Problem
Diamond Manufacturing Company regularly purchases janitorial and maintenance services from its wholly owned subsidiary, Schwartz Maintenance Services, Inc. Schwartz bills Diamond monthly at its regular rates for the services provided, which consist primarily of cleaning, grounds keeping, and small repairs. The cost of providing the services that Schwartz sells consists mostly of salaries and associated labor costs that total about 60 percent of the amount billed. Diamond issues consolidated financial statements annually.
1) When Diamond prepares consolidated financial statements, what account balances of Diamond and Schwartz related to the intercompany sale of services must be adjusted or eliminated in the consolidation workpaper? Why?
2) What impact do these adjustments or eliminations have on consolidated net income? Why?
3) In this case, if the intercompany sale of service results in a profit, at what point in time, if ever, is the intercompany profit considered to be realized? Explain.