Ask Joey ™ a Question

FAR Practice Question – Eliminations and Consolidations

Prestige Worldwide owns 90% of Alaska’s common stock and 80% of Hawaii’s common stock. The remaining common shares of Alaska and Hawaii are owned by their respective employees. Alaska sells exclusively to Hawaii, Hawaii buys exclusively from Alaska, and Hawaii sells exclusively to unrelated companies. Selected Year 1 information for Alaska and Hawaii follows:

What amount should be reported as gross profit in Alaska and Hawaii’s combined income statement for the year ended December 31, Year 1?

A) $26,000

B) $41,000

C) $47,800

D) $56,000

$41,000 is correct. Since Alaska sells to Hawaii, that is an example of an intercompany transaction that must be eliminated. Since Alaska sold the product to Hawaii at a markup of 30% ($130,000 of sales vs $100,000 of cost of sales), that means that there is sales and cost of sales that must be eliminated in the consolidated financials.

Since this question is asking about gross profit, we need to figure out what the 3rd party sales to customers were and what the related cost of sales figure. We know that 3rd party sales to customers are $91,000, since Hawaii is the only entity that sells directly to customers. However, the $65,000 of cost of sales is incorrect because that includes the markup from Alaska.

Step 1) If we create an inventory rollforward for Hawaii, we can see that they purchased $130,000 of product from Alaska, and since $65,000 is still in inventory, that means that they sold 50% of what they purchased.

Step 2) If we take that 50% ratio and apply it cost of goods sold for Alaska, that means that of the $100,000 that it actually cost to produce the goods that were sold to the end customer, only 50% or $50,000 should be recognized in cost of sales. The other $50,000 is still in inventory.

Step 3) Now that we know cost of sales with no markup is $50,000, when we subtract that from sales to customer of $91,000, we are left with gross profit of $41,000.


You might also be interested in...

  • Are you looking for a CPA review course?

    Universal CPA Review is the only CPA review course that has explanation videos for every single multiple choice question. These videos focus on helping identify the big picture and developing a systematic approach to tackling the concept. Our content creators are masters of their craft. They know what it takes to pass the exam and […]

  • How is audit risk impacted with changes in the assessment of inherent risk, control risk, and detection risk?

    Audit risk is the combination of inherent risk, control risk, and detection risk. Remember, the audit team will “assess” inherent risk and control risk. Based on the assessment, then audit team will set detection risk, which ultimately impacts the amount of substantive procedures that must be performed. So in the visual below, you can see […]

  • Scores Came Out: I Just Got a 73% on Audit, Now What?

    Yesterday morning a student interested in trying Universal CPA Review reached out and expressed concern with the fact that they just took audit for the fourth time and scored a 73%.  Audit is a lot of candidate’s “kryptonite” and the reason is because it is sort of like skiing. Easy to learn, extremely hard to […]