Question

A parent provides services to a subsidiary, at a markup of 20% over cost. The subsidiary reports the cost of the services as part of its operating expenses. What elimination entry is necessary with respect to this intercompany transaction?

Answer 1

The necessary elimination entry would decrease both the subsidiary’s operating expenses and the parent company’s revenues by the amount of the markup to accurately represent the economic activities in the consolidated financial statements.

Step-by-step explanation:

When a parent company provides services to a subsidiary at a markup, for accounting purposes within consolidated financial statements, an elimination entry is required to remove the effects of the intercompany transaction. Since the services were provided at a 20% markup, the cost reported in the subsidiary's operating expenses is inflated by this intercompany profit. To address this in the consolidated financial statements, the elimination entry would reduce the subsidiary's operating expenses by the amount of the markup, and also reduce the parent company's revenue by the same amount. This is necessary to present a true picture of the economic activities of the combined entities, free from any distortions caused by the intercompany transactions.