X Inc. owns 80% of Y Inc. During 2020, X Inc. sold inventory to Y for $10,000. Half of this inventory remained in Y's warehouse at year end. Y Inc. sold Inventory to X Inc. for $5,000. 40% of this inventory remained in X's warehouse at year end.
Both companies are subject to a tax rate of 40%. The gross profit percentage on sales is 20% for both companies. Unless otherwise stated, assume X Inc. uses the cost method to account for its Investment in Y Inc.
Assume that Y Inc. reported an after-tax net income of $20,000 in 2020, what would be Y's adjusted net income for the year?

A) $202,400
B) $20,000
C) $19,840
D) $19,760

Question

Jewelia Olayo · Accepted Answer

Final Answer : D, Explanation :  Y's adjusted net income is $19,760. This is calculated by taking Y's reported after-tax net income of $20,000 and subtracting the amount of intercompany profit that was eliminated in consolidation, which is $240. The intercompany profit is calculated as follows:Sales from X to Y: $10,000Cost of goods sold (50% of $10,000): $5,000Gross profit: $5,000Intercompany profit: $5,000 x 20% = $1,000Sales from Y to X: $5,000Cost of goods sold (40% of $5,000): $2,000Gross profit: $3,000Intercompany profit: $3,000 x 20% = $600Total intercompany profit: $1,000 + $600 = $1,600Intercompany profit eliminated in consolidation: $1,600 x 80% = $1,280Tax on intercompany profit eliminated in consolidation: $1,280 x 40% = $512Intercompany profit eliminated in consolidation, net of tax: $1,280 - $512 = $768Y's adjusted net income: $20,000 - $768 = $19,232

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