Nolan owns 100% of the capital stock of both Twill Corp. and Webb Corp. Twill purchases merchandise inventory from Webb at 140% of Webb’s cost. During year 2, merchandise that cost Webb $40,000 was sold to Twill. Twill sold all of this merchandise to unrelated customers for $81,200 during year 2. In preparing combined financial statements for year 2, Nolan’s bookkeeper disregarded the common ownership of Twill and Webb. What amount should be eliminated from cost of goods sold in the combined income statement for year 2?
A. $24,000
B. $56,000
C. $40,000
D. $16,000
Answer:B
B is corrent. When computing combined cost of goods sold (CGS), the objective is to restate the accounts as if the intercompany transactions had not occurred. Assuming that there was no sale between Twill and Webb, the correct amount of consolidated CGS would be $40,000, the original cost of the merchandise to Webb. However, Webb recognized $40,000 for CGS and Twill recognized $56,000 ($40,000 × 140%) for a total of $96,000. Thus, $56,000 ($96,000 – $40,000) should be eliminated from CGS in the combined income statement for year 2.
A is incorrect since the cost of goods sold related to the intercompany transaction needs to be eliminated ($40,000 × 140% = $56,000).
C is incorrect since the cost of goods sold related to the intercompany transaction needs to be eliminated, not the original cost.
D is incorrect because the cost of goods sold related to the intercompany transaction needs to be eliminated, not the difference between the cost to Webb and to Twill.