Chapter 4 Chapter 4 Consolidatio Consolidatio n: n: Intragroup Intragroup Transactions Transactions © 2013 Advanced Accounting, Canadian Edition by G. Fayerman
Dec 28, 2015
Chapter 4Chapter 4
Consolidation: Consolidation: Intragroup Intragroup
TransactionsTransactions
© 2013 Advanced Accounting, Canadian Edition by G. Fayerman
The Consolidation ProcessThe Consolidation ProcessTwo 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 pre-acquisition equity of the subsidiary (see Chapter 3).
•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).
acquisition date fair value adjustmentsacquisition date fair value adjustments
eliminate intragroup balances and transactions arising when members of the group trade with each other
LO 1
Rationale for Adjusting for Rationale for Adjusting for Intragroup TransactionsIntragroup 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
Subsidiary
ParentS purchases inventory for
$8,000 on Dec 31, 2012
S sells inventory to P for $10,000 on
Jan 1, 2013 All inventory still held by the parent at Dec
31, 2012
Example 4.2
LO 2
Transfers of InventoryTransfers of Inventory• The broad effect of intragroup sales and
purchases of inventory can be illustrated by reference to the diagram below
• 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
Example 4.2
LO 2
Unrealized Profit in Ending InventoryUnrealized Profit in Ending Inventory
Subsidiary ParentDec 31, 2012Dr Inventory 8,000
Cr A/P 8,000
January 1, 2013Dr Cash 10,000 Dr Inventory 10,000
Cr Sales 10,000 Cr Cash 10,000
Dr COGS 8,000Cr Inventory 8,000
Dr Inc. Tax Exp 600Cr Curr. Tax Liab. 600
Example 4.2
LO 2
Unrealized Profit in Ending InventoryUnrealized Profit in Ending Inventory
(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 eliminationDeferred 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.
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 ↓
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 ↓
Example 4.2
LO 2
Unrealized Profit in Ending InventoryUnrealized Profit in Ending Inventory
Unrealized Profit in Ending InventoryUnrealized Profit in Ending Inventory Parent Sub Adjustments Consolidated
Group DR CR
Statement of Financial Position (PARTIAL)
-
Accounts Receivable 0 10,000 ???
Inventory 10,000 0 (ii)
2,000 8,000
Deferred Tax Asset (iii) 600 600
Accounts Payable 10,000 8,000 ??? Current Tax Liability 0 600 600 Statement of comprehensive income (PARTIAL)
Sales 0 10,000
(i) 10,000
0
COGS 0 8,000 (ii) 2,000
(i) 10,000
0
Gross profit 0 2,000 0 Income tax expense 0 600 (iii) 600 0
Profit / (Loss) after tax 0 1,400 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.
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.
Example 4.2
LO 2
What if the purchaser (i.e., the parent), subsequently sells some of the inventory to external parties before the end of the year?
Subsidiary
ParentS purchases inventory for $8,000 on
Dec 31, 2012
S sells inventory to P for $10,000 on
Jan 1, 2013
The journal entries processed by each entity and the consolidation journal adjustments required are shown on the following slides.
P sells 75% of the inventory to external entities for $14,000 on
Dec 31, 2013
Example 4.3
LO 2
Unrealized Profit in Ending InventoryUnrealized Profit in Ending Inventory
Subsidiary ParentDec 31, 2012
Dr Inventory 8,000Cr A/P 8,000
January 1, 2013Dr Cash 10,000 Dr Inventory 10,000
Cr Sales 10,000 Cr Cash 10,000 Dr COS 8,000
Cr Inventory 8,000Dr Inc. Tax Exp. 600
Cr Curr. Tax Liab. 600December 31, 2013Dr A/R 14,000
Cr Sales 14,000
Dr COS 7,500Cr Inventory 7,500
Dr Income Tax Exp. 1,950Cr Curr. Tax Liab.
1,950
COS calculated as 75% of the inventory purchased (i.e., 75% of $10,000) = $7,500
Example 4.3
LO 2
Unrealized Profit in Ending InventoryUnrealized Profit in Ending Inventory
(i) Eliminate intragroup sale Sales revenue 10,000 ↓ 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 }
Consolidation adjustments are required at Dec 31, 2013 for the following:
As with the previous example, adjustments (i) and (ii) can be combined if desired
As with the previous example, adjustments (i) and (ii) can be combined if desired
Example 4.3
LO 2
Unrealized Profit in Ending InventoryUnrealized Profit in Ending 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 InventoryUnrealized Profit in Beginning Inventory
Go back to our original example (where all inventory was still held by the parent at December 31, 2013)
Subsidiary
Parent
S purchases inventory for $8,000 on Dec 31,
2012
S sells inventory to P for $10,000 on
Jan 1, 2013 P sells 100% of the
inventory to external
entities for $18,000 on
Dec 31, 2013
Example 4.5
LO 2
Unrealized Profit in Beginning InventoryUnrealized Profit in Beginning Inventory
• To carry forward the net effect of last year’s consolidation journals the following entry would be required on January 1, 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 ↓
Sales, COGS, ITE adjustments closed to R/E
Sales, COGS, ITE adjustments closed to R/E
No entry required in future years as the profit has been “realized”. (All accounts will close to retained earnings).
No entry required in future years as the profit has been “realized”. (All accounts will close to retained earnings).
Example 4.5
LO 2
Unrealized Profit in Beginning InventoryUnrealized Profit in Beginning Inventory
• 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
Example 4.7
Transfers of Property, Plant, & EquipmentTransfers of Property, Plant, & Equipment
Parent SubsidiaryJanuary 1, 2012
Dr Plant 20,000Cr Cash 20,000
December 31, 2012Dr Deprec. Exp. 2,000
Cr Accum. Depr. 2,000
January 1, 2013Dr Cash 18,500 Dr Machine 18,500Dr Accum. Depr. 2,000 Cr Cash
18,500Cr Plant 20,000Cr Gain on sale 500
Dr Income Tax Exp. 150Cr Curr. Tax Liability 150
LO 3
Example 4.7
Intragroup Sale of Depreciable AssetsIntragroup Sale of Depreciable Assets
(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)
Consolidation journal adjustments are required at Dec 31, 2013 for the following:
LO 3
Example 4.7
Intragroup Sale of Depreciable AssetsIntragroup Sale of Depreciable Assets
• 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 30,000
CR Service revenue 30,000
Company S DR Service expense 30,000
CR Cash 30,000 LO 4
Example 4.8
Intragroup ServicesIntragroup Services
• 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
Example 4.8
Intragroup ServicesIntragroup Services
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 DividendsIntragroup Dividends
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 Journal Entry in PDR Dividend Declared 4,000 DR Dividend Receivable 4,000
CR Dividend Payable 4,000 CR Dividend Revenue 4,000
The consolidation adjustments are:Dividend payable ↓ 4,000Dividend declared ↓ 4,000(To adjust for the effects of the adjustment made by S)Dividend revenue ↓ 4,000Dividend 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 ServicesIntragroup 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 Journal Entry in PDR Dividend Paid 4,000DR Cash 4,000
CR Cash 4,000 CR Dividend Revenue 4,000
The consolidation adjustments are:Dividend revenue ↓ 4,000Dividend declared and paid ↓ 4,000
From the group’s perspective, no dividends have been paid and no dividend revenue has been received.
LO 5
Intragroup ServicesIntragroup Services
• 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 BorrowingsIntragroup 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 SDR Advance to S 100,000 DR Cash 100,000
CR Cash 100,000 CR Advance from P 100,000DR Cash 15,000 DR Interest Expense 15,000
CR Interest Revenue 15,000 CR Cash 15,000
The consolidation adjustments are:Advances from P ↓ 100,000Advances to S ↓ 100,000Interest revenue ↓ 15,000Interest 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 BorrowingsIntragroup 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 Journal Entry in SDR Cash 100,000 DR Bonds in P 50,000
CR Bonds 100,000 CR Cash 50,000DR Interest Expense 2,500 DR Interest Receivable 1,250
CR Interest Payable 2,500 CR Interest Revenue 1,250
The consolidation adjustments are:Bonds ↓ 50,000Bond investment ↓ 100,000Interest receivable ↓ 1,250Interest payable ↓ 1,250Interest revenue ↓ 1,250Interest 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
Intragroup BorrowingsIntragroup Borrowings
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