Advanced Financial

Accounting: Chapter 5
Group Reporting IV:
Consolidation under IFRS 10

Tan, Lim & Lee Chapter 5 © 2015 1

Learning Objectives

1. Understand the principles underlying elimination of intragroup

balances and transactions;
2. Understand the rationale for consolidation adjustments to opening
retained earnings (RE);
3. Appreciate the significance of upstream vs downstream sales &
the impact on non-controlling interests (NCI); and

4. Pass the appropriate consolidation adjustments to eliminate

unrealized profit or loss from transfers of fixed assets and
inventory.

Tan, Lim & Lee Chapter 5 © 2015 2

Content

1.
1. Elimination of
Elimination of intragroup
intragroup transactions
transactions and
and balances
balances

2. Elimination of realized intragroup transactions

3. Elimination of intragroup balances
4. Adjustment of unrealized profit or loss arising from intercompany
transfers
5. Impact on non-controlling interests arising from adjustments of
unrealized profit or loss
6. Special considerations for intercompany transfers of fixed assets
7. Special accounting considerations when intragroup transfers are
made at a loss

Tan, Lim & Lee Chapter 5 © 2015 3

Elimination of Intragroup Transactions
and Balances
• Operational and financial interdependencies within the group entities
– Lead to intragroup transactions and balances

• Intragroup transactions include for example:

– Buying or selling of inventory
– Transferring of long lived assets
– Rendering or procuring of services
– Providing financing among the companies within the group

Tan, Lim & Lee Chapter 5 © 2015 4

Elimination of Intragroup Transactions
and Balances
• Transfer of assets within the group:
– Rarely transacted at the carrying amounts of the assets
– Profit margin included in transfer price if transaction done on an arm’s
length basis
– Profit is unrealized until the asset is sold to a 3rd party
– Lag between purchase and resale of assets results in
overstatement/understatement of group profit/loss and assets
– From the group’s perspective, the unrealized profit has to be eliminated
and the asset restated to the carrying amount based on original cost
transacted with third parties
– For transferred inventory, the carrying amount for the group should be
the lower of original cost as transacted with third parties and net
realizable value

Tan, Lim & Lee Chapter 5 © 2015 5

Elimination of Intragroup Transactions
and Balances
• Intragroup transactions give rise to intragroup balances
– E.g. Loan receivable/payable to or from group companies, Dividend
receivable, Accounts payable/receivable to or from group companies

• From an economic perspective, an entity is not able to transact with

itself
– Intragroup assets and liabilities, equity, income, expenses and cash
flows relating to transactions between entities of the group are to be
eliminated in full during consolidation
– Elimination adjustments are made in relation to the original entries
passed in the legal entity’s financial statements

Tan, Lim & Lee Chapter 5 © 2015 6

Elimination of Intragroup Transactions
and Balances
• Consolidation involves a three step process:

– Preparing consolidation adjusting entries to arrive at consolidated totals

that reflect the effects of transactions of the economic entity with
external third parties

– Preparing consolidation worksheets which combine the legal entities’

financial statements and show adjustments of consolidation entries

– Analysing final consolidated totals to independently substantiate the

reported numbers

Tan, Lim & Lee Chapter 5 © 2015 7

Principles Governing Elimination

• Outstanding balances due to or from companies within a group are

eliminated
• Transactions in the income statement between the group companies
are eliminated
• Profit or loss resulting from intragroup transactions that are included
in the asset are eliminated in full (both parent’s & NCI’s share)
• Tax effects on unrealized profit or loss included in the asset should
be adjusted according to IAS 12 Income Taxes
• Associates (“significant influence) are not part of the group
– Balances with associates are not eliminated
– Unrealized profit or loss from transactions between an investor and its
associates are eliminated to the extent of investor’s interests
Tan, Lim & Lee Chapter 5 © 2015 8
Content

1. Elimination of intragroup transactions and balances

2. Elimination of
Elimination of realized
realized intragroup
intragroup transactions
transactions
3. Elimination of intragroup balances
4. Adjustment of unrealized profit or loss arising from intercompany
transfers
5. Impact on non-controlling interests arising from adjustments of
unrealized profit or loss
6. Special considerations for intercompany transfers of fixed assets
7. Special accounting considerations when intragroup transfers are
made at a loss

Tan, Lim & Lee Chapter 5 © 2015 9

Elimination of Realized Intragroup
Transactions
• “Offsetting” effect on the group net profit from realized transactions
– Profit recorded by the selling company offset the expense recorded by
buying company
– Elimination is still required to avoid overstatement of individual line items

Examples:
1. Transactions relating to interest:
– Usually no time lag in the recognizing of interest by borrower and lender
i.e. interest income exactly offsets the interest expense
– Elimination entry:
Dr Interest Income (lender)
Cr Interest Expense (borrower)

Tan, Lim & Lee Chapter 5 © 2015 10

Elimination of Realized Intragroup
Transactions
– Exception: borrower capitalizes interest on borrowed money into the
cost of construction of a long-lived asset

Dr Interest Income
Cr Fixed assets in progress

2. Transactions relating to services provided

– Provision and consumption of services are simultaneous
– Elimination entry:
Dr Service Income
Cr Service Expense

– Exception: service receiver capitalizes service fee when the service

provided creates or enhances an asset or extends its useful life

Tan, Lim & Lee Chapter 5 © 2015 11

Elimination of Realized Intragroup
Transactions
3. Transfers of inventories that are resold to 3rd party in the same period
– Profit recorded by selling company offset the higher cost of sale
recorded by buying company
– Consolidated financial statements should only show the sale to third
parties and the original cost of purchasing the inventory from third
parties
– Elimination entry:
Dr Sales
Cr Cost of Sales

Tan, Lim & Lee Chapter 5 © 2015 12

Content

1. Elimination of intragroup transactions and balances

2. Elimination of realized intragroup transactions
3. Elimination of
Elimination of intragroup
intragroup balances
balances
4. Adjustment of unrealized profit or loss arising from intercompany
transfers
5. Impact on non-controlling interests arising from adjustments of
unrealized profit or loss
6. Special considerations for intercompany transfers of fixed assets
7. Special accounting considerations when intragroup transfers are
made at a loss

Tan, Lim & Lee Chapter 5 © 2015 13

Prior to Elimination

• Reconciliation is carried out when the balances recorded in both

companies differ
• Usually, reconciling items are due to:

Problems Reconciliation adjustments

 Either adjusted out or recognized in a

In-transit items (recorded only by one
company) manner consistent with the other party’s
treatment

 Correct the error account or pass entry

Errors and omissions
to record the omitted entry

 Either recognized by the disputing party

Dispute on the transaction or adjusted out by the party that recorded
the items in books

Tan, Lim & Lee Chapter 5 © 2015 14

Reconciliation of intercompany balances

Example of a reconciliation of intercompany balances

Reconciliation of balances between Sub A and Sub B $
Amount owing by B in A’s book as at 31 December 20X5 40,000

Less: Items in A’s book but not in B’s books:

Disputed (note 1) (1,500)
Goods received on 29 December 20X5 (note 2) (3,200)
Repair for goods not under warranty (note 3) (300)

Less: payment made in December 20X5 by B not

recorded by A (note 4) (17,000)
Amount owing to A in B’s book as at 31 December 20X5 18,000

Tan, Lim & Lee Chapter 5 © 2015 15

Reconciliation of intercompany balances

Note 1: Either Sub A had to reverse the sale or Sub B had to accrue for
the invoice
Note 2: Since goods were received before the year ended, Sub B had
to record the inventory
Dr Inventory 3,200
Cr Payable to A 3,200
Note 3: Since repairs were not covered under warranty, Sub B had to
record the repair cost
Dr Repair costs 300
Cr Payable to A 300
Note 4: Follow –up action is necessary to ascertain the reason for the
non-clearance. If the cheque is lost, Sub B is required to reverse the
payment entry
Dr Bank 17,000
Cr Payable to A 17,000
Tan, Lim & Lee Chapter 5 © 2015 16
Elimination of Intragroup Balances

Examples:
Dr Intercompany payable (SFP)
Cr Intercompany receivable (SFP)

Dr Dividend payable to parent (SFP)

Cr Dividend receivable from subsidiary (SFP)

Dr Loan payable to parent(SFP)

Cr Loan receivable from subsidiary (SFP)

Tan, Lim & Lee Chapter 5 © 2015 17

Content

1. Elimination of intragroup transactions and balances

2. Elimination of realized intragroup transactions
3. Elimination of intragroup balances
4.
4. Adjustmentof
Adjustment ofunrealized
unrealizedprofit
profitor
orloss
lossarising
arisingfrom
fromintercompany
intercompany
transfers
transfers
5. Impact on non-controlling interests arising from adjustments of
unrealized profit or loss
6. Special considerations for intercompany transfers of fixed assets
7. Special accounting considerations when intragroup transfers are
made at a loss

Tan, Lim & Lee Chapter 5 © 2015 18

Intragroup Transfers of Inventory
and Fixed Assets
• Unrealized profit and loss in asset (arising from intragroup
transaction) should be eliminated in full unless loss is impairment
loss

• If the transferred asset is inventory:

– It should be carried at lower of cost and net realizable value
– Cost is the exchange price when the goods were originally purchased
from a third party
– Adjustments are made to eliminate the profit element in the carrying
amount of the inventory arising from intragroup transaction
– Recognize profit only when the inventory is sold to 3rd party
 Cost of sales in the consolidated financial statements should be the
original cost as transacted with unrelated third parties and not the
transfer price invoiced by one group company to another

Tan, Lim & Lee Chapter 5 © 2015 19

Intragroup Transfers of Inventory
and Fixed Assets
• Unrealized profit in inventory

Transfer
price (TP) Unrealized profit
Original
cost Inventory amount in
(OC)* Inventory amount buying company’s
on consolidation books

• TP - OC (unrealized profit arising from intragroup transaction) in

remaining inventory should be eliminated

* Assuming that the carrying amount prior to the transfer is the original cost

Tan, Lim & Lee Chapter 5 © 2015 20

Intragroup Transfers of Inventory
and Fixed Assets
• If the transferred asset is a fixed asset:
– Asset should be carried at original cost less accumulated depreciation
from date of original purchase to current period
– Subsequent depreciation is based on original cost and not the
transferred price
– If there is a change in useful life or estimates, the changes for the
group should be made with reference to the carrying amount based
on original cost and not the transfer price

Tan, Lim & Lee Chapter 5 © 2015 21

Adjustment to Opening Retained Earnings (RE)

• When a transaction is recognized by a legal entity in one period and

by the economic entity in another period
– Consolidation adjustments are passed through opening RE
– Consolidated opening RE should be the same as the consolidated
closing RE of the previous period

• Sum of the opening RE of the legal entities in the group will not be
equal to the consolidated opening RE
– Consolidated adjustments that have a “one sided effect” on RE (i.e.
elimination adjustments on buyer and seller entries are not fully off-
setting) must be re-enacted every year

• E.g. Unrealized profit from intragroup balances in the previous year

are adjusted against opening RE in the subsequent year
– Re-enactment continue for as long as the asset remains in the group

Tan, Lim & Lee Chapter 5 © 2015 22

Adjustment to Opening Retained Earnings (RE)

Example:
• Subsidiary Co sells inventory to Parent Co and makes a profit of
$20,000 in 20x1. Parent Co resells 10% of the inventory to third
parties in 20x1 and 90% in 20x2. Only 10% of the profit is earned by
the group.
– Opening RE of Subsidiary Co in 20x2 includes “unrealized” profit of
$18,000
– Consolidated RE at the end of 20x1 and beginning of 20x2 should only
include profit of $2,000 and not $20,000
– Re-enactment continue for as long as the asset remains in the group

Tan, Lim & Lee Chapter 5 © 2015 23

Tax Effects on Adjustments to Eliminate
Unrealized Profit (Loss)
• Consolidated tax expense must reflect the tax effects of the
consolidated profit before tax
– Tax expense should be aligned with income recognition
• When unrealized profit is eliminated:
– Profit is taxable for the legal entity but not the economic entity
– A deferred tax asset arises (i.e. in the form of a prepaid tax)
– Consolidation adjustment:
In the current period: In the following period:
Dr Deferred tax asset Dr Deferred tax asset
Cr Tax expense Cr Opening RE
– The tax expense is recognized when the asset is sold to 3rd party
Sold in the current period: Sold in the following period:
Dr Tax expense Dr Tax expense
Cr Deferred tax asset Cr Opening RE
Tan, Lim & Lee Chapter 5 © 2015 24
Illustration 1:
Upstream Sale
• S is a wholly owned subsidiary of P
• On 1 April 20X1, S sold inventory costing $7,000 to its P for $10,000
• On 5 Jan 20X2, P sold the inventory to external party for $15,000
• Assumed tax rate of 20% . Year-end is 31 Dec 20X1.
Q1 What are the consolidation journal entries as at YE 31 Dec 20X1 ?
Dr Sales (S’s I/S) 10,000
Cr Cost of sales (S’s I/S) 7,000
Cr Inventory (P’s SFP) 3,000
This entry is to reduce current year profits and overstatement of
inventory from the unrealized profit of $3,000
Dr Deferred tax asset (Group SFP) 600 (3,000 * 20%)
Cr Tax expense (S’s I/S) 600
This entry is to reduce current year profits and overstatement of
inventory from the unrealized©profit
Tan, Lim & Lee Chapter 5 2015
of $3,000 25
Illustration 1:
Upstream Sale
Q2: What are the consolidation entries as at 31 Dec 20X2?
(1) Dr Opening RE (S’s SFP) 3,000
Cr Cost of Sale (P’s I/S) 3,000
This entry is to reduce previous year profit through opening RE
and recognize profit in the current year when the inventory is sold
to a 3rd party
(2) Dr Tax expense (Group’s P/L) 600
Cr Opening RE (S’s SFP) 600
Since the profit is realized in this year, the tax expense should be
recognized in the group’s income statement in the current year
Or
Dr Deferred tax asset 600
Cr Opening RE 600
Dr Tax expense 600
Cr Deferred tax asset 600
Tan, Lim & Lee Chapter 5 © 2015 26
Illustration 1:
Upstream Sale
If sale to an external party is only made in 20x3:
(1) Dr Opening RE (S’s SFP) 3,000
Cr Inventory (P’s I/S) 3,000
This entry is to reduce previous year profit through opening RE
and eliminate “unrealized” profit in the current year when the
inventory remains unsold to external 3rd party
(2) Dr Deferred tax asset (Group’s P/L) 600
Cr Opening RE (S’s SFP) 600
This entry reinstates the prepaid tax and implicitly shifts the tax
expense from the past period to the future period

Tan, Lim & Lee Chapter 5 © 2015 27

Content

1. Elimination of intragroup transactions and balances

2. Elimination of realized intragroup transactions
3. Elimination of intragroup balances
4. Adjustment of unrealized profit or loss arising from intercompany
transfers
5. Impact
Impacton
onnon-controlling
non-controllinginterests
interestsarising
arisingfrom
fromadjustments
adjustmentsof
of
unrealizedprofit
unrealized profitor
orloss
loss
6. Special considerations for intercompany transfers of fixed assets
7. Special accounting considerations when intragroup transfers are
made at a loss

Tan, Lim & Lee Chapter 5 © 2015 28

Downstream Sale

Unrealized profit
resides in Parent’s Parent
book
Sales were
made from
90 % parent to
owned subsidiary

Mark-up inventory
remains on Subsidiary
Subsidiary’s SFP

In downstream sale, NCI’s share of profit of the subsidiary is not affected

because the adjustment affects the parent’s profit not the subsidiary
Tan, Lim & Lee Chapter 5 © 2015 29
Upstream Sale

Mark-up inventory
remains on Parent’s Parent
SFP

Sales were
made from
90 % subsidiary to
owned parent

Unrealized profit
resides in Subsidiary’s Subsidiary
book

In upstream sale, the unrealized profit resides in the subsidiary. Thus, NCI’s
share of the unrealized profit or loss needs to be adjusted from the carrying
amount of the asset (IFRS 10 Para B86(c))
Tan, Lim & Lee Chapter 5 © 2015 30
Illustration 2:
Upstream and Downstream Sales
• P invested in 70% of shares of S
• Intercompany transfers of inventory are as follows:
20X3 20X4
Sale of inventory from P to S $60,000
Original cost of inventory $(50,000)
Gross profit $10,000
Percentage unsold to 3rd party at year end 10% 4%
Sale of inventory from S to P $200,000
Original cost of inventory $(170,000)
Gross profit $30,000
Percentage unsold to 3rd party at year end 30% 0%
• Tax rate: 20%
• Net profit after tax of S: $800,000 (31 Dec 20X3)
$900,000 (31 Dec 20X4)

Tan, Lim & Lee Chapter 5 © 2015 31

Illustration 2:
Upstream and Downstream Sales
31 Dec 20X3
CJE 1: Elimination of intercompany sales and adjustment
of unrealized profit from downstream sale
Dr Sale 60,000
Cr Cost of sales 59,000 Residual value

Cr Inventory 1,000 Unrealized profit x

percentage unsold

Cost of sales (as reported in P’s I/s) $50,000

Cost of sales (as reported in S’s I/s) 54,000 (90% of $60,000)
Combined cost of sales 104,000
Cost of sales (from group’s perspective) (45,000) (90% of $50,000)
Amount to be eliminated $59,000

Tan, Lim & Lee Chapter 5 © 2015 32

Illustration 1:
Upstream and Downstream Sales
31 Dec 20X3
CJE 1: Elimination of intercompany sales and adjustment
of unrealized profit from downstream sale
Dr Sale 60,000
Cr Cost of sales 59,000 Residual value

Cr Inventory 1,000 Unrealized profit x

percentage unsold

Cost of sales (as reported in P’s I/s) $50,000

Cost of sales (as reported in S’s I/s) 54,000 (90% of $60,000)
Combined cost of sales 104,000
Cost of sales (from group’s perspective) (45,000) (90% of $50,000)
Amount to be eliminated $59,000

Tan, Lim & Lee Chapter 5 © 2015 33

Illustration 1:
Upstream and Downstream Sales
CJE 1 is a composite of two sub-entries:

CJE 1(a): Elimination of realized sales from downstream sale

Dr Sales (P) 54,000 (90% x $60,000)
Cr Cost of sales (S) 54,000
Eliminates the sales of P against the cost of sales of S for the proportion of
inventory that was resold to third parties during 20x3

CJE 1(b): Reversal of unrealized sales and removal of profits from inventory
Dr Sales (P) 6,000 (10% x $60,000)
Cr Cost of sales (S) 5,000 (10% x $50,000)
Cr Inventory (S) 1,000 (10% x $10,000)
Reverses the sales, cost of sales and profit in inventory for the proportion of
inventory that remained unsold as at 31 Dec 20x3

Tan, Lim & Lee Chapter 5 © 2015 34

Illustration 2:
Upstream and Downstream Sales
CJE 2: Adjustment for the tax effects on unrealized profit
in inventory from downstream sales
Dr Deferred tax asset 200 Unrealized profit
from unsold
Cr Tax expense 200 inventory x 20%

CJE 3: Elimination of intercompany sales and adjustment of unrealized profit

from upstream sale
Dr Sale 200,000
Cr Cost of sales 191,000
Cr Inventory 9,000 (30% x $30,000)

CJE 4: Adjustment for the tax effects on unrealized profit in inventory

from upstream sales
Dr Deferred tax asset 1,800
Cr Tax expense 1,800 (20% x $9,000)
Tan, Lim & Lee Chapter 5 © 2015 35
Illustration 2:
Upstream and Downstream Sales
CJE5: Allocation of current profit after tax to non-controlling interests
Dr Income to NCI 237,840
Cr NCI 237,840

Net profit after tax of S for 20x3 * $800,000

Less: unrealized profit from upstream sale (CJE 3) (9,000)
Add: tax expense on unrealized profit (CJE 4) 1,800
Adjusted net profit after tax of S for 20x3 $792,800
NCI’s share of profit after tax for 20x3 (30%) $237,840

* Note: No adjustment is required for the unrealized profit from

downstream sale as profits reside in parent income

Tan, Lim & Lee Chapter 5 © 2015 36

Illustration 2:
Upstream and Downstream Sales
31 Dec 20X4
CJE1: Adjustment of unrealized profit from downstream sale in RE as at 1
Jan 20x4
Dr Opening RE 1,000 (10% x $10,000)
Cr Cost of sales 600 (6% x $10,000)
Cr Inventory 400 (4% x $10,000)

CJE 2: Adjustment of tax on unrealized profit from downstream sale in RE

as at 1 Jan 20x4
Dr Tax expense 120
Dr Deferred tax asset 80
Cr Opening RE 200

Tan, Lim & Lee Chapter 5 © 2015 37

Illustration 2:
Upstream and Downstream Sales

CJE 3: Allocation of post-acquisition RE as at 1 Jan 20x4

Dr Opening RE 240,000 (30% x $800,000)*
Cr NCI 240,000
*Use unadjusted profit after tax for YE 20x3 to compute NCI’s share of
post-acquisition RE.

CJE 4: Adjustment of unrealized profit from upstream sale in RE as at 1

Jan 20x4
Dr Opening RE 6,300 (70% x 30% x $30,000)
Dr NCI 2,700 (30% x 30% x $30,000)
Cr Cost of sale 9,000 (30% x $30,000)

Tan, Lim & Lee Chapter 5 © 2015 38

Illustration 2:
Upstream and Downstream Sales

CJE 5: Adjustment of tax on unrealized profit from upstream sale as at 1

Jan 20x4
Dr Tax expense 1,800
Cr Opening RE 1,260
Cr NCI 540

Combined effect of CJE 3, CJE 4, CJE 5 results in NCI’s share of

adjusted opening RE, which corresponds to CJE 5 passed in 20x3

Tan, Lim & Lee Chapter 5 © 2015 39

Illustration 2:
Upstream and Downstream Sales
CJE6: Allocation of current profit after tax to non-controlling interests
Dr Income to NCI 272,160
Cr NCI 272,160

Net profit after tax of S for 20x4* $900,000

Add: realized profit from upstream sale (CJE 4) 9,000
Less: tax expense on realized profit (CJE 5) (1,800)
Adjusted net profit after tax of S for 20x4 $907,200
NCI’s share of profit after tax for 20x4 (30%) $272,160
* Note: adjustment to current year profit is needed for:
1) Realized profit & tax effects from current sale of inventory
transferred from group companies in prior years are added back
2) Unrealized profit & tax effects from unsold inventory transferred
from group companies in current year are deducted
Tan, Lim & Lee Chapter 5 © 2015 40
Content

1. Elimination of intragroup transactions and balances

2. Elimination of realized intragroup transactions
3. Elimination of intragroup balances
4. Adjustment of unrealized profit or loss arising from intercompany
transfers
5. Impact on non-controlling interests arising from adjustments of
unrealized profit or loss
6. Special
Special considerations
considerations for
for intercompany
intercompany transfers
transfers of
of fixed
fixed assets
assets
7. Special accounting considerations when intragroup transfers are
made at a loss

Tan, Lim & Lee Chapter 5 © 2015 41

Transfers of Fixed Assets

• When fixed assets (FA) are transferred at a marked-up price

– The unrealized profit (or loss) must be eliminated from the carrying
amount of FA
– Account for the FA as if the transfer did not take place (group’s view)

Mark up
Profit
$40,000
+ Transfer
Acc. Dep. on
Original Acc. Dep. price
sale
cost
NBV NBV

Before Transfer After Transfer

Tan, Lim & Lee Chapter 5 © 2015 42

 Adjustments of Transfers of Fixed Assets

1. Restate the FA carrying amount to the NBV as of the date of transfer

2. Profit on sale of FA is adjusted out of:

 Consolidated income statement if sale occurred in same period

 Opening RE if sale occurred in the previous period and corresponding

impact on NCI if the transfer is an upstream sale

3. Subsequent depreciation is determined on the basis of the original

historical cost of asset & estimated useful life (include revision of
estimate)
 ”new” depreciation that is expensed to the legal entity’s financial
statements is calculated on the basis of the transfer price

Tan, Lim & Lee Chapter 5 © 2015 43

Adjustments of Transfers of Fixed Assets

− The difference between the legal entity’s depreciation* and group’s

depreciation is adjusted to:

 Consolidated income statement for current year

 Opening RE for prior year accumulated depreciation

4. The profit or loss on transfers of FA is realized through the series of

higher or lower depreciation charge subsequently
 Over the remaining useful life, aggregate of the additional
depreciation equals the “profit” of the sale

5. Tax effect must be adjusted on the unrealized profit and subsequent

corrections of depreciation
Tan, Lim & Lee Chapter 5 © 2015 44
Adjustments of Transfers of Fixed Assets

• Principles and processes relating to adjustment of profit on transfer

of fixed assets between group companies also apply to other long-
lived assets such as intangible assets

• If fixed assets are carried at revalued amounts:

 OCI arising from the revaluation must be determined on the basis
of the original cost of the fixed assets

 Consolidation adjustments are required to measure OCI from the

group’s perspective as if no transfer took place within the group

Tan, Lim & Lee Chapter 5 © 2015 45

Impact on NCI When an Unrealized Profit
Arises from an Intragroup Transfer of FA
• Downstream sales:
– No impact on NCI
– Elimination of unrealized profit from the carrying amount of the
FA will apply only to the parent

• Upstream sales:
– NCI is adjusted against:
 Unrealized profit on sale of FA
 Subsequent depreciation to unwind the unrealized profit
 Tax effect on profit and depreciation adjustments

Tan, Lim & Lee Chapter 5 © 2015 46

Illustration 3:
Downstream Transfer of Fixed Assets
• 1 Jan 20X2 P sold equipment to S for $360,000
• The original cost of equipment was $400,000
• The remaining useful life was 10 year from the original purchase
date
• The remaining useful life is 8 years from date of transfer
• Assume a tax rate of 20%

Tan, Lim & Lee Chapter 5 © 2015 47

Illustration 3:
Downstream Transfer of Fixed Assets
Acc. Dep.
Profit
$80,000 $40,000
Original on sale Transfer
cost NBV NBV price
$400,000 $320,000 $320,000 $360,000

Before Transfer After Transfer

Profit on sale recorded by P

= Transfer price – NBV
= $360,000 – ($400,000 - $80,000)
= $40,000

Tan, Lim & Lee Chapter 5 © 2015 48

Illustration 3:
Downstream Transfer of Fixed Assets
Acc. Dep.
Profit
$80,000 $40,000
Original on sale Transfer
cost NBV NBV price
$400,000 $320,000 $320,000 $360,000

Before Transfer After Transfer

As at 31 Dec 20x2
Amount to be
Status Quo With sale restored/adjusted
Cost of asset $400,000 $360,000 $40,000
Acc. Dep. 120,000 45,000 75,000
Current Dep. 40,000 45,000 5,000
Profit on sale - 40,000 40,000
Tax on profit - 8,000 8,000
Tan, Lim & Lee Chapter 5 © 2015 49
 Illustration 3:
Downstream Transfer of Fixed Assets
31 Dec 20X2
CJE 1: Adjustment of unrealized profit Reinstate cost of FA
Dr Equipment (S) 40,000 to original historical
cost; reinstate acc.
Dr Profit on sale (P) 40,000
dep. since date of
Cr Accumulated depreciation (S) 80,000 original acquisition
Reversal of these entries: from third party

In P’s Book In S’s Book

Dr Cash 360,000 Dr Equipment 360,000
Dr Acc. dep 80,000 Cr Cash 360,000
Cr Equipment 400,000 Dr Dep 45,000
Cr Profit on sale 40,000 Cr Acc. Dep 45,000

Tan, Lim & Lee Chapter 5 © 2015 50

Illustration 3:
Downstream Transfer of Fixed Assets
CJE 2: Reverse tax on profit on sale
Dr Deferred tax asset (Group’s SFP) 8,000
Cr Tax expense (P) 8,000

$20,00 Dep exp: $45,000

Depreciation
Transfer 0
$60,000
$40,000
$360,000
Acc. Dep. 8 yrs NBV: $315,000
$40,000 Dep exp
overstated by
$5,000!

Depreciation
Dep Exp: $40,000
No Transfer
$320,000
8 yrs
NBV: $280,000

Tan, Lim & Lee Chapter 5 © 2015 51

Illustration 3:
Downstream Transfer of Fixed Assets
CJE 3: Correct the over-depreciation on unrealized profit included in equipment
Dr Accumulated depreciation (S) 5,000
Cr Depreciation (S) 5,000

Depreciation recorded by S $45,000

Original depreciation had P not sold to S 40,000
Excess depreciation $5,000

Alternatively, excess depreciation = unrealized profit/remaining useful life

= $40,000/8
= $5,000

CJE 4: Increase in tax arising from correction of over-depreciation

Dr Tax expense (S) 1,000
Cr Deferred tax asset (group’s BS) 1,000
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Illustration 3:
Downstream Transfer of Fixed Assets
When the equipment is fully depreciated:
CJE 5: Reinstate to original cost, accumulated
depreciation and reverse profit
Dr Equipment (S) 40,000
Dr Opening RE (P) 40,000
Cr Accumulated depreciation (S) 80,000

CJE 6 : Correction of past excess depreciation

Dr Accumulated depreciation 40,000
Cr Opening RE (S) 40,000

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Illustration 3:
Downstream Transfer of Fixed Assets

CJE 7: Tax effects on unrealized profit on sale of fixed assets

Dr Deferred tax asset 8,000
Cr Opening RE (P) 8,000

CJE 8: Tax effects on unrealized profit on sale of fixed assets

Dr Opening RE (S) 8,000
Cr Deferred tax asset 8,000

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Illustration 4:
Upstream Transfer of Fixed Assets
• Assume extension from illustration 3
• 1 Jan 20X2 S sold equipment to P for $360,000
• The original cost of equipment was $400,000
• The remaining useful life is 8 years from date of transfer
• Net profit after tax of S for YE 31 Dec 20X2 : 500,000
YE 31 Dec 20X3 : 800,000
• Assume a tax rate of 20%
Acc. Dep.
Profit
$80,000 $40,000
Original on sale Transfer
cost NBV NBV price
$400,000 $320,000 $320,000 $360,000

Before Transfer After Transfer

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Illustration 4:
Upstream Transfer of Fixed Assets
31 Dec 20X2
CJE 1: Adjustment of unrealized profit
Dr Equipment (S) 40,000
Dr Profit on Sale (P) 40,000
Cr Accumulated depreciation (S) 80,000

CJE 2: Reverse of tax on profit on sale

Dr Deferred tax asset 8,000
(Group’s SFP)
Cr Tax expense (S) 8,000

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Illustration 4:
Upstream Transfer of Fixed Assets
CJE 3: Correct the over-depreciation on unrealized profit
included in equipment
Dr Accumulated depreciation (P) 5,000
Cr Depreciation (P) 5,000

Depreciation recorded by P $45,000

Original depreciation had S not sold to P 40,000
Excess depreciation $5,000

CJE 4: Increase in tax arising from correction of over-

depreciation
Dr Tax expense (P) 1,000
Cr Deferred tax asset
(Group’s SFP) 1,000
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Illustration 4:
Upstream Transfer of Fixed Assets
CJE 5: Allocation of current year profit to NCI
Dr Income to NCI 47,200
Cr NCI 47,200

Net profit after tax of S $500,000

Less: unrealized profit on sale, after-tax (CJE 1, CJE 2) (32,000)*
Add: realization through depreciation, after-tax (CJE 3, CJE 4) 4,000*
Adjusted net profit after tax of S $472,000
NCI’s share (10%) $ 47,200

* Depreciation will “unwind” the original profit on sale (net of tax) until the
end of the remaining useful life of 8 years is reached

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Illustration 4:
Upstream Transfer of Fixed Assets
31 Dec 20X3
CJE 1: Adjustment of unrealized profit in prior year
Dr Equipment (P) 40,000
Dr Opening RE (S) 36,000 (90% x $40,000)
Dr NCI 4,000 (10% x $40,000)
Cr Accumulated depreciation (P) 80,000

CJE 2: Reversal of tax on profit on sale in prior year

Dr Deferred tax asset (Group’s SFP) 8,000
Cr Opening RE (S) 7,200 (20% x $36,000)
Cr NCI 800 (20% x $4,000)

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Illustration 4:
Upstream Transfer of Fixed Assets
CJE 3: Correct the over-depreciation for prior and current year
Dr Accumulated depreciation (P) 10,000
Cr Depreciation (P) 5,000
Cr Opening RE (P) 4,500 (90% x $5,000)
Cr NCI 500 (10% x $5,000)

CJE 4: Increase in tax arising from correction of over-depreciation in

prior and current year
Dr Tax expense (P) 1,000
Cr Opening RE (P) 900 (20% x $4,500)
Cr NCI 100 (20% x $500)
Cr Deferred tax asset (Group’s SFP) 2,000

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Illustration 4:
Upstream Transfer of Fixed Assets

CJE 5: Allocation of current year profit to NCI

Dr Income to NCI 80,400
Cr NCI 80,400

Net profit after tax of S $800,000

Add: realization through depreciation (CJE 3) 5,000
Less: tax expense on depreciation (CJE 4) (1,000)
Adjusted net profit $804,000
NCI’s share (10%) $ 80,400

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Content

1. Elimination of intragroup transactions and balances

2. Elimination of realized intragroup transactions
3. Elimination of intragroup balances
4. Adjustment of unrealized profit or loss arising from intercompany
transfers
5. Impact on non-controlling interests arising from adjustments of
unrealized profit or loss
6. Special considerations for intercompany transfers of fixed assets
7. Special accounting
Special accounting considerations
considerations when
when intragroup
intragroup transfers
transfers are
are
made at a loss

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Transfers of Assets at a Loss

• Need to reassess whether the loss is indicative of impairment loss

• If loss is indicative of impairment loss:

– Loss is not adjusted out of the carrying amount of asset
– Only reverse the sale and cost of sale account for inventory
– Only reverse the sale and accumulated depreciation for FA

• If loss is not indicative of impairment loss:

– Same as unrealized profit treatment
– Unrealized loss is adjusted out of the carrying amount of asset
– Realized only when the inventory is sold to 3rd party or depreciation for
FA are corrected

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Illustration 5:
Unrealized Loss Arising From Intragroup Transfers

Example 1
• Parent transferred inventory to subsidiary during the year ended 31
Dec 20X6 Transfer price $60,000
Original Cost $80,000
Gross loss ($20,000)
• The loss on transfer indicated an impairment loss on the inventory
What is the consolidation journal entry?
Dr Sale 60,000
Cr Cost of Sales 60,000
Eliminate the transfer of inventory – no adjustment is
made to remove the unrealized loss
Implicit recognition of $20,000 of loss in the consolidated income statement

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Illustration 5:
Unrealized Loss Arising From Intragroup Transfers
Example 2
• Parent transferred fixed asset to subsidiary during the year ended 31 Dec
20X6

Transfer price $120,000

Original cost $200,000
Accumulated depreciation 50,000
NBV at date of transfer $150,000
Loss on transfer $(30,000)

• The loss on transfer indicated an impairment loss on the fixed asset

What is the consolidation journal entry?

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Illustration 5:
Unrealized Loss Arising From Intragroup Transfers

Dr Fixed asset 80,000

Cr Accumulated depreciation 80,000

Reinstatement of accumulated depreciation $50,000

Recognition of impairment loss of fixed asset 30,000
Adjustment to accumulated depreciation $80,000

Reclassification of loss on sale to impairment loss

Dr Impairment loss 30,000
Cr Loss on sale 30,000

Note: subsequent depreciation will take into account any revision in

useful life of the impairment in value

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Transfers of Assets at a Loss

• A number of other situations exists when the loss on transfer is:

 Either wholly an artificial or “unrealized” loss; or
 Combination of artificial or “unrealized” loss and impairment loss

• To determine whether a loss on an intra-group transfer includes an

impairment loss and/or artificial or “unrealized” loss:
 Compare the transfer price against the fair value of the asset at date of
transfer and its carrying amount

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Illustration 6:
Transfers at a Loss
Background:
• Parent Co transferred inventory to Subsidiary Co on 4 April 20x1
• Assume that the inventory had not yet been resold to third parties

Situation A:
Transfer price $90,000
Original cost $120,000
Carrying amount in P’s books $100,000
Fair value $100,000

TP FV=CA OC

“Artificial loss” “Impairment loss”

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Illustration 6:
Transfers at a Loss
Situation A:
Group Legal entity
LCNRV test at year end “What should be” “What is” Difference
Original cost $120,000 $90,000
NRV $100,000 $100,000
LCNRV $100,000 $90,000 $10,000

“Artificial loss” adjusted as if an unrealized loss of $10,000

Impairment loss of $20,000 is recognized; no reversal on consolidation

CJE: Eliminate intercompany transfer

Dr Sales 90,000
Dr Inventory 10,000
Cr Cost of sales 100,000
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Illustration 6:
Transfers at a Loss
Situation B:

Transfer price $90,000

Original cost $100,000
Fair value $120,000
Carrying amount in P’s books $100,000

TP OC=CA FV

“Artificial loss” No adjustment

Adjusted as if an required as no breach
unrealized loss of LCNRV rule
$10,000

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Illustration 6:
Transfers at a Loss
Situation B:

Group Legal entity

LCNRV test at year end “What should be” “What is” Difference
Original cost $100,000 $90,000
NRV $120,000 $120,000
LCNRV $100,000 $90,000 $10,000

CJE: Eliminate intercompany transfer

Dr Sales 90,000
Dr Inventory 10,000
Cr Cost of sales 100,000

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Illustration 6:
Transfers at a Loss
Situation C:

Transfer price $120,000

Original cost $100,000
Fair value $90,000
Carrying amount in P’s books $90,000

FV=CA OC TP

Impairment loss Unrealized gain

should be should be adjusted
recognized out
$10,000 $20,000

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Illustration 6:
Transfers at a Loss
Situation C:

Group Legal entity

LCNRV test at year end “What should be” “What is” Difference
Original cost $100,000 $120,000
NRV $90,000 $90,000
LCNRV $90,000 $90,000 0
Impairment loss $10,000 $30,000 $20,000

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Illustration 6:
Transfers at a Loss
Situation C:
CJE 1: To reverse unrealized gain in inventory
Dr Sales 120,000
Cr Inventory 20,000
Cr Cost of sales 100,000

CJE 2: To adjust the excess impairment loss

Dr Inventory 20,000
Cr Impairment loss (COS) 20,000

Combined CJE: Elimination of sales and cost of sales

Dr Sales 120,000
Cr Cost of sales 120,000

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Conclusion
• Consolidation adjustments are passed to eliminate intragroup
balances and transactions
• Consolidation is a three-step process that includes the preparation
of adjusting entries, preparation of a consolidation worksheet and
analysis of final balances
• From the group’s perspective, an asset on the statement of financial
position should be carried on the basis of the original cost
transacted with third parties and not internal transfer prices
• Internally-generated profit or loss should be eliminated unless the
loss is indicative of an impairment loss of the asset
• Multi-period consolidation requires correction of unrealized gains or
losses in opening retained earnings
• Special considerations apply to adjustments for transfers of long-
term assets between group companies and transfers made at a loss

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