Download Advanced Accounting, Canadian Edition (Fayerman)

Chapter 4
Consolidation:
Intragroup
Transactions
© 2013 Advanced Accounting, Canadian Edition by G. Fayerman
The Consolidation Process
Two major adjustments are necessary to effect the consolidation:
• 1. Adjustments must be made involving equity at the
acquisition date, namely the fair value adjustments (if any) and
the pre-acquisition adjustment, that eliminate the investment
account in the parent’s financial statements against the preacquisition equity of the subsidiary (see Chapter 3).
acquisition date fair value adjustments
• 2. Adjustments must be made to eliminate intragroup balances
and the effects of transactions whereby profits or losses are
made by different members of the group through trading with
each other (see Chapter 4).
eliminate intragroup balances and transactions arising
when members of the group trade with each other
LO 1
Rationale for Adjusting for
Intragroup Transactions
• Intragroup transactions: transactions that occur
between entities in the group.
• They must be eliminated on consolidation
because, from a group viewpoint, they are not
dealings with external parties
• IFRS 10 requires intragroup balances (assets,
liabilities, and equity), transactions, revenues, and
expenses to be eliminated in full
• IFRS 10 and IAS 12 also require tax effect
accounting to be applied where temporary
differences arise due to the elimination of profits
and losses
LO 1
Transfers of Inventory
Example 4.2
• The broad effect of intragroup sales and purchases
of inventory can be illustrated by reference to the
diagram below
S purchases
inventory for
$8,000 on Dec
31, 2012
S sells
inventory to P
for $10,000 on
Jan 1, 2013
Subsidiary
Parent
All inventory
still held by the
parent at Dec
31, 2012
LO 2
Unrealized Profit in Ending Inventory
Example 4.2
• The subsidiary would record sales of $10,000 and
COGS of $8,000 – recognizing a profit of $2,000
• The parent would record inventory of $10,000
• The $2,000 profit made by the subsidiary is
considered to be unrealized at December 31, 2013,
as the inventory is yet to be sold to an external
party
• 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
LO 2
Unrealized Profit in Ending Inventory
Example 4.2
Subsidiary
Dec 31, 2012
Dr Inventory
Cr A/P
Parent
8,000
8,000
January 1, 2013
Dr Cash
10,000
Cr Sales
10,000
Dr Inventory
Cr Cash
10,000
10,000
Dr COGS
8,000
Cr Inventory
8,000
Dr Inc. Tax Exp 600
Cr Curr. Tax Liab.
600
LO 2
Unrealized Profit in Ending Inventory
Example 4.2
Consolidation journal adjustments are required at
Dec 31, 2013 for the following: Note: Transactions (i) and (ii) can be
combined into a single entry as follows:
Sales revenue
10,000 ↓
Cost of sales 10,000 ↓ – 2,000 ↑ = 8,000 ↓
Ending inventory
2,000 ↓
(i) Eliminate intragroup sale
Sales revenue
10,000 ↓
Cost of sales
10,000 ↓
(ii) Eliminate unrealized profit and adjust overstated inventory
Cost of sales
2,000 ↑
Ending inventory
2,000 ↓
From a consolidated viewpoint, there is NO sale, NO COS
(and therefore no profit). In addition, inventory must be
shown at the cost to the group (i.e., $8,000 not $10,000).
(iii) Recognize tax effect of profit elimination
Deferred tax asset
600 ↑
Income tax expense
600 ↓
No profit and therefore no tax expense, from group
viewpoint. In future, when inventory sold by parent the
group will recognize the tax expense.
LO 2
Unrealized Profit in Ending Inventory
Parent
Sub
Adjustments
DR
Statement of Financial
Position (PARTIAL)
Accounts Receivable
Inventory
Statement of
comprehensive income
(PARTIAL)
Sales
Example 4.2
CR
0 10,000
10,000
0
(ii)
2,000
(iii) 600
Deferred Tax Asset
Accounts Payable
Current Tax Liability
Consolidated
Group
10,000
0
600
8,000
600
0
COGS
0
10,000
8,000
Gross profit
Income tax expense
Profit / (Loss) after tax
0
0
0
2,000
600
1,400
???
8,000
???
600
(i)
10,000
(ii)
2,000
0
(i)
10,000
(iii) 600
0
0
0
0
Notes:
1. Inventory is now recorded at the original $8,000 cost to the group.
2. All impacts on the Profit and Loss resulting from the inter-entity sale have been removed.
LO 2
Unrealized Profit in Ending Inventory
Example 4.3
What if the purchaser (i.e., the parent), subsequently
sells some of the inventory to external parties before
the end of the year?
S purchases
inventory for
$8,000 on
Dec 31, 2012
S sells
inventory to P
for $10,000 on
Jan 1, 2013
Subsidiary
Parent
P sells 75% of
the inventory
to external
entities for
$14,000 on
Dec 31, 2013
The journal entries processed by each entity and the
consolidation journal adjustments required are shown
on the following slides.
LO 2
Unrealized Profit in Ending Inventory
Subsidiary
Dec 31, 2012
Dr Inventory
Cr A/P
Example 4.3
Parent
8,000
8,000
January 1, 2013
Dr Cash
10,000
Cr Sales
10,000
Dr COS
8,000
Cr Inventory
8,000
Dr Inc. Tax Exp.
600
Cr Curr. Tax Liab.
600
COS calculated as 75% of the
inventory purchased
(i.e., 75% of $10,000) = $7,500
Dr Inventory
Cr Cash
December 31, 2013
Dr A/R
Cr Sales
10,000
14,000
Dr COS
Cr Inventory
7,500
Dr Income Tax Exp.
Cr Curr. Tax Liab.
1,950
10,000
14,000
7,500
1,950
LO 2
Unrealized Profit in Ending Inventory
Consolidation adjustments are required at Dec 31, Example 4.3
2013 for the following:
As with the previous example,
(i) Eliminate intragroup sale
adjustments (i) and (ii) can be
Sales revenue
10,000 ↓
combined if desired
Cost of sales
10,000 ↓
The WHOLE amount of the sale is eliminated regardless of
the amount subsequently disposed of by the parent.
(ii) Eliminate unrealized profit and adjust overstated inventory
Cost of sales
500 ↑
Ending inventory
500 ↓
From a consolidated viewpoint, the UNREALIZED portion (i.e.,
25% × $2,000) of the profit needs to be eliminated.
(iii) Recognize tax effect of profit elimination
Deferred tax asset
150 ↑
Income tax expense
150 ↓
Note that the increase (debit) is recorded against the
Deferred Tax Asset, not the Current Tax Liability (as was done
in the sub’s books) { = $500 unrealized profit × 30% tax rate }
LO 2
Unrealized Profit in Beginning Inventory
• If inventory is 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 realized when the
inventory is sold to an external party (in the next
financial year).
• As inventory is 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.
LO 2
Unrealized Profit in Beginning Inventory
Example 4.5
Go back to our original example (where all inventory was
still held by the parent at December 31, 2013)
S purchases
inventory for
$8,000 on
Dec 31,
2012
S sells
inventory to P
for $10,000 on
Jan 1, 2013
Subsidiary
Parent
P sells 100%
of the
inventory to
external
entities for
$18,000 on
Dec 31, 2013
LO 2
Unrealized Profit in Beginning Inventory
Example 4.5
•
To carry forward the net effect of last year’s consolidation
journals the following entry would be required on January 1,
Sales, COGS, ITE adjustments closed to R/E
2013 (refer back to slide 7):
Sales revenue
10,000 ↓
Cost of sales
10,000 ↓ – 2,000 ↑ = 8,000 ↓
Ending inventory
2,000 ↓
•
Once the inventory is sold to an external third party (and
the profit therefore realized) the above entry must be
amended to reflect the following for the remainder of the
2013 financial year:
Retained earnings (1/1/2013) 2,500 ↓ – 750 ↑ = 1,750 ↓
Income tax expense
750 ↑
Cost of sales
2,500 ↓
No entry required in future years as the profit has been “realized”. (All accounts will close
to retained earnings).
LO 2
Transfers of Property, Plant, & Equipment
Example 4.7
• Consider the following example
• Parent P purchases plant for $20,000 – the plant has a
useful life of 10 years, P uses straight-line depreciation with
no residual value
• Subsidiary S purchases plant from Parent P for $18,500 on
Jan 1, 2013
• The tax rate is 30%
• The journal entries processed by each entity and
the consolidation journal adjustments required are
shown on the following slides
LO 3
Intragroup Sale of Depreciable Assets
Parent
January 1, 2012
Dr Plant
Cr Cash
Subsidiary
Example 4.7
20,000
20,000
December 31, 2012
Dr Deprec. Exp.
2,000
Cr Accum. Depr.
2,000
January 1, 2013
Dr Cash
18,500
Dr Accum. Depr.
2,000
Cr Plant
20,000
Cr Gain on sale
500
Dr Machine
Cr Cash
18,500
18,500
Dr Income Tax Exp.
150
Cr Curr. Tax Liability
150
LO 3
Intragroup Sale of Depreciable Assets
Example 4.7
Consolidation journal adjustments are required at
Dec 31, 2013 for the following:
(i) Eliminate unrealized profit and reduce asset to group WDV
Gain on sale of plant
↓ 500
Cost of sales
↓ 500
(ii) Recognize tax effect of profit elimination
Deferred tax asset
↑ 150 (30% × $500)
Income tax expense
↓ 150
Note that the increase (debit) is recorded against the
Deferred Tax Asset, not the Current Tax Liability (as was
done in the sub’s books)
LO 3
Intragroup Services
Example 4.8
• Quite often in a group, one entity (normally the
parent) provides services (such as accounting, HR,
IT) to the other entities (normally the subsidiaries) to
reduce duplication.
• Example: During 2013, P offered the services of a
specialist employee to S for two months, in return
for which S paid $30,000 to P. The journal entries in
the records of P and S in relation to this transaction
are: be eliminated on consolidation as follows:
Company P
DR Cash
CR Service revenue
30,000
Company S
DR Service expense
CR Cash
30,000
30,000
30,000
LO 4
Intragroup Services
Example 4.8
• From the group’s perspective there has been no
service revenue received or service revenue
expense made to entities external to the group.
Hence, to adjust to adjust from what has been
recorded by the legal entities to the group’s
perspective, the consolidation adjustment is:
Service revenue
↓ 30,000
Service expense
↓ 30,000
• If payable/receivable balances also exist, these
balances must be eliminated on consolidation.
LO 4
Intragroup Dividends
Assumptions:
• All dividends received by the parent from
the subsidiary are accounted for as
revenue by the parent since the parent has
been recording its investment using the
cost method on its own non-consolidated
financial statements.
• It is assumed that the company expecting
to receive the dividend recognizes revenue
when the dividend is declared.
LO 5
Intragroup Services
Dividends Declared in the Current Period but Not Paid
Example: Assume that, on December 31, 2013, S declares a dividend of
$4,000. At the end of the period, the dividend is unpaid. The journal
entries recorded by the legal entities are:
Journal Entry in S
DR Dividend Declared 4,000
CR Dividend Payable 4,000
Journal Entry in P
DR Dividend Receivable 4,000
CR Dividend Revenue
4,000
The consolidation adjustments are:
Dividend payable
↓ 4,000
Dividend declared
↓ 4,000
(To adjust for the effects of the adjustment made by S)
Dividend revenue
↓ 4,000
Dividend receivable ↓ 4,000
(To adjust for the effects of the adjustment made by P)
From the group’s perspective, there is no reduction in equity and the
group has no obligation to pay dividends outside the group. Similarly,
the group expects no dividends to be received from entities outside the
group.
LO 5
Intragroup Services
Dividends Declared and Paid in the Current Period
Example: Assume S declares and pays an interim dividend of
$4,000 in the current period. Entries by the legal entities are:
Journal Entry in S
DR Dividend Paid
CR Cash
Journal Entry in P
4,000
4,000
DR Cash
4,000
CR Dividend Revenue
4,000
The consolidation adjustments are:
Dividend revenue
Dividend declared and paid
↓ 4,000
↓ 4,000
From the group’s perspective, no dividends have been paid
and no dividend revenue has been received.
LO 5
Intragroup Borrowings
• Members of a group often borrow and lend
money among themselves and charge
interest on the money borrowed.
• Consolidation adjustments are necessary in
relation to these intragroup borrowings and
interest thereon because, from the stance
of the group, these transactions create
assets and liabilities and revenues and
expenses that do not exist in terms of the
group’s relationship with external entities.
LO 6
Intragroup Borrowings
Intragroup Advances with Interest
Example: P lends $100,000 to S, with S paying $15,000 interest to P. The
relevant journal entries in each of the legal entities are:
Journal Entry in P
Journal Entry in S
DR Advance to S
100,000
DR Cash
100,000
CR Cash
100,000
CR Advance from P
100,000
DR Cash
15,000
DR Interest Expense
15,000
CR Interest Revenue
15,000
CR Cash
15,000
The consolidation adjustments are:
Advances from P
↓ 100,000
Advances to S
↓ 100,000
Interest revenue
↓ 15,000
Interest expense
↓ 15,000
From the group’s perspective, The adjustment to the asset and
liability is necessary as long as the intragroup loan exists. In relation
to any past period’s payments and receipt of interest, no ongoing
adjustment to accumulated profits (opening balance) is necessary
as the net effect of the consolidation adjustment is zero on that
item. There are no tax effects since the effect on consolidated net
assets is zero.
LO 6
Intragroup Borrowings
Intragroup Bonds Acquired at Date of Issue
Example: On July 1, 2013, P issues 1,000 $100 bonds with an interest rate
of 5% p.a. payable on July 1 of each year. S, a wholly owned
subsidiary of P, acquires half the bonds issued.
Journal Entry in P
DR Cash
100,000
CR Bonds
100,000
DR Interest Expense
2,500
CR Interest Payable 2,500
Journal Entry in S
DR Bonds in P
50,000
CR Cash
50,000
DR Interest Receivable 1,250
CR Interest Revenue
1,250
The consolidation adjustments are:
Bonds
↓ 50,000
Bond investment
↓ 100,000
Interest receivable
↓ 1,250
Interest payable
↓ 1,250
Interest revenue
↓ 1,250
Interest expense
↓ 1,250
From the group’s perspective, the group has now retired the portion
of the bonds that are part of the intragroup borrowings. There are
no tax effects since the effect on consolidated net assets is zero.
LO 6
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