How should consolidation adjustments for intercompany profits on sales of property between consolidated entities be recorded and tested?

• A. Eliminate intercompany profits on consolidation until asset is sold externally; test with reconciliations of intercompany sales and verify basis.
• B. Delay elimination until dissolution
• C. Recognize profit immediately
• D. Only adjust for tax purposes

Answer: (C)

Intercompany profits on transfers of property within a consolidated group are unrealized from the group’s perspective. To present the group as a single economic entity, the profit embedded in the intercompany sale must be eliminated in consolidation, and the asset should be carried at the cost to the group rather than the sale price between the subsidiaries. The profit is deferred and only recognized in consolidated earnings when the asset is ultimately sold to an external party.

Testing this requires confirming that the intercompany sale and related profit are properly eliminated in the consolidation. This includes reconciling intercompany sales between entities and verifying that the asset’s carrying amount in the consolidated books reflects the original cost to the group (not the intercompany selling price), adjusted for any depreciation or basis changes. It also means ensuring that any previously deferred intercompany profit is recognized in earnings only when the asset leaves the group through an external sale.

In short, you eliminate the unrealized profit at consolidation and adjust the asset to the group’s cost basis, testing through intercompany reconciliations and basis verification, with profit recognition deferred until external sale.