Perez, Inc. owns 80% of Senior, Inc. During year 1, Perez
sold goods with a 40% gross profit to Senior. Senior sold all of
these goods in year 1. For year 1 consolidated financial statements,
how should the summation of Perez and Senior income
statement items be adjusted?

(a) When computing consolidated income, the objective
is to restate the accounts as if the intercompany transactions
had not occurred. As a result of the intercompany sales, sales and
cost of goods sold are overstated and an eliminating entry is
needed to reduce these accounts by the entire amount of the
intercompany sales. Therefore, answer (a) is correct. Answer
(b) is incorrect because sales and cost of goods sold need to
be reduced by the entire amount of the intercompany sales in
order to arrive at their proper consolidated amounts. Answer (c)
is incorrect because net income is not affected by the intercompany
sale. Sales and cost of goods sold are overstated by the same
amount; thus, net income is correct for consolidated purposes.
Answer (d) is incorrect because an adjustment is necessary.