Not sure why I’m getting stuck on this as recognizing unrealized profit in transaction with an Associate seems intuitive to me, however, I am caught up in the logic of the downstream side, particularly on how unrealized profit is calculated.
Example 6 on page 137 - 138 of the CFAI curriculum (Book 2) asks you to calculate the 2011 equity income to be reported on the Investor’s income statement:
Investor owns 25% of Associate. Associate reports income of $800,000 and amortization of excess purchase price of $8,000. In addition, Investor sold $96,000 of inventory to Associate for $160,000, netting a profit of $64,000, however, 25% of inventory remains unsold by Associate in 2011.
So the 2011 contribution from net income would be $200,000 less the $8,000 amortization hit., less $4,000 unrealized profit. Easy peasy. I understand how to do the calculations, just not the full logic behind them.
My problem comes when calculating this portion of unrealized profit . If $64,000 was the profit, then $16,000 is the total unrealized profit since 25% of the inventory sold to the Associate remains unsold. What I don’t understand is why this $16,000 is further reduced to $4,000 by the Investor’s share of the unrealized profit of 25%. It seems like the Investor should swallow the whole $16,000 unrealized profit hit otherwise the Investor could just be using the Associate as a way to pump up its own bottom line.
In another situation, if the Investor profited $64,000 but the Associate did not sell any of the inventory, then we would say 100% of the profit is unrealized, but would we take away all of the Investor’s profit made in that sale?
Thank you x 1 million in advance for your help!!