Golden owns 100% of the capital stock of both GF Corp. and TM Corp. GF purchases merchandise inventory from TM at 140% of TM’s cost. During year 2, merchandise that cost TM $40,000 was sold to GF. GF sold all of this merchandise to unrelated customers for $81,200 during year 2. In preparing combined financial statements for year 2, Golden’s bookkeeper disregarded the common ownership of GF and TM. By what amount was unadjusted revenue overstated in the combined income statement for year 2?
A. $16,000
B. $40,000
C. $56,000
D. $81,200
Answer:C
This answer is correct. When computing combined revenue, the objective is to restate the accounts as if the intercompany transaction had not occurred. Assuming that there was no sale between GF and TM, the correct amount of consolidated revenue would be the $81,200 sold to unrelated customers. Thus, unadjusted revenue is overstated by the $56,000 ($40,000 × 140%) intercompany revenue recognized by TM.