ACCT 6010 Advanced Financial Reporting
Class 5: Intragroup transactions
The University of 1
Learning objectives
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After completing this topic, students should be able to:
1. Explain the need for consolidation adjustments where there have been intragroup transactions
Arthur et al. 4.1 to 4.4.1
2. Describe how (and when) unrealised profits on intragroup transactions become realised
Arthur et al. 4.4.2 to 4.4.5
3. Prepare consolidation journal entries (including tax effects) in relation to the intragroup transactions
Arthur et al. 2.5, 4.4.6 & 4.5 to 4.5.3
4. Prepare consolidated statement of comprehensive income and statement of financial position after adjusting for the effects of intragroup transactions
Arthur et al. 4.6
5. Identify and explain why some (but not all) intragroup transactions in prior periods lead to adjustments to
(i) consolidated opening retained earnings and
(ii) income tax expense
Arthur et al. 4,2, 4.4.4,
The University of 2
LS Class 4 1
– Arthur et al. Chapter 2, section 2.5. Chapter 4 – AASB 10.B86(c)
– Class 5 materials on Canvas:
The University of 3
unilateral
Wholly owned
Consolidated Financial Statements • Balance Sheet
Remove effect of intra-group transactions from the consolidated financial statements
Comprehensive Income Statement Statement of Changes in Equity
The University of Accounting
LS Class 4 2
ACCT 6010 Advanced Financial Reporting
Intra-group eliminations: Concept
The University of 5
1. Introduction
Intra-group transactions can be common where there is vertical or horizontal integration.
“Downstream” = ParentàSubsidiary ”Upstream” = SubsidiaryàParent
From the group’s perspective:
– Nothing has moved outside the boundary of the group;
– Within the group the transactions might not be negotiated on an arms length basis.
– Groups might also manipulate the timing of transfers as another way of moving profits between related parties.
Ø Refer to Coca-Cola case (Reading List)
The University of 6
v LSQ 4.1: How might the transfer price be determined?
LS Class 4 3
1. Introduction (cont.)
Need for consolidation adjustments
Given that:
1. Consolidated financial statements report on the financial affairs of the
2. Transactions within the group can lead to:
– Revenues, expenses, gains/losses recorded by individual entities; and – consequential effects on depreciation; or
cost of sales; or
– gain or loss on subsequent sale to third parties of the related assets.
1 & 2 together suggest the need for consolidation adjustments.
The University of 7
1. Introduction (cont.)
Consolidation procedure
Recall (class 2) AASB 10 uses entity approach to consolidation.
Eliminate in full intragroup assets, liabilities, income, expenses… relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets such as inventory and fixed assets, are eliminated in full)”
(emphasis added)
[AASB 10 (par. B86(c))]
In contrast, if the Standard employed the parent entity concept, only the parent entity portion of unrealised profits would
be eliminated on consolidation.
The University of 8
LS Class 4 4
1. Introduction (cont.)
– First need to consider how the transactions are recognised in each entity’s financial statements.
– On consolidation reverse the effect of transaction recognised in each entity’s financial statements –
– unless they offset each other (e.g. cash received and cash paid) there is no net effect on the account balance.
The University of 9
ACCT 6010 Advanced Financial Reporting
Intra-group eliminations: Transactions involving transfer of cash
The University of 10
LS Class 4 5
2 Transactions that involve the transfer of cash
2.1 Dividends
– Dividends are recognised as revenue by the parent, and as an appropriation of profits by the subsidiary, IN THEIR SEPARATE FINANCIAL STATEMENTS
– On consolidation, dividend revenue (of parent) and dividend paid (by subsidiary) are eliminated.
– [AASB 10.B86 (c)]
The University of 11
v LSQ: Why do we treat dividends in this way?
Is the dividend revenue a revenue from the perspective of the group? Is the dividend paid an allocation of profits
from the perspective of the group?
2 Transactions that involve the transfer of cash
Eliminate all effects of the proposed and/or paid dividends from the financial statements on consolidation
Ø Refer Arthur et al. section 2.5.1
Any adjusting entry will depend on how the members of the group have recorded the transaction in their individual financial statements (i.e. which accounts will have entries to them for the dividends):
• Dividend paid / Dividend proposed (Retained Eearnings) • Dividend revenue/ received (Income)
• Dividend payable (Liability) • Dividends receivable (Asset)
The University of 12
LS Class 4 6
2 Transactions that involve the transfer of cash
Example: Sub Ltd declares a dividend of $10,000 to Parent Ltd Both Parent and Sub would record journal entries in their books: Parent Ltd: Dr Dividend receivable 10,000
Cr Dividend revenue 10,000 Sub Ltd: Dr Dividend declared 10,000
Cr Dividend payable 10,000
The effects of these entries would be appearing in both companies’ columns on the worksheet
Parent Ltd
Adjustment
Div. revenue
Div. declared
Div. receivable
Div. payable
The University of Sydney
2 Transactions that involve the transfer of cash
2.1 Other inter entity transactions that transfer cash include:
– Management fees; – Loans;
The University of 14
LS Class 4 7
2 Transactions that involve the transfer of cash
(iii) Loan Balances: Dr Loan payable
Cr Loan receivable
(iv) Interest paid:
Dr Interest revenue
Cr Interest expense
What if the interest is payable?
Dr _____________________________
Cr ___________________________ The University of 15
2 Transactions that involve the transfer of cash
(i) Rent paid
Dr Rent revenue xxx Cr Rent expense
Note: No adjustment to Cash. Why?
(ii) Management fees charged but not yet paid
Dr Management fee revenue xxx Cr Management fee expense
Dr Management fee payable xxx Cr Management fee receivable
The University of Sydney
LS Class 4 8
ACCT 6010 Advanced Financial Reporting
Intra-group eliminations: Transactions involving sale of inventory (perpetual system)
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3. Sale of inventory
3.1 Sales of inventory – Perpetual
Case 1: Example 1 – Downstream sale, no markup
– During the year ended December 31 20X6, National Ltd sold inventory to its subsidiary, State Ltd, for $1,000,000.
– There is no mark-up (profit) on the transaction.
– The inventory has neither been paid for nor on-sold to an external customer by State Ltd before the end of the accounting period.
– Both companies use the perpetual method of accounting for inventory.
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LS Class 4 9
3. Sale of inventory
3.1. Sales of inventory – Perpetual (cont.) Effects on financial statements
Issues, from the group viewpoint, without adjustment:
– group revenue:
– group cost of sales:
– group receivables:
– group payables:
The University of Sydney
overstated overstated overstated
overstated
3. Sale of inventory
3.1. Sales of inventory – perpetual (cont.)
1. What are the consolidation journal entries for 20X6? (in $000)
Consider how the above journals would differ under the periodic system of accounting for inventory (we’ll get to that later).
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Accounts payable
Cr Accounts receivable
LS Class 4 10
3. Sale of inventory
3.2 Unrealised profit in closing inventory – Perpetual
Case 1: Example 2 Downstream sale with markup
The mark-up on all sales was 25% on cost, and State Ltd has inventory worth $100,000 (at invoice cost to State Ltd) on hand at the end of the period.
The University of 21
3. Sale of inventory
3.2 Unrealised profit in closing inventory – Perpetual (cont.)
Sale price (SP) = $100,000 Mark (M) up was 25% on cost (C)
SP = C * (1 + M) SP = C * 1.25
Therefore:
C = SP 1.25,
C = $100,000 1.25 = $80,000
Profit (before tax) = Sales – cost of sales
Profit (before tax) = $100,000 – $80,000 = $20,000
The University of 22
LS Class 4 11
3. Sale of inventory
3.2 Unrealised profit in closing inventory – Perpetual (cont.)
Effects on financial statements
Issues, from the group viewpoint, without adjustment: – COGS overstated
– Inventory (assets) overstated
There will be ‘unrealised profit’ in the COGS and closing inventory
(assets) of State Ltd.
Profit will not be realised from group perspective until the inventory
is sold to an external customer.
The University of 23
3. Sale of inventory
3.2 Current period sales and unrealised profit – perpetual (cont.)
2. What are the consolidation journal entries for the year ended 31/12/20X6 (ignoring tax effects? (in $000)
Cr COGS ———————————————-
Cr Inventory ———————————————– Dr Accounts payable
Cr Accounts receivable
1,000 20 1,000
Note: Assuming that the sale occurred in the current period.
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3. Sale of inventory
3.3 Unrealised profit in opening inventory – perpetual
Case 1: Example 3
Assume that the inventory was sold in 20X7.
What are the required consolidation entries for 20X7?
Accounts affected:
– Opening retained earnings (1.1.20X7)
The University of 25
Opening retained earnings
vLSQ What consolidated journal entry would be required if the inventory had not been sold by the end of 20X7?
3. Sale of inventory
3.4 Sale of inventory – periodic
Case 1: Example 4 – Use of periodic inventory system
Use the same information as case 1, except that both companies use the periodic inventory system.
Accounts affected:
COGS (Purchases); Inventory (Asset); Receivables; Payables
The University of 27
LS Class 4 13
3. Sale of inventory
3.5. Tax effects of adjustments to inventory
– Tax effect accounting is applied by the entity holding the inventory, based on cost to that entity (purchaser)
– Carrying amount (CA) to the group: – Generally cost to the group
– Adjustment to inventory on consolidation creates a temporary difference on consolidation as the group has changed the CA while the tax base (TB) stays the same.
The University of 32
3. Sale of inventory
3.5. Tax effects of adjustments to inventory
Case 1 Example 5
Unrealised profit in closing inventory with tax effects
Company tax rate
Elimination of unrealised profit from ending inventory Reduces group’s carrying amount (CA) by:
Group CA < Group TB
→ Deductible temporary difference
→ Deferred tax asset (DTA) Periodic method is used
The University of Sydney
30% $20,000 $20,000
LS Class 4 14
3. Sale of inventory
3.5 Tax effects of adjustments to inventory (cont.)
Amount of the deferred tax adjustment year ended 31/12/20X6:
$20,000 x 30% = $6,000
Therefore, an additional consolidated journal entry is required:
Recognise deferred component of income tax expense and adjust DTA.
The University of 34
Deferred tax asset (DTA)
Cr Tax expense
vLSQ: Why is the credit to tax expense? ___________________________________________________
3. Sale of inventory
3.5. Tax effects of adjustments to inventory (cont.)
2. Full presentation of the consolidation journal entries to eliminate unrealised profit in ending inventory with tax effect
Eliminate $20,000 unrealised profit in ending inventory and recognise tax effect, tax rate = 30%
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Cr Inventory
Deferred Tax Asset
Cr Tax expense
vLSQ: What is the net effect of the above on consolidated earnings?
$___________ Dr/Cr
LS Class 4 15
3. Sale of inventory
3.5 Tax effects of adjustments to inventory (cont.)
3. Consolidation journal entries 20X7 (in $000)
Opening retained earnings
Tax expense
Cr Opening retained earnings
The University of 36
3. Sale of inventory
What about unrealised losses in closing inventory?
– Less common – Tax issues
– Lower of cost and net realisable value [AASB 102]
– The effects of transfer of inventory at a loss must also be
generally be eliminated on consolidation
The University of 37
LS Class 4 16
ACCT 6010 Advanced Financial Reporting
Intra-group eliminations: Transactions involving transfer of non-current assets (non- depreciable)
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4. Transfers of non-current assets
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LS Class 4 17
4. Transfers of non-current assets
Financial effects can span many years.
Depreciable assets and assets subject to amortisation:
– depreciation (or amortisation) expense; and
– accumulated depreciation (or amortisation) effects.
4.1 Transfer of land
Accounts potentially affected:
• Income or Expenses (in the year of the transfer) • PPE / Land (until sold outside the group)
• Receivables and payables
(if any amount is still owing at year end) The University of 40
4.1 Transfer of land
Case 2: Example 6 - Sale of land at a profit
– Big Ltd ("Big") is the parent of Small Ltd ("Small).
– Small Ltd sold land to Big $800,000.
The land had a carrying amount in the books of Small of $500,000.
– Policy of the Big Ltd group is to use the cost basis to account for PPE.
– Consideration is paid in cash.
The University of Ltd Control
Small Ltd Original cost $500k
Sale to Big for $800K
LS Class 4 18
4.1 Transfer of land (cont.)
Accounts affected
Land Income
The University of or over-stated from the groups perspective?
overstated overstated
300,000 300,000
4.1 Transfer of land (cont.)
Consolidation adjustment
Eliminating effect of intragroup transaction and unrealised profit
Question: what will be the adjustment required if the land is still on hand at the end of the next accounting period?
The University of 43
Gain on sale of land
LS Class 4 19
4.1 Transfer of land (cont.)
Tax effect
– Carrying amount from the group's perspective must be the original cost to the group:
• $500,000
– However the tax base of the asset is now:
• $800,000 (the cost to Big)
àTemporary difference amount: type: assessable/ deductible? DTA or DTL?
$ 300,000 deductible DTA
àAmount? The University of Sydney
$300,000 x TR
ACCT 6010 Advanced Financial Reporting
Intra-group eliminations: Transactions involving transfer of non-current assets (depreciable)
The University of 45
LS Class 4 20
4.2 Transfer of depreciable asset
Continuing with Case 2 Example 6:
– The company income tax rate is 30%
– The consolidated journal entry to account for deferred
tax relating to the asset transfer is:
Deferred tax asset
Cr Tax expense
Question: what will be the adjustment required if
the land is still on hand at the end of the next accounting period?
The University of 46
4.2 Transfer of depreciable asset (cont.)
Consideration needs to be given to the consequent effects: – depreciation expense; and
– accumulated depreciation.
Compare (i) depreciation expense and (ii) accumulated depreciation amounts after the transfer with the amounts that would have been recorded absent the transaction.
Also Consider Accounting policies
The accounting policies & accounting periods of the parent entity & its subsidiaries must be consistent.
[AASB 10.B92, B93 and B87]
e.g. motor vehicles depreciated over 5 years straight-line The University of 47
LS Class 4 21
4.3 Transfer of depreciable asset (cont.)
Case 3 Example 7:
– On 1 January 20X6, Newport Ltd (Newport) sold a car to Arms Ltd (Arms), another entity in the group, for $42,000 cash. The car had been purchased by Newport on 1 January 20X5 for $50,000.
– The car was being depreciated straight-line over 5 years (nil residual) for both tax and accounting purposes.
– The accounting year end is 31 December.
– Arms depreciates the car over its remaining useful life of 4 years.
The University of 48
4.3 Transfer of depreciable asset (cont.)
Transferor (Newport) records:
Transferee (Arms) records:
What is the combined effect?
Cash $0 & 3 other accounts are affected. The University of 49
Accumulated depreciation
Cr Motor vehicles at cost
Cr Gain on disposal
Motor vehicles at cost
LS Class 4 22
4.3 Transfer of depreciable asset (cont.)
Effects on the group’s financial statements
$ Under/ Over stated ________________________________________________
Assets [Motor vehicles – at cost] Accumulated depreciation Gain on disposal
8,000 Under 10,000 Under
2,000 Over
The group accountant now needs to return everything back to the way it would have been had the intragroup transfer never occurred.
The University of 50
4.3 Transfer of depreciable asset (cont.)
1. Consolidation adjustment entry
Note: Income tax effects considered next.
The University of 51
Motor Vehicles at cost
Gain on disposal
Cr Accumulated depreciation
LS Class 4 23
4.3 Transfer of depreciable asset (cont.)
Tax effects - assume:
– The company income tax rate is 30%; and
– Each company is treated as a separate entity for income tax
At date of transfer:
Tax base of asset (to Arms):
Carrying amount of asset to the group: *($50,000 - $10,000 accum. depn)
Temporary difference:
Deferred tax asset:
*(Temp. difference $2000 x tax rate)
The University of Sydney
$42,000 $40,000*
$2,000, deductible $600*
4.3 Transfer of depreciable asset (cont.)
2. Consolidation adjustment entry
Adjustment for tax effect of elimination of unrealised profit on transfer of the asset
The University of 53
Deferred tax asset
Cr Tax expense
LS Class 4 24
4.3 Transfer of depreciable asset (cont.)
Depreciation
Depreciation in the books of Arms for the year ended 20X6: $42,000 /4 = $10,500
Depreciation that would have been recorded by Newport had the transfer not been made:
$50,000 / 5 = $10,000
Difference: Excess depreciation charge: $10,500 - $10,000 = $500
The University of 54
4.3 Transfer of depreciable asset (cont.)
3. Consolidation adjustment entry
Note: some of the unrealised gain (1/4) is now regarded as being realised.
The University of 55
Accumulated depreciation
Cr Depreciation expense
vLSQ: Are the benefits of the asset realised through use or sale? _____________________________________________________
LS Class 4 25
4.3 Transfer of depreciable asset (cont.)
Tax effect of the depreciation adjustment
Adjustment to the carrying amount on consolidation (current period): $500 increase
Tax rate 30%
Reversal of deferred tax asset = $150
The consolidated journal entry is:
The University of 56
Tax expense
Cr Deferred tax asset
4.3 Transfer of depreciable asset (cont.)
Subsequent periods
– Carry forward elimination of gain on sale and tax effect against opening retained earnings (ORE);
– Carry forward depreciation adjustment and related tax effect from prior period(s) against ORE; and
– Account for current period depreciation adjustment and related tax effect.
Consolidation adjustment entries for the year ended 20X7:
The University of 57
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