit 20As far as I understand the issue, we have to carry out the following procedures:
1. Eliminate 100 from Revenue (due to I transaction)
2. Eliminate 80 from Cost of Sales (due to I transaction)
3. Adjust COS of resold goods (deduct amounts to receive its original COS, before I transaction had taken place).
(60-80*60%)=12 – to be deducted from cost of sales.
4. Adjust balance of total remained inventories.
40*20%=8 – to be deducted from balance of inventories.Net effect on the profit calculated:
+100-80-12=8The same case would be solved by the book more easily, like:
Net effect on the profit:
40 (left inventory) * 20% (mark up) = 8Figures calculated by me always equal to the answers in revision kit.
That makes me think that I understand the issue and I am solving the problems in a complicated, by still in a right way.
I just do not understand the logic under calculating the PURP in a way in which it is done in the book. Most of all, I do not understand how is that my answers calculated in a way presented above, always correspond to the answers in the book???? I am almost sure that it is magic.btw, thanks for timely response 🙂
Forget all this fancy unnecessary procedures that you have detailed
Step 1 – eliminate the intra-group trade by reducing group revenue and reducing group cost of sales – $ for $
I sell $100 goods to you.
How much did you buy from me?
$100
Step 2 – now consider the pup
First of all, calculate the amount that needs to be eliminated as an unrealised profit
Then recognise which entity it is that has recognised the profit – the selling entity. In your example that would be the parent
When you have calculated the pup ADD the amount to cost of sales. there is a natural tendency to want to deduct the amount because that feels like what should happen when you eliminate something
But we’re eliminating a profit and we do that by INCREASING costs
The entry, should you want to know, is a reduction in the closing inventory figure
That reduction has a double effect …
… it increases cost of sales and …
… it decreases inventory on the Statement of Financial Position
So, two steps
1 eliminate the trade IN FULL
2 add the pup on to cost of sales (and decrease combined inventory on the CSoFP
OK?
OK, thanks a lot!!
One more question regarding Intra group trading, now about associates.
Jarvis owns 30% of McLintock. During the year to 31 December 20X4 McLintock sold $2 million of goods to Jarvis, of which 40% were still held in inventory by Jarvis at the year end. McLintock applies a mark-up of 25% on all goods sold.
What effect would the above transactions have on group inventory at 31 December 20X4?
A Debit group inventory $48,000
B Debit group inventory $160,000
C Credit group inventory $48,000
D No effect on group inventoryThe answer is C.
As it is mentioned in the problem Jarvis owns 30% of McLintock. Therefore I assumed that McLintock is an associate of Jarvis, not subsidiary. If so, why are we adjusting group inventories? As far as I am concerned, in the consolidated financial statements we do not combine figures of parent company and its associate, instead of this we have a one line entry for parent’s share in associates. Should group inventories still be adjusted? Why?
Sorry, forget.
I already answered myself.Profit was made by an associate but left inventory is held by the parent. So, despite the fact that we are not combining financial figures of an associate and the parent company, we still need an adjustment – we have to eliminating profit earned from the PARENT’S left inventory.
In case left inventory was held by an associate (parent was the seller), we would not have to carry out an adjustment ON INVENTORY, am I right?
If you follow my way of accounting for pups arising from transactions with associates, it doesn’t matter whether it’s an up-stream or a down-stream transaction!
Always eliminate the FULL pup from the associate’s results and then take our share to consolidated retained earnings
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