Question

"A parent company sells merchandise to a subsidiary company during 2015 at a price of $1,000,000. The subsidiary company sells all the merchandise to outside customers during 2015 for $1,250,000. The parent always sells to the subsidiary at a markup of 25% on cost. Which statement is TRUE concerning the required consolidation eliminating entries related to these transactions?

a) Eliminating entries will decrease the consolidated revenue by $1,250,000.
b) Eliminating entries will decrease the consolidated cost of goods sold by $1,250,000.
c) Eliminating entries will increase the consolidated cost of goods sold by $1,000,000.
d) Eliminating entries will increase the consolidated revenue by $1,000,000."

Answer 1

The correct statement concerning the required consolidation eliminating entries related to intercompany transactions is that the entries will decrease the consolidated revenue by $1,250,000 to remove the effects of intercompany sales. So the correct answer is option A.

Step-by-step explanation:

When consolidating financial statements, all intercompany transactions need to be eliminated to avoid double-counting. In this scenario, the parent company sells merchandise to a subsidiary at a markup of 25% on cost. Since the subsidiary sells this merchandise to outside customers for $1,250,000, we need to adjust the consolidated entries to reflect the true cost and revenue figures without intercompany profit.

When calculating the original cost to the parent company, we use the fact that $1,000,000 represents a 25% markup on cost. Hence, the cost is $800,000 ($1,000,000 / 1.25), and the markup is $200,000. This intercompany profit needs to be eliminated in the consolidated financial statements.

Answer option a) Eliminating entries will decrease the consolidated revenue by $1,250,000 is true because it removes the subsidiary's sales from consolidated revenue. This ensures that the revenue from sales to external customers is not overstated in the consolidated figures.