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ACCA Applied Skills · Financial Reporting · Limitations of financial statements

Parent Co sells inventory to its subsidiary Sub Co at a profit just before the year end, and Sub Co still holds all of it at the reporting date. Parent Co's directors propose not to adjust the consolidated financial statements. Which statement is correct?

Consolidated profit and inventory would be overstated. Because the group is treated as one entity, profit on goods still held within the group is unrealised and must be eliminated on consolidation, along with intragroup revenue and cost of sales. Leaving it in could be used to inflate group results.

  1. AConsolidated profit and inventory would be overstated because the unrealised intragroup profit must be eliminatedCorrect
  2. BConsolidated profit is correctly stated because the sale was legally completed
  3. COnly consolidated revenue is overstated, and profit and inventory are correct
  4. DOnly the non-controlling interest is affected, and not the group inventory

Explanation

On consolidation the group is a single entity, so profit on intragroup sales is unrealised until sold outside the group. The unrealised profit in closing inventory must be eliminated from profit and inventory, and intragroup revenue and cost of sales must also be removed. Failing to do so overstates both profit and inventory.

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