Document classification: Internal ACCM4300 FINANCIAL REPORTING Workshop 10 : Consolidation : Intragroup Transactions (AASB10) WARNING This material has been reproduced and communicated to you by or on behalf of Kaplan Business School pursuant to Section 113P of the Copyright Act 1968 (Act). This material in this communication may be subject to copyright under the Act. Any further reproduction or communication of this material by you may be the subject of copyright protection under the Act. Do not remove this notice. Unless otherwise specifically referenced, material in this slide deck has been adopted from Financial reporting in Australia / Janice Loftus, Ken Leo, Sorin Daniliuc, Noel Boys, Belinda Luke, Hong Ang, Karyn Byrnes. Second edition. John Wiley & Sons Australia, Ltd; Leo, K, Knapp, J, McGowan, S, Sweeting, J & Meng, L, Company Accounting, 12th edition, John Wiley & Sons Australia, Ltd, Queensland. . Prepared by © Kaplan Business School Document classification: Internal Learning objectives After this workshop you should be able to: 1. Justify the need for adjusting for intragroup transactions 2. Determine worksheet entries for intragroup transactions involving profits and losses in inventories 3. Determine worksheet entries for intragroup transactions involving profits and losses on the transfer of property, plant and equipment 4. Construct the worksheet entries for intragroup services 5. Construct the worksheet entries for intragroup dividends Document classification: Internal Learning objectives After this workshop you should be able to: 1. Justify the need for adjusting for intragroup transactions 2. Determine worksheet entries for intragroup transactions involving profits and losses in inventories 3. Determine worksheet entries for intragroup transactions involving profits and losses on the transfer of property, plant and equipment 4. Construct the worksheet entries for intragroup services 5. Construct the worksheet entries for intragroup dividends Document classification: Internal Introduction • In this workshop, the group under discussion is restricted to one where: ̶ There are only two entities within the group (i.e. one parent and one subsidiary) ̶ The parent owns all the shares of the subsidiary. (Loftus,2020) Document classification: Internal Introduction • Adjustments involving equity at the acquisition date, namely the business combination valuation entries (if any) and the pre-acquisition entry, eliminating the investment account in the parent’s financial statements against the pre-acquisition equity of the subsidiary. • Elimination of intragroup balances and the effects of transactions whereby profits or losses are made by different members of the group through trading with each other. Document classification: Internal Rationale for adjusting for intragroup transactions • Whenever related entities trade with each other, or borrow and lend money to each other, the separate legal entities disclose the effects of these transactions in the assets and liabilities recorded and the profits and losses reported. • Hence, the effects of transactions within the group must be adjusted for in the preparation of the consolidated financial statements. Document classification: Internal Rationale for adjusting for intragroup transactions • The requirement for the full adjustment for the effects of intragroup transactions is stated in paragraph B86(c) of AASB 10/IFRS 10 Consolidated Financial Statements: • Eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group. • Intragroup losses may indicate an impairment that requires recognition in the consolidated financial statements. • AASB 112[IAS 12] Income Taxes applies to temporary differences that arise from the elimination of profits and losses resulting from intragroup transactions. Document classification: Internal Workshop Activity 1 Jessica Ltd sold inventory during the current period to its wholly owned subsidiary, Amelie Ltd, for $15 000. These items previously cost Jessica Ltd $12 000. Amelie Ltd subsequently sold half the items to Ningbo Ltd for $8000. The tax rate is 30%. The group accountant for Jessica Ltd, Li Chen, maintains that the appropriate consolidation adjustment entries are as follows: Required Discuss whether the entries suggested by Li Chen are correct, explaining on a line-by-line basis the correct adjustment entries. Document classification: Internal Learning objectives After this workshop you should be able to: 1. Justify the need for adjusting for intragroup transactions 2. Determine worksheet entries for intragroup transactions involving profits and losses in inventories 3. Determine worksheet entries for intragroup transactions involving profits and losses on the transfer of property, plant and equipment 4. Construct the worksheet entries for intragroup services 5. Construct the worksheet entries for intragroup dividends Document classification: Internal Transfers of inventories • Paragraph B86(c) of AASB 10/IFRS 10 states that the profits and losses resulting from intragroup transactions that require consolidation adjustments to be made are those ‘recognised in assets’. • The test for realisation is the involvement of an external party in relation to the item involved in the intragroup transaction. • If the parent then sells the inventories to a party external to the group, the intragroup profit becomes realised to the group. Document classification: Internal Transfers of inventories – Example 1 On 1 January 2022, Jessica acquired $10,000 worth of inventory for cash from Amelia Ltd. The inventories had previously cost Amelia Ltd $8,000. 30 June 2022, all the inventories sold by Amelie Ltd to Jessica Ltd are still on hand. The adjustment entries in the consolidation worksheet at 30 June 2022 are: Sales Revenue Cost of Sales Inventories Dr Cr Cr DTA Dr 600 Income tax expense Document classification: Internal 10 000 8 000 2 000 Cr 600 Transfers of inventories – Example 2 Transferred inventories partly sold On 30 June 2022, only 25% of the inventories sold by Amelie Ltd to Jessica Ltd are still on hand. 75% of the inventories is sold to external party The adjustment entry for the preparation of consolidated financial statements at 30 June 2022 is: Sales Dr 10 000 Cost of Sales Cr 9 500 Inventories Cr 500 DTA Dr 150 Income tax expense Cr Document classification: Internal 150 Transfers of inventories – Example 3 Transferred inventories completely sold • On 1 January 2022, Jessica Ltd acquired $10 000 worth of inventories for cash from Amelie Ltd. • The inventories had previously cost Amelie Ltd $8000. • By the end of the year, 30 June 2022, Jessica Ltd had sold all the transferred inventories to an external party for $18 000. Document classification: Internal Transfers of inventories – Example 3 (contd.) The adjustment entry for the preparation of consolidated financial statements at 30 June 2022 is: Document classification: Internal Sales Dr 10 000 Cost of Sales Cr 10 000 Transfers of inventories – Example 3 (contd.) Example: Transferred inventories completely sold Amelie Ltd records a profit of $ 2 000 Jessica Ltd records a profit of $ 8 000 Total recorded profit is $10 000 Profit to the group = Selling price to external entities less cost to the group = $18 000 − $8000 = $10 000 Document classification: Internal Workshop Activity 2 Koala Ltd owns all of the shares of Kangaroo Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2022. Assume an income tax rate of 30%. a) In April 2022, Koala Ltd sells inventory to Kangaroo Ltd for $12000. This inventory had previously cost Koala Ltd $8000, and it remains unsold by Kangaroo Ltd at the end of the period. b) All the inventory in (a) is sold to Cockatoo Ltd, an external party, for $16500 on 19 June 2022. c) Half the inventory in (a) is sold to Galah Ltd, an external party, for $7200 on 20 June 2022. The remainder is still unsold at the end of the period. d) Koala Ltd, in January 2022, sold inventory for $8000. This inventory had been sold to it by Kangaroo Ltd in the previous year. It had originally cost Kangaroo Ltd $4800, and was sold to Koala Ltd for $9600. Document classification: Internal Learning objectives After this workshop you should be able to: 1. Justify the need for adjusting for intragroup transactions 2. Determine worksheet entries for intragroup transactions involving profits and losses in inventories 3. Determine worksheet entries for intragroup transactions involving profits and losses on the transfer of property, plant and equipment 4. Construct the worksheet entries for intragroup services 5. Construct the worksheet entries for intragroup dividends Document classification: Internal Transfers of property, plant and equipment • The worksheet adjustment entries are shown in two parts: ̶ The entries to adjust for any profit or loss on sale of the assets ̶ The entries relating to any depreciation of the assets after sale. • If a non-depreciable asset is transferred, only the first of these entries is required, and realisation of the profit or loss occurs, as with inventories, on sale of the asset to an external party. Document classification: Internal Transfers of property, plant and equipment – Example 1 ̶ Transfer in current year • Jessica Ltd sold Amelie Ltd plant for $18 500 cash on 1 July 2021. It had cost Jessica Ltd $20 000 when acquired one year previously. • Depreciation charged on plant by Jessica Ltd is 10% p.a. on cost, and Amelie Ltd applies a rate of 6% p.a. on cost. • The income tax rate is 30%. Document classification: Internal Transfers of property, plant and equipment – Example 1 (Contd.) The journal entries in the records of Jessica Ltd at the date of sale, 1 July 2021, are: Jessica Ltd Cash Dr 18 500 Proceeds from Sale of Plant Cr 18 500 Carrying Amount of Plant Sold Dr 18 000 Accumulated Depreciation Dr 2 000 Plant Cr Document classification: Internal 20 000 Transfers of property, plant and equipment – Example 1 (Contd.) The journal entries in the records of Amelie Ltd at the date of sale, 1 July 2021, are: Amelie Ltd Plant Cash Document classification: Internal Dr 18 500 Cr 18 500 Transfers of property, plant and equipment – Example 1 (Contd.) • From the group’s viewpoint, there is no sale of plant to entities external to the group. • The consolidation adjustment entry is: Proceeds from Sale of Plant Dr 18 500 Carrying Amount of Plant Sold Cr 18 000 Plant Cr 500 Document classification: Internal Transfers of property, plant and equipment – Example 1 (Contd.) The consolidation worksheet adjustment entry is: Deferred Tax Asset Dr 150 Income Tax Expense Cr 150 (30% $500) Document classification: Internal Transfers of property, plant and equipment Depreciation and realisation of profits or losses • The profit is realised when the buying entity, say the parent, sells the transferred inventories or land to an external party. • The former course of action is impractical because adjustments for the profit would have to be made for every year in the life of the group after the transaction occurred. Document classification: Internal Transfers of property, plant and equipment Depreciation and realisation of profits or losses The realisation of the profit or loss on a depreciable asset transferred within the group is assumed to occur when the future benefits embodied in the asset are consumed by the group. Document classification: Internal Transfers of property, plant and equipment Depreciation and realisation of profits or losses ̶ Depreciation • The adjustment for depreciation at the end of the first year after the sale is determined by comparing the depreciation charge on the cost to the legal entity with the depreciation charge on the cost to the group: Document classification: Internal Transfers of property, plant and equipment - Example Depreciation and realisation of profits or losses ̶ Depreciation Amelie Ltd : Cost of asset = $18 500 Depreciation expense = 6% $18 500 Group: = $1110 Cost of asset = $18 000 Depreciation expense = 6% $18 000 = $1080 Adjustment = $1110 − $1080 = $30 Document classification: Internal Transfers of property, plant and equipment Depreciation and realisation of profits or losses ̶ Depreciation • On consolidation, depreciation is reduced by $30. • The worksheet entry is: Accumulated Depreciation Dr 30 Depreciation Expense Cr 30 • The amount of profit realised is in proportion to the depreciation charged, namely 6% p.a. Income tax exp Dr 9 DTA Cr 9 Document classification: Internal Workshop Activity 3 Dingo Ltd owns all of the shares of Bilby Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2022. Assume an income tax rate of 30%. a) On 1 January 2022, Bilby Ltd sold an item of plant to Dingo Ltd for $2000. Immediately before the sale, Bilby Ltd had the item of plant on its accounts for $3000. Bilby Ltd depreciated items at 5% p.a. on the diminishing balance and Dingo Ltd used the straight-line method over 10 years. b) On 1 July 2021, Dingo Ltd sold a motor vehicle to Bilby Ltd for $12 000. This had a carrying amount to Dingo Ltd of $9600. Both entities depreciate motor vehicles at a rate of 10% p.a. on cost. Document classification: Internal Learning objectives After this workshop you should be able to: 1. Justify the need for adjusting for intragroup transactions 2. Determine worksheet entries for intragroup transactions involving profits and losses in inventories 3. Determine worksheet entries for intragroup transactions involving profits and losses on the transfer of property, plant and equipment 4. Construct the worksheet entries for intragroup services 5. Construct the worksheet entries for intragroup dividends Document classification: Internal Intragroup services • Many different examples of services between related entities exist. • For instance: ̶ Jessica Ltd may lend to Amelie Ltd some specialist personnel for a limited period of time for the performance of a particular task by Amelie Ltd. ̶ For this service, Jessica Ltd may charge Amelie Ltd a certain fee, or expect Amelie Ltd to perform other services in return. ̶ One entity may lease or rent an item of plant or a warehouse from the other. Document classification: Internal Intragroup services ̶ A subsidiary may exist solely for the purpose of carrying out some specific task, such as research activities for the parent, and a fee for such research is charged. ̶ In this situation, all service revenue earned by the subsidiary is paid for by the parent, and must be adjusted in the consolidation process. Document classification: Internal Intragroup services Realisation of profits or losses • With the transfer of services within the group, the consolidation adjustments do not affect the profit of the group. • In a transaction involving a payment by a parent to a subsidiary for services rendered, the parent shows an expense and the subsidiary shows revenue. • The net effect on the group’s profit is zero. Document classification: Internal Workshop Activity 4 Numbat Ltd owns all of the shares of Goanna Ltd. In relation to the following intragroup transactions. On 1 July 2017, Goanna Ltd rented a spare warehouse to be used jointly by Numbat Ltd and Galah Ltd with each company paying half the agreed rent to Goanna Ltd. The rent paid to Goanna Ltd in the 2017–18 year was $300 while the rent paid in the 2021–2022 year was $350. Required prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2022. Assume an income tax rate of 30%. Document classification: Internal Learning objectives After this workshop you should be able to: 1. Justify the need for adjusting for intragroup transactions 2. Determine worksheet entries for intragroup transactions involving profits and losses in inventories 3. Determine worksheet entries for intragroup transactions involving profits and losses on the transfer of property, plant and equipment 4. Construct the worksheet entries for intragroup services 5. Construct the worksheet entries for intragroup dividends Document classification: Internal Intragroup dividends • Three situations are considered in this section: ̶ Dividends declared in the current period but not paid ̶ Dividends declared and paid in the current period ̶ Bonus share dividends from post-acquisition equity. Document classification: Internal Intragroup dividends - Example Dividends declared in the current period but not paid • Assume that, on 25 June 2022, Amelie Ltd declares a dividend of $4000. At the end of the period, the dividend is unpaid. Document classification: Internal Intragroup dividends – Example (Contd.) Dividends declared in the current period but not paid • The entries passed by the legal entities are: Amelie Ltd Dividend Declared (In retained earnings)Dr 4 000 Dividend Payable Cr 4 000 Jessica Ltd Dividend Receivable Dividend Revenue Document classification: Internal Dr 4 000 Cr 4 000 Intragroup dividends – Example (Contd.) Dividends declared and paid in the current period • Assume Amelie Ltd declares and pays an interim dividend of $4000 in the current period. • Entries by the legal entities are: Jessica Ltd Cash Dr 4 000 Dividend Revenue Cr 4 000 Amelie Ltd Interim Dividend Paid (In retained earnings) Dr 4 000 Cash Cr 4 000 Document classification: Internal Intragroup dividends Bonus share dividends • A subsidiary may occasionally pay a dividend to its parent in the form of shares rather than cash. • For consolidation purposes, two alternative adjustments are possible: ̶ Eliminate the bonus dividend paid against the share capital of Amelie Ltd — that is, reverse the entry made by the subsidiary to record the dividend: ̶ Do not eliminate the bonus dividend paid but set up a new capitalised profits reserve in the consolidation worksheet. Document classification: Internal Workshop Activity 5 Emu Ltd owns all of the shares of Cassowary Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2022. Assume an income tax rate of 30%. a) During June 2022, Cassowary Ltd declared a $2000 dividend. The dividend was paid in August 2022. b) In January 2022, Cassowary Ltd paid a $4500 interim dividend. Document classification: Internal Summary ➢ Intragroup transactions can take many forms and may involve transfers of inventories or property, plant and equipment, or they may relate to the provision of services by one member of the group to another member. ➢ Intragroup transfers of inventories, property, plant and equipment, services, dividends and debentures and their adjustment in the consolidation process are associated with a need to consider the implications of applying tax-effect accounting in the consolidation process ➢ Note again that there are no actual adjusting entries made in the records of the individual legal entities which constitute the group. The consolidation process may be performed by the use of special consolidation worksheets. Document classification: Internal Additional Readings and Resources Please refer to the additional resources listed below, available under Weekly Content > Week 10 on your Resource List. Australian Accounting Standards Board (AASB), 2022, AASB 10 Consolidated Financial Statements, AASB. Silvia of CPDbox 2021, IFRS 10 Consolidated Financial Statements: Summary 2021, [online video] YouTube. AG OnlineTutor 2020, Inter-Company transactions - Elimination (consolidation accounting), [online video] YouTube. Leo, K, Knapp, J, McGowan, S, Sweeting, J & Meng, L 2021 Company Accounting: Chapter 11, 12th edition, John Wiley & Sons Australia, Ltd, Queensland. Document classification: Internal