1. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-1 Chapter 28 Further consolidation issues I: Accounting for intragroup transactions

2. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-2 Objectives of this lecture Understand the nature of intragroup transactions Understand how and why to eliminate intragroup dividends on consolidation Understand how to account for intragroup sales of inventory inclusive of the related tax expense effects Understand how to account for intragroup sales of non-current assets inclusive of the related tax expense effects

3. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-3 Introduction to accounting for intragroup transactions Overview During a financial period it is common for separate legal entities within an economic entity to transact with each other In preparing consolidated financial statements, the effects of all transactions between entities within the economic entity are eliminated in full, even where the parent entity holds only a fraction of the issued equity. Examples of intragroup transactions Consolidation adjustments for intragroup transactions: –Typically eliminate these transactions by reversing the original accounting entries –Such eliminations can also introduce temporary tax differences into the consolidated financial statements

4. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-4 Dividend payments from pre- and post-acquisition earnings Dividend payments In the consolidation process it is necessary to eliminate: –all dividends paid/payable to other entities within the group –all dividends received/receivable from other entities within the group Only dividends paid externally should be shown in the consolidated financial statements AASB 10 requires that: on consolidation of intragroup balances, transactions, income and expenses are all to be eliminated in full Refer to Worked Example 28.1 on pp. 922–924—Dividend payments to a subsidiary out of post-acquisition earnings

5. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-5 Dividend payments out of pre- and post-acquisition earnings (cont.) Dividends out of pre-acquisition profits If an entity pays dividends out of profits earned before acquisition, it is effectively returning part of the net assets originally acquired (return of part of investment in subsidiary) In 2008 the above treatment was changed and now dividends paid by a subsidiary are to be recorded as dividend revenue in the parent entity’s accounts AASB 127 Separate Financial Statements now states: An entity shall recognise a dividend from a subsidiary, jointly controlled entity or associate in profit or loss in its separate financial statements when its right to receive the dividend is established

6. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-6 Dividends paid from pre-acquisition earnings of the investee If a dividend payment is made out of pre-acquisition profits of the subsidiary then this in itself may have implications for the value of the parent’s investment in the subsidiary. The dividend payment will have the effect of reducing the net assets of the subsidiary. This in turn might provide an indication that the parent entity’s investment in the subsidiary may thereafter have a value that may be below the original cost of the investment. If an impairment loss is recognised in the accounts of the parent entity then that impairment loss would be reversed as a consolidation adjustment prior to the consolidation entry that eliminates the parent’s investment in a subsidiary....

7. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-7 Intragroup sale of inventory From the group’s perspective, revenue should not be recognised until inventory is sold to parties outside the group We will need to eliminate any unrealised profits from the consolidated financial statements Unrealised profits result from inventory, which is sold within the group for a profit, remaining on hand within the group at the end of the reporting period As we know, AASB 10 requires: Consolidated financial statements eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full).

8. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-8

9. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-9 Intragroup sale of inventory (cont.) Each member of a group is typically taxed individually on its income, not the group collectively If tax has been paid by one member of the group, from the group’s perspective this represents a prepayment of tax (deferred tax asset) to the extent that the inventory remains within the group (meaning that the related profit is unrealised from the perspective of the economic entity) This income will not be earned by the economic entity until the inventory is sold outside the group

10. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-10 Intragroup sale of inventory (cont.) Journal entry to eliminate inter-company sales To eliminate total intragroup sales as no sales have occurred from perspective of group DrSalesx CrCost of goods sold (perpetual) orx purchases (periodic)

11. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-11 Intragroup sale of inventory (cont.) Journal entry to eliminate unrealised profit in closing stock Accounting Standards require that inventory must be valued at the lower of cost and net realisable value. Therefore, on consolidation we must reduce the value of closing inventory to its cost to the economic entity. DrCost of goods sold (perpetual) orx closing inventory—(periodic) CrInventoryx

12. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-12 Intragroup sale of inventory (cont.) Consideration of tax paid on intragroup sale of inventory Any tax paid by members of the group related to intragroup sales where full amount of revenue has not been earned from the group’s perspective, effectively represents a prepayment of tax. The adjusting consolidation entry would be: DrDeferred tax assetx CrIncome tax expensex Refer to Worked Example 28.3 on p. 930—Unrealised profit in closing inventory

13. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-13 Intragroup sale of inventory (cont.) Unrealised profit in opening inventory If there have been intragroup sales in the previous period, and some of the inventory is still on hand at the previous year end, then the cost of opening inventory held by one of the entities within the group will be overstated from the group’s perspective In the consolidation journal entries we need to shift income from the previous period, in which inventory was still on hand, to the period in which the inventory is ultimately sold to external parties

14. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-14 Intragroup sale of inventory (cont.) Unrealised profit in opening inventory (cont.) Consolidation entries: Unrealised profits in opening inventory Reducing opening inventory reduces cost of goods sold DrOpening retained earningsx CrCost of goods soldx Higher profits lead to higher tax expense—and remember from an accounting perspective, tax expense is based on accounting profit DrIncome tax expensex CrOpening retained earningsx Consider Worked Example 28.4 (pp. 936–38)—Unrealised profit in opening inventory

15. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-15 Sale of non-current assets within the group Assets of the group need to be valued as if the intragroup sale had not occurred Need to reinstate the non-current asset to the original cost or revalued amount –Eliminate any unrealised profits on sale –Adjust depreciation –There may be tax on profit of sale, which will represent a temporary difference in the consolidated financial statements

16. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-16 Sale of non-current assets within the group (cont.) Consolidation journal entries to eliminate sale of non- current asset Reversing gain and reinstating accumulated depreciation DrGain on salex DrAssetx CrAccumulated depreciationx Recognising deferred tax asset DrDeferred tax assetx CrIncome tax expensex

17. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-17 Sale of non-current assets within the group (cont.) Consolidation journal entries to eliminate sale of non- current asset (cont.) Adjusting depreciation to reflect correct amount DrAccumulated depreciationx CrDepreciation expensex Partially reversing deferred tax asset to reflect depreciation adjustment DrIncome tax expensex CrDeferred tax assetx Refer to Worked Example 28.5 on pp. 939–42—Intragroup sale of a non-current asset

18. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-18 Summary The lecture considered the consolidation process and, in particular, how to account for intragroup transactions Only dividends paid externally should be shown in the consolidated financial statements—intragroup dividends paid by one entity within the group are to be offset against the dividend revenue recorded in other entity Within the consolidation worksheet, the liability associated with dividends payable is to be offset against dividend receivable Where intragroup sales of inventory have taken place and inventory remains on hand at year end, consolidation adjustments are required to reduce the consolidated balance of closing inventory

19. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 16-19 Summary (cont.) Where there is sale of non-current assets within the group, consolidation adjustments are required to eliminate any intragroup profit on sale and to adjust the cost of the asset to reflect the cost of the asset to the economic entity—this may also require adjustments to depreciation expense If there are non-controlling interests, the effect of intragroup transactions will be still eliminated in full even though the parent entity might hold only a proportion of the capital of the respective subsidiaries