Question:

On January 1, 2019, King Corp. acquired 80% of Kong Corp. for $500,000. King uses the cost method to account for its investment.

On January 1, 2019, Kong's retained earnings and common shares were $350,000 and $110,000, respectively.

Kong's book values did not differ materially from its fair values on the date of acquisition with the following exceptions:

• Inventory had a fair value that was $20,000 higher than its book value. This inventory was sold to outsiders during 2019.
• A patent (which had not previously been accounted for) was identified on the acquisition date with an estimated fair value of $15,000. The patent had an estimated useful life of 3 years.

The Financial Statements of King Corp. and Kong Corp. for the year ended December 31, 2020 are shown below:

OtherInformation:

• King sold a tract of Land to Kong at a profit of $10,000 during 2020. This land is still the property of Kong Corp.
• On January 1, 2020, Kong sold equipment to King at a price that was $20,000 higher than its book value. The equipment had a remaining useful life of 4 years from that date.
• On January 1, 2020, King's inventories contained items purchased during 2019 from Kong for $10,000. This entire inventory was sold to outsiders during 2020. Also during 2020, King sold inventory to Kong for $50,000. Half this inventory is still in Kong's warehouse at year end. All sales are priced at a 25% mark-up above cost, regardless of whether the sales are internal or external.
• There was a goodwill impairment loss of $4,000 during 2020.
• Both companies are subject to an effective tax rate of 40%
• Both companies use straight-line amortization.

What is the total amount of pre-tax profit from intercompany inventory sales that was realized during 2020?

Multiple Choice

• $10,000

• $2,000

• $5,000

• $7,000

 

Income Statements King Corp. Kong Corp. Sales $500,000 S300,000 Other Revenues $300,000 $120,000 Less: Expenses Cost of Goods Sold $400,000 $240,000 Depreciation Expense $ 20,000 $10,000 Other Expenses $80,000 $40,000 Income Tax Expense $120,000 $52,000 Net Income $180,000 $78,000