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Chapter 28

Further consolidation
issues I: Accounting for
intragroup transactions

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PPTs to accompany Deegan, Australian Financial Accounting 7e
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Objectives of this lecture
• Understand the nature of intragroup transactions
• Understand how and why to eliminate intragroup
dividends on consolidation
• Understand how to account for intragroup sales of
inventory inclusive of the related tax expense effects
• Understand how to account for intragroup sales of
non-current assets inclusive of the related tax
expense effects

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Introduction to accounting for
intragroup transactions
Overview
• During a financial period it is common for separate legal entities
within an economic entity to transact with each other
• In preparing consolidated financial statements, the effects of all
transactions between entities within the economic entity are
eliminated in full, even where the parent entity holds only a
fraction of the issued equity.
• Examples of intragroup transactions
• Consolidation adjustments for intragroup transactions:
– Typically eliminate these transactions by reversing the original accounting
entries
– Such eliminations can also introduce temporary tax differences into the
consolidated financial statements

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Dividend payments from pre- and
post-acquisition earnings
Dividend payments
• In the consolidation process it is necessary to eliminate:
– all dividends paid/payable to other entities within the group
– all dividends received/receivable from other entities within
the group
• Only dividends paid externally should be shown in the
consolidated financial statements
AASB 10 requires that:
• on consolidation of intragroup balances, transactions, income
and expenses are all to be eliminated in full
Refer to Worked Example 28.1 on pp. 922–924—Dividend payments to a
subsidiary out of post-acquisition earnings

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Dividend payments out of pre- and
post-acquisition earnings (cont.)
Dividends out of pre-acquisition profits
• If an entity pays dividends out of profits earned before
acquisition, it is effectively returning part of the net assets
originally acquired (return of part of investment in
subsidiary)
• In 2008 the above treatment was changed and now
dividends paid by a subsidiary are to be recorded as
dividend revenue in the parent entity’s accounts
AASB 127 Separate Financial Statements now states:
An entity shall recognise a dividend from a subsidiary, jointly
controlled entity or associate in profit or loss in its separate
financial statements when its right to receive the dividend is
established

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Dividends paid from pre-acquisition
earnings of the investee
• If a dividend payment is made out of pre-acquisition profits of
the subsidiary then this in itself may have implications for the
value of the parent’s investment in the subsidiary.
• The dividend payment will have the effect of reducing the net
assets of the subsidiary. This in turn might provide an indication
that the parent entity’s investment in the subsidiary may
thereafter have a value that may be below the original cost of
the investment.
• If an impairment loss is recognised in the accounts of the parent
entity then that impairment loss would be reversed as a
consolidation adjustment prior to the consolidation entry that
eliminates the parent’s investment in a subsidiary....

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Intragroup sale of inventory
• From the group’s perspective, revenue should not be
recognised until inventory is sold to parties outside the group
• We will need to eliminate any unrealised profits from the
consolidated financial statements
• Unrealised profits result from inventory, which is sold within
the group for a profit, remaining on hand within the group at
the end of the reporting period
As we know, AASB 10 requires:
Consolidated financial statements eliminate in full intragroup assets
and liabilities, equity, income, expenses and cash flows 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).

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Intragroup sale of inventory (cont.)
• Each member of a group is typically taxed individually
on its income, not the group collectively
• If tax has been paid by one member of the group, from
the group’s perspective this represents a prepayment of
tax (deferred tax asset) to the extent that the inventory
remains within the group (meaning that the related profit
is unrealised from the perspective of the economic
entity)
• This income will not be earned by the economic
entity until the inventory is sold outside the group

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Intragroup sale of inventory (cont.)

Journal entry to eliminate inter-company sales


• To eliminate total intragroup sales as no sales
have occurred from perspective of group
Dr Sales x
Cr Cost of goods sold (perpetual) or x
purchases (periodic)

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Intragroup sale of inventory (cont.)

Journal entry to eliminate unrealised profit in closing stock


Accounting Standards require that inventory must be valued
at the lower of cost and net realisable value. Therefore, on
consolidation we must reduce the value of closing inventory to
its cost to the economic entity.
Dr Cost of goods sold (perpetual) or x
closing inventory—(periodic)
Cr Inventory x

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Intragroup sale of inventory (cont.)

Consideration of tax paid on intragroup sale of inventory


Any tax paid by members of the group related to intragroup
sales where full amount of revenue has not been earned from
the group’s perspective, effectively represents a prepayment
of tax. The adjusting consolidation entry would be:

Dr Deferred tax asset x


Cr Income tax expense x

Refer to Worked Example 28.3 on p. 930—Unrealised profit


in closing inventory
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PPTs to accompany Deegan, Australian Financial Accounting 7e
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Intragroup sale of inventory (cont.)
Unrealised profit in opening inventory
• If there have been intragroup sales in the
previous period, and some of the inventory is still
on hand at the previous year end, then the cost
of opening inventory held by one of the entities
within the group will be overstated from the
group’s perspective
• In the consolidation journal entries we need to
shift income from the previous period, in which
inventory was still on hand, to the period in which
the inventory is ultimately sold to external parties

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PPTs to accompany Deegan, Australian Financial Accounting 7e
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Intragroup sale of inventory (cont.)
Unrealised profit in opening inventory (cont.)

Consolidation entries: Unrealised profits in opening inventory

Reducing opening inventory reduces cost of goods sold


Dr Opening retained earnings x
Cr Cost of goods sold x

Higher profits lead to higher tax expense—and remember from


an accounting perspective, tax expense is based on accounting
profit
Dr Income tax expense x
Cr Opening retained earnings x

Consider Worked Example 28.4 (pp. 936–38)—Unrealised profit in


opening inventory

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PPTs to accompany Deegan, Australian Financial Accounting 7e
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Sale of non-current assets within
the group
• Assets of the group need to be valued as if the
intragroup sale had not occurred

• Need to reinstate the non-current asset to the


original cost or revalued amount
– Eliminate any unrealised profits on sale
– Adjust depreciation
– There may be tax on profit of sale, which will represent a
temporary difference in the consolidated financial
statements

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Sale of non-current assets within the
group (cont.)
Consolidation journal entries to eliminate sale of non-
current asset
Reversing gain and reinstating accumulated depreciation
Dr Gain on sale x
Dr Asset x
Cr Accumulated depreciation x

Recognising deferred tax asset


Dr Deferred tax asset x
Cr Income tax expense x

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Sale of non-current assets within the
group (cont.)
Consolidation journal entries to eliminate sale of non-
current asset (cont.)
Adjusting depreciation to reflect correct amount
Dr Accumulated depreciation x
Cr Depreciation expense x

Partially reversing deferred tax asset to reflect depreciation


adjustment
Dr Income tax expense x
Cr Deferred tax asset x
Refer to Worked Example 28.5 on pp. 939–42—Intragroup sale
of a non-current asset

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PPTs to accompany Deegan, Australian Financial Accounting 7e
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Summary
• The lecture considered the consolidation process and,
in particular, how to account for intragroup transactions
• Only dividends paid externally should be shown in the
consolidated financial statements—intragroup dividends
paid by one entity within the group are to be offset
against the dividend revenue recorded in other entity
• Within the consolidation worksheet, the liability
associated with dividends payable is to be offset
against dividend receivable
• Where intragroup sales of inventory have taken place
and inventory remains on hand at year end,
consolidation adjustments are required to reduce the
consolidated balance of closing inventory

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Summary (cont.)

• Where there is sale of non-current assets within


the group, consolidation adjustments are required
to eliminate any intragroup profit on sale and to
adjust the cost of the asset to reflect the cost of the
asset to the economic entity—this may also require
adjustments to depreciation expense
• If there are non-controlling interests, the effect of
intragroup transactions will be still eliminated in full
even though the parent entity might hold only a
proportion of the capital of the respective
subsidiaries

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