DC Company purchased 100% of the outstanding common shares of FA Company on December 31, 20X3, for $170,000. At that date, FA had $100,000 of outstanding common shares and retained earnings of $30,000. It was agreed that the net assets were fairly valued except that the fair value of the capital assets exceeded their net book value by $20,000 and the carrying value of the inventory exceeded its fair value by $10,000. The capital assets had a remaining useful life of eight years as of the acquisition date and have no residual value. Inventory turns over four times a year.
- What adjustment should be made to the consolidated financial statements for the year ended December 31, 20X4, with respect to the $10,000 fair value adjustment to inventory?
A)An adjustment should be made through opening retained earnings.
B)An adjustment should be made to cost of sales.
C)No adjustment is required as an adjustment would have already been made to inventory at the time of sale.
D)No adjustment is required as an adjustment would have already been made to cost of sales at the time of sale.

Question

Quizplus · Accepted Answer

The fair value adjustment to inventory reflects a decrease in the value of inventory from its carrying value on the books. This decrease in value should be recognized as an expense on the income statement, in the cost of sales account. Therefore, an adjustment should be made to cost of sales in the consolidated financial statements for the year ended December 31, 20X4. Choice A is incorrect because adjusting opening retained earnings wouldn't reflect the current period's activity. Choice C and D are incorrect because they suggest that an adjustment has already been made, which is not the case for the fair value adjustment to inventory.

DC Company Purchased 100% of the Outstanding Common Shares of FA