Question

My question from this problem is where did the $900 in unrealized profit come from ? Nothing from the given information states that there was remaining intercompany merchandise in Peanut's inventory at the end of 2017. Can you please explain/show a calculation on how to find this.

Prepare a schedule showing Peanut's income from Sam for the years 2016, 2017, 2018 using the following information:

Comparative income statements of Son Corp
	2016	2017	2018
Sales	48,000,000	51,000,000	57,000,000
COGS	25,200,000	26,400,000	30,000,000
Gross profit	22,800,000	24,600,000	27,000,000
Operating expenses	18,000,000	19,200,000	22,800,000
Net income	4,800,000	5,400,000	4,200,000

1. Sam was a 75% owned subsidiary of Peanut Corp throughout the 2016-2018 period. Peanut’s separate income (excludes income from Sam) was $21,600,000, $20,400,000, and $24,000,000 in 2016, 2017, and 2018, respectively. Peanut acquired its interest in Sam at its underlying book value, which was equal to the fair value on July 1, 2015.
2. Peanut Co. sold inventory to Sam Co. during 2016 at a gross profit to Pop of $2,400,000. Half the merchandise remained in Son’s inventory at Dec 31, 2016. Total sales by Peanut to Sam in 2016 were $6,000,000. The remaining merchandise was sold by Sam in 2017.
3. Peanut’s inventory at December 31, 2017, included items acquired from Sam on which Sam made a profit of $1,200,000. Total sale by Sam to Peanut during 2017 were $4,800,000.
4. There were no unrealized profits in the December 31, 2018, inventories of either company.
5. Peanut uses the equity method for its investment in Sam

This is the answer from the solutions manual:

1	Pop's income from Son	2016	2017	2018
	75% of Son's net income	$3,600	$4,050	$3,150
	Unrealized profit in December 31,
	2016 inventory (downstream)
	($2,400 1/2) 100%	(1,200)	1,200
	Unrealized profit in December 31,
	2017 inventory (upstream)
	$1,200 75%		(900)	900
	Pop's income from Son	$2,400	$4,350	$4,050

Answer 1

Here there are two adjustments for inventory

a) downstream

b) upstream

a) Downstream

here inventory flow from holding to subsidiary i.e., (it is stock of holding) so profit to the extent left in stock will be eliminated

($2,400,000 1/2) * 100% = $1,200,000 ( as only half of the stock is left unsold )

b) upstream

here inventory flow from subsidiary to holding i.e., ( it is stock of holding to extent it has control over subsidiary )

in the question it is stated " Peanut’s inventory at December 31, 2017, included items acquired from Sam on which Sam made a profit of $1,200,000."

Since items are still in peanut's inventory profit on acquisition of inventory from subsidiary to holding to the extent of ownership held by holding has to be eliminated

$1,2000,000 * 75% = $900,000