Deegan6e ch29

Chapter 29
Further consolidation
issues I: Accounting for
intragroup transactions
Copyright 2010 McGraw-Hill Australia Pty Ltd

PPTs to accompany Deegan, Australian Financial Accounting 6e
29-1
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

29-2
Introduction to accounting for

consolidation issues
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. Specifically, paragraph 20 of AASB
127 states in relation to the consolidation process that:
Intragroup balances, transactions, income and expenses
shall be eliminated in full

29-3
Introduction to accounting for

consolidation issues (cont.)
Examples of intragroup transactions
Payment of dividends to group members
Payment of management fees to a group member
Intragroup sales of inventory
Intragroup sales of non-current assets
Intragroup loans
Consolidation adjustments for intragroup transactions
Typically eliminate these transactions by reversing the original

accounting entries made to recognise the transactions in the
separate legal entities

29-4
Dividend payments from pre- and postacquisition 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 127 requires that:
on consolidation of intragroup balances, transactions, income
and expenses are all to be eliminated in full

29-5
Dividend payments pre- and postacquisition (cont.)

Dividends paid from post-acquisition profits
Only dividends paid externally should be shown in the consolidated
financial statements
Journal entry to eliminate dividends payable (in consolidation journal)
Dr Dividends payable (statement of financial position)

Cr
Dividends declared (statement of changes in equity)
Journal entry to eliminate dividends receivable (in consolidation
journal)
Dr Dividend income (statement of comprehensive income)

Cr
Dividend receivable (statement of financial position)

29-6
Dividend payments pre- and postacquisition (cont.)

Note
Consolidation journal entries are not written in the
journals of either company but are entered in a
separate consolidation journal
Refer to Worked Example 29.1 on pp. 900-902
Dividend payments to a subsidiary out of postacquisition earnings

29-7
Worked Example 29.2Dividend payments to a subsidiary out

of post-acquisition earnings
Company A acquired all the issued capital of Company B on 1
July 2011 for a cost of $800 000. The share capital and
reserves of Company B on the date of acquisition are:
Share capital
Retained earnings
$500 000
$300 000
$800 000
Dividends of $50 000 paid by Company B come from profits

earned since 1 July 2011
It is considered that the assets of Company B are fairly stated
at the date that Company A acquires its shares
Company A recognises dividend income when it is declared by
the investee
The financial statements of Company A and Company B as at
30 June 2012 (one year later) reveal the following:

29-8
Worked Example 29.2Dividend payments to a subsidiary out of

post-acquisition earnings (cont.)
Company A Company B
($000) ($000)
Reconciliation of opening and closing retained earnings

Profit before tax
Tax expense
Profit after tax
Opening retained earnings1 July 2011
less Dividends declared
Closing retained earnings30 June 2012
200 100
50 40
150 60
400 300
550 360
70 50
480 310
Statement of financial position

Shareholders funds
Retained earnings
Share capital
480 310
500 500
Liabilities
Accounts payable
Dividends payable
Assets
Cash
Accounts receivable
Dividends receivable
Inventory
Plant and equipment
Investment in Company B

1 000 100
70 50
2 050 960
100 70
50 130
50
200 160
850 600
800
2 050 960
29-9
Worked Example 29.2Solution

In relation to recognising the dividends, the entry in Company Bs own
journal would be:
Dr Dividend declared (statement of changes in equity)
50 000
Cr Dividend payable (statement of financial position)
50 000
As Company A recognises dividend income when the dividend is declared
by the investee, it would have the following entry in its own journal:
Dr Dividend receivable (statement of financial position) 50 000
Cr Dividend income (statement of comprehensive income)
50 000
We need to know the entries the individual entities made (above) so that
we can reverse them on consolidation

29-10
Worked Example 29.2Solution (cont.)

Elimination entry for dividends declared by Company B
Dr Dividend payable (statement of financial position) 50 000
Cr Dividend declared (statement of changes in equity)
50 000
Elimination entry for dividends receivable by Company A

Dr Dividend income (statement of comprehensive
income)
50 000
Cr Dividend receivable (statement of financial position)
50 000
Consolidation entry to eliminate investment in Company B

Dr Share capital
500 000
Dr Retained earnings
300 000
Cr Investment in Company B
800 000

29-11

Reconciliation of opening and
closing retained earnings
Profit before tax
Tax expense
Profit after tax
Opening retained earnings
less Dividends declared
Closing retained earnings
Statement of financial position
Shareholders funds
Retained earnings
Share capital
Liabilities
Accounts payable
Dividends payable
Assets
Cash
Accounts receivable
Dividends receivable
Inventory
Plant and equipment
Investment in Company B
Company A
($000)
Company B
($000)
Dr
($000)
Cr Consolidated
($000)
($000)
200
50
150
400
550
70
480
100
40
60
300
360
50
310
50(b)
250
90
160
400
560
70
490
480
500
310
500
1 000
70
2 050
100
50
960
100
50
50
200
850
800
2 050
70
130
160
600
960

300(c)
50(a)
490
500
500(c)
1 100
70
2 160
50(a)
50(b)
900
800(c)
900
170
180
360
1 450
2 160
29-12
Dividend payments pre- and

post-acquisition (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)
The traditional treatment was for the pre-acquisition
dividends not to be treated as revenue, but rather as a
return of part of the initial investment (this seemed logical)

29-13

Dividends out of pre-acquisition profits (cont.)
In 2008 the above treatment was changed and now dividends
paid by a subsidiary are to be recorded as dividend revenue in the
parent entitys accounts, regardless of whether they are paid out
of:
(a) pre-acquisition profits/equity (that is, paid out of
profits earned by the subsidiary prior to the
purchase by the parent of the interest in the
subsidiary), or
(b) post-acquisition profits/equity (that is, paid out of
profits earned by the subsidiary after the purchase
by the parent entity of the interest in the
subsidiary)

29-14

AASB 127 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

29-15
Intragroup sale of inventory
From the groups 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 period
AASB 127 (par. 21)
Intragroup balances and transactions, including income,
expenses and dividends, are eliminated in full. Profits
and losses resulting from intragroup transactions that are
recognised in assets, such as inventory and fixed assets,
are eliminated in full

29-16
Illustration of intragroup sale of inventory

Let us assume that Company A controls Company B
and:
Company A sells $200 000 of inventory to Company B
(see diagram next page)
Company B in turn sells the inventory to an external
organisation, Company C, for $350 000
What total amount of sales should be recorded in the
consolidated financial statements?
(Hint: What amount of sales was actually made to
parties external to the group?)

29-17

29-18
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 groups 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

29-19

Journal entry to eliminate inter-company sales
To eliminate total intragroup sales as no sales have
occurred from perspective of group
Dr
Sales
Cr
Cost of goods sold (perpetual) or

purchases (periodic)

29-20

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
closing inventory(periodic)
Cr
Inventory

29-21

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 groups perspective, effectively
represents a prepayment of tax. The adjusting
consolidation entry would be:
Dr Deferred tax asset
Cr
Income tax expense
Refer to Worked Example 29.3 on p. 908Unrealised profit

in closing inventory

29-22
Worked Example 29.3Unrealised profit in

closing inventory
Big Ltd owns 100% of the shares of Little Ltd
These shares are acquired on 1 July 2011
During the 2012 financial year, Little Ltd sells inventory to
Big Ltd at a sales price of $200 000. The inventory cost
Little Ltd $120 000 to produce
At 30 June 2012 half of the stock is still on hand with Big
Ltd. The tax rate is assumed to be 33%

29-23
Worked Example 29.3Unrealised profit in

closing inventoryConsolidation entries
Elimination of intragroup sales
We need to eliminate the intragroup sales because, from the perspective
of the economic entity, no sales have in fact occurred. This will ensure
that we do not overstate the turnover of the economic entity
Dr
Sales
200 000
Cr
Cost of goods sold
200 000
Elimination of unrealised profit in closing inventory
The total profit earned by Little Ltd on the sale of the inventory is
$80 000
Since some of this inventory remains in the economic entity, this amount
has not been fully earned from the perspective of the group. In this case,
half of the inventory is still on hand, so unrealised profit amounts to
$40 000. In accordance with AASB 102 Inventories, we must value the
inventory at the lower of cost and net realisable value
Dr
Cost of goods sold
40 000
Cr
Inventory
40 000

29-24
Worked Example 29.3Unrealised profit in closing

inventoryConsolidation entries (cont.)
Consideration of the tax paid on the sale of inventory that is
still held within the group
From the groups perspective, $40 000 has not been earned.
However, from Little Ltds individual perspective (as a separate
legal entity), the full amount of the sale has been earned
This will attract a tax liability in Little Ltds accounts of $26 400
(33% of $80 000)
However, from the groups perspective, some of this will represent
a prepayment of tax as the full amount has not been earned by the
group even if Little Ltd is obliged to pay the tax
Dr
Deferred tax asset 13 200
Cr
Income tax expense 13 200
($40000 33%)

29-25

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 groups
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

29-26

Unrealised profit in opening inventory (cont.)
Consolidation entries: Unrealised profits in opening inventory
Reducing opening inventory reduces cost of goods sold
Dr
Cr
Cost of goods sold
Higher profits lead to higher tax expense
Dr
Income tax expense
Cr
Consider Worked Example 29.4 (pp. 91416)Unrealised profit
in opening inventory

29-27
Worked Example 29.4Unrealised profit in opening inventory

This worked example is a continuation of Worked Example 29.3.
Eliminating unrealised profit in opening inventory
From the previous example we know that there were unrealised profits in closing
inventory in the previous financial period
Therefore, in the consolidation adjustments of the current period we need to shift
the income from the previous period, in which the inventory was still on hand, to
the period in which the inventory will ultimately be sold to parties external to the
economic entity
The effect of reducing cost of goods sold is to increase consolidated profits in the
current year
Dr
Opening retained earnings1 July 2012
40 000
Cr
Cost of goods sold
40 000
Consideration of the tax on the sale of inventory held within the group at the
beginning of the reporting period
Reducing the value of opening inventory will reduce the cost of goods sold. This
entry will effectively shift the income from 2012 to 2013
Higher profits will lead to a higher tax expense, which is based upon accounting
profits
Dr
Income tax expense
13 200
Cr
Retained earnings1 July 2012
13 200

29-28
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

29-29
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
Dr
Asset
Cr
Accumulated depreciation
Recognising deferred tax asset

Dr
Deferred tax asset

Cr
Income tax expense

29-30
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
Cr
Depreciation expense
Partially reversing deferred tax asset to reflect depreciation

adjustment
Dr
Income tax expense

Cr
Deferred tax asset
Refer to Worked Example 29.5 on pp. 91720 Intragroup sale

of a non-current asset

29-31
Worked Example 29.5Intragroup sale of a non-current

asset
On 1 July 2011 Eddie Ltd acquired a 100% interest in
Sandy Ltd
On 1 July 2011 Eddie Ltd sells an item of plant to Sandy
Ltd for $780 000
This plant cost Eddie Ltd $1 million, is four years old and
has accumulated depreciation of $400 000 at the date of
the sale
The remaining useful life of the plant is assessed as six
years
The tax rate is 30%

29-32
Worked Example 29.5Solution

The result of the sale of the item of plant to Sandy Ltd is that the
gain of $180 000the difference between the sales proceeds of
$780 000 and the carrying amount of $600 000will be shown in
Eddie Ltds financial statements
However, from the economic entitys perspective there has been
no sale and therefore no gain on sale given that there has
been no transaction with a party external to the group
The following entry is necessary so that the financial statements
will reflect the balances that would have applied had the
intragroup sale not occurred
Dr
Dr
Cr
Gain on sale of plant

Plant
180 000
220 000
400 000
The result of this entry is that the intragroup gain is removed and
the asset and accumulated depreciation accounts revert to
reflecting the situation had no sales transaction occurred

29-33

Impact of tax on gain on sale of item of plant
From Eddie Ltds individual perspective it would have made a gain of $180
000 on the sale of the plant and this gain would have been taxable
At a tax rate of 30%, $54 000 would be payable in tax by Eddie Ltd and
$54 000 would similarly have been included in the income tax expense
account
However, from the economic entitys perspective, no gain has been made,
which means that the related tax expense must be reversed and a related
deferred tax benefit recognised
Dr Deferred tax asset
54 000
Cr Income tax expense
54 000
Reinstating accumulated depreciation in the statement of financial
position
Sandy Ltd would be depreciating the asset on the basis of the cost it
incurred to acquire the asset. Its depreciation charge would be
$780 000 6 = $130 000
From the economic entitys perspective, the asset had a carrying value of
$600 000, which was to be allocated over the next six years, giving a
depreciation charge of $600 000 6 = $100 000. An adjustment of
30
000 is therefore required
Dr Accumulated depreciation
30 000
Cr Depreciation expense
30 000

29-34

Consideration of the tax effect of the reduction in
depreciation expense
The increase in the tax expense from the perspective of the
economic entity is due to the reduction in the depreciation
expense
The additional tax expense is $9000, which is $30 000 30%
This entry represents a partial reversal of the deferred tax asset
of $54 000 recognised in the earlier entry. After six years the
balance of the deferred tax asset relating to the sale of the item of
plant will be $nil
Dr
Cr
000
Income tax expense

Deferred tax asset

9 000
9
29-35
Summary
The lecture considered the consolidation process and, in
particular, how to account for intragroup transactions (e.g.
dividend payments, sales of inventory, sales of non-current
assets)
Only dividends paid externally should be shown in the
consolidated financial statementsintragroup 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 (as recorded by other entities within the group)
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 (inventory is to be valued at lower of cost
and net realisable value from the groups perspective)

29-36
Summary
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 entitythis 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

29-37

Deegan6e ch29

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Chapter 29

Copyright 2010 McGraw-Hill Australia Pty Ltd

Objectives of this lecture

Copyright 2010 McGraw-Hill Australia Pty Ltd

Introduction to accounting for

Copyright 2010 McGraw-Hill Australia Pty Ltd

Introduction to accounting for

Payment of dividends to group members

Payment of management fees to a group member

Intragroup sales of inventory

Intragroup sales of non-current assets

Consolidation adjustments for intragroup transactions

Typically eliminate these transactions by reversing the original

Copyright 2010 McGraw-Hill Australia Pty Ltd

Dividend payments from pre- and postacquisition earnings

In the consolidation process it is necessary to eliminate:

Copyright 2010 McGraw-Hill Australia Pty Ltd

Dividend payments pre- and postacquisition (cont.)

Dr Dividends payable (statement of financial position)

Dr Dividend income (statement of comprehensive income)

Copyright 2010 McGraw-Hill Australia Pty Ltd

Dividend payments pre- and postacquisition (cont.)

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 29.2Dividend payments to a subsidiary out

Dividends of $50 000 paid by Company B come from profits

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 29.2Dividend payments to a subsidiary out of

Reconciliation of opening and closing retained earnings

Statement of financial position

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Worked Example 29.2Solution

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Worked Example 29.2Solution (cont.)

Elimination entry for dividends receivable by Company A

Consolidation entry to eliminate investment in Company B

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Worked Example 29.2Solution (cont.)

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Dividend payments pre- and

If an entity pays dividends out of profits earned before

Copyright 2010 McGraw-Hill Australia Pty Ltd

Dividend payments pre- and

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Dividend payments pre- and

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Intragroup sale of inventory

From the groups perspective, revenue should not be

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Illustration of intragroup sale of inventory

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Copyright 2010 McGraw-Hill Australia Pty Ltd

Intragroup sale of inventory (cont.)

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Intragroup sale of inventory (cont.)

Cost of goods sold (perpetual) or

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Intragroup sale of inventory (cont.)

Copyright 2010 McGraw-Hill Australia Pty Ltd

Intragroup sale of inventory (cont.)

Income tax expense

Refer to Worked Example 29.3 on p. 908Unrealised profit

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Worked Example 29.3Unrealised profit in