Answer:

1.) Unrealized profits are those profits which result from inter-group transactions and need to be eliminated as these are not real profits and are liable to manipulations. The group as a whole earns profit only when the goods are sold to an independent third party. Hence, the unrealized profit element in the closing inventory is liable to be eliminated.

If the accountant did not prepare the elimination entry of unrealized profit in inventories at the end of the year, it would lead to an overstatement of both the inventory in the balancesheet and the Net Income in the consolidated Profit & Loss account because the unrealized profit adjustment is directly debited to the Cost of Goods Sold account.

This would also lead to an understatement of consolidated Net Income in the subequent year(s) when the unrealized profit is required to recorded in the profit & loss but the accountant would be unable to do so as he has already booked profit in the first year. Thus in subsequent year(s) the Net Income would be understated to the tune of unrealized profits being realized in that year.

The Numerical entry would be

Cost of goods Sold Dr $100

Inventory Cr $100

if the unrealized profit is $100.

2.) In order to eliminate the unrealized profits, we need to know that who earned that unrealized profit in their standalone financial statements, so that we can record an appropriate adjustment. In case of a downstream transaction (sale by Parent to Subsidiary), the unrealized profit is earned by the parent and needs to be eliminated fully from the Net Income portion of the Parent. However, in case of an upstream transaction (sale by Subsidiary to Parent), the unrealized profit is earned by both the Parent (to the extent of shareholding of Subsidiary) and by the Non-Controlling Interest of the Subsidiary. Hence, if the direction is upstream, the profit needs to be reduced for the NCI as well and the consolidated Net Income attributable to NCI is reduced by their proportion of the unrealized profit

It is mainly due to this NCI adjustment, that the direction of sale is required to be established for preperation of  the consolidated financial statements.