Reference no: EM132973699

Your firm has recently been chosen as the auditor of Plainfield Unlimited, a company which was formed on October 15, 2020. Mr. Strokes owns 70% of the voting shares of Plainfield Unlimited and his wife owns the remaining 30%. On October 31, 2020, Plainfield Unlimited acquired all of the voting shares of Clubs, a company which was founded by Mr. Strokes' wife four years ago. Clubs will sell golf club production supplies to Plainfield Unlimited at a gross profit of 25%. In a meeting with Mr. Strokes, he asks your audit partner the following questions.

a) Why do accounting standards require that profits on sales of inventory between a subsidiary and its parent must be eliminated? My wife is working hard to ensure that Clubs is a profitable company and it seems unfair that the profits of this company will not be reflected in Plainfield's financial statements.

b) Clubs owns some metal shaping equipment with a net book value of $45,000. At the time that Plainfield Unlimited bought Clubs was estimated to be worth $45,000. However, our tax advisor has suggested that Clubs should sell the equipment to Plainfield Unlimited for $40,000. The equipment is really only currently worth $40,000 because it is becoming obsolete due to the recent introduction of superior technology. Clubs can use the tax loss that the sale will generate because the company has been paying a lot of income taxes since it was formed. Assuming the sale takes place, how should we account for this equipment?

c) An intercompany gain on the sale of land is eliminated in the preparation of the consolidated statements in the year that the gain was recorded. Will the gain be eliminated in the preparation of subsequent consolidated statements? Explain

REQUIRED

Draft responses to each of Mr. Strokes' questions, for use by your audit partner in a follow-up meeting with Mr. Strokes to discuss his concerns.