 Hello and welcome to the session. This is Professor Farhad in which we would look at transaction between a parent company and a subsidiary and we look at some intercompany sales and elimination entries. This topic is obviously covered on the CPA exam. This could be a small simulation, could be an exercise in your advanced accounting. Regardless, they're both the same thing. As always, I would like to remind you to connect with me only then. If you haven't done so, subscribe to my YouTube and like and share this recording as well as my other recording. If they help you, it might it might mean they help other people on my website. I do have additional accounting courses if you're an accounting students or if you're studying for your CPA exam. And I strongly suggest you do visit my website if you're a CPA candidate because I can add 10 to 15 points on your CPA exam. Put the exam behind you, focus on your career. So I strongly suggest you check out my website. Now bear in mind, I do not replace your becker, your Roger, your Wiley or your Glyme. That's not what I do. All what I do is I supplement your course. So think about this as extra vitamin, extra preparation. I go into the material a little bit more in depth than the other CPA prep courses. That's how I can help you. Check it out. It's only you can subscribe and cancel any time. So it's worth looking into it. So let's take a look at this example. P company owns 80 percent of the outstanding stock of S company. During 2014, S reported net income of 525,000 and declared no dividend. At the end of the year, S company inventory included 487,500 in unrealized profit on purchases from P company. So they made purchases from P company and they have an unrealized profit in that inventory. Enter company sales for 2014 totaled 2.7 million. The question is, prepare the journal entries for all consolidated financial statement, work paper entries necessary at the end of the year to eliminate the effect of 2014 enter company sales. So it's very important before you prepare the enter company, the eliminating entries between the two units, the parent and the subsidiaries. It's very important to understand how did we get there? In other words, what were the original entries? So let's take a look at it from the parent's perspective as well as the subsidiary. The parent company, they will debit a counter-receivable dash sub because they sold to the sub 2.7 million and some textbook or on some CPA exam, they would say do from, do from, which is the same thing as a receivable. But I'm going to be using the term that you are most likely familiar with, a counter-receivable, but do from is the same. And they will credit sales 2.7 million. That's what the parent company did. They made a sale to the subsidiary. On the subsidiaries, they're going to debit purchases. We're going to assume they're using the periodic inventory method, sorry, the periodic inventory method. And they will credit accounts payable or due to, due to 2.7 million, due to parent, okay, 2.7 million. It doesn't matter. We're going to use the term that we are familiar with, accounts payable. Now the parent company, also they're going to have to record the cost of the sale. And we're going to assume here that they're using perpetual regardless, whether they're using perpetual or periodic, they're going to end up debiting cost of goods sold, $2,112,500 and credit inventory for the same amount. So you're asking, how did you come up with this number? We're going to assume, we're not going to assume anything. We're going to assume, actually we're going to assume, if we have sales of 2.7 million, we're going to assume all the sales is the, we have a profit on it, a 487,500, because that's the profit that's sitting in the sub. Therefore the cost of the price, the cost of the sale, the cost of sales, must have been that amount. So this is how I, this is how I came up with that amount. We're giving the sale, we're giving the profit, therefore the cost is this much. So this is what the parent company also recorded, okay? Now again, here I'm using perpetual, but the net effect, whether it's perpetual, perpetual or periodic, the cost of the sale is this much, and they would reduce inventory by this much. Now, here we go at the end of the year. The first thing we have to do, actually we have to eliminate the intercompany receivable and payable. The first thing we do is we debit this account. We debit accounts payable 2.7 million. We credit account receivable 2.7 million, you know. So you credit this, debit this. So this is gone. So the intercompany receivable and payable is gone. Then we're going to eliminate the sale. We're going to debit sales. We're going to have to debit this account 2.7 million, and we're going to credit purchases. So this is gone, and this is gone. So the sale is gone, and the purchases are gone. We still have one thing to worry about, and that's the profit. You remember, we reported profit of, we have unrealized profit. Yeah, we have unrealized profit of 487,500. Now, how can we eliminate the profit? Well, how do we eliminate the profit? One way to eliminate the profit is increase your cost of goods sold. Therefore, what we're going to do, we're going to debit inventory, the beginning inventory on the income statement. Hold on a second. What does that mean? Think of this as cost of goods sold. Now, why did I do this? Why did I use inventory and not cost of goods sold? Because we're going to assume in the subsidiary, you know, if it's, if you're using, if they're both using perpetual, just you debit cost of goods sold. But here's what's going to happen. Hopefully you remember this. If we have beginning inventory plus purchases minus ending inventory, let me write them again. So I'm going to abbreviate. Bi is beginning inventory. So beginning inventory plus purchases minus ending inventory. This formula gives us cost of goods sold. So let's assume, let's use some numbers. We have beginning inventory of 10. We purchased 15. This is 10 plus 15 equal to 25. And we have ending inventory of five. Our cost of goods sold equal to 20. Now here's what's going to happen. If we add $3 to beginning inventory. So if I add $3 to beginning inventory, now beginning inventory is 13. Purchases is 15 minus five. This is going to give us 28 minus five. It's going to give us cost of goods sold of 23. So notice by increasing inventory on the income statement, beginning inventory by $3, we increased cost by $3. So what I do is under the periodic system, what you do is you debit inventory income statement for this amount. And by doing so, you increase cost of goods sold. By increasing cost of goods sold, you eliminated this intercompany profit. That's one thing. The other thing that happened is when the subsidiary purchased that dose, when the subsidiary purchased 2.7 million, eventually that purchase is counted in inventory. So what happened is this, we eliminated 2,212,500 of inventory and somehow we turned it into 2.7 million of inventory. So we inflated our inventory by the amount of the profit for 87,500. So what do we have to do? We have to reduce our inventory. How do we reduce our inventory? We credit inventory balance sheet for 87,500. So this credit here make the inventory equal to its original amount, which is 2,212,500. And this debit here, to beginning inventory income statement or debit to cost of goods sold, increase cost of goods sold on the income statement which remove the profit. All as well where we are technically back to as if nothing happened because we sold those merchandise to the subsidiary and here we are assuming the subsidiary did not sell any of them. That's why the unrealized profit that we have, it's sitting on our statement. So we had to remove it. So by going through this entry, you get rid of the intercompany receivable and payable, you get rid of the sales and the purchase and you get rid of the profit and you put the inventory back on the books as it's supposed to be. So this is a sample of what I do in terms of lectures. So if you are looking for more resources, especially if you're studying for the CPA exam, I strongly suggest you check out farhatlectures.com, whatever section you are working with, you could find out CPA FAR, if you're taking advanced accounting and you want to have more resources about advanced accounting, you could check out my courses, my courses, accounting courses, I have many courses. If you are studying for the exam, this is a lifetime investment. The CPA exam is maybe a 30 to 40 year investment in your career. Don't short change yourself. My subscription is nominal in the grand scheme of things and anyway, if you don't think it's worth it, guess what? You are risking $30, that's all what you are risking. That's it. Are you willing to risk $30 to find out if you can improve your knowledge and your base accounting knowledge by 10 to 15 points on your CPA exam? I think it's a no brainer deal. Anyhow, good luck, study hard and as always, stay safe.