Which of the following statements best describes the required accounting treatment with respect to income taxes on unrealized intercompany profits?

A) These taxes can be ignored since an increase in income tax expense for one company is offset by an equivalent reduction in income tax expense for the other.
B) They would be recognized as assets for the purchasing entity and liabilities for the selling entity.
C) The income tax will be expensed when the profit is realized in accordance with the matching principle.
D) They would be charged to retained earnings during the preparation of financial statements.

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Gurman Singh · Accepted Answer

Final Answer : C, Explanation :  According to the matching principle, income taxes on unrealized intercompany profits should not be recognized until the profits are realized. Therefore, income tax will be expensed when the profit is realized, and not until then. Option A is incorrect because income taxes cannot be completely ignored, even if they are offset. Option B is incorrect because recognizing an asset or liability for intercompany profits would be premature because the profits have not yet been realized. Option D is incorrect because charging the taxes to retained earnings is not a valid accounting treatment.

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