Intercompany Profit in Inventories

When affiliated companies sell inventory/merchandise to one another, this inventory/merchandise is normally sold at a profit. The total amount of the intercompany sale and cost of goods sold is eliminated in preparing consolidated financial statements. In addition, any intercompany profit remaining in the ending inventory (not sold) is eliminated from the ending inventory and the cost of goods sold of the purchasing affiliate. 100 percent of the profit is eliminated even if the parent's ownership interest is less than 100 percent. The intercompany profit in beginning inventory that was recognized by the selling affiliate in the previous year is eliminated by an adjustment (debit) to retained earnings.