Hi,
my question relates to Example 6 of Reading 18 (Equity Method with Sale of Inventory: Downstream Sale).
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Thanks for helping out.
You are close.
First, the sale entry will not affect the Investment Accounts at all. It will be COGS, Inventory, Sales Revenue, and Cash. No effect at all yet on the Investment account or Investment Income. If the affiliate sold everything before the reporting date, I do not beleive any adjusting entry would be required. Jones would just record 25% of James’ Net Income. Plus the $64K gross profit from the sale. Done.
But, since the investee (James) still holds inventory that the investor (Jones) made a profit on, we must eliminate part of the $64K gross profit until the inventory is sold. How much?
Gross Profit x Unsold Inventory% x % ownership ($64*.25*.25). After James sells the inventory, Jones can reverse that entry.
I actually don’t thnk that this is super-solid conceptually. it is more like a partial hold-back until the inventory is sold to a third party. But there you have it.
Hi, When there is an arms length transaction ( transaction between an independent buyer and independent seller), only the allocated share of unrealized gain or loss would be elminated. In this case the unrealized gain is 25% of 64000 = 16000. Hence based on 25% of share it holds, 4000 need to be eliminated.
You are right. Jone’s income statement would record a gain of 64 K. But when you come down to Equity income line, Jone cannot put any more profit as 64K is already realized, he has to deduct now the unrealized gain. That unrealized gain is based on the share. In this case, the unrealized gain is 16k and share is 25% , hence 4000 will be deducted in the Equity income section.
Why is realized profit added to equity income in question 2, but not in question 1? Part of the profit should be realized in 2011.
In 2011, the downstream company sold 75% of the inventory purchased. The profit from the portion sold was realized in 2011, but the profit from the unsold portion is eliminated through the unrealized profit adjustment.
In 2012, the remaining inventory was sold so it’s added back as realized profit.