Question

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.
. HO. Branch
Sales............ 5880000.......3360000
Purchases....6000000........ ---
Inventory
beginning...... 350000.........200000
Shipment to branch..2000000......-----
Shipment from
HO... ……………......…-----……........... 2375000
Allowance and
overvaluation......... 540000.......-----
Operating
Expense……………1200000…………325000
Required: Determine the following:
a. Inventory of branch on Dec,31
b. Consolidated inventory
c. True net income of the branch
d. Net income reported by the branch
e. Consolidated net income
f. Allowance for over valuation

Answer 1

Below are concise computations and results (showing key workings).

Given/derived facts used
- Branch sales 3,360,000; branch gross margin = 40% on cost ⇒ branch COGS = 3,360,000 / 1.40 = 2,400,000.
- Branch beginning inventory = 200,000; branch purchases from HO (per branch books) = 2,375,000.
- HO sales to outsiders 5,880,000; HO gross margin = 40% on cost ⇒ HO COGS = 5,880,000 / 1.40 = 4,200,000.
- HO beginning inventory = 350,000; HO purchases = 6,000,000; HO shipments to branch = 2,000,000.

a) Branch inventory on Dec 31 (per branch books)
- Goods available = Beg. inv. 200,000 + Purchases 2,375,000 = 2,575,000
- Ending inventory = 2,575,000 − COGS 2,400,000 = 175,000

Answer (a): 175,000

b) Consolidated inventory (eliminate unrealized intercompany profit)
- HO ending inventory = Beg. inv. 350,000 + Purchases 6,000,000 − HO COGS 4,200,000 − Shipments to branch 2,000,000 = 150,000
- Branch ending inventory (per branch books) = 175,000
- Intercompany unrealized profit in branch inventory: branch cost includes HO’s 25% markup. HO cost portion of branch ending inventory = 175,000 / 1.25 = 140,000 → unrealized profit = 175,000 − 140,000 = 35,000
- Consolidated inventory = HO ending inv. + branch ending inv. (at HO cost) = 150,000 + 140,000 = 290,000

Answer (b): 290,000

c) True net income of the branch (measured at group/HO cost)
- Sales 3,360,000
- COGS at HO cost = branch COGS at branch price 2,400,000 / 1.25 = 1,920,000 (or compute sales/1.40 then /1.25)
- Gross profit (at HO cost) = 3,360,000 − 1,920,000 = 1,440,000
- Less operating expense (branch) 325,000 → True net income = 1,440,000 − 325,000 = 1,115,000

Answer (c): 1,115,000

d) Net income reported by the branch (per branch books)
- Gross profit per branch books = Sales 3,360,000 − COGS 2,400,000 = 960,000
- Less operating expense 325,000 → Reported net income = 960,000 − 325,000 = 635,000

Answer (d): 635,000

e) Consolidated net income
- Sum of reported incomes: HO net income + Branch reported net income
- HO net income = HO gross profit (5,880,000 − 4,200,000 = 1,680,000) − HO operating expense 1,200,000 = 480,000
- Branch reported net income = 635,000
- Sum = 480,000 + 635,000 = 1,115,000
- Less unrealized intercompany profit in ending inventory (35,000) → Consolidated net income = 1,115,000 − 35,000 = 1,080,000

Answer (e): 1,080,000

f) Allowance for overvaluation (unrealized profit in branch ending inventory)
- As computed above = 35,000

Answer (f): 35,000

Summary of results
- a) Branch ending inventory (books): 175,000
- b) Consolidated inventory: 290,000
- c) True net income of branch (at group cost): 1,115,000
- d) Net income reported by branch: 635,000
- e) Consolidated net income: 1,080,000
- f) Allowance for overvaluation (unrealized profit): 35,000

If you want, I can show a full ledger-style reconciliation (HO and branch schedules and the elimination entries).