Chapter 29

Consolidation: intragroup
transactions

©2022 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation you should be able to:

29.1 Explain the need for making adjustments for
intragroup transactions
29.2 Outline the adjustment process and the key
questions to consider
29.3 Prepare worksheet entries for intragroup
transactions involving profits or losses in beginning
and ending inventories
 Learning objectives

29.4 Prepare worksheet entries for intragroup

transactions involving profits or losses on the
transfer of property, plant and equipment in both the
current and previous periods
29.5 Prepare worksheet entries for intragroup services
29.6 Prepare worksheet entries for intragroup
dividends
29.7 Prepare worksheet entries for intragroup
borrowings.
 The need for intragroup adjustments

• The consolidation process involves adding together the

financial statements of the parent and its subsidiaries,
subject to some adjustments.
• Two sets of adjustments were made in the adjustment
columns of the worksheet, namely the business
combination valuation entries and the pre-acquisition
entries.
• These adjustments are made to ensure that the financial
position and financial performance of the group are only
reflecting the effects of transactions with external
entities.
 The need for intragroup adjustments

• A key point to remember is that the consolidated

financial statements are the statements of a group
and are presented as those of a single economic
entity.
• Consolidated revenues are earned only from
transactions with entities external to the group.
• Consolidated expenses are incurred only from
transactions with entities external to the group.
• Consolidated profit arises only in relation to
transactions with entities external to the group.
 The need for intragroup adjustments

• Consolidated assets are recorded at the cost to the

group, not necessarily the cost to the legal entity that
owns them.
• Consolidated liabilities are obligations to entities
external to the group.
• The accounting standard that is applied is AASB
10/IFRS 10 Consolidated Financial Statements.
 The adjustment process

• The requirement for the full adjustment for the

effects of intragroup transactions is stated in
paragraph B86(c) of AASB 10/IFRS 10:
– 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.
 The adjustment process

• The effects of transactions are recognised by

individual entities in accounts disclosed in the
individual statements of financial position (i.e. assets,
liabilities and equity) and/or in accounts disclosed in
the individual statements of comprehensive income
(i.e. income and expenses).
• The accounts from the individual statements of
comprehensive income are closed at the end of each
period to the retained earnings account.
 The adjustment process

• Therefore, it is critically important when determining

an adjustment entry to firstly classify the underlying
economic transaction as a ‘prior period’ transaction
or a ‘current period’ transaction, especially when
adjusting income and expenses accounts.
• The effects of current period transactions on the
current period income and expenses are present in
accounts such as sales, cost of sales, depreciation
expense and income tax expense.
 The adjustment process

• The effects of prior period transactions on the prior

period income and expenses are present in the retained
earnings account (opening balance), while their effects
on the current period income and expenses are present
in the respective accounts.
• If a transaction is not correctly classified, an incorrect
adjustment entry can result.
• According to paragraph B86(c) of AASB 10/IFRS 10: AASB
112 [IAS 12] Income Taxes applies to temporary
differences that arise from the elimination of profits and
losses resulting from intragroup transactions.
 The adjustment process

• Realisation of intragroup profits or losses:

– According to paragraph B86(c) of AASB 10/IFRS
10: profits or losses resulting from intragroup
transactions that are recognised in assets, such as
inventory and fixed assets, are eliminated in full.
– It is important to understand the reasons the
adjustments are made in the consolidation
worksheet and how they are determined.
 Inventories

• Sales of inventories in the current period:

– Realisation of intragroup profits or losses.
– As all inventories transferred intragroup are still on
hand with the group, the entire profit on the
intragroup sale is unrealised.
– In other words, as none of the inventories
transferred intragroup are still on hand, there is no
unrealised profit.
 Inventories

• Sales of inventories in the current period:

– In all cases, regardless of the amount of
inventories on-sold, the adjustment to sales is
always the amount of the sales within the group
(i.e. $10 000, refer to example in section 29.3.1).
– The adjustment to inventories is always equal to
the percentage (%) of inventories still on hand
within the group multiplied by the profit on the
sale within the group.
 Inventories

• Sales of inventories in the current period:

– The adjustment to cost of sales can be determined
as a balancing item once the adjustments to sales
and inventories have been determined.
– The tax effect adjustment is always equal to the
tax rate multiplied by the unrealised profit and is
posted as a debit to deferred tax asset and a credit
to income tax expense.
 Inventories

• Sales of inventories in the prior period:

– Any inventories sold within the group in a prior
period and remaining on hand at the end of that
period are still on hand at the beginning of the
next period.
– As such, the unrealised profit related to
inventories still on hand at the end of the prior
period is still unrealised at the beginning of the
next period.
 Inventories

• Sales of inventories in the prior period:

– The adjustment to retained earnings (opening
balance) is the after-tax profit on transferred
inventories remaining on hand at the beginning of
the period.
– The adjustment to cost of sales is the before-tax
profit on inventories on hand at the beginning of
the period.
 Inventories

• Sales of inventories in the prior period:

– The adjustment to income tax expense is the tax rate
times the adjustment to cost of sales.
– Note that the amount for which the inventories are
on-sold to external entities after the intragroup
transfer does not matter in the adjustments.
– Note that only the amount of unrealised profit in
beginning inventories is needed in the adjustments;
the amount for which the inventories are transferred
intragroup in the prior period does not matter per se.
 Property, plant and equipment

• Besides transferring inventories, it is possible for

property, plant and equipment to be transferred
within the group.
• The worksheet adjustment entries are shown in two
parts:
– entries to adjust for any profit or loss on transfer
of the assets
– entries relating to any depreciation of the assets
after transfer.
 Property, plant and equipment

• If a non-depreciable asset such as land is transferred,

only the first of the above two sets of entries is
required, and realisation of the profit or loss occurs,
as with inventories, on sale of the asset to an
external entity.
 Property, plant and equipment

• Sale of property, plant and equipment:

– In preparing the consolidation adjustment entry
for intragroup sale, for a profit, of non-current
assets remaining on hand at the end of the
current period, note the following.
• The adjustment to both gain on sale and the
non-current asset is the difference between the
intragroup sale price and the carrying amount
at the point of sale (i.e. intragroup profit).
 Property, plant and equipment

• Sale of property, plant and equipment:

• The tax effect adjustment is always equal to the
tax rate multiplied by the intragroup profit and
is posted as a debit to deferred tax asset and a
credit to income tax expense.
• The adjustment to the retained earnings
(opening balance) is the after-tax intragroup
profit.
 Property, plant and equipment

• Depreciation and realisation of profits:

– Depreciation is generally measured as a function
of the cost of the asset.
– As the cost of the asset to the group is different
from that recorded by the legal entity holding the
asset, it is necessary to make adjustments in
relation to depreciation.
 Property, plant and equipment

• Depreciation and realisation of profits:

– The adjustment per annum to the accumulated
depreciation and depreciation expense is the
difference between the intragroup selling price of
the asset and its carrying amount at the time of
the intragroup sale times the depreciation rate.
 Property, plant and equipment

• Depreciation and realisation of profits:

– The tax effect adjustment is equal to the tax rate
multiplied by the adjustment to accumulated
depreciation or depreciation expense and is
posted as a debit to income tax expense and a
credit to deferred tax asset.
 Property, plant and equipment

• Depreciation and realisation of profits:

– The tax effect adjustment is:
• Reversing deferred tax asset by the tax rate
multiplied by the adjustment to accumulated
depreciation.
• Increasing income tax expense by the tax rate
multiplied by the adjustment to current
depreciation expense.
 Property, plant and equipment

• Depreciation and realisation of profits:

– Decreasing retained earnings (opening balance) by
the tax rate multiplied by the adjustment to prior
depreciation expenses.
 Property, plant and equipment

• Depreciation and realisation of profits:

– Realisation of intragroup profits or losses:
• Realisation of profits or losses normally occurs
when an external entity is involved in the
transaction.
• With depreciable assets, determining when the
gain or loss on sale becomes realised to the group
is not as simple.
 Property, plant and equipment

• Depreciation and realisation of profits:

– Realisation of intragroup profits or losses:
• The depreciable asset normally remains within
the group and is used in production rather than
being sold to external entities.
• 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.
 Property, plant and equipment

• Change in classification of transferred assets:

– It is possible for an item that is transferred within
the group to be regarded by the seller as a non-
current asset and by the buyer as inventories or
vice versa.
 Property, plant and equipment

• Change in classification of transferred assets:

– In preparing the consolidation adjustment entry
for current period intragroup transfer of non-
current assets to inventories still on hand at the
end of the period, note the following (Example 1).
• The adjustment to both gain on sale and
inventories is the difference between the
intragroup sale price and the carrying amount
at the point of sale (i.e. intragroup profit).
 Property, plant and equipment

• Change in classification of transferred assets:

• The tax effect adjustment is equal to the tax
rate multiplied by the intragroup profit and is
posted as a debit to deferred tax asset and a
credit to income tax expense.
 Property, plant and equipment

• Change in classification of transferred assets:

– In preparing the consolidation adjustment entry
for current period intragroup transfer of non-
current assets to inventories sold by the end of
the period, note the following (Example 1).
• The adjustment to both gain on sale and cost of
sales is the difference between the intragroup
sale price and the carrying amount at the point
of intragroup sale (i.e. intragroup profit).
 Property, plant and equipment

• Change in classification of transferred assets:

• There is no tax effect adjustment as the
intragroup profit is realised and no net
adjustment to profit or carrying amount of
assets was necessary.
 Intragroup services

• Many different examples of services between a

parent and its subsidiary exist, as follows.
– A parent may lend some specialist personnel to its
subsidiary for a limited period of time to perform
a particular task for the subsidiary. For this service,
the parent may charge the subsidiary a certain fee,
or expect the subsidiary to perform other services
in return.
– A subsidiary may lease or rent an item of plant or
a warehouse from the parent or vice versa.
 Intragroup services

• Realisation of intragroup 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, or vice versa, for services rendered,
the parent shows an expense and the subsidiary
shows a revenue.
– The net effect on the group’s profit is zero.
 Intragroup services

• Realisation of intragroup profits or losses:

– In preparing the consolidation adjustment entries
for current period intragroup services, note the
following.
• The adjustment to service revenue and service
expense is the intragroup fee charged for those
services.
 Intragroup services

• Realisation of intragroup profits or losses:

• If the intragroup services have not been paid by
the end of the current period, an adjustment to
fees receivable and fees payable is also
required for the amount unpaid.
• There is no tax adjustment.
 Dividends

• According to paragraph 12 of AASB 127/IAS 27

Separate Financial Statements:
– Dividends from a subsidiary, a joint venture or an
associate are recognised in the separate financial
statements of an entity when the entity’s right to
receive the dividend is established.
– The dividend is recognised in profit or loss unless
the entity elects to use the equity method, in which
case the dividend is recognised as a reduction from
the carrying amount of the investment.
 Dividends

• Dividends declared in the current period but not

paid:
– In preparing the consolidation adjustment entries
for current period dividends declared and not yet
paid, note the following.
• The adjustment to dividend revenue, dividend
declared, dividend receivable and dividend
payable is the amount of dividend declared
intragroup.
• There is no tax adjustment.
 Dividends

• Dividends declared and paid in the current period:

– In preparing the consolidation adjustment entries
for current period dividends declared and paid,
note the following.
• The adjustment to dividend revenue and
dividend declared is the amount of dividend
declared intragroup.
• There is no tax adjustment.
 Intragroup borrowings

• Members of a group often borrow and lend money

among themselves, and may charge and pay interest
on the money borrowed.
• Consolidation adjustments are necessary in relation
to these intragroup borrowings and interest thereon
because these transactions create assets and
liabilities, and revenues and expenses, that do not
exist in terms of the group’s relationship with
external entities.
 Intragroup borrowings

• In preparing the consolidation adjustment entries for

intragroup borrowings, note the following.
– The adjustment to intragroup liability and
intragroup receivable is the amount of intragroup
borrowings.
– The adjustment to interest revenue and interest
expense is the amount of interest incurred on the
intragroup borrowing during the current period.
– There is no tax adjustment.
 Ethics in action

• Ethical considerations related to intragroup

transactions involving loans:
– Intragroup transactions can result in transfers of
assets or liabilities between group entities that
may negatively affect various stakeholders in those
entities (e.g. creditors).
– Special attention should be given to cross-
guarantees, where two or more entities within a
group provide guarantees to each other, as they
may provide false assurances to external creditors.
 Summary

• Reasons for making adjustments for intragroup

transactions.
• The adjustment process and the key questions to
consider during the process.
• Worksheet entries for intragroup transactions
involving profits or losses in beginning and ending
inventories.
 Summary

• Worksheet entries for intragroup transactions

involving profits or losses on the transfer of property,
plant and equipment in both the current and
previous periods.
• Worksheet entries for intragroup services, intragroup
dividends and intragroup borrowings.
• Ethical considerations related to intragroup
transactions involving loans.