Logan regularly sells inventory to its 100% owned subsidiary, Newton. It sells at a gross profit of 40%. Newton sells inventory to its customers at a gross profit of 30%. Logan pays tax at a rate of 40% and Newton pays a lower tax rate of 28%. Sara Beghetto, the accountant for Logan, is preparing the consolidated financial statements of Logan and its subsidiary Newton. She is unclear as to which gross profit and tax rate to use in the elimination of any intragroup profit.
Required
Provide an explanation to Sara regarding the correct treatment of these intragroup profits.