(a) Jessica Ltd sold inventory during the current period to its wholly owned subsidiary, Amelie Ltd, for $15 000.These items previously cost Jessica Ltd $12 000. Amelie Ltd subsequently sold half the items to Ningbo Ltd for$8000. The tax rate is 30%. The group accountant for Jessica Ltd, Li Chen, maintains that the appropriateconsolidation adjustment entries are as follows: Sales Dr 15 000Cost of Sales Cr 13000Inventory Cr 2000Deferred Tax Asset Dr 300Income Tax Expense Cr 300Required(i) Discuss whether the entries suggested by Li Chen are correct, explaining on a line-by-line basisthe correct adjustment entry. (ii)Determine the consolidation worksheet entries in the following year, assuming the inventoryhas been –sold, and explain the adjustments on a line-by-line basis. (b) On 1 July 2016 Liala Ltd sold an item of plant to Jordan Ltd for $450000 when its’ carrying value in Liala Ltd bookwas $600000 (costs $900000, accumulated depreciation $300000). This plant has a remaining useful life of five (5)years form the date of sale. The group measures its property plants and equipment using a costs model. Tax rateis 30 percent.
(a) Jessica Ltd sold inventory during the current period to its wholly owned subsidiary, Amelie Ltd, for $15 000.
These items previously cost Jessica Ltd $12 000. Amelie Ltd subsequently sold half the items to Ningbo Ltd for
$8000. The tax rate is 30%. The group accountant for Jessica Ltd, Li Chen, maintains that the appropriate
consolidation
Sales Dr 15 000
Cost of Sales Cr 13000
Inventory Cr 2000
Income Tax Expense Cr 300
Required
(i) Discuss whether the entries suggested by Li Chen are correct, explaining on a line-by-line basis
the correct adjustment entry.
(ii)Determine the consolidation worksheet entries in the following year, assuming the inventory
has been –sold, and explain the adjustments on a line-by-line basis.
(b) On 1 July 2016 Liala Ltd sold an item of plant to Jordan Ltd for $450000 when its’ carrying value in Liala Ltd book
was $600000 (costs $900000, accumulated depreciation $300000). This plant has a remaining useful life of five (5)
years form the date of sale. The group measures its property plants and equipment using a costs model. Tax rate
is 30 percent.
a) This is a case of intergroup transactions at profit
- For consolidation purposes, we eliminate the effect of profit on intergroup transactions
- Inter group transactions has 2 effects
- Sales is overstated, amount is calculated as Sales - cost
- Inventory is overstated, with the same amount
- Thus we pass adjustment entry to bring down the value of sales and inventory to their original costs
- The entry suggested by the accountant is wrong
- Sales will not be debited with the entire $15,000. This is because aim is not to reverse the entry, but simply eliminate the profit on sale by debiting sales by the overstated amount (sales - cost)
- Cost of sales is not credited at all while passing the adjustment entry unless goods are sold in the succeeding year
- Inventory will be credited with the amount of unrealized inter group profit only
- The correct entry to record the adjustment will be as follows
Sales A/c $1,500
To Inventory A/c $1,500
- Adjustment entry will only be passed for corrected of unrealized profits on inter group sales
- The entry for sales to Ningbo will normally be recorded in the books of Amellie Ltd as
Cash A/c $8,000
To Sales A/c $8,000
This is not an adjustment entry
- However the amount of adjustment is calculated as follows
Total Sales to Amelie = $15,000
Amount of sales for half goods (sold further) = $15,000/2 = $7,500
Total Cost of goods sold to Amelie = $12,000
Amount of cost for half goods (sold further) = $12,000/2 = $6,000
Amount of adjustment = $7,500 - $6,000 = $1,500
Also, Income tax expense will be computed on profit on sale from half of the goods sold to Ningbo
- Sales = $8,000
- Original Cost = $6,000 (12,000/2)
- Thus profit = $8,000 - $6,000 = $2,000
- Tax rate = 30%
- Amount of tax expense = 30% x $2,000 = $600
- Since the tax wont be paid in cash, it will be added to liabilities under the head "Deferred tax Liabilities"
- Also since it is due, it will be added to current year's tax expense
- Thus the following entry will be passed to record the tax expense
Income tax expense $600
To Deferred Tax Liabilities $600
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