The consolidated income statement of a parent and its 90%-owned subsidiary appears below. It was prepared by an accounting student before reading this chapter.
consolidated income statement
Sales.................. $500,000
Rental revenue.............. 24,000
Interest revenue.............. 50,000
Total revenue.............. 574,000
Cost of goods sold............. 350,000
Rent expense.............. 24,000
Interest expense.............. 35,000
Administration expenses........... 45,000
Income tax expense............ 42,000
Non-controlling interest in profit....... 9,000
Total costs and expenses......... 505,000
Profit ................. $ 69,000
The following items were overlooked when the statement was prepared:
• The opening inventory of the parent contained an intercompany profit of $5,000. This inventory was sold by the parent during the current year.
• During the year, intercompany sales (at a 30% gross profit rate) were made as follows:
By the parent to the subsidiary....... $100,000
By the subsidiary to the parent....... 80,000
• At the end of the year, half of the items purchased from the parent remained in the inventory of the subsidiary and none of the inventory purchased from the subsidiary remained in the parent’s inventory.
• All of the rental revenue and 70% of the interest revenue were intercompany and appeared on the income statement of the parent.
• Assume a 40% rate for income tax.
Required:
(a) Prepare a correct consolidated income statement.
(b) Use the matching principle to explain the adjustments for unrealized profits on intercompany sales when preparing consolidated financial statements.