Chapter 29: Intra group transaction Part 1

CQ1 Why is it necessary to make adjustments for intragroup transactions?

Answer:

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.

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

period transactions?

Answer:
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.

CQ 3: 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
CQ 6: 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.

CQ13 What adjustments are needed for intragroup services in the period when the
services are provided and in subsequent periods?

With the transfer of services within the group, the consolidation adjustments do not affect the
profit of the group. In a transaction involving a payment by a parent to a subsidiary, or vice
versa, for services rendered, the client shows an expense and the service provider shows a
revenue. The net effect on the group’s profit is zero. Hence, from the group’s perspective,
there are no unrealised profits or losses from intragroup services. Profits/losses on intragroup
services are considered immediately realised to the group.

In preparing the consolidation adjustment entries for current period intragroup services, note
the following.
• The adjustment to service revenue and service expense is the intragroup fee charged
for those services.
• If the intragroup services have not been paid by the end of the current period, an
adjustment to fees receivable and fees payable is also required for the amount unpaid.
• There is no tax adjustment.
• Note that no adjustment needs to be posted in the subsequent periods, unless the fee
remains unpaid by the end of a future period (in those cases, an adjustment to fees
receivable and fees payable will still be required for the amount unpaid).

In conclusion:
• Adjustments for previous periods intragroup services affect only statement of
financial position accounts, but only if the fees for those services have not been paid.
• Adjustments for current period intragroup services affect statement of profit or loss
and other comprehensive income accounts and statement of financial position
accounts if the fees for those services have not been paid and only statement of profit
or loss and other comprehensive income accounts if the fees have been paid.

2
CQ 14: What adjustments are needed for intragroup dividends in the period when the
dividends are provided and in subsequent periods?

Answer:
In preparing the consolidation adjustment entries for current period intragroup dividends
declared and not yet paid, note the following.
• The adjustment to dividend revenue, dividend declared, dividend receivable and
dividend payable is the amount of dividend declared intragroup.
• There is no tax adjustment.
• Note that no adjustment needs to be posted in the subsequent periods.

In preparing the consolidation adjustment entries for current period intragroup dividends
declared and paid, note the following.
• The adjustment to dividend revenue and dividend declared is the amount of dividend
declared intragroup.
• There is no tax adjustment.
• No adjustment needs to be posted in the subsequent periods.

For intragroup bonus share dividends, two consolidation worksheet adjustments are possible.

(1) Eliminate the bonus dividend paid against the share capital of the subsidiary;
that is, reverse the entry made by the subsidiary to record the dividend. If this entry is
used, the fact that the subsidiary has provided for a bonus dividend does not appear in
the consolidated financial statements unless disclosed by way of a note. The
consolidated retained earnings balance will include profits that have been distributed
as bonus shares and are not available for the payment of dividends.
(2) Do not eliminate the bonus dividend paid but set up a new capitalised profits
reserve in the consolidation worksheet. The purpose of creating this reserve is to
disclose the fact that part of the retained earnings of the group has been distributed by
the subsidiary and is therefore no longer available for payment of dividends to the
parent. This alternative is recommended as the preferred treatment of bonus share
dividends on consolidation as it raises the capitalised profits reserve in the
consolidated financial statements as a non-distributable reserve.

Case study 29.1

Consolidation adjustments

Yidaki Ltd sold inventories during the current period to its wholly owned subsidiary,
Moncrieff Ltd, for $20 000. These items previously cost Yidaki Ltd $15 000. Moncrieff
Ltd subsequently sold half the items to Mendoza Ltd, an external entity, for $12 000.
The income tax rate is 30%.

The group accountant for Yidaki Ltd, Qin Wei, maintains that the appropriate
consolidation adjustment entries are as follows.

3
Sales Dr 20 000
Cost of sales Cr 15 000
Inventories Cr 5 000

Deferred tax asset Dr 1 500

Income tax expense Cr 1 500

Required
1. Discuss whether the entries suggested by Qin Wei 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 Dr 20 000
Cost of sales Cr 17 500
Inventories Cr 2 500

Deferred tax asset Dr 750

Income tax expense Cr 750

Sales:
Recorded sales = $20 000 (Yidaki Ltd) + $12 000 (Moncrieff Ltd) = $32 000
Group sales = $12 000 [external entity sales only]
Adjustment = $20 000 (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 $20 000.

Cost of sales:
Recorded = $15 000 (Yidaki Ltd) + ½ x $20 000 (Moncrieff Ltd) = $25 000
Group = ½ x $15 000 = $7500 [the original cost of the inventories sold externally only]
Adjustment = $17 500
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 $17 500.

Inventories:
Recorded = $0 (Yidaki Ltd) + ½ x $20 000 (Moncrieff Ltd) = $10 000
Group = ½ x $15 000 = $7500 [the original cost of the inventories not sold externally]
Adjustment = $2500

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 $2500. That is actually equal to the amount of unrealised profit, i.e. the

4
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 Moncrieff Ltd’s
accounts.

Deferred tax asset:

The first adjustment entry reduces the carrying amount of the inventories by $2500. 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 $2500 was taxed in
Yidaki Ltd’s accounts and, as a result, Yidaki 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:

Retained earnings (opening balance) Dr 1 750

Income tax expense Dr 750
Cost of sales Cr 2 500

Retained earnings (opening balance):

In the prior period, Yidaki Ltd recorded an after-tax profit of $3500 on sale of inventories to
Alldritt Ltd. Half of this inventories was on-sold to an external entity, leaving half the profit,
$1750, 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 $750. 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 (Yidaki Ltd) + ½ x $20 000 (Moncrieff Ltd) = $10 000
Group = ½ x $15 000 = $7500 [the original cost of the inventories sold externally]
Adjustment = $2500

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 $2500. This adjustment decreases an
expense for the current period which increases the current period’s profit, recognising the fact

5
that the profit was realised.

Application and analysis exercises

Exercise 29.1

Current and prior periods intragroup transfers of inventories

Koch Ltd owns all of the share capital of Sutton Ltd. The income tax rate is 30%. The
following transactions took place during the periods ended 30 June 2023 or 30 June
2024.

(a) In January 2024, Koch Ltd sells inventories to Sutton Ltd for $50 000 in cash. These
inventories had previously cost Koch Ltd $40 000, and remain unsold by Sutton Ltd
at the end of the period.
(b) In February 2024, Koch Ltd sells inventories to Sutton Ltd for $40 000 in cash.
These inventories had previously cost Koch Ltd $35 000, and are on-sold externally
on 2 April 2024.
(c) In February 2024, Sutton Ltd sells inventories to Koch Ltd for $60 000 in cash
(original cost to Sutton Ltd was $54 000) and 40% are on-sold externally by 30 June
2024.
(d) In March 2024, Koch Ltd sold inventories for $36 000 to Carramar Ltd, an external
entity. These inventories were transferred from Sutton Ltd on 1 June 2023. The
inventories had originally cost Sutton Ltd $31 000, and were sold to Koch Ltd for
$33 000.

Required
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2024
in relation to the intragroup transactions.
2. Explain in detail why you made each adjusting journal entry.
(LO2 and LO3)

1.
KOCH LTD – SUTTON LTD
30 June 2024

(a) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June
2024. As the inventories remain unsold at the end of the period, at 30 June 2024 the entire
profit on the intragroup sale is unrealised and should be eliminated on consolidation by:
- Debiting “Sales” 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 2024 by raising a deferred tax asset for the tax recognised by
Koch Ltd in advance on the unrealised intragroup profit.

6
(a) Sales Dr 50 000
Cost of sales Cr 40 000
Inventories Cr 10 000

Deferred tax asset Dr 3 000

Income tax expense Cr 3 000

(b) The only adjusting entry eliminates the intragroup sales revenue recognised by Koch Ltd
(on the intragroup sale) and the cost of sales recognised by Sutton 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 2024 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 Sutton 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.

(b) Sales Dr 40 000

Cost of sales Cr 40 000

(c) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June
2024. As half of the inventories remain unsold at the end of the period, at 30 June 2024 60%
of the profit on the intragroup sale is unrealised and should be eliminated on consolidation
by:
 Debiting “Sales” with an amount equal to the intragroup price – this eliminates the
amount recognised by Sutton 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. 60% of the
profit on the intragroup sale) – this corrects the overstatement of inventories still on hand
(60% of the original amount transferred intragroup) that are recorded by Koch 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” and the credit amount to “Inventories” – this eliminates the cost of
sales recognised by Sutton Ltd (which was based on the original cost) and adjusts the cost
of sales recognised by Koch 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 2024 by raising a deferred tax asset for the tax recognised by
Sutton Ltd in advance on the unrealised intragroup profit.

7
(c) Sales Dr 60 000
Cost of sales Cr 56 400
Inventories Cr 3 600

Deferred tax asset Dr 1 080

Income tax expense Cr 1 080

(d) In this case, the unrealised profit in closing inventories from the period ended 30 June
2023 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 (1/7/23)” 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.

(d) Retained earnings (1/7/23) Dr 1 400

Income tax expense Dr 600
Cost of sales Cr 2 000

Exercise 29.5

Current period intragroup transfers of inventories and non-current assets

8
Wattle Ltd owns all the share capital of Ashgrove Ltd. The income tax rate is 30%.
During the period ended 30 June 2024, the following transactions took place:

(a) Ashgrove Ltd sold inventories costing $50 000 to Wattle Ltd. Ashgrove Ltd
recorded a $10 000 profit before tax on these transactions. At 30 June 2024, Wattle
Ltd has none of these goods still on hand.
(b) Wattle Ltd sold inventories costing $15 000 to Ashgrove Ltd for $22 000. By 30 June
2024, one-third of these were sold to Mulla Ltd for $8000 and one-third to Sylvan
Ltd for $9000; the rest are still on hand with Ashgrove Ltd. Mulla Ltd and Sylvan
Ltd are external entities.
(c) On 1 January 2024, Wattle Ltd sold land for cash to Ashgrove Ltd at $40 000 above
cost. The land is still on hand with Ashgrove Ltd.
(d) Ashgrove Ltd sold a warehouse to Wattle Ltd for $250 000 on 1 July 2023. The
carrying amount of this warehouse recognised by Ashgrove Ltd at the time of sale
was $224 000. Wattle Ltd charges depreciation at a rate of 5% p.a. on cost.

Required
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2024
in relation to the intragroup transactions.
2. Explain in detail why you made each adjusting journal entry.
(LO2, LO3 and LO4)

1. 30 June 2024
(a) Sales Dr 50 000
Cost of sales Cr 50 000

(b) Sales Dr 22 000

Cost of sales Cr 19 667
Inventories Cr 2 333

Deferred tax asset Dr 699

Income tax expense Cr 699

(c) Gain on sale of land Dr 40 000

Land Cr 40 000

Deferred tax asset Dr 12 000

Income tax expense Cr 12 000

(d) Proceeds on sale of warehouse Dr 250 000

Carrying amount of warehouse sold Cr 224 000
Warehouse Cr 26 000

OR
Gain on sale of warehouse Dr 26 000
Warehouse Cr 26 000
Deferred tax asset Dr 8 400
Income tax expense Cr 8 400

Accumulated depreciation - warehouse Dr 1 300

9
 Depreciation expense Cr 1 300

Income tax expense Dr 390

Deferred tax asset Cr 390

2. Detailed explanations on the adjusting journal entries

30 June 2024:

(a) The only adjusting entry eliminates the intragroup sales revenue recorded by Ashgrove
Ltd and the cost of sales recognised by Wattle Ltd 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 2024 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 Wattle 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.

(b) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June
2024. As one third of the inventories remain unsold at the end of the period, at 30 June 2024
one third of the profit on the intragroup sale is unrealised and should be eliminated on
consolidation by:
 Debiting “Sales” with an amount equal to the intragroup price – this eliminates the
amount recognised by Wattle 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. one third of the
profit on the intragroup sale) – this corrects the overstatement of inventories still on hand
(one third of the original amount transferred intragroup) that are recorded by Ashgrove
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” and the credit amount to “Inventories” – this eliminates the cost of
sales recognised by Wattle Ltd (based on the original cost) and adjusts the cost of sales
recognised by Ashgrove Ltd (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 2024 by raising a deferred tax asset for the tax recognised by
Wattle Ltd in advance on the unrealised intragroup profit.

(c) The first adjusting entry decreases the land’s value down from the price paid intragroup to
the original value of the land at the moment of intragroup sale and eliminates the proceeds on
sale and the carrying amount of the land sold recognised as a result of the intragroup sale (or
alternatively it eliminates the gain on the intragroup sale of land that is unrealised at 30 June
2024); 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.

10
(d) The first journal entry eliminates the proceeds on sale and the carrying amount of the
warehouse sold recognised as a result of the intragroup sale (or alternatively it eliminates the
intragroup gain on sale of the warehouse). The adjusting entry will also bring down the
balance of the “Warehouse” account to reflect the original carrying amount of the warehouse
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 amount
recognised for 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 Ashgrove Ltd on the unrealised profit from 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 overstated and should be decreased by an amount equal to the
depreciation rate multiplied by the gain on 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
fourth adjusting entry adjusts the tax effect of the previous entry that eliminated the entire
profit on the intragroup sale, 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.

11