Question

"A subsidiary sells merchandise to its parent at a markup of 30% on cost. In 2014, the parent paid $1,040,000 for merchandise received from the subsidiary. By year-end 2014, the parent has sold $780,000 of the merchandise to outside customers for $850,000 but still holds the other $260,000 in its ending inventory. Which statement is TRUE concerning the information reported on the 2014 consolidated financial statements?

a) The consolidated financial statements will reflect the ending inventory at the parent's cost of $1,040,000.
b) The consolidated financial statements will recognize the markup of 30% on cost for the ending inventory.
c) The consolidated financial statements will include the total sales of $780,000 but will exclude the intercompany sales.
d) The consolidated financial statements will report the merchandise at its original cost of $780,000."

Answer 1

The consolidated financial statements will report the merchandise at its original cost of $780,000, as intercompany markups are eliminated in consolidation to present the financial statements as if the companies are a single entity.

Step-by-step explanation:

The question revolves around the topic of intercompany transactions and the elimination of profit in such transactions when preparing consolidated financial statements. The correct statement is that the consolidated financial statements will report the merchandise at its original cost of $780,000. This reflects the parent's cost without the subsidiary markup on the closing inventory.

To find the original cost to the parent company without the markup, we calculate 100% / 130% of $1,040,000, which gives us $800,000. However, since the parent sold merchandise of $780,000, the ending inventory remains at $260,000 (the difference between $1,040,000 and $780,000). Therefore, the original cost of this ending inventory without markup would be 100/130 of $260,000, which is $200,000 and not $260,000.