Consolidation: intragroup transactions

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07/04/2021
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Chapter 11a
Consolidation: intragroup
transactions
Part A
©2021 John Wiley & Sons Australia Ltd
Introduction
• The structure of the group under discussion in this lecture is
restricted to one where:
– There are only two entities within the group
– The parent owns all the shares of the subsidiary
• Consolidation involves adding together the financial
statements, with two major adjustments
– BCVR entries and pre‐acquisition equity entries (see Chapter 10)
– Elimination of intragroup balances and transactions
Rationale for adjusting intragroup
transactions
• Intragroup transactions
– Are transactions that occur between entities in the group, such as
borrowing / lending money or trading with other
– Each separate legal entity records such transactions in their accounts
– The effects of such transactions will be included in the consolidated assets,
liabilities, equity, income and expenses when the separate financial
statements are added together
• These transactions must be eliminated on consolidation
– From a group viewpoint a transaction has not occurred with an entity
outside of the group
• AASB 10/IFRS 10 Consolidated Financial Statements requires:
– The full adjustment for the effects of intragroup transactions
– Eliminate in full intragroup assets and liabilities, equity, income, expenses
and cash flows
• Adjustments will also be required in future periods
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Rationale for adjusting intragroup
transactions
• AASB 112/IAS 12 Income Taxes applies to temporary
differences that arise from the elimination of profits and
losses resulting from intragroup transactions (AASB
10/IFRS 10 – para. B86(c))
– Where the carrying amount of an asset or liability is adjusted
on consolidation the tax effect must be accounted for in the
worksheet
• The combination of the tax‐effect entries in the
subsidiaries and the tax‐effect adjustments on
consolidation will account for the temporary difference
between
– The carrying amount as reported by the group and
– The tax base for the individual entity
Transfers of inventories
Realisation of intragroup profits or losses
• Paragraph B86(c) of AASB 10/IFRS 10 states that profits and losses
resulting from intragroup transactions that are recognised in assets,
e.g., inventories, are eliminated in full – profits regarded as
‘unrealised’ to the group.
• The test for realisation is the involvement of an external party in
relation to the item involved in the intragroup transaction.
• If inventories are transferred from subsidiary to parent, no
external is involved
• Profit made by subsidiary is unrealised
• When parent then sells the inventories to a party external to the
group, the intragroup profit becomes realised to the group.
Sales of inventories
The broad effect of intragroup sales and purchases of
inventories can be illustrated by reference to the diagram below
Subsidiary
External Parent
supplier sells
inventories to
the subsidiary
for $100 on
1 June 2022
Sub sells
inventories to
parent for $150
on 25 June 2022 All inventories
still held by the
parent at 30
June 2022
Transfers of inventories
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Transfers of inventories
Realisation of profits and losses
• The subsidiary would record sales of $150 and Cost of sales of
$100 ‐ recognising a profit of $50
– The $50 profit made by the subsidiary is considered to be unrealised to the
group at 30 June 2022, as the inventories are yet to be sold to an external
party
• The parent would record inventories of $150
– The inventories asset balance reported in the consolidated accounts
includes this unrealised profit
– AASB 10/IFRS 10 requires profits /(losses) ‘recognised in assets’ be fully
eliminated
• To determine how to eliminate the effects of this transaction it is
helpful to consider the journal entries that would have been
recorded in the subsidiary and parent’s books respectively
Transfers of inventories
Subsidiary Parent
1 June 2022
Dr Inventories 100
Cr Acc. Payable 100
25 June 2022
Dr Cash 150
Cr Sales revenue 150
Dr Cost of sales 100
Dr Inventories 150
Cr Cash 150
Cr Inventories
100
Dr ITE
15
Cr Current Tax Liability
(CTL)
15
Transfers of inventories
Profits in ending inventories – inventories still on hand
• Consolidation journal adjustment (1) is required at 30 June
2022 for the following:
Dr Sales revenue
150
Cr Cost of sales
100
Cr Inventories
50
• From a consolidated viewpoint, there is NO sale, NO cost of
sales (and therefore no profit).
• In addition, inventories must be shown at the cost to the
group (i.e., $100 not $150)
The credit to inventories eliminates in full the unrealised profit on the internal sale of the inventories
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Transfers of inventories
Profits in ending inventories – inventories still on hand
• Consolidation journal adjustment (2) is required to recognise the
tax effect of decreasing the carrying amount of the inventories
asset (to remove the unrealised profit):
Dr Deferred tax asset (DTA) 15
Cr Income tax expense (ITE) 15
• From group viewpoint there was NO profit and therefore should be
NO tax expense.
• The relevant tax expense will be recognised in the future, when the
inventories are sold by the parent to an entity outside of the group
– Made up of the ITE recognised by the parent
– Plus the reversal of the DTA recognised above
$50 x 30% = $15
Transfers of inventories
Parent Sub
Adjustments Group
Dr
Cr
S’ment of Financial Position EXTRACT
Cash at bank (150) 150 0
Inventories 150 0 (1) 50 100
Deferred Tax Asset (2) 15 15
Accounts Payable 100 100
Current Tax Liability 0 15 15
S’ment of Profit or Loss EXTRACT
Sales revenue 0 150 (1) 150 0
Cost of sales 0 100 (1) 100 0
Gross Profit 0 50 0
Income Tax Expense 0 15 (2) 15 0
Profit / (Loss) after tax 0 35 0
Note how all impacts on the Profit or Loss resulting from the intragroup
sales have been removed
Note that
inventories
are now
recorded at
the original
$100 cost to
the group
Transfers of inventories
Profits in ending inventories – transferred inventories partly sold
What if the purchaser (i.e., the parent), subsequently sells some of the
inventories to external parties before the end of the year?
Subsidiary
External Parent
supplier sells
inventories to
the subsidiary
for $100 on 1
June 2022
Sells
inventories for
$150 on 25 June
2022
The journal entries processed by each entity and the consolidation
journal adjustments required are shown on the following slides
Sells 40% of
the inventories
for $100 on 30
June 2022
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Transfers of inventories
25 June 2022 25 June 2022
Dr Inventories 150
150 Cr Cash 150
100
15
30 June 2022
Dr Acc. Receivable 100
Cr Sales revenue 100
Dr Cost of sales 60
Cr Inventories 60
Dr ITE 12
Cr CTL 12
Cost of sales calculated as 40% of the
inventories purchased
(i.e. 40% of $150) = $60
Subsidiary Parent
1 June 2022
Dr Inventories 100
Cr Acc. Payable 100
Dr Cash 150 Cr Sales revenue Dr Cost of sales 100
Cr Inventories Dr ITE 15
Cr CTL Transfers of inventories
Profits in ending inventories – transferred inventories partly sold
• Consolidation journal adjustment (1) is required at 30 June 2022
for the following:
Dr Sales revenue
150
Cr Cost of sales
120
Cr Inventories
30
The desired group cost of sales is $100 x 40% = 40. The adjustment is $100 (subs) + $60 (parent)
‐ $40 (group) = $120
The credit to inventories eliminates 60% of the unrealised profit of $50 on the internal sale,
i.e., ($150 [transfer price] ‐ $100 [original cost]) x 60% = $30
The whole amount of the sale is
eliminated regardless of the
amount subsequently disposed
of by the parent
Transfers of inventories
Profits in ending inventories – transferred inventories partly sold
• Consolidation journal adjustment (2):
– Recognise the tax effect of removing the unrealised profit from the carrying
amount of the inventories:
Dr DTA 9
Cr ITE 9
• From group viewpoint there was a profit of $60
– Sales revenue $100 – Cost of sales $40 (40% of $100)
– ITE for the group should be $18 ($60 x 30%)
– The worksheet shows $12 (parent) + $15 (sub) ‐ $9 (elimination) = $18
• The balance in the DTA
– Will be reversed in the period in which the remaining inventories are sold by
the parent to an entity outside of the group
$30 x 30% = $9
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Transfers of inventories
Consolidation worksheet (extract)
Parent
Sales revenue 100
Sub
Dr
Cr Group
150 (1) 150
100
(40)
60
(18)
60
Cost of sales
(60)
(100)
50
(15)

(1) 120
Profit before tax 40
ITE
Inventories
(150 – 60)
(12)
90
(2) 9
(1) 30
Group profit before tax = 100 [external sales] – 40 [external cost
of sale; 40% x 100] = 60
Transfers of inventories
Profits in opening inventories
• If inventories are sold between entities within the group one year
and not sold by the end of the year, then we need to consider
how this affects the following year’s consolidated accounts
• The profit will become realised when the inventories are sold to
an external party (in the next financial year)
• As inventories are a current asset you should assume (unless
specifically told otherwise) that it is sold to external parties
within 12 months of being acquired by the group
Profits in opening inventories
Go back to our original example – where all inventories were still
held by the parent at 30 June 2022
Subsidiary
External Parent
supplier sells
inventories to
the subsidiary
for $100 on
1 June 2022
Sells inventories
for $150 on 25
June 2022
All inventories
still held by the
parent at 30
June 2022
Transfers of inventories
Sells 100%
of the
inventories
for $175 on
30 July
2022
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Transfers of inventories
• Recall the worksheet entries recorded on 30 June 2022 were:
Dr Sales revenue
150
Cr Cost of sales
100
Cr Inventories
50
Dr DTA
15
Cr ITE
15
• To carry forward the net effect of last year’s consolidation journals
the following entry would be required on 1 July 2022:
Dr Retained earnings
35
Dr DTA
15
Cr Inventories
50
Sales revenue, Cost of sales, ITE adjustments closed to Retained Earnings
Transfers of inventories
Profits in opening inventories
• Once the inventories are sold to an external third party the profit is
realised from group’s viewpoint
• The consolidation worksheet entry must be amended to reflect the
following for the remainder of the 2022/23 financial year:
Dr Retained earnings 35
Dr ITE
15
Cr Cost of sales
50
No entry required in future years as the profit has been “realised”
(All accounts will close to retained earnings)
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