Question

Selected data for two subsidiaries of Dunn Corp. taken from December 31, year 1 preclosing trial balances are as follows:

	Banks Co. debit	Lamm Co. credit
Shipments to Banks	$ --	$150,000
Shipments from Lamm	200,000	--
Intercompany inventory profit on total shipments	--	50,000

Additional data relating to the December 31, year 1 inventory are as follows:

Inventory acquired from outside parties	$175,000	$250,000
Inventory acquired from Lamm	60,000	--

At December 31, year 1, the inventory reported on the combined balance sheet of the two subsidiaries should be

	$425,000
	$435,000
	$470,000
	$485,000

This Answer is Correct (Answer is C, $470,000)

The inventory reported on the 12/31/Y1 combined balance sheet should reflect the original cost to the companies of any inventory on hand. The inventory on hand that was acquired from outside parties should be reported at its cost ($175,000 + $250,000 = $425,000). The Banks inventory on hand that was acquired from Lamm must be restated back to the cost Lamm originally paid when it was purchased from outside parties. This must be done to eliminate intercompany profits. During year 1, Lamm shipped inventory that originally cost $150,000 to Banks at a billing price of $200,000. Therefore, the original cost is 75% of Banks' carrying amount. Therefore, the correct inventory amount is $470,000 [$175,000 + $250,000 + ($60,000 × 75%)].

Can please explain this problem step by step in an easy way regardless of the explanation above because I really don't understand it? How do they get 75% and why are they using it to multiply the inventory acquired from Lamm of 60,000. Also, why is the inventory amount reported on the combined balance sheet [$175,000 + $250,000 + ($60,000 × 75%)]?

Answer 1

Intercompany profits should be eliminated while preparing consolidated financial statements.
Here inventory of Bank Co. includes inventory acquired from Lamm Co. ie $ 60,000. it include cost and inter company inventory profit.
Let's find out what is cost portion and what is profit portion in this $ 60,000.
W N
Cost % of inter company Transfer	75	%	($ 1,50,000/$ 2,00,000)*100
Profit % of inter company Transfer	25	%	($ 50,000/$ 2,00,000)*100
Inventory acquired from Lamm Co.	$ 60,000
Cost Portion	$     45,000.00	($ 60,000*75%)
Inventory Acquired from Outside Parties	$ 4,25,000.00	($1,75,000+$2,50,000)
Total Inventory to be reported	$ 4,70,000.00	($ 45,000+$ 4,25,000)