Chapter 28: Consolidation: intragroup transactions

Comprehension questions

1. Why is it necessary to make adjustments for intragroup transactions?

The consolidated financial statements are the statements of the group, i.e. an economic entity

consisting of a parent and its subsidiaries. These consolidated financial statements then can

only contain revenues, expenses, profits, assets and liabilities that relate to parties external to

the group.

Adjustments must be made for intragroup transactions as these are internal to the economic

entity, and do not reflect the effects of transactions with external parties. This is consistent

with the entity concept of consolidation, which defines the group as the net assets of the

parent, together with the net assets of the subsidiaries. Transactions between these parties

internal to the group must be adjusted in full.

2. Why is it important to identify intragroup transactions as current or previous

period transactions?

Current period intragroup transactions affect different accounts than prior period transactions.

For example, current period intragroup sales of inventories affect sales and cost of sales

accounts, whereas prior period sales of inventories affect retained earnings (opening balance)

and, to the extent that inventories are sold externally during the current period, the cost of

sales account. If the transactions are not correctly placed into a time context, then
the

adjustments posted in the consolidation worksheet to eliminate the effects of the intragroup

transactions may be inappropriate

3. In making consolidation worksheet adjustments, sometimes tax-effect entries are

made. Why?

Obviously, not all adjustments have tax consequences. The only adjustment entries that have

tax consequences are those where profits or losses are eliminated and carrying amounts of

assets or liabilities are adjusted.

Accounting for tax is governed by AASB 112/IAS 12 Income Taxes. Deferred tax accounts

are raised when a temporary difference arises because the tax base of an asset or liability

differs from the carrying amount. Some consolidation adjustments result in changing the

carrying amounts of assets and liabilities. Where this occurs, a temporary difference arises as
there is no change to the tax base. In these situations, tax-effect entries requiring the

recognition of deferred tax assets and liabilities are necessary.

Consider an example of an item of inventories carried at cost of $10 000 being sold by a

parent to a subsidiary for $12 000, with the item still being on hand at the end of the period.

The tax rate is 30%.

In the consolidation worksheet, the adjustment entry necessary to eliminate the unrealised

profit of the intragroup transaction includes a credit adjustment to inventories of $2000 as the

cost to the economic entity for that item differs from that to the subsidiary. In the subsidiary’s

accounts, the inventories are carried at $12 000 and has a tax base of $12 000, giving rise to

no temporary differences. However, from the group’s point of view, the asset has a carrying

amount of $10 000, and, combined with a tax base of $12 000, gives a deductible temporary

difference of $2000 (the expected future deduction is greater than the future
assessable

amount). As a result, a deferred tax asset exists for the group and should be recognised in a

tax-effect entry. This has no effect on the amount of tax payable in the current period, but

will decrease the Income Tax Expense from the perspective of the group.

Another explanation for the tax effect of the consolidation worksheet entry to eliminate the

unrealised profit of the intragroup transaction can be provided as follows: as profit of $2000

is eliminated (by crediting Cost of Sales by $10 000 and debiting Sales Revenue by $12 000),

the group’s profit is decreased and therefore, the Income Tax Expense (which is normally

calculated as 30% of the profit) should decrease as well by 30% of $2000. Also, the entity

that made the intragroup sale and recorded the profit would have paid tax on that profit; from

the perspective of the group, that tax should not have been paid yet and represents
a

prepayment of tax in advance of the actual profit being realised by the group; this prepayment

is going to be recognised by the group as a future tax benefit, a Deferred Tax Asset

4. What are the key questions to consider when preparing consolidation worksheet

adjustments for intragroup transactions?

The five key questions to consider when preparing consolidation worksheet adjustments for

intragroup transactions are as follows.

1. Is this a prior period or a current period transaction?

2. What has been recorded by the legal entities?

3. What should be reported by the group?

4. What adjustments are necessary to get from the legal entities’ amounts to the group

amounts?

5. What is the tax effect of the adjustments made?

1. Is this a prior period or a current period transaction?

If it is a current period transaction, its effects will be eliminated against the respective

accounts. If it is a prior period transaction, the effects on prior period income and expenses

accounts will be eliminated against the retained earnings account (opening balance), while its

effects on current period accounts will be eliminated against the respective accounts.

2. What has been recorded by the legal entities?

That is, what accounts on the left-hand side of the worksheet contain amounts arising from,

or affected by, the intragroup transaction and what are the amounts recorded in
those

accounts?

3. What should be reported by the group?

That is, what amounts should the group report on the right-hand side of the worksheet for the

individual accounts affected by the intragroup transaction?

4. What adjustments are necessary to get from the legal entities’ amounts to the group

amounts?

That is, the adjustments are determined by comparing what has been recorded by the legal

entities to what the group needs to report.

5. What is the tax effect of the adjustments made?

Having determined the consolidation adjustment for the intragroup transaction, the tax-effect

consequences need to be considered. Obviously, not all adjustments have tax consequences.

The only adjustment entries that have tax consequences are those where profits or losses are

eliminated (current tax effect) and carrying amounts of assets or liabilities are adjusted

(deferred tax effect)

5. What is meant by ‘realisation of intragroup profits or losses’?

Profits/losses are realised when an economic entity transacts with another external entity. For

a group, this is consistent with the concept that the consolidated financial statements show

only the results of transactions with external entities. The consolidated statement of profit or
loss and other comprehensive income will thus show only realised profits and realised losses.

Profits/losses recognised by group members on sale of assets within the group are unrealised

profits/losses to the extent that the assets are still within the group. Realisation of

profits/losses on intragroup transactions involving assets normally occurs when an external

party gets involved.

With intragroup sales of inventories, involvement of an external party, or realisation, occurs

when the inventories are on-sold to an external entity.

With intragroup sales of depreciable assets, realisation occurs as the asset is used up, as the

benefits are received by the group as a result of use of the asset. The proportion of

profits/losses realised in any one period is measured by reference to the depreciation charged

on the transferred depreciable asset

6. With regards to intragroup transfers of inventories, are adjustments for current

period transfers different from adjustments for such transfers happening in a

previous period? Explain.

In preparing the adjustment entries for inventories sold intragroup for a profit within the

current period, note the following.

 In all cases, regardless of the amount of inventories on-sold, the adjustment to sales is

always a decrease by the amount of the sales within the group as those should not be

recognised by the group.

 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 (i.e. the

unrealised profit = % of inventories still on hand × (transfer price − original cost)).

Without this adjustment, the inventories on hand would be overstated from the

perspective of the group – this adjustment manes sure that the inventory on hand are

recognised in the consolidated financial statements based on the original cost to the

group.

 The adjustment to cost of sales can be determined as a balancing item once the

adjustments to sales and inventories have been determined (as the difference between the

adjustment to sales and the adjustment to inventories). However, the reason for this

adjustment is the need to eliminate the cost of sale recognised on the intragroup

transaction and adjust the cost of sales on the external transaction to the original cost to
the group of the inventory sold externally.

 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.

That is needed to reflect that the tax paid on the unrealised profit from the intragroup

transaction is a pre-payment of tax, i.e. a tax benefit.

In preparing the consolidation adjustment entry for inventories transferred intragroup in a

previous period for the profit remaining in inventories on hand at the beginning of the current

period, to the extent that the inventories are on-sold to external entities by the end of the

current period, note the following.

 The adjustment to retained earnings (opening balance) is the after-tax profit on transferred

inventories remaining on hand at the beginning of the period (also known as after-tax

unrealised profit in beginning inventories). That is done in order to eliminate the

unrealised profit from the previous period from retained earnings.

 The adjustment to cost of sales is the before-tax profit on inventories on hand at the

beginning of the period (also known as before-tax unrealised profit in beginning

inventories). This adjustment is needed to adjust the cost of sales recorded on the external

sale based on the price paid intragroup to the original cost of the inventory sold externally

in the current period.

 The adjustment to income tax expense is the tax rate times the adjustment to cost of sales.

That is needed to reflect the current tax effect given by the realisation of the profit

7. When are profits realised in relation to inventories transfers within the group?

Realisation occurs on involvement of an external entity, namely when the inventories are on-

sold to an entity that is not a member of the group. If only a part of the inventories initially

transferred intragroup is on-sold to external parties by the end of a period, only the part of the

intragroup profit related to the inventories on-sold is realised. It should be noted that, as

inventories are current assets which should be eventually sold to external parties, it is

normally assumed, unless otherwise specified, that inventories transferred intragroup that are

not sold to external parties by the end of a period are sold to external parties by the end of the

next period and therefore any unrealised profit in opening inventories in one period is

considered realised by the end of that period.

8. Where a current period intragroup transaction involves a depreciable asset, why is

depreciation expense adjusted?

The cost of the depreciable asset to the group is different from that recorded by the acquirer

of the depreciable asset within an intragroup transaction if the intragroup transaction

generated a profit or loss. The acquirer of the asset (i.e. the new owner) records depreciation

in each period after the intragroup transaction based on the price paid for the asset intragroup

while in the consolidated financial statements, the group wants to show depreciation

calculated based on cost to the group (i.e. the carrying amount of the asset prior to the

intragroup transaction). Hence an adjustment is necessary for the depreciation recorded in

each period after the intragroup transaction.

If a profit is made on a current period intragroup sale of a depreciable asset, then the cost of

the asset to the group is less than the cost recorded by the acquirer of the asset (i.e. the new

owner) and therefore the current depreciation expense that should be recognised by the group

is less than the current depreciation expense recorded by the new owner of the asset. Hence

an adjustment is necessary to reduce the depreciation expense and accumulated depreciation

recorded by the new owner of the asset in relation to the asset.

If a loss is made on a current period intragroup sale of a depreciable asset, then the cost of the

asset to the group is more than the cost recorded by the acquirer of the asset (i.e. the new

owner) and therefore the current depreciation expense that should be recognised by the group

is more than the current depreciation expense recorded by the new owner of the asset. Hence

an adjustment is necessary to increase the depreciation expense and accumulated depreciation

by the new owner of the asset in relation to the asset.

Please note that if the intragroup transaction took place sometime after the start of the current

period, the adjustment to depreciation expense is calculated based on the time passed since

the intragroup transaction until the end of the current period. For example, if the intragroup

transaction took place on 1 January 2019, on 30 June 2019 we will need to adjust

depreciation expense for 0.5 years’ worth of annual depreciation expense adjustments (for the

period from 1 January 2019 to 30 June 2019).

9. Where a previous period intragroup transaction involves a depreciable asset, why is

retained earnings adjusted?

The cost of the depreciable asset to the group is different from that recorded by the acquirer

of the depreciable asset within an intragroup transaction if the intragroup transaction

generated a profit or loss. The acquirer of the asset (i.e. the new owner) records depreciation

in each period after the intragroup transaction based on the price paid for the asset intragroup

while in the consolidated financial statements, the group wants to show depreciation

calculated based on cost to the group (i.e. the carrying amount of the asset prior to the

intragroup transaction). Hence an adjustment is necessary for the depreciation recorded in

each period after the intragroup transaction.

If a profit is made on a previous period intragroup sale of a depreciable asset, then the cost of

the asset to the group is less than the cost recorded by the acquirer of the asset (i.e. the new

owner) and therefore the depreciation expenses that should be recognised by the group each

period are less than the depreciation expenses recorded by the new owner of the asset. Hence

an adjustment is necessary to reduce the depreciation expenses (from the current period, but

also from the previous periods) and accumulated depreciation recorded by the new owner of

the asset in relation to the asset. However, the depreciation expenses from the previous

periods are in the retained earnings (together with all the other income and expenses from

previous periods, including income tax expense) and therefore in order to reduce those, we

need to increase retained earnings. The current depreciation expense will be adjusted against

the depreciation expense account.

If a loss is made on a previous period intragroup sale of a depreciable asset, then the cost of

the asset to the group is more than the cost recorded by the acquirer of the asset (i.e. the new

owner) and therefore the depreciation expenses that should be recognised by the group are

more than the depreciation expenses recorded by the new owner of the asset. Hence an

adjustment is necessary to increase the depreciation expenses (from the current period, but

also from the previous periods) and accumulated depreciation recorded by the new owner of

the asset in relation to the asset. However, as mentioned above, the depreciation expenses

from the previous periods are in the retained earnings (together with all the other income and

expenses from previous periods, including income tax expense) and therefore in order to

increase those, we need to decrease retained earnings. The current depreciation expense will

be adjusted against the depreciation expense account.

Please note that if the intragroup transaction took place in a previous period, the adjustment

to retained earnings is calculated based on the time passed since the intragroup transaction

until the beginning of the current period as that will capture all the previous periods’
depreciation expenses. For example, if the intragroup transaction took place on 1 July 2010,

on 30 June 2016 we will need to adjust retained earnings for 5 years’ worth of annual

depreciation expense adjustments (for the period from 1 July 2010 to 1 July 2015), together

with an adjustment to the current depreciation expense for 1 year worth of annual

depreciation expense adjustments

10. When are profits realised on transfers of depreciable assets within the group?

As a depreciable asset may never be on-sold by a member of the group to external parties,

remaining instead within the group and being consumed by use, the point of realisation may

not be directly and exclusively determined by reference to involvement of an external entity.

Realisation is then indirectly determined by usage of the asset within the group, that is, in

proportion to the consumption of the benefits from the asset within the group. Realisation of

the profit/loss on sale within the group is then measured in the same proportion to the

depreciation of the asset recorded by the entity that uses it. For example, if the transferred

asset is being depreciated on a straight line basis over a 10-year period, that is, at 10% per

annum, then the profit on sale is realised at 10% per annum. As such, if the asset is used in

the group up to the end of its useful life, the profit will be realised in full only at the end of

the useful life. However, the depreciable asset may be on-sold to external parties before the

end of the useful life, in which case, the profit is realised in full at the moment of external

sale, with a part of it being realised through depreciation (based on the period of time since

the intragroup transfer up to the moment of external sale) and the rest through the external

sale

11. Are tax effect-entries required when adjusting for intragroup services or intragroup

borrowings? Explain.

The consolidation worksheet adjustment entry to eliminate the effects of intragroup services

or intragroup borrowings does not affect the carrying amount of any asset or liability that are

taxable or the overall profit. Therefore, there is no deferred or current tax-effect adjustment

12. Are adjustments for post-acquisition intragroup dividends different from those for

pre-acquisition intragroup dividends? Explain.

All dividends are accounted for as post-acquisition dividends. This treatment is hard to justify

conceptually and this decision was made by the standard-setters on pragmatic grounds. Refer

to AASB 127/IAS27 and AASB 9/IFRS 9 (paragraph 5.7.6). As a consequence, there is no

difference between the form of the main adjustments posted on consolidation for pre- and

post-acquisition dividends:

 For interim dividends paid: the consolidation adjustment entry will eliminate dividend

revenue recorded by the parent and dividends paid recorded by the subsidiary.

 For final dividends declared: the consolidation adjustment entry will eliminate dividend

revenue recorded by the parent and dividends declared recorded by the subsidiary and

also the dividend receivable recorded by the parent and dividends payable recorded by the

subsidiary.

However, there are two subtle differences in the adjustments posted for pre-acquisition or

post-acquisition dividends:

 Adjustments for pre-acquisition dividends are normally posted under the pre-acquisition

entries, while adjustments for post-acquisition dividends are posted in the elimination

entries for intragroup transactions.

 If the pre-acquisition dividends cause an impairment of the investment account

recognised by the parent, then the pre-acquisition entries will include an additional entry

to reverse the effect of that impairment

Case studies
Case study 28.1
Consolidation adjustments

Jessica Ltd sold inventories 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, an external entity, for $8000. The

income tax rate is 30%.

The group accountant for Jessica Ltd, Li Chen, maintains that the appropriate

consolidation adjustment entries are as follows

Required
1. Discuss whether the entries suggested by Li Chen are correct, explaining on a line-

by-line basis the correct adjustment entries.

2. Determine the consolidation worksheet entries in the following period, assuming the

inventories are on-sold to external parties, and explain the adjustments on a line-

by-line basis.

1.
The correct entries are:
Sales
Cost of sales
Inventories
Dr
Cr
Cr
15 000
13 500
1 500
Deferred tax asset
Income tax expense
Dr
Cr
450
450
Sales:
Recorded sales = $15 000
(Jessica Ltd) + $8 000 (Amelie
Ltd) = $23 000
Group sales = $8 000 [external
entity sales only]
1.

The correct entries are:

Dr Sales 15 000

CR Cost of sales 13500

Cr Inventories 1500

Dr Deferred tax asset 450

Cr Income tax expense 450

Sales:

Recorded sales = $15 000 (Jessica Ltd) + $8 000 (Amelie Ltd) = $23 000

Group sales = $8 000 [external entity sales only]

Adjustment = $15 000 (decrease)

From the point of view of the group, only the external sales should be reported and therefore

an adjustment is needed on consolidation to decrease the aggregate figure of Sales by $15

000.
Cost of sales:

Recorded = $12 000 (Jessica Ltd) + ½ x $15 000 (Amelie Ltd) = $19 500

Group = ½ x $12 000 = $6 000 [the original cost of the inventories sold externally only]

Adjustment = $13 500

From the point of view of the group, only the cost of inventories sold to external parties

should be reported and that should be based on the original cost of those inventories to the

group. Therefore, an adjustment is needed on consolidation to decrease the aggregate figure

of Cost of sales by $13 500

Inventories:

Recorded = $0 (Jessica Ltd) + ½ x $15 000 (Amelie Ltd) = $7 500

Group = ½ x $12 000 = $6 000 [the original cost of the inventories not sold externally]

Adjustment = $1 500

From the point of view of the group, only the cost of inventories not sold to external parties

should be reported and that should be based on the original cost of those inventories to the

group. Therefore, an adjustment is needed on consolidation to decrease the aggregate figure

of Inventories by $1 500. That is actually equal to the amount of unrealised profit, i.e. the

profit on the intragroup sale of the inventories not yet sold to external parties, as
the

inventories are overstated from the group’s perspective by this amount in Amelie Ltd’s

accounts

Deferred tax asset:

The first adjustment entry reduces the carrying amount of the inventories by $1500. This

reduction in the carrying amount, not compensated by a change in the tax base, creates a

deductible temporary difference between it and the tax base giving rise to a deferred tax

benefit which will be recognised as a deferred tax asset based on the tax rate of 30%. Another

explanation for the tax-effect entry arises from the fact that the profit of $1500 was taxed in

Jessica Ltd’s accounts and, as a result, Jessica Ltd would have paid tax which from the

group’s perspective is a payment of tax in advance of the profit being realised by the group.

As such, the group should recognise that in the future when the profit will be realised, it

won’t be required to pay tax of that profit – this is equivalent to having a tax benefit with will

be recognised as a deferred tax asset.

Income tax expense:

The income tax expense, which normally is calculated as the tax rate multiplied by the profit,

is reduced as a result of the unrealised profit being eliminated

2.

Assuming inventories are on-sold to an external party in the following year, the entry in the

following year will be:

DR Retained earnings (opening balance) 1050

DRIncome tax expense 450

CR Cost of sales 1500

Retained earnings (opening balance):

In the prior period, Jessica Ltd recorded an after tax profit of $2 100 on sale of inventories to

Amelie Ltd. Half of this inventories was on-sold to an external entity, leaving half the profit,

$1 050, unrealised. In the current period, this profit unrealised at the end of the prior period is

in the opening balance of Retained Earnings and, on consolidation, it should be eliminated

from there.

Income tax expense:

In the prior period, the group raised a deferred tax asset of $450. When inventories are on-

sold this year the tax benefit for which the deferred tax asset was raised is realised and

therefore it doesn’t need to be recognised anymore. Instead, given that the profit is realised,

the group’s current profit will increase and therefore an income tax expense calculated as the

tax rate multiplied by this realised profit should be recognised.

Cost of sales:

Recorded = $0 (Jessica Ltd) + ½ x $15 000 (Amelie Ltd) = $7 500

Group = ½ x $12 000 = $6 000 [the original cost of the inventories sold externally]

Adjustment = $1 500

From the point of view of the group, the original cost to the group of inventories sold to

external parties should be reported. Therefore, an adjustment is needed on consolidation to

decrease the aggregate figure of Cost of Sales by $1 500. This adjustment decreases an

expense for the current period which increases the current period’s profit, recognising the fact

that the profit was realised.

Case study 28.2

Depreciation expense

At the beginning of the current period, Jessica Ltd sold a depreciable asset to its wholly

owned subsidiary, Amelie Ltd, for $80 000. Jessica Ltd had originally paid $200 000 for

this asset, and at time of sale to Amelie Ltd had charged accumulated depreciation of

$150 000. This asset is used differently in Amelie Ltd from how it was used in Jessica

Ltd; thus, whereas Jessica Ltd used a 10% p.a. straight-line depreciation method,

Amelie Ltd uses a 20% straight-line depreciation method.

In calculating the depreciation expense for the consolidated group (as opposed to that

recorded by Amelie Ltd), the group accountant, Rui Xue, is unsure of which amount the

depreciation rate should be applied to ($200 000, $50 000 or $80 000) and which

depreciation rate to use (10% or 20%).

Required

Provide a detailed response, explaining which depreciation rate should be used and to

what amount it should be applied.

For the group, depreciation of an asset transferred intragroup is based on the depreciation rate

applied by the entity using the asset and on the carrying amount of the asset at the moment of

the intragroup transfer.

Note that when an asset is transferred within the group, consolidation adjustments are not

based on just reversing the intragroup transaction. The purpose of the adjustments is to

remove all the effects of the intragroup transaction so that only the group’s position in

relation to external entities is reported. As the usage of the asset in the group has changed as a

result of transfer within the group, then the depreciation rate used by the group must reflect

the actual consumption of benefits within the group. This depreciation rate will then be

applied to the carrying amount of the asset at the moment of the intragroup transfer to get the

depreciation expense for the asset from the group’s perspective.

In this example, the carrying amount at the time of the intragroup transfer is $50 000 ($200

000 (original cost) - $150 000 (accumulated depreciation)). The asset is now being used by

Amelie Ltd which applies a 20% depreciation rate. Therefore, the depreciation expense from

the group’s perspective for the current period will be calculated as 20% multiplied by $50

000 (i.e. $10 000) assuming that the asset was transferred intragroup on the first day of the

current period. Given that Amelie Ltd would have recognised a depreciation expense of 20%
x $80 000 = $16 000, on consolidation an adjustment is posted against the depreciation

expense decreasing it by $6000 or 20% of the profit on the intragroup transfer of $30 000 (i.e.

$80 000 (price paid intragroup) - $50 000 (carrying amount at the moment of the intragroup

sale))

Application and analysis exercises

Exercise 28.1
Current and prior periods intragroup transfers of inventories

Amani Ltd owns all of the share capital of Rebecca Ltd. The income tax rate is 30%.

The following transactions took place during the periods ended 30 June 2019 or 30 June

2020.

(a) In January 2020, Amani Ltd sells inventories to Rebecca Ltd for $15 000 in cash.

These inventories had previously cost Amani Ltd $10 000, and remain unsold by

Rebecca Ltd at the end of the period.

(b) In February 2020, Amani Ltd sells inventories to Rebecca Ltd for $17 000 in cash.

These inventories had previously cost Amani Ltd $12 000, and are on-sold

externally on 2 April 2020.

(c) In February 2020, Rebecca Ltd sells inventories to Amani Ltd for $22 000 in cash

(original cost to Rebecca Ltd was $16 000) and half are on-sold externally by 30

June 2020.

(d) In March 2020, Amani Ltd sold inventories for $10 000 to Zara Ltd, an external

entity. These inventories were transferred from Rebecca Ltd on 1 June 2019. The

inventories had originally cost Rebecca Ltd $6000, and were sold to Amani Ltd for

$12 000.

Required

In relation to the above intragroup transactions:

1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2020.

2. Explain in detail why you made each adjusting journal entry.

(LO2 and LO3)

AMANI LTD – REBECCA LTD

30 June 2020

(a) Sales revenue Dr 15 000

Cost of sales Cr 10 000

Inventories Cr 5 000

Deferred tax asset Dr 1 500

Income tax expense Cr 1 500

(b) Sales revenue Dr 17 000

Cost of sales Cr 17 000

(c) Sales revenue Dr 22 000

Cost of sales Cr 19 000

Inventories Cr 3 000

Deferred tax asset Dr 900

Income tax expense Cr 900

(d) Retained earnings (1/7/19) Dr 4 200

Income tax expense Dr 1 800

Cost of sales Cr 6 000

2. Detailed explanations on the adjusting journal entries

30 June 2020:

(a) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June

2020. As the inventories remain unsold at the end of the period, at 30 June 2020 the entire

profit on the intragroup sale is unrealised and should be eliminated on consolidation by:

- Debiting Sales Revenue with an amount equal to the intragroup price

- Crediting Cost of Sales with an amount equal to the original cost of inventories

- Crediting Inventories with an amount equal to the unrealised profit (i.e. the entire

profit on the intragroup sale).

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 30 June 2020 by raising a Deferred Tax Asset for the tax recognised

by Amani Ltd in advance on the unrealised intragroup profit.

(b) The only adjusting entry eliminates the intragroup sales revenue recognised by Amani Ltd

(on the intragroup sale) and the cost of sales recognised by Rebecca Ltd (on the external sale)

as the profit on the intragroup sale is entirely realised during the current period. As the

inventories are sold by the end of the period to an external entity, at 30 June 2020 the entire

profit on the intragroup sale is realised; however, the aggregate sales revenues and cost of
sales are overstated from the group’s perspective as they include the intragroup sales revenue

and the cost of sales recognised based on the price paid intragroup by Rebecca Ltd. On

consolidation, this overstatement needs to be corrected. There won’t be any tax-effect

adjustment entry as the only adjusting entry posted now does not have any net effect on the

profit or on the carrying amount of inventories

(c) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June

2020. As half of the inventories remain unsold at the end of the period, at 30 June 2020 half

of the profit on the intragroup sale is unrealised and should be eliminated on consolidation

by:

 Debiting Sales Revenue with an amount equal to the intragroup price – this eliminates the

amount recognised by Rebecca Ltd on the intragroup sale, so that the consolidated figure

reflects only the sales revenues generated from transactions with external parties

 Crediting Inventories with an amount equal to the unrealised profit (i.e. half of the profit

on the intragroup sale) – this corrects the overstatement of inventories still on hand (half

of the original amount transferred intragroup) that are recorded by Amani Ltd based on

the intragroup price, making sure that those inventories are recorded at the original cost to

the group

 Crediting Cost of Sales with an amount equal to the difference between the debit amount

to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales

recognised by Rebecca Ltd (which was based on the original cost) and adjusts the Cost of

Sales recognised by Amani Ltd (which was based on the intragroup price), so that the

consolidated figure reflects only the cost of sales of the inventories sold to the external

party based on their original cost to the group.

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 30 June 2020 by raising a Deferred Tax Asset for the tax recognised

by Rebecca Ltd in advance on the unrealised intragroup profit

(d) In this case, the unrealised profit in closing inventories from the period ended 30 June

2019 and recognised as unrealised profit in opening inventories in this period becomes

realised by the end of the current period. As such, this profit needs to be transferred from the

previous period to the current period by:

 Debiting Retained Earnings (1/7/19) with an amount equal to the after-tax unrealised
profit in opening inventories – this eliminates the unrealised profit from the prior period’s

profit

 Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in

opening inventories – this increases the current profit as the previously unrealised profit is

now realised.

As a result of this transfer of profit to the current period, the current period profit increases

and a tax effect should also be recognised in the adjusting entry by:

 Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in

opening inventories

Exercise 28.2
Current and prior periods intragroup transfers of inventories

Charlotte Ltd owns all the share capital of Aloise Ltd. The income tax rate is 30%. The

following transactions took place during the periods ended 30 June 2019 or 30 June

2020.

(a) On 1 May 2019, Charlotte Ltd sold inventories to Aloise Ltd for $10 000 on credit,

recording a profit of $2000. Half of the inventories were unsold by Aloise Ltd at 30

June 2019 and none at 30 June 2020. Aloise Ltd paid half the amount owed on 15

June 2019 and the rest on 1 July 2019.

(b) On 10 June 2019, Aloise Ltd sold inventories to Charlotte Ltd for $15 000 in cash.

The inventories had previously cost Aloise Ltd $12 000. Half of these inventories

were unsold by Charlotte Ltd at 30 June 2019 and 30% at 30 June 2020.

(c) On 1 January 2020, Aloise Ltd sold inventories costing $6000 to Charlotte Ltd at a

transfer price of $7000, paid in cash. The entire inventories were sold by Charlotte

Ltd to external entities by 30 June 2020.

Required

In relation to the above intragroup transactions:

1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2019

and 30 June 2020.

2. Explain in detail why you made each adjusting journal entry.

(LO2 and LO3)

1. At 30 June 2019, there will only be adjusting entries for transactions (a) and (b) as these

are the only transactions related to the financial period ended on 30 June 2019. At 30 June

2020, there will be adjusting entries for all transactions.

CHARLOTTE LTD – ALOISE LTD

30 June 2019

(a) Sales revenue Dr 10 000

Inventories Cr 1 000

Cost of sales Cr 9 000

Deferred tax asset Dr 300

Income tax expense Cr 300

Accounts payable Dr 5 000

Accounts receivable Cr 5 000

b) Sales revenue Dr 15 000

Cost of sales Cr 13 500

Inventories Cr 1 500

Deferred tax asset Dr 450

Income tax expense Cr 450

30 June 2020

(a) Retained earnings (1/7/19) Dr 7000

Income tax expense Dr 300

Cost of sales Cr 1000

(b) Retained earnings (1/7/19) Dr 1 500

Cost of sales Cr 600

Inventories Cr 900

Deferred tax asset Dr 270

Income tax expense Dr 180

Retained earnings (1/7/19) Cr 450

(c) Sales revenue Dr 7 000

Cost of sales Cr 7 000

2. Detailed explanations on the adjusting journal entries

30 June 2019:
(a) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June

2019. As half of the inventories remain unsold at the end of the period, at 30 June 2019 half

of the entire profit on the intragroup sale is unrealised and should be eliminated on

consolidation by:

 Debiting Sales Revenue with an amount equal to the intragroup price – to eliminate the

intragroup revenues

 Crediting Inventories with an amount equal to the unrealised profit – to decrease the value

of the inventories left on hand with the group to their original cost to the group

 Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of

credit to Inventories – to adjust the aggregate figure for Cost of Sales to the amount that

should be recognised by the group, i.e. the original cost of the inventories sold to external

parties.

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 30 June 2019 by raising a Deferred Tax Asset for the tax recognised

by Charlotte Ltd on the unrealised profit.

The third adjusting entry eliminates the intragroup Accounts Payable and Accounts

Receivable for the amount still unpaid on the intragroup sale.

(b) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June

2019. As half of the inventories remain unsold at the end of the period, at 30 June 2019 half

of the entire profit on the intragroup sale is unrealised and should be eliminated on

consolidation by:

 Debiting Sales Revenue with an amount equal to the intragroup price

 Crediting Inventories with an amount equal to the unrealised profit – to decrease the value

of the inventories left on hand with the group to their original cost to the group

 Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of

credit to Inventories.

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 30 June 2019 by raising a Deferred Tax Asset for the tax recognised

by Aloise Ltd in advance on the unrealised intragroup profit.

30 June 2020:

(a) In this case, the unrealised profit in closing inventories from the period ended 30 June
2019 and recognised as unrealised profit in opening inventories in this period becomes

realised by the end of the current period. As such, this profit needs to be transferred from the

previous period to the current period by:

 Debiting Retained Earnings (1/7/19) with an amount equal to the after-tax unrealised

profit in opening inventories – this eliminates the unrealised profit from the prior period’s

earnings

 Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in

opening inventories – this increases the current profit as the previously unrealised profit is

now realised.

As a result of this transfer of profit to the current period, the current period profit increases

and a tax effect should also be recognised in the adjusting entry by:

 Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in

opening inventories.

(b) In this case, a part (20%) of the inventories originally transferred intragroup in the

previous period is sold during the current period to external parties, while another part (30%)

is still unsold. That means that the unrealised profit in closing inventories from the period

ended 30 June 2019 and recognised as unrealised profit in opening inventories in this period

is only partly realised by the end of the current period. This is recognised in the first adjusting

entry by:

 Debiting Retained Earnings (1/7/19) with an amount equal to the before-tax unrealised

profit in opening inventories – this eliminates the unrealised profit from the prior period’s

profit

 Crediting Cost of Sales with an amount equal to the unrealised profit in opening

inventories that becomes realised during the current period – this increases the current

profit as the previously unrealised profit is now realised

 Crediting Inventories with an amount equal to the unrealised profit in opening inventories

that is still unrealised at the end of the current period – this decreases the value of the

nventories still on hand to their original cost to the group.

As a result of the recognition of the part of profit that is realised in the current period, the

current period profit increases and a current tax effect should also be recognised by:

 Debiting Income Tax Expense with an amount equal to the tax on the part of the
unrealised profit in opening inventories that is realised by the end of the period.

As a result of the elimination of the part of the profit that is unrealised by the end of the

current period, a deferred tax effect should also be recognised by:

 Debiting Deferred Tax Asset with an amount equal to the tax on the part of the unrealised

profit in opening inventories that is still unrealised at the end of the period.

Given that Retained Earnings only recognises profits after tax, debiting Retained Earnings

(1/7/19) in the first adjusting entry with the before-tax unrealised profit eliminated from that

account more than what it should and therefore the balance of Retained Earnings (1/7/19)

should be adjusted by:

Crediting Retained Earnings (1/7/19) with an amount equal to the tax on the unrealised

profit in opening inventories – this ensures that the net adjustment to Retained Earnings

(1/7/19) is only for the after-tax unrealised profit.

(c) The only adjusting entry eliminates the intragroup sales revenue recognised by Aloise Ltd

(on the intragroup sale) and the cost of sales recognised by Charlotte Ltd (on the external

sale) as the profit on the intragroup sale is entirely realised during the current period. As the

inventories are sold by the end of the period to an external entity, at 30 June 2020 the entire

profit on the intragroup sale is realised; however, the aggregate sales revenues and cost of

sales are overstated from the group’s perspective as they include the intragroup sales revenue

and the cost of sales recognised based on the price paid intragroup by Charlotte Ltd. On

consolidation, this overstatement is corrected. There won’t be any tax-effect adjustment entry

as the only adjusting entry posted now does not have any net effect on the profit or on the

carrying amount of inventories

Exercise 28.10
Intragroup transfers of inventories, non-current assets, services and dividends

Karen Ltd owns all the share capital of Anne Ltd. The income tax rate is 30%. The

following transactions took place during the periods ended 30 June 2018 to 30 June

2020.

(a) In February 2018, Karen Ltd sold inventories to Anne Ltd for $6000, at a mark-up

of 20% on cost. One-quarter of this inventories were unsold by Anne Ltd at 30 June

2018 to external parties and none at 30 June 2019.

(b) On 1 January 2018, Anne Ltd sold a new tractor to Karen Ltd for $20 000. This had

cost Anne Ltd $16 000 on that day. Both entities charged depreciation at the rate of

10% p.a. on the diminishing balance. The tractor was still on hand with Karen Ltd

at 30 June 2020.

(c) A non-current asset with a carrying amount of $1000 was sold by Karen Ltd to

Anne Ltd for $800 on 1 January 2020. Anne Ltd intended to use this item as

inventories, being a seller of second-hand goods. The item was still on hand at 30

une 2020.

(d) Anne Ltd rented a spare warehouse to Karen Ltd starting from 1 July 2019 for 1

year. The total charge for the rental was $300, and Karen Ltd paid half of this

amount to Anne Ltd on 1 January 2017 and the rest is to be paid on 1 July 2020.

(e) In December 2019, Anne Ltd paid a $1500 interim dividend.

(f) During March 2020, Anne Ltd declared a $3000 dividend. The dividend was paid in

August 2020.

Required

In relation to the above intragroup transactions:

1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2019

and 30 June 2020.

2. Explain in detail why you made each adjusting journal entry.

(LO2, LO3, LO4, LO5 and LO6)

1. At 30 June 2019, there will only be adjusting entries for transactions (a) and (b) as these

are the only transactions related to the financial period ended on 30 June 2019. At 30 June

2020, there will be adjusting entries for all transactions excluding (a) for which the intragroup

profit was fully realised by the beginning of that period.

KAREN LTD – ANNE LTD

30 June 2019

(a) Retained earnings (1/7/19) Dr 175

Income tax expense Dr 75

Cost of sales Cr 250

(b) Retained earnings (1/7/18) Dr 2 800

Deferred tax asset Dr 1 200

Tractor Cr 4 000

Accumulated depreciation - tractor Dr 580

Retained earnings (1/7/18) Cr 200

Depreciation expense Cr 380

Retained earnings (1/7/18) Dr 60

Income tax expense Dr 114

Deferred tax asset Cr 174

30 June 2020

(b) Retained earnings (1/7/19) Dr 2 800

Deferred tax asset Dr 1 200

Tractor Cr 4 000

Accumulated depreciation - tractor Dr 922

Retained earnings (1/7/19) Cr 580

Depreciation expense Cr 342

Retained earnings (1/7/19) Dr 174

Income tax expense Dr 103

Deferred tax asset Cr 277

(c) Proceeds on sale of non-current asset (NCA) Dr 800

Inventories Dr 200

Carrying amount of NCA sold Cr 1 000

OR

Inventories Dr 200

Loss on sale of non-current asset Cr 200

income tax expense Dr 60

Deferred tax liability Cr 60

(d) Rent revenues Dr 300

Rent expenses Cr 300

Rent payable Dr 150

Rent receivable Cr 150

(e) Dividend revenue Dr 1 500

Dividend paid Cr 1 500

(f) Dividend revenue Dr 3 000

Dividend declared Cr 3 000

Dividend payable Dr 3 000

Dividend receivable Cr 3 000

2. Detailed explanations on the adjusting journal entries

30 June 2019:

(a) In this case, the unrealised profit in closing inventories from the period ended 30 June

2018 and recognised as unrealised profit in opening inventories in this period becomes

realised by the end of the current period (the assumption is that the remaining inventories still

on hand with the group at 30 June 2018 are sold to external entities by the end of the current

period). As such, this profit needs to be transferred from the previous period to the current

period by:

 Debiting Retained Earnings (1/7/18) with an amount equal to the after-tax unrealised

profit in opening inventories – this eliminates the unrealised profit from the prior period’s

profit

 Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in

opening inventories – this increases the current profit as the previously unrealised profit is

now realised.

As a result of this transfer of profit to the current period, the current period profit increases

and a tax effect should also be recognised in the adjusting entry by:

 Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in

opening inventories.

(b) The first journal entry eliminates the after-tax profit on sale of the tractor intragroup from

the previous period’s profits as the intragroup sale took place in the previous period and

generated unrealised profits from the group’s perspective. The adjusting entry will also bring

down the balance of the tractor account to reflect the original carrying amount of the tractor

before the intragroup sale. As this entry decreases the carrying amount of the tractor, without

any effect on its tax base, a deferred tax asset needs to be recognised for the deductible

temporary difference created or, using another explanation, for the tax that was paid by Anne

Ltd on the unrealised profit on the intragroup sale. All of these adjustments are necessary as

the asset is still on hand with the group and there was no sale involving an external entity.
The second adjusting entry is necessary to adjust the depreciation expenses recorded after the

intragroup sale by the entity that now uses the asset within the group. As this entity records

the depreciation based on the price paid intragroup, while the group should recognise the

depreciation based on the carrying amount of the asset at the moment of the intragroup sale

the previous and current period’s depreciation expenses are overstated and should be

decreased by amounts calculated and recorded as follows.

 For the previous period’s depreciation: Karen Ltd records a previous period’s

depreciation of $20 000 x 10% x 6/12 = $1000, while the group should record a previous

period’s depreciation of $16 000 x 10% x 6/12 = $800. Therefore, the adjustment would

be a decrease of $200 in previous period’s expenses which will be recorded as a credit to

Retained Earnings (1/7/18) as previous period’s expenses are now in the retained

earnings.

 For the current period’s depreciation: Karen Ltd records a current depreciation of ($20

000 - $1000) x 10% = $1900, while the group should record a depreciation of ($16 000 -

$800) x 10% = $1520. Therefore, the adjustment would be a decrease of $380 in current

expenses which will be recorded as a credit to Depreciation expense.

Overall, the accumulated depreciation is adjusted by the total adjustment to depreciation, i.e.

$580.

It should be noted that these adjustments to depreciation expenses increase the previous and

the current profit and therefore it is said to be an indication that a part of the profit on the

intragroup sale is now realised.

The third adjusting entry is recognising the tax effect of the second entry. As a part of the

intragroup gain is now realised through the depreciation adjustments, this entry adjusts the

tax effect recognised in the first entry that eliminated the gain on the intragroup sale. This

tax-effect entry is needed because the depreciation adjustment entry increases the carrying

amount of the asset, with no effect on the tax base and therefore decreases the deductible

temporary difference that was recorded in the deferred tax asset when eliminating the gain on

the intragroup sale.

30 June 2020:

(b) The first journal entry is the same as the first entry for this intragroup transaction at 30

June 2019 because the tractor is still on hand with the group and the intragroup profit is still
unrealised.

The second adjusting entry is similar to the depreciation adjustment entry at 30 June 2019

with the following differences:

 the amount credited to Retained earnings (1/7/19) represents the depreciation adjustments

for the periods ended 30 June 2018 and 30 June 2019 (i.e. $580 in total).

 the amount credited to Depreciation expense for the current period’s depreciation is the

difference between what Karen Ltd records as current depreciation, i.e. ($20 000 - $1000

- $1900) x 10% = $1710, and what the group should record as depreciation, i.e. ($16 000

- $800 - $1520) x 10% = $1368. Therefore, the adjustment to current depreciation would

be $342.

 overall, the accumulated depreciation is adjusted by the total adjustment to depreciation,

i.e. $580 + $342 = $922.

The third adjusting entry is recognising the tax effect of the second entry

(c) The first journal entry eliminates the proceeds on sale of the non-current asset intragroup

and the carrying amount of the asset sold recognised at the movement of the intragroup sale -

or alternatively the loss on the intragroup sale of the non-current asset which is unrealised

from the point of view of the group. This adjusting entry will also bring up the balance of the

asset account (now treated as inventories) to reflect the original carrying amount of the asset

before the intragroup sale. All of these adjustments are necessary as the asset is still on hand

with the group and there was no sale involving an external entity.

The second adjusting entry is recognising the tax effect of the first entry. As the first entry

eliminates the loss on sale (which increases the current profit) and increases the carrying

amount of the asset, without any effect on its tax base, the income tax expense, normally

calculated based on the current profit, needs to increase and a deferred tax liability needs to

be recognised for the taxable temporary difference created or, using another explanation, for

the tax that should have been paid by Karen Ltd if it wouldn’t have claimed the unrealised

loss on the intragroup sale as a tax deduction.

It should be noted here that although the original classification of the asset before the

intragroup sale was a non-current asset, there won’t be any reclassification needed on

consolidation as, from the group’s perspective, the asset is going to be used as

inventories from the moment of the intragroup sale. As a consequence of this, there
won’t be any depreciation adjustments or the related tax effect.

(d) The current period’s rent expense recognised by Karen Ltd and rent revenue recognised

by Anne Ltd is one full year of rent of $300. As the consolidated financial statements should

not recognise this intragroup rent, the first adjusting entry will eliminate this amount. As this

adjusting entry does not have any net impact of the profit there won’t be any tax-effect

adjusting entry.

As the rent was only paid during the next period on 1 July 2020, at 30 June 2020 there will be

rent payable for the current period recognised by Karen Ltd and the equivalent rent receivable

recognised by Anne Ltd; therefore the second adjustment entry will need to eliminate these

further effects of the intragroup transaction.

(e) The adjusting entry eliminates the dividend revenue recognised by Karen Ltd and the

dividend paid recognised by Anne Ltd during the current period. As this adjusting entry does

not have any net impact of the consolidated retained earnings there won’t be any further

adjusting entries in the next period for the dividends paid this current period. Also, for

dividends there are no tax effects that should be recognised or adjusted on consolidation. As

the dividends were paid during the current period, there won’t be a need to eliminate any

Dividends Payable or Dividends Receivable.

(f) The adjusting entry eliminates the dividend revenue recognised by Karen Ltd and the

dividend declared recognised by Anne Ltd during the current period. As this adjusting entry

does not have any net impact of the consolidated retained earnings there won’t be any further

adjusting entries in the next period for the dividends paid this current period. Also, for

dividends there are no tax effects that should be recognised or adjusted on consolidation. As

the dividends were not paid during the current period, there will be a need to eliminate

Dividends Payable and Dividends Receivable in the second adjusting entry.

Exercise 28.11
Intragroup transfers of inventories, non-current assets, services and borrowings

Judith Ltd owns all the share capital of Mary Ltd. The income tax rate is 30%. The

following transactions took place during the periods ended 30 June 2019 or 30 June

2020.

(a) On 1 May 2019, Mary Ltd sold inventories costing $200 to Judith Ltd for $400 on
credit. On 30 June 2019, only half of these goods had been sold by Judith Ltd, and

Judith Ltd had paid $300 to Mary Ltd. All remaining inventories were sold to

external entities by 30 June 2020 and Judith Ltd paid the outstanding amount to

Mary Ltd on 5 May 2020.

(b) On 1 January 2019, Judith Ltd sold an item of plant to Mary Ltd for $1000.

Immediately before the sale, Judith Ltd had the item of plant on its accounts for

$1500. Judith Ltd depreciated items at 5% p.a. on the diminishing balance and

Mary Ltd used the straight-line method over 10 years.

(c) An inventories item with a cost of $1000 was sold by Judith Ltd to Mary Ltd for

$800 on 1 January 2020. Mary Ltd intended to use this item as equipment. Both

entities charge depreciation at the rate of 10% p.a. on the diminishing balance on

non-current assets. The item was still on hand at 30 June 2020.

(d) Judith Ltd provided management services to Mary Ltd during the period ended 30

June 2020. The total charge for those services was $3000 that was unpaid at 30 June

2020.

(e) Judith Ltd borrows $50 000 from Mary Ltd on 1 July 2018 with an interest rate of

6% p.a. The loan is for 5 years. The interest is to be paid biannually in arrears,

starting on 31 December 2018.

Required

In relation to the above intragroup transactions:

1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2019

and 30 June 2020.

2. Explain in detail why you made each adjusting journal entry.

(LO2, LO3, LO4, LO5 and LO7)

1. At 30 June 2019, there will only be adjusting entries for transactions (a), (b) and (e) as

these are the only transactions related to the financial period ended on 30 June 2019. At 30

June 2020, there will be adjusting entries for all transactions.

JUDITH LTD – MARY LTD

30 June 2019

(a) Sales revenue Dr 400

Cost of sales Cr 300

Inventories Cr 100

Deferred tax asset Dr 30

Income tax expense Cr 30

Accounts payable Dr 100

Accounts receivable Cr 100

(b) Proceeds on sale of plant Dr 1 000

Plant Dr 500

Carrying amount of plant sold Cr 1 500

OR

Plant Dr 500

Loss on sale of plant Cr 500

Income tax expense Dr 150

Deferred tax liability Cr 150

Depreciation expense Dr 25

Accumulated depreciation - plant Cr 25

Deferred tax liability Dr 7.5

Income tax expense Cr 7.5

(e) Loan from Mary Ltd Dr 50 000

Loan to Judith Ltd Cr 50 000

Interest revenue Dr 3 000

Interest expense Cr 3 000

30 June 2020

(a) Retained earnings (1/7/19) Dr 70

Income tax expense Dr 30

Cost of sales Cr 100

(b) Plant Dr 500

Retained earnings (1/7/19) Cr 500

Retained earnings (1/7/19) Dr 150

Deferred tax liability Cr 150

Depreciation expense Dr 25

Retained earnings (1/7/19) Dr 25

Accumulated depreciation - plant Cr 50

eferred tax liability Dr 15

Income tax expense Cr 7.5

Retained earnings (1/7/19) Cr 7.5

(c) Equipment Dr 200

Sales revenue Dr 800

Cost of sales Cr 1 000

Income tax expense Dr 60

Deferred tax liability Cr 60

Depreciation expense Dr 10

Accumulated depreciation - equipment Cr 10

Deferred tax liability Dr 3

Income tax expense Cr 3

(d) Management fees revenue Dr 3 000

Management fees expense Cr 3 000

Management fees payable Dr 3 000

Management fees receivable Cr 3 000

(e) Loan from Mary Ltd Dr 50 000

Loan to Judith Ltd Cr 50 000

Interest revenue Dr 3 000

Interest expense Cr 3 000

2. Detailed explanations on the adjusting journal entries

30 June 2019:

(a) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June

2019. As only half of the inventories transferred intragroup were sold in the current period to

external parties, at 30 June 2019 half of the entire profit on the intragroup sale is unrealised

and should be eliminated on consolidation by:

 Debiting Sales Revenue with an amount equal to the intragroup price – this eliminates the

amount recognised by Mary Ltd on the intragroup sale so that the consolidated figure

reflects that no revenues have been generated from transactions with external parties.

 Crediting Inventories with an amount equal to the unrealised profit on the intragroup sale
– this corrects the overstatement of inventories still held by Judith Ltd which are recorded

based at the intragroup price (i.e. 50% x $400), making sure that those inventories are

recorded at the original cost to the group (i.e. 50% x $200).

 Crediting Cost of Sales with an amount equal to the difference between the debit amount

to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales

recognised by Mary Ltd (based on the original cost) and adjusts the Cost of Sales

recognised by Judith Ltd (based on the intragroup price) so that the consolidated figure

reflects only the cost of sales of the inventories sold to external entities based on their

original cost to the group.

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 30 June 2019 by raising a Deferred Tax Asset for the tax recognised

by Mary Ltd on the intragroup unrealised profit. This tax adjustment is needed because the

first adjustment entry adjusted downwards the carrying amount of inventories still on hand

with no effect on the tax base and therefore created a deductible temporary difference that

gives rise to a Deferred Tax Asset.

The third adjusting entry is needed to eliminate the amount still unpaid intragroup by Judith

Ltd. This amount is recognised by Judith Ltd in Accounts Payable and in Accounts

Receivable by Mary Ltd and those accounts need to be eliminated as they represent

intragroup liabilities and assets.

(b) The first journal entry eliminates the proceeds on sale of plant intragroup and the carrying

amount of plant sold recognised at the movement of the intragroup sale (or alternatively the

loss on sale of plant which is unrealised from the group’s perspective). The adjusting entry

will also bring up the balance of the plant account to reflect the original carrying amount of

the plant before the intragroup sale. All of these adjustments are necessary as the asset is still

on hand with the group and there was no sale involving an external entity.

The second adjusting entry is recognising the tax effect of the first entry. As the first entry

eliminates the loss on sale (which increases the current profit) and increases the carrying

amount of the plant, without any effect on its tax base, the income tax expense, normally

calculated based on the current profit, needs to increase and a deferred tax liability needs to

be recognised for the taxable temporary difference created or, using another explanation, for

the tax that should have been paid if Judith Ltd wouldn’t have claimed a deduction based on
the unrealised loss on the intragroup sale.

The third adjusting entry is necessary to adjust the depreciation expense recorded after the

intragroup sale by the entity that now uses the asset within the group. As this entity records

he depreciation based on the price paid intragroup, while the group should recognise the

depreciation based on the carrying amount of the asset at the moment of the intragroup sale,

the depreciation expense is understated and should be increased by an amount equal to the

depreciation rate multiplied by the loss on the intragroup sale, but only for half a year since

the intragroup sale took place on 1 January 2019. Note that the depreciation method that is

used by the new owner of the asset is the one used by the group as well as that reflect how the

asset is being used in the group, i.e. the asset is being depreciated on a straight-line method

over 10 years, so the depreciation rate is 10% p.a. It should also be noted that this adjustment

to depreciation expense decreases the current profit and therefore it is said to be an indication

that a part of the loss on the intragroup sale is now realised.

As a part of the intragroup loss is now realised through the depreciation adjustments, the

fourth adjusting entry adjusts the tax effect of the previous entry that eliminated the entire

loss on the intragroup sale, basically reversing that previous tax effect entry for the part of the

loss that is now realised. That is because the depreciation adjustment entry decreases the

carrying amount of the asset, with no effect on the tax base and therefore decreases the

taxable temporary difference that was recorded in the deferred tax liability when eliminating

the loss on intragroup sale.

(e) The first adjusting entry for this transaction is needed to eliminate the liability recognised

by Judith Ltd for the loan taken from Mary Ltd (as it is an intragroup liability) and the

receivable recognised by Mary Ltd for the amount it lends to Judith Ltd and that should be

paid back to them (as it is an intragroup receivable). As the loan is not an interest free loan, a

second adjusting entry is needed to eliminate the intragroup interest recognised as revenue by

Mary Ltd and expense by Judith Ltd during the current period. As the interest was paid on 31

December 2018 and 30 June 2019 only for the current period up to 30 June 2019, there is no

interest payable, receivable, prepaid interest or interest received in advance that needs to be

eliminated. There is also no tax effect entry as none of the adjusting entries posted have any

net impact on the consolidated profit

30 June 2020:
(a) In this case, the unrealised profit in closing inventories from the period ended 30 June

2019 and recognised as unrealised profit in opening inventories in this period becomes

realised by the end of the current period. As such, this profit needs to be transferred from the

previous period to the current period by:

 Debiting Retained Earnings (1/7/19) with an amount equal to the after-tax unrealised

profit in opening inventories – this eliminates the unrealised profit from the prior period’s

profit

 Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in

opening inventories – this increases the current profit as the previously unrealised profit is

now realised.

As a result of this transfer of profit to the current period, the current period profit increases

and a tax effect should also be recognised in the adjusting entry by:

 Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in

opening inventories.

(b) The explanation for the adjusting journal entries posted now for the intragroup sale of the

plant for a loss on 1 January 2019 is as follows:

 the first adjusting entry increases the plant’s value up from the price paid intragroup to

the original carrying amount of the plant at the moment of intragroup sale and eliminates

the net loss on the intragroup sale of plant recorded in the previous period that is now in

the Retained Earnings (1/7/19).

 the second entry recognises the tax effect of the first entry by raising a deferred tax

liability for the tax unpaid by the intragroup seller due to the loss that is unrealised from

the group’s perspective and adjusting the Retained Earnings (1/7/19) for the previous

period’s tax effect.

 the third adjusting entry increases the depreciation expenses from the previous and

current periods up from the depreciation recorded by the user of the plant (based on the

intragroup price paid) to the depreciation expenses that should be recorded by the group

(based on the carrying amount of the plant at the moment of the intragroup sale); the

previous period’s depreciation expense is now in the Retained Earnings (1/7/19) and

should be adjusted in there.

 the fourth entry recognises the tax effect of the third entry by decreasing the deferred tax
liability recognised in the second entry by the tax on the loss realised during the current

and previous periods through the depreciations adjustments.

(c) The first journal entry eliminates the intragroup sales revenue and cost of sales recognised

by Judith Ltd as those should not be recorded from the group’s perspective. The adjusting

entry will also bring up the balance of the equipment account to reflect the original carrying

amount of the asset (initially recorded as inventories, but now reclassified as equipment)

before the intragroup sale. All of these adjustments are necessary as the asset is still on hand

with the group and there was no sale involving an external entity.

The second adjusting entry is recognising the tax effect of the first entry. As the first entry

eliminates the loss on sale (which increases the current profit) and increases the carrying

amount of the equipment, without any effect on its tax base, the income tax
expense,

normally calculated based on the current profit, needs to increase and a deferred tax liability

needs to be recognised for the taxable temporary difference created or, using another

explanation, for the tax that should have been paid if Judith Ltd wouldn’t have claimed a

deduction based on the unrealised loss on the intragroup sale.

The third adjusting entry is necessary to adjust the depreciation expense recorded after the

intragroup sale by the entity that now uses the asset within the group. As this entity records

the depreciation based on the price paid intragroup, while the group should recognise the

depreciation based on the carrying amount of the asset at the moment of the intragroup sale,

the depreciation expense is understated and should be increased by an amount equal to the

depreciation rate multiplied by the loss on the intragroup sale, but only for half a year since

the intragroup sale took place on 1 January 2020. It should be noted that this adjustment to

depreciation expense decreases the current profit and therefore it is said to be an indication

that a part of the loss on the intragroup sale is now realised.

As a part of the intragroup loss is now realised through the depreciation adjustments, the

fourth adjusting entry adjusts the tax effect of the previous entry that eliminated the entire

loss on the intragroup sale, basically reversing that previous tax effect entry for the part of the

loss that is now realised. That is because the depreciation adjustment entry decreases the

carrying amount of the asset, with no effect on the tax base and therefore decreases the

taxable temporary difference that was recorded in the deferred tax liability when eliminating
the loss on intragroup sale.

(d) The first adjusting entry eliminates the management fee revenue recognised by Judith Ltd

and the management fee expense recognised by Mary Ltd during the current period. As this

adjusting entry does not have any net impact of the profit:

 there won’t be any tax-effect adjusting entry

 there won’t be any further adjusting entries in the next period for the management fees

incurred this current period.

As the management fees were not paid during the current period, there is a need to eliminate

further accounts, i.e. Management Fees Payable and Management Fees Receivable. These

accounts are eliminated in the second adjusting entry.

(e) The explanation for the adjusting entries for this transaction at 30 June 2020 is exactly the

same as that for the adjusting entries for this transaction at 30 June 2019.This is because the

entries are exactly the same as those posted at 30 June 2019 as it is assumed there are no

repayments on the loans during the period and the interest is the same across the two periods

Exercise 28.12
Consolidation worksheet with pre-acquisition equity transfers and intragroup

transactions

On 1 January 2017, Olivia Ltd acquired all the share capital of Chloe Ltd for $300 000.

The equity of Chloe Ltd at 1 January 2017 was as follows

At this date, all identifiable assets and liabilities of Chloe Ltd were recorded at fair

value.

On 1 May 2020, Chloe Ltd transferred $15 000 from the general reserve (pre-

acquisition) to retained earnings. The income tax rate is 30%.

The following information has been provided about transactions between the two

entities:

(a) The beginning and ending inventories of Olivia Ltd and Chloe Ltd in relation to the

current period ended on 31 December 2020 included the following inventories

transferred intragroup:

Olivia Ltd sold inventories to Chloe Ltd during the current period for $3000. This was

$500 above the cost of the inventories to Olivia Ltd. Chloe Ltd sold inventories to Olivia

Ltd in the current period for $2500, recording a pre-tax profit of $800.

(b) Olivia Ltd sold an inventories item to Chloe Ltd on 1 July 2020 for use as
machinery. The item cost Olivia Ltd $4000 and was sold to Chloe Ltd for $6000.

Chloe Ltd depreciated the item at a rate of 10% p.a. on cost.

(c) On 31 December 2020, Chloe Ltd owes Olivia Ltd $1000 for items sold on credit.

(d) Chloe Ltd undertook an advertising campaign for Olivia Ltd during the period

ended 31 December 2020. Olivia Ltd was charged and paid $8000 to Chloe Ltd for

this service.

(e) Olivia Ltd received dividends totalling $63 000 during the current period ended 31

December 2020 from Chloe Ltd. These dividends were declared in the current

period out of post-acquisition profits

Required

1. Prepare the acquisition analysis at 1 January 2017.

2. Prepare the business combination valuation entries and pre-acquisition entries at 1

January 2017.

3. Prepare the business combination valuation entries and pre-acquisition entries at

31 December 2020.

4. Prepare the consolidation worksheet journal entries to eliminate the effects of

intragroup transactions at 31 December 2020.

(LO3, LO4, LO5, LO6 and LO7)

1.

OLIVIA LTD – CHLOE LTD

At 1 January 2017:

Net fair value of identifiable assets

and liabilities of Chloe Ltd = $200 000 + $50 000 + $20 000 (equity)

= $270 000

Consideration transferred = $300 000

Goodwill = $30 000

2.

Business combination valuation entry 1 January 2017

Goodwill Dr 30 000

Business combination valuation reserve Cr 30 000

Pre-acquisition entry at 1 January 2017

Retained earnings (1/1/17) Dr 50 000

Share capital Dr 200 000

General reserve Dr 20 000

Business combination valuation reserve Dr 30 000

Shares in Chloe Ltd Cr 300 000

3.

Business combination valuation entry 31 December 2020

Goodwill Dr 30 000

Business combination valuation reserve Cr 30 000

Pre-acquisition entry at 31 December 2020

Retained earnings (1/1/20) Dr 50 000

Share capital Dr 200 000

General reserve Dr 20 000

Business combination valuation reserve Dr 30 000

Shares in Chloe Ltd Cr 300 000

Transfer from general reserve Dr 15 000

General reserve Cr 15 000

4.

Adjustments for intragroup transactions at 31 December 2020

(a) Retained earnings (1/1/20) Dr 700

Income tax expense Dr 300

Cost of sales Cr 1 000

Sales revenue Dr 5 500

Cost of sales Cr 5 100

Inventories Cr 400

Deferred tax asset Dr 120

Income tax expense Cr 120

The first adjusting entry deals with the unrealised profits in opening (beginning) inventories.

It is assumed that the unrealised profits in closing inventories from the period ended 31

December 2019 and recognised as unrealised profits in opening inventories in this period (i.e.

$2000 - $1400 for Olivia Ltd and $1200 - $800 for Chloe Ltd) become realised by the end of
the current period. As such, these profits need to be transferred from the previous period to

the current period by:

 Debiting Retained Earnings (1/1/20) with an amount equal to the after-tax unrealised

profits in opening inventories (i.e. $1000 x (1 – 30%)) – this eliminates the unrealised

profits from the prior period’s profit.

 Crediting Cost of Sales with an amount equal to the before-tax unrealised profits in

opening inventories – this increases the current profit as the previously unrealised profit is

now realised.

As a result of this transfer of profits to the current period, the current period’s profit increases

and a tax effect should also be recognised in the adjusting entry by:

 Debiting Income Tax Expense with an amount equal to the tax on the unrealised profits in

opening inventories

The second adjusting entry eliminates the unrealised profits in closing (ending) inventories of

Olivia Ltd and Chloe Ltd at 31 December 2020. As inventories that were originally

transferred intragroup are still on hand with both entities at 31 December 2020, the profits

related to those inventories items are unrealised and should be eliminated on consolidation

by:

 Debiting Sales Revenue with an amount equal to the intragroup price for current period

sales from both Olivia Ltd to Chloe Ltd (i.e. $3000) and from Chloe Ltd to Olivia (i.e.

$2500) – this eliminates the amount of revenue recognised by the entities on the

intragroup sales so that the consolidated figure reflects only the sales revenues generated

from transactions with external parties.

 Crediting Inventories with an amount equal to the unrealised profits in ending inventories

($500 - $300 for Olivia Ltd and $900 - $700 for Chloe Ltd) – this corrects the

overstatement of inventories still on hand that are recorded by the entities based on the

intragroup price, making sure that those inventories are recorded at the original cost to the

group.

 Crediting Cost of Sales with an amount equal to the difference between the debit amount

to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales

recognised by the entities on the intragroup sales (based on the original cost) and adjusts

the Cost of Sales recognised by the entities on external sales (based on the intragroup
price) so that the consolidated figure reflects only the cost of sales of the inventories sold

to the external parties based on their original cost to the group.

The second adjusting entry recognises the tax effect of the elimination of the unrealised

profits in closing inventories at 31 December 2020 by raising a Deferred Tax Asset for the

tax recognised by Olivia Ltd and Chloe Ltd, in advance on the unrealised intragroup profits.

It is worth noting that the entire profits on the current period’s intragroup sales do not matter

for the adjusting entries; it is only the unrealised profits in closing inventories that are

considered as they are the ones that need to be eliminated.

(b) Sales revenue Dr 6 000

Cost of sales Cr 4 000

Plant & machinery Cr 2 000

Deferred tax asset Dr 600

Income tax expense Cr 600

Accumulated depreciation – plant

& machinery Dr 100

Depreciation expense Cr 100

(10% x 1/2 x $2000)

Income tax expense Dr 30

Deferred tax asset Cr 30

The first adjusting entry decreases the machine’s value down from the price paid intragroup

to the original carrying amount of the machine at the moment of intragroup sale and

eliminates the sales revenue and the cost of sales recognised on the intragroup sale,

considering that the machine was recognised by the initial owner as inventories; the second

entry recognises the tax effect of the first entry by raising a Deferred Tax Asset for the tax

paid by the intragroup seller on the profit that is unrealised from the group’s perspective (i.e.

the entire profit on the intragroup sale).

The third adjusting entry decreases the depreciation expense recognised for the machine

down from the depreciation recorded by the user of the vehicle (based on the intragroup price

paid) to the depreciation that should be recorded by the group (based on the carrying amount

of the machine at the moment of the intragroup sale). The annual depreciation adjustment is

equal to the intragroup profit multiplied by the depreciation rate per year. As the asset was
transferred intragroup on 1 July 2020, six months before the end of the current period, the

depreciation adjustment is only half of the annual depreciation adjustment, i.e. ($6000 -

$4000) x 10% x ½. This depreciation adjustment decreases the expenses for the current

period and therefore increases the current profit by a part of the profit on the intragroup sale.

As such, it is said that a part of the intragroup profit has been realised. The fourth entry

recognises the tax effect of the third entry by decreasing the Deferred Tax Asset recognised

in the second entry by the tax on the profit realised through the depreciation adjustment.

It should be noted here that although the original classification of the asset before
the

intragroup sale was inventories, there won’t be any reclassification needed on consolidation

as, from the group’s perspective, the asset is going to be used as a machine from the moment

of the intragroup sale.

(c) Accounts payable Dr 1 000

Accounts receivable Cr 1 000

As Chloe Ltd owes Olivia Ltd for items purchased during the period, in the individual

accounts a liability Accounts Payable is recognised by Chloe Ltd and an asset Accounts

Receivable is recognised by Olivia Ltd. As those accounts reflect obligations and resources

receivable from within the group, they are eliminated on consolidation in this adjusting entry.

(d) Revenue - services fees Dr 8 000

Advertising expenses Cr 8 000

This adjusting entry eliminates the services fee revenue recognised by Chloe Ltd and the

advertising expense recognised by Olivia Ltd as a result of the advertising campaigned that

ran intragroup during the current period. As this adjusting entry does not have any net impact

on the profit:

 there won’t be any tax-effect adjusting entry

 there won’t be any further adjusting entries in the next period for the fees incurred this

urrent period.

As the services fees were paid during the current period, there won’t be a need to eliminate

any another accounts during the current period as there is no Services Fees Payable or

Services Fees Receivable. Also, there were no services fees paid in advance for the next
period and therefore there are no Prepaid Services Fees and Services Fees Received in

Advance to eliminate.

(e) Dividend revenue Dr 63 000

Dividend paid Cr 63 000

This adjusting entry eliminates the dividend revenue recognised by Olivia Ltd and the

dividend paid recognised by Chloe Ltd during the current period. As this adjusting entry does

not have any net impact of the consolidated retained earnings, there won’t be any further

adjusting entries in the next period for the dividends paid this current period. Also, for

dividends there are no tax effects that should be recognised or adjusted on consolidation.

As the dividends were paid during the current period, there won’t be a need to eliminate any

Dividends Payable or Dividends Receivable.

Exercise 28.13
Consolidation with differences between carrying amount and fair value at acquisition

date, impairment of goodwill and intragroup transactions

Financial information for Kaija Ltd and its 100% owned subsidiary, Helena Ltd, for the

period ended 31 December 2020 is provided below.

Kaija Ltd acquired its shares in Helena Ltd at 1 January 2020, buying the 10 000 shares

in Helena Ltd for $20 000 on a cum div. basis. At that date, Helena Ltd recorded share

capital of $10 000. Helena Ltd had declared prior to the acquisition a dividend of $3000

that was paid in March 2020.

At 1 January 2020, all identifiable assets and liabilities of Helena Ltd were recorded at

fair value except for inventories, for which the carrying amount was $400 less than fair

value. Some of the inventories has been a little slow to sell, and 10% of it is still on hand

at 31 December 2020. Inventories on hand in Helena Ltd at 31 December 2020 also

includes some items acquired from Kaija Ltd during the period ended 31 December

2020. These were sold by Kaija Ltd for $5000, at a profit before tax of $1000.

Half of the goodwill on acquisition of Helena Ltd by Kaija Ltd was written off as the

result of an impairment test on 31 December 2020.

During March 2020, Kaija Ltd provided some management services to Helena Ltd at a
fee of $500 paid by 31 December 2020.

On 1 July 2020, Helena Ltd sold machinery to Kaija Ltd at a gain of $2000. This

machinery had a carrying amount to Helena Ltd of $20 000, and was considered by

Kaija Ltd to have a 5-year life

By 31 December 2020, the financial assets acquired by Kaija Ltd and Helena Ltd from

external entities increased in value by $1000 and $650 respectively with gains and losses

being recognised in other comprehensive income.

The income tax rate is 30%.

Required

1. Prepare the acquisition analysis at 1 January 2020.

2. Prepare the business combination valuation entries and pre-acquisition entries at 1

January 2020.

3. Prepare the business combination valuation entries and pre-acquisition entries at

31 December 2020.

4. Prepare the consolidation worksheet journal entries to eliminate the effects of

intragroup transactions at 31 December 2020.

5. Discuss the concept of ‘realisation’ using the intragroup transactions in this

question to illustrate the concept.

6. Prepare the consolidation worksheet for the preparation of the consolidated

financial statements for the period ended 31 December 2020.

7. Prepare the consolidated statement of profit or loss and other comprehensive

ncome for Kaija Ltd and its subsidiary, Helena Ltd, at 31 December 2020.

(LO1, LO2, LO3, LO4, LO5, LO6 and LO7)

KAIJA LTD – HELENA LTD

1.

At 1 January 2020:

Net fair value of identifiable assets

and liabilities of Helena Ltd = $10 000 + $3000 (equity) + $400 (1 – 30%)

(BCVR - inventories)

= $13 280

Net consideration transferred = $20 000 - $3000 (dividend)

= $17 000

Goodwill = $17 000 - $13 280

= $3720

2.

Business combination valuation entries at 1 January 2020

Inventories Dr 400

Deferred tax liability Cr 120

Business combination valuation reserve Cr 280

Goodwill Dr 3 720

Business combination valuation reserve Cr 3 720

Pre-acquisition entries at 1 January 2020

Retained earnings (1/1/20) Dr 3 000

Share capital Dr 10 000

Business combination valuation reserve Dr 4 000

Shares in Helena Ltd Cr 17 000

Dividend payable Dr 3 000

Dividend receivable Cr 3 000

Note that the adjusting entry for these dividends is posted here as they relate to
pre-

acquisition equity being declared prior to the acquisition. This adjusting entry related to

intragroup pre-acquisition dividends eliminates from the individual financial statements the

dividend payable recognised by Helena Ltd and the dividend receivable recognised by Kaija

Ltd during the current period. As these dividends would be paid by 31 December 2020, this

entry does not need to be repeated then. There is no adjustment to Dividend Revenue as Haija

Ltd did not recognise these dividends as revenue, but as a refund on the
consideration

transferred as they were declared prior to the acquisition. Moreover, since these dividends

were declared prior to the acquisition, there is no need to adjust Dividend Declared

recognised by Helena Ltd

3.

(1) Business combination valuation entries at 31 December 2020

Cost of sales Dr 360

Income tax expense Cr 108

Transfer from business combination

valuation reserve Cr 252

Inventories Dr 40

Deferred tax liability Cr 12

Business combination valuation reserve Cr 28

Goodwill Dr 3 720

Business combination valuation reserve Cr 3 720

(2) Pre-acquisition entries at 31 December 2020

Retained earnings (1/1/20) Dr 3 000

Share capital Dr 10 000

Business combination valuation reserve Dr 4 000

Shares in Helena Ltd Cr 17 000

Transfer from business combination

valuation reserve Dr 252

Business combination valuation reserve Cr 252

Impairment loss - goodwill Dr 1 860

Accumulated impairment losses Cr 1 860

4.

Elimination of the effects of intragroup transactions at 31 December 2020

(3) Dividend paid

Dividend revenue Dr 1 000

Interim dividend paid Cr 1 000

This adjusting entry eliminates from the individual financial statements the dividend revenue

recognised by Kaija Ltd and the dividend paid recognised by Helena Ltd during the current

period for the post-acquisition dividends. As this adjusting entry does not have any net

impact of the consolidated retained earnings there won’t be any further adjusting entries in

the next period for the dividends paid this current period. Also, for dividends there are no tax

effects that should be recognised or adjusted on consolidation.

As the dividends were paid during the current period, there won’t be a need to eliminate any

Dividends Payable or Dividends Receivable.

(4) Sales of inventories

Sales revenue Dr 5 000

Cost of sales Cr 4 000

Inventories Cr 1 000

Deferred tax asset Dr 300

Income tax expense Cr 300

The first adjusting entry eliminates the unrealised profit in closing inventories at 31

December 2020. As inventories originally transferred intragroup are still on hand with the

group at 31 December 2020, the profit of $1000 related to those items is unrealised and

should be eliminated on consolidation by:

 Debiting Sales Revenue with an amount equal to the intragroup price of the inventories

transferred intragroup (it is assumed that the inventories still on hand are all the

inventories that were transferred intragroup) – this eliminates the amount recognised by

Kaija Ltd on the intragroup sale so that the consolidated figure reflects only the sales

revenues generated from transactions with external parties.

 Crediting Inventories with an amount equal to the unrealised profit – this corrects the

overstatement of inventories still on hand that are recorded by Helena Ltd based on the
intragroup price, making sure that those inventories are recorded at the original cost to the

group.

 Crediting Cost of Sales with an amount equal to the difference between the debit amount

to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales

recognised by Kaija Ltd (based on the original cost) so that the consolidated figure

reflects only the cost of sales of the inventories sold to external entities based on their

original cost to the group.

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 31 December 2020 by raising a Deferred Tax Asset for the tax

recognised by Kaija Ltd in advance on the unrealised intragroup profit.

(5) Management services

Other income Dr 500

Other expenses Cr 500

The adjusting entry eliminates the management fee revenue recognised in Other Income by

Kaija Ltd and the management fee expense recognised in Other Expenses by Helena Ltd

during the current period. As this adjusting entry does not have any net impact of the profit:

 there won’t be any tax-effect adjusting entry

 there won’t be any further adjusting entries in the next period for the management fees

incurred this current period.

As the management fees were paid during the current period, there won’t be a need to

eliminate any another accounts during the current period as there is no Management Fees

Payable or Management Fees Receivable. Also, there were no management fee paid in

advance for the next period and therefore there are no Prepaid Management Fees
and

Management Fees Received in Advance to eliminate.

(6) Sale of machinery

Gain on sale of property, plant and equip. Dr 2 000

Machinery Cr 2 000

Deferred tax asset Dr 600

Income tax expense Cr 600

The first journal entry eliminates the intragroup gain on sale of the machinery. The adjusting
entry will also bring down the balance of the machinery account to reflect the original

carrying amount of the machinery before the intragroup sale. All of these adjustments are

necessary as the asset is still on hand with the group and there was no sale involving an

external entity.

The second adjusting entry is recognising the tax effect of the first entry. As the first entry

eliminates the gain on sale (which decreases the current profit) and decreases the carrying

amount of the asset, without any effect on its tax base, the income tax expense, normally

calculated based on the current profit, needs to decrease and a deferred tax asset needs to be

recognised for the deductible temporary difference created or, using another explanation, for

the tax prepayment made by Helena Ltd on the unrealised profit from the intragroup sale.

(7) Depreciation of machinery

Accumulated depreciation - machinery Dr 200

Depreciation expense Cr 200

(20% x $2000 x 1/2)

Income tax expense Dr 60

Deferred tax asset Cr 60

These adjusting entries are necessary to adjust the depreciation expense recorded after the

intragroup sale by the entity that now uses the asset within the group. As this entity records

the depreciation based on the price paid intragroup, while the group should recognise the

depreciation based on the carrying amount of the asset at the moment of the intragroup sale,

the depreciation expense is overstated and should be decreased by an amount equal to the

depreciation rate multiplied by the gain on the intragroup sale, but only for the 6 months

starting with the intragroup sale. It should be noted that this adjustment to depreciation

expense increases the current profit and therefore it is said to be an indication that a part of

the profit on the intragroup sale is now realised.

As a part of the intragroup profit is now realised through the depreciation adjustments, the

other adjusting entry here adjusts the tax effect of the previous entry that eliminated the entire

profit on the intragroup sale (see worksheet adjustment (6)), basically reversing that previous

tax effect entry for the part of the profit that is now realised. That is because the depreciation

adjustment entry increases the carrying amount of the asset, with no effect on the tax base

and therefore decreases the deductible temporary difference that was recorded in the deferred
tax asset when eliminating the gain on intragroup sale.

5. Concept of realisation

Profits recognised by group members on sale of assets within the group are unrealised profits

to the extent that the assets are still within the group. Realisation of profits on intragroup

transactions involving assets normally occurs when an external entity gets involved.

For intragroup sales of inventories or non-depreciable assets, realisation occurs when

these assets are on-sold to external entities – see worksheet adjustment (4) where adjustment

is made for unrealised profits from sales of inventories. If only a part of the inventories

initially transferred intragroup is on-sold to external parties by the end of a period, only the

part of the intragroup profit related to the inventories on-sold is realised. It should be noted

that, as inventories are current assets which should be eventually sold to external parties, it is

normally assumed, unless otherwise specified, that inventories transferred intragroup that are

not sold to external parties by the end of a period are sold to external parties by the end of the

next period and therefore any unrealised profit in opening inventories in one period is

considered realised by the end of that period.

For intragroup sale of depreciable assets, as a depreciable asset may never be on-sold by a

member of the group to external parties, remaining within the group and being consumed by

use instead, the point of realisation may not be directly and exclusively determined by

reference to involvement of an external entity. Realisation is then indirectly determined by

usage of the asset within the group, that is, in proportion to the consumption of the benefits

from the asset within the group. Realisation of the profit/loss on sale within the group is then

measured in the same proportion to the depreciation of the asset recorded by the entity that

uses it. As such, if the asset is used in the group up to the end of its useful life, the profit will

be realised in full only at the end of the useful life. However, the depreciable asset may be

on-sold to external parties before the end of the useful life, in which case, the profit is

realised in full at the moment of external sale, with a part of it being realised through

depreciation (based on the period of time since the intragroup transfer up to the moment of

external sale) and the rest through the external sale. In this exercise, for the intragroup sale of

plant, realisation of the profit occurs as plant is used up and benefits received – see worksheet

adjustments (6) and (7). Note that the gain on sale is considered to be fully unrealised at the

moment of the intragroup sale but as the asset is depreciated, profit is realised; the credit to
depreciation expense in adjustment (7) means an increase in group profit.

6. Consolidation worksheet at 31 December 2020

7.

HELENA LTD

Consolidated Statement of Profit or Loss and Other Comprehensive Income

for the financial year ended 31 December 2020

Revenue: sales $43 600

Other income 2 500

$46 100

Expenses:

Cost of sales 35 360

Other 5 160 40 520

5 580

Gain on sale of non-current assets 1 000

Profit before income tax 6 580

Income tax expense 2 352

Profit for the period $4 228

Other comprehensive income:

Gains on financial assets 1 650

Comprehensive income for the period $5 878

Exercise 28.14
Consolidation with differences between carrying amount and fair value at acquisition

date and intragroup transactions

Zoe Ltd purchased 100% of the shares of Matilda Ltd on 1 July 2017 for $50 000. At

that date the equity of the two entities was as follows.

At 1 July 2017, all the identifiable assets and liabilities of Matilda Ltd were recorded at

fair value except for the following

All of the inventories were sold by December 2017. The plant and equipment had a

further 5-year useful life. Any valuation adjustments are made on consolidation.

Financial information for Zoe Ltd and Matilda Ltd for the period ended 30 June 2019 is

shown below.
Additional information

(a) Zoe Ltd records dividend receivable as revenue when dividends are declared.

(b) The beginning inventories of Matilda Ltd at 1 July 2018 included goods which cost

Matilda Ltd $2000. Matilda Ltd purchased these inventories from Zoe Ltd at cost
plus 33% mark-up.

(c) Intragroup sales totalled $10 000 for the period ended 30 June 2019. Sales from Zoe

Ltd to Matilda Ltd, at cost plus 10% mark-up, amounted to $5600. The ending

inventories of Zoe Ltd included goods which cost Zoe Ltd $4400. Zoe Ltd

purchased these inventories from Matilda Ltd at cost plus 10% mark-up.

(d) On 31 December 2018, Matilda Ltd sold Zoe Ltd office furniture for $3000. This

furniture originally cost Matilda Ltd $3000 and was written down to $2500 just

before the intragroup sale. Zoe Ltd depreciates furniture at the rate of 10% p.a. on

cost.

(e) The asset revaluation surplus relates to land. The following movements occurred in

this account.

(f) The income tax rate is 30%

Required

1. Prepare the acquisition analysis at 1 July 2017.

2. Prepare the business combination valuation entries and pre-acquisition entries at 1

July 2017.

3. Prepare the business combination valuation entries and pre-acquisition entries at

30 June 2019.

4. Prepare the consolidation worksheet journal entries to eliminate the effects of

intragroup transactions at 30 June 2019.

5. Prepare the consolidation worksheet for the preparation of the consolidated

financial statements for the period ended 30 June 2019.

6. Prepare the consolidated statement of profit or loss and other comprehensive

income for the period ended 30 June 2019.

(LO3, LO4, LO5, LO6 and LO7)

ZOE LTD – MATILDA LTD

1.

At 1 July 2017:

Net fair value of identifiable assets

and liabilities of Matilda Ltd = ($40 000 + $4 000 + $2 800) (equity)

+ ($3 500 – $3 000) (1 – 30%) (BCVR - inventories)

+ ($61 000 – $60 000) (1 – 30%) (BCVR - plant)

= $47 850

Consideration transferred = $50 000

Goodwill = $50 000 - $47 850

= $2 150

2.

Business combination valuation entries at 1 July 2017

Accumulated depreciation – plant and equip. Dr 20 000

Plant and equipment Cr 19 000

Deferred tax liability Cr 300

Business combination valuation reserve Cr 700

Inventories Dr 500

Deferred tax liability Cr 150

Business combination valuation reserve Cr 350

Goodwill Dr 2 150

Business combination valuation reserve Cr 2 150

Pre-acquisition entries at 1 July 2017

Retained earnings (1/7/17) Dr 2 800

Share capital Dr 40 000

Asset revaluation surplus Dr 4 000

Business combination valuation reserve Dr 3 200

Shares in Matilda Ltd Cr 50 000

3.

(1) Business combination valuation entries at 30 June 2019

Accumulated depreciation – plant & equip. Dr 20 000

Plant & equipment Cr 19 000

Deferred tax liability Cr 300

Business combination valuation reserve Cr 700

Depreciation expense Dr 200

Retained earnings (1/7/18) Dr 200

Accumulated depreciation - plant & equip. Cr 400

Deferred tax liability Dr 120

Income tax expense Cr 60

Retained earnings (1/7/18) Cr 60

Goodwill Dr 2 150

Business combination valuation reserve Cr 2 150

(2) Pre-acquisition entries at 30 June 2019

Retained earnings (1/7/18)* Dr 3 150

Share capital Dr 40 000

Asset revaluation surplus Dr 4 000

Business combination valuation reserve Dr 2 850

Shares in Matilda Ltd Cr 50 000

* $2800 + $500 (1 – 30%) (BCVR - inventories)

4. Elimination of the effects of intragroup transactions at 30 June 2019

(3) Dividend paid

Dividend revenue Dr 2 000

Dividend paid Cr 2 000

This adjusting entry eliminates the dividend revenue recognised by Zoe Ltd and the dividend

paid recognised by Matilda Ltd during the current period (this dividend is identified by

inspecting the financial statements of Matilda Ltd). As this adjusting entry does not have any

net impact of the consolidated retained earnings, there won’t be any further adjusting entries

in the next period for the dividends paid this current period. Also, for dividends there are no

tax effects that should be recognised or adjusted on consolidation. As the dividends were paid

during the current period, there won’t be a need to eliminate any Dividends Payable or

Dividends Receivable

(4) Dividend declared

Dividend revenue Dr 2 400

Dividend declared Cr 2 400

Dividend payable Dr 2 400

Dividend receivable Cr 2 400

The first adjusting entry eliminates the dividend revenue recognised by Zoe Ltd and the

dividend declared recognised by Matilda Ltd during the current period (this dividend is also
identified by inspecting the financial statements of Matilda Ltd). As this adjusting entry does

not have any net impact of the consolidated retained earnings there won’t be any further

adjusting entries in the next period for the dividends paid this current period. Also, for

dividends there are no tax effects that should be recognised or adjusted on consolidation. As

the dividends were not paid during the current period, there will be a need to eliminate

Dividends Payable and Dividends Receivable in the second adjusting entry.

(5) Profit in beginning inventories: sales from Zoe Ltd to Matilda in the previous period

Retained earnings (1/7/18) Dr 350

Income tax expense Dr 150

Cost of sales Cr 500

In this case, the unrealised profit in closing inventories from the period ended 30 June 2018

and recognised as unrealised profit in opening inventories in this period (i.e. $2000 – $2000 /

1.33 = $500) is assumed to become realised by the end of the current period. As such, this

profit needs to be transferred from the previous period to the current period by:

 Debiting Retained Earnings (1/7/18) with an amount equal to the after-tax unrealised

profit in opening inventories ($500 x (1 – 30%)) – this eliminates the unrealised profit

from the prior period’s profit

 Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in

opening inventories – this increases the current profit as the previously unrealised profit is

now realised.

As a result of this transfer of profit to the current period, the current period profit increases

and a tax effect should also be recognised in the adjusting entry by:

 Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in

pening inventories.

(6) Sales of inventories from Zoe Ltd to Matilda Ltd in the current period

Sales revenue Dr 5 600

Cost of sales Cr 5 600

The only adjusting entry eliminates the intragroup sales revenue and the cost of sales

recognised by Zoe Ltd as the profit on the intragroup sale to Matilda Ltd is entirely realised

during the current period. As the inventories are sold by the end of the period to an external

entity, at 30 June 2019 the entire profit on the intragroup sale is realised; however, the
aggregate sales revenues and cost of sales are overstated from the group’s perspective as they

include the intragroup sales revenue and the cost of sales recognised based on the price paid

intragroup by Matilda Ltd. On consolidation, this overstatement needs to be corrected. There

won’t be any tax-effect adjustment entry as the only adjusting entry posted now does not

have any net effect on the profit or on the carrying amount of inventories.

(7) Profit in ending inventories: sales from Matilda Ltd to Zoe Ltd

Sales revenue Dr 4 400

Cost of sales Cr 4 000

Inventories Cr 400

Deferred tax asset Dr 120

Income tax expense Cr 120

The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June

2019. As inventories originally transferred intragroup by Matilda Ltd remain unsold at the

end of the period, at 30 June 2016 the profit on the intragroup sale related to inventories still

on hand (i.e. $4400 - $4400 / 1.1 = $400) is unrealised and should be eliminated on

consolidation by:

 Debiting Sales Revenue with an amount equal to the intragroup price – this eliminates the

amount recognised by Matilda Ltd on the intragroup sale so that the consolidated figure

reflects only the sales revenues generated from transactions with external parties.

 Crediting Inventories with an amount equal to the unrealised profit (i.e. $400) – this

corrects the overstatement of inventories still on hand that are recorded by Zoe Ltd based

on the intragroup price, making sure that those inventories are recorded at the original

cost to the group.

 Crediting Cost of Sales with an amount equal to the difference between the debit amount

to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales

recognised by Matilda Ltd (based on the original cost) so that the consolidated figure

reflects only the cost of sales of the inventories sold to the external party based on their

original cost to the group.

The second adjusting entry recognises the tax effect of the elimination of the unrealised profit

in closing inventories at 30 June 2019 by raising a Deferred Tax Asset for the tax recognised

by Matilda Ltd in advance on the unrealised intragroup profit.

(8) Sale of furniture

Gain on sale of office furniture Dr 500

Office furniture Cr 500

Deferred tax asset Dr 150

Income tax expense Cr 150

The first journal entry eliminates the intragroup gain on sale of office furniture (i.e. $3000 -

$2500). The adjusting entry will also bring down the balance of the office furniture account

to reflect the original carrying amount of the asset before the intragroup sale. All of these

adjustments are necessary as the asset is still on hand with the group and there was no sale

involving an external entity

The second adjusting entry is recognising the tax effect of the first entry. As the first entry

eliminates the gain on sale (which decreases the current profit) and decreases the carrying

amount of the asset, without any effect on its tax base, the income tax expense, normally

calculated based on the current profit, needs to decrease and a deferred tax asset needs to be

recognised for the deductible temporary difference created or, using another explanation, for

the tax prepayment made by Matilda Ltd on the unrealised profit from the intragroup sale.

(9) Depreciation of furniture

Accumulated depreciation - furniture Dr 25

Depreciation expense Cr 25

(10% x 1/2 x $500)

Income tax expense Dr 8

Deferred tax asset Cr 8

(30% x $25 – rounded upwards)

The first adjusting entry is necessary to adjust the depreciation expense recorded after the

intragroup sale by the entity that now uses the asset within the group. As this entity records

the depreciation based on the price paid intragroup, while the group should recognise the

depreciation based on the carrying amount of the asset at the moment of the intragroup sale,

the depreciation expense is overstated and should be decreased by an amount equal to the

depreciation rate multiplied by the gain on the intragroup sale but only for the 6 months since

the intragroup sale. It should be noted that this adjustment to depreciation expense increases

the current profit and therefore it is said to be an indication that a part of the profit on the
intragroup sale is now realised.

As a part of the intragroup profit is now realised through the depreciation adjustments, the

second adjusting entry adjusts the tax effect of the previous entry that eliminated the entire

profit on the intragroup sale (see worksheet entry (8)), basically reversing that previous tax

effect entry for the part of the profit that is now realised. That is because the depreciation

adjustment entry increases the carrying amount of the asset, with no effect on the tax base

and therefore decreases the deductible temporary difference that was recorded in the deferred

tax asset when eliminating the gain on intragroup sale in worksheet entry (8)

6.
 ZOE LTD

Consolidated Statement of Profit or Loss and Other Comprehensive Income

for the financial year ended 30 June 2019

Revenues:

Sales revenue $108 000

Dividend revenue 1 600

$109 600

Expenses:

Cost of sales 79 900

Other expenses 15 975

95 875

Profit before income tax 13 725

Income tax expense 5 028

Profit for the period $8 697

Other comprehensive income:

Asset revaluations: Increments 2 500

Comprehensive income for the period $ 11 197