Sally Corporation, an 80%-owned subsidiary of Reynolds Company, buys half of its raw materials from Reynolds.The transfer price is exactly the same price as Sally pays to buy identical raw materials from outside suppliers and the same price as Reynolds sells the materials to unrelated customers.In preparing consolidated statements for Reynolds Company and Subsidiary Sally Corporation,
A)the intercompany transactions can be ignored because the transfer price represents arm's length bargaining.
B)any unrealized profit from intercompany sales remaining in Reynolds' ending inventory must be offset against the unrealized profit in Reynolds' beginning inventory.
C)any unrealized profit on the intercompany transactions in Sally's ending inventory is eliminated in its entirety.
D)eighty percent of any unrealized profit on the intercompany transactions in Sally's ending inventory is eliminated.

Question

Sally Corporation, an 80%-owned subsidiary of Reynolds Company, buys half of its raw materials from Reynolds.The transfer price is exactly the same price as Sally pays to buy identical raw materials from outside suppliers and the same price as Reynolds sells the materials to unrelated customers.In preparing consolidated statements for Reynolds Company and Subsidiary Sally Corporation,
A)​the intercompany transactions can be ignored because the transfer price represents arm's length bargaining.
B)​any unrealized profit from intercompany sales remaining in Reynolds' ending inventory must be offset against the unrealized profit in Reynolds' beginning inventory.
C)​any unrealized profit on the intercompany transactions in Sally's ending inventory is eliminated in its entirety.
D)​eighty percent of any unrealized profit on the intercompany transactions in Sally's ending inventory is eliminated.

Quizplus · Accepted Answer

Any unrealized profit on intercompany transactions in a subsidiary's inventory is eliminated in its entirety in consolidated statements to avoid double counting of profits. This is in line with the concept of a single economic entity for consolidated financial reporting purposes. Option A is incorrect because the mere fact of the transfer price being the same as the external market price does not necessarily indicate that it is an arm's length transaction. Option B is incorrect because unrealized profits in inventories are eliminated in their entirety, not just offset between beginning and ending inventories. Option D is incorrect because the 80% ownership does not impact the elimination of unrealized profits in a subsidiary's ending inventory.

Sally Corporation, an 80%-Owned Subsidiary of Reynolds Company, Buys Half