What happens to the parent's inventory on consolidation when an associate sells goods to them?

In a consolidation scenario involving an associate, when the associate sells goods to the parent company, the situation centers on the concept of "proportionate unearned profit" (PUP) in the context of consolidated financial statements. When the associate sells goods to the parent at a profit, the profit embedded in the inventory held by the parent (which has not yet been sold to third parties) must be adjusted in the consolidated accounts.

This adjustment is necessary to prevent the overstatement of both revenue and assets. Hence, the inventory on the parent's balance sheet is adjusted upwards by a portion of this unrealized profit, reflecting the share of the profit that is attributable to the equity interest in the associate. This aligns with the accounting principles that aim to present a true and fair view of the financial position of the consolidated group by eliminating any unrealized profits that exist within the inventory.

Recognizing only the share of the unrealized profit in the inventory ensures that the consolidated financial statements provide a faithful representation of the group's economic reality, avoiding the inflation of assets and profits resulting from transactions within the group. This treatment helps maintain the integrity of the consolidation process, reflecting only realized earnings and actual economic transactions.