Question

Q3. ABC Company has a branch in Arba Minch. Arba Minch branch receives all its merchandise from ABC at 25% above cost and sells them at 40% mark-up on cost. ABC also sells merchandise to outsiders at 40% above cost. Below are the data from the trail balance of ABC and Arba Minch branch.
Home Office, Branch
Sales Br.5,880,000. Br.3,360,000 .
Purchases 6,000,000. - .
Inventory beginning 350,000. 200,000.
Shipment to branch 2,000,000. - .
Shipment from Ho -. 2,375,000.
Allowance for overvaluation 540,000 . - .
Operating expense 1,200,000. 325,000, respectively.
Required: a,Determine the following:
E,Inventory of branch on Dec,31.
a,Consolidated inventory
b,True net income of the branch
c,Net income reported by the branch
d,Consolidated net income
e,Allowance for over valuation.

Answer 1

Summary answers
- Branch ending inventory (per branch books) on Dec 31 = Br.175,000
- Consolidated ending inventory = Br.290,000
- Branch net income reported (per branch books) = Br.635,000
- Branch true net income (group basis, after eliminating unrealized intercompany profit) = Br.600,000
- Consolidated net income = Br.1,080,000
- Allowance for over‑valuation (unrealized profit in branch closing inventory) = Br.35,000

Workings and explanation

1) Branch ending inventory (reported by branch)
- Branch goods available = Beg. inventory 200,000 + Purchases (shipments from HO, branch side) 2,375,000 = 2,575,000
- Branch cost of goods sold (branch uses selling price = 1.4 × branch cost, so COGS at branch cost = Sales / 1.4) = 3,360,000 / 1.4 = 2,400,000
- Branch ending inventory (branch books) = 2,575,000 − 2,400,000 = 175,000

2) Amount of unrealized intercompany profit in branch closing inventory
- Transfer markup was 25% over home cost (transfer price = 1.25 × home cost).
- Unrealized profit portion of branch inventory = transfer price − home cost = transfer × [0.25 / 1.25] = transfer × 0.20
- = 0.20 × 175,000 = 35,000

3) Consolidated inventory
- Home ending inventory (home books, at home cost):
Beg. 350,000 + Purchases 6,000,000 = 6,350,000 available.
Home cost of goods sold on home sales = 5,880,000 / 1.4 = 4,200,000
Goods shipped to branch (cost) = 2,000,000
Home ending inventory = 6,350,000 − (4,200,000 + 2,000,000) = 150,000
- Branch ending inventory on consolidated books must be at home cost: = 175,000 − 35,000 = 140,000
- Consolidated ending inventory = Home 150,000 + Branch (at cost) 140,000 = 290,000

4) Branch net income reported (per branch books)
- Gross profit (branch) = Sales 3,360,000 − COGS (branch cost) 2,400,000 = 960,000
- Less operating expenses 325,000 → Net income = 960,000 − 325,000 = 635,000

5) Branch true net income (group basis)
- Eliminate unrealized profit in closing inventory (35,000) which inflated branch reported profit.
- True branch net income = 635,000 − 35,000 = 600,000

6) Consolidated net income
- Home net income (per home books):
Home gross profit = Sales 5,880,000 − COGS 4,200,000 = 1,680,000
Less operating expenses 1,200,000 → Home net income = 480,000
- Consolidated net income = Home net income + Branch true net income
= 480,000 + 600,000 = 1,080,000

7) Allowance for over‑valuation (required elimination)
- Amount to eliminate (allowance) = unrealized intercompany profit in closing inventory = Br.35,000

If you want, I can show the consolidation elimination journal entry(s) (e.g., eliminate intercompany sales/purchases and record allowance to reduce branch inventory by Br.35,000) and present a combined income statement and balance sheet extracts.