deegan5e sm ch29

Chapter 29

Further consolidation issues I: Accounting for intra-group transactions

29.1 Intragroup transactions are transactions undertaken between the separate legal entities (subsidiaries and the parent entity) comprising an economic entity (the group). We need to know about them because there is a requirement that on consolidation the effects of all intragroup transactions must be eliminated in full – and this applies even if the subsidiary is not 100 percent owned. Specifically, Paragraph 29 of AASB 127 stipulates that: ‘Intragroup balances, transactions, income and expenses shall be eliminated in full’.

29.2 An intragroup inventory transaction will require us to perform a consolidation adjustment to tax expense when the related profits are unrealised from the perspective of the economic entity (the profits can be considered to be realised if the related assets have been sold by the economic entity). Although unrealised profits (for example, where a subsidiary sells inventory to the parent entity at a profit, but the parent entity still holds the inventory at year end) are eliminated from the consolidated accounts, from the perspective of the separate individual legal entity the profits have been earned, leading to a liability for taxation. The economic entity does not necessarily pay tax on a collective basis if the group has not notified the Tax Office that it wants to be treated as a ‘tax consolidated entity’. If the companies have not notified the Tax Office that they want to be treated as a single entity for tax purposes – and this is the maintained assumption throughout this text - then the individual legal entities pay tax on their own account. From the group’s perspective, an amount of profit related to the sale has not been realised and should not be included in the economic entity’s profits until such time as a sale has been made to an entity that is not part of the group. Therefore, if tax has been paid by one of the separate legal entities, from the group’s perspective this represents a prepayment of tax (a deferred tax asset), as this income will not be earned by the economic entity until the inventory is sold outside the group.

29.3 The only dividends that should be shown as paid, declared, payable or receivable in the consolidated financial statements are dividends that are paid or payable to entities outside of the group. Intragroup dividends are not to be included as part of dividends paid or payable.

29.4 They would be treated as a return of part of the investment in the subsidiary. Consequently, the amount received out of pre-acquisition profits of the subsidiary would be credited to the investment account.

29.5 There would be no effect on the amount of goodwill recognised. The payment out of pre-acquisition reserves will reduce the carrying value of the investment, and the pre-acquisition capital and reserves by the same amount.

29.6 AASB 127 requires that, in preparing consolidated accounts, the effects of all transactions between entities within the economic entity shall be eliminated in full. This is the case if a subsidiary is 100 percent owned, or 80 percent owned.

29.7 (a) The only revenue that should be shown in the consolidated financial statements of the economic entity is the revenue that relates to sales external to the entity. In this case, the sales revenue for the financial year from the economic entity’s perspective would be $180 000, as shown diagrammatically below.

Solutions Manual t/a Australian Financial Accounting 5/e by Craig Deegan 29–1

(b) Inventory must be valued at the lower of cost and net-realisable value. From the economic entity’s perspective, the inventory cost $100 000 to produce. As half of this inventory is on hand at reporting date, the value of inventory for the purposes of the consolidated financial statements is $50 000.


29.8Big Small

Eliminations andadjustments Consolidated

Company Company Dr Cr StatementIncome statementProfit before tax 500 250 1252 625Tax 125 100 225Profit after tax 375 150Opening retained earnings 1 000 750 7501 1 000

1 375 900 1 400Less: dividends proposed 175 125 1252 175

Balance sheetShareholders’ fundsRetained profits 1 200 775 1 225Share capital 1 250 1 250 1 2501 1 250LiabilitiesAccounts payable 2 500 250 2 750Dividends payable 175 125 1253 175

5 125 2 400 5 400

AssetsCash 250 175 425Accounts receivable 125 325 450Dividends receivable 250 — 1253 125Inventory 375 400 775Plant and equipment 2 125 1 500 3 625Investment in Small Company 2 000 — 2 000 1 —

5 125 2 400 2 250 2 250 5 400

Consolidation adjustments

1. Dr Share capital 1 250Dr Retained earnings 750Cr Investment in Small Company 2 000

To eliminate investment in Small Company

2. Dr Profit before tax 125Cr Dividend proposed 125

To eliminate inter-company dividend income

3. Dr Dividend payable 125Cr Dividend receivable 125

To eliminate inter-company receivable/payable. It is assumed that there are dividends receivable from other entities that were not controlled and were sold prior to reporting date—that is why there is still a balance of $125 in dividends receivable in the consolidated balance sheet.


29.9 2009 Consolidation entries

Dr Profit on sale of non-current assets 900 000Dr Plant 900 000Cr Accumulated depreciation 1 800 000

To reverse the profit that would have been recorded in Bernie Ltd’s accounts [$3 600 000 – ($4 500 000 – $1 800 000)], and to reinstate accumulated depreciation so that the accounts will reflect the balances that would have been in place if the inter-entity sale did not occur.

Dr Deferred tax asset 297 000Cr Income tax expense 297 000

Bernie Ltd would have recorded a related tax expense of $900 000 × 33%. From the economic entity’s perspective, no gain has been made and hence the tax expense is reversed.

Dr Accumulated depreciation 75 000Cr Depreciation expense 75 000

Computer Ltd would be depreciating the asset by $3 600 000/12 = $300 000. From the economic entity’s perspective, the depreciation should be $2 700 000/12 = $225 000.

Dr Income tax expense 24 750Cr Deferred tax asset 24 750

Increase in tax expense due to the reduction in depreciation expense. Additional tax expense = 75 000 × 33%). This entry represents a partial reversal of the deferred tax asset of $297 000 recognised in the earlier entry. After 12 periods, the balance of the deferred tax asset related to the sale of the non-current asset will be $nil.

2010 consolidation entries

Dr Retained earnings 603 000Dr Deferred tax asset 297 000Dr Plant 900 000Cr Accumulated depreciation 1 800 000

The debit to retained earnings = the gain on sale × (1 – tax rate) = $900 000 × 0.67.

Dr Accumulated depreciation 150 000Cr Retained earnings 75 000Cr Depreciation expense 75 000

Depreciation adjustment for the current and prior period.

Dr Retained earnings 24 750Dr Income tax expense 24 750Cr Deferred tax asset 49 500

Tax effects of this period’s and last period’s depreciation adjustments. Each decrease of $75 000 in depreciation leads to an increase in accounting income of $75 000 and an


associated increase in income tax expense of $24 750 ($75 000 × 33%) with the adoption of tax-effect accounting.

29.10Bigger Smaller


Company Company Dr Cr Statement

Income statementProfit before tax 500 500 2502 700

504

Tax 125 200 325Profit after tax 375 300 375Opening retained earnings 4 000 1 500 1 5001 4 000

4 375 1 800 4 375Less: dividends proposed 175 250 2502 175

Balance sheetShareholders’ fundsRetained earnings 4 200 1 550 4 200Share capital 1 250 2 500 2 5001 1 250LiabilitiesAccounts payable 2 500 500 3 000Dividends payable 175 250 2503 175

8 125 4 800 8 625

AssetsCash 250 350 600Accounts receivable 125 650 775Dividends receivable 250 — 2503 —Inventory 375 800 1 175Plant and equipment 2 125 3 000 5 125Investment in Smaller Company 5 000 — 5 0001 —Goodwill — — 1 000 1 50 4 950

8 125 4 800 5 550 5 550 8 625


1. Dr Share capital 2 500Dr Retained earnings 1 500Dr Goodwill 1 000Cr Investment in Smaller Company 5 000

To eliminate investment in Smaller Company.


2. Dr Profit before tax 250Cr Dividend proposed 250

To eliminate inter-company dividend income.

3. Dr Dividend payable 250Cr Dividend receivable 250

To eliminate inter-company receivable/payable.

4. Dr Goodwill impairment loss 50Cr Goodwill 50

To recognise goodwill impairment expense. (NOTE: the question should say that the impairment loss is $50 and not $5000.)

29.11Nat Midget


Company Company Dr Cr statementCurrent assetsCash 60 45 105Accounts receivable 900 135 1 035Non-current assetsPlant 4 440 1 800 6 240Investment in Midget Ltd 1 500 — 1500Goodwill — — 150 150

6 900 1 980 7 530

Current liabilitiesAccounts payable 300 90 390

Non-current liabilitiesLoans 2 400 540 2 940

Shareholders’ equityShare capital 3 000 600 600 3 000Retained earnings 1 200 750 750 ______ 1 200

6 900 1 980 1 500 1 500 7 530

Consolidation adjustmentsIn this question there has been a payment of a dividend by the subsidiary out of pre-acquisition earnings. The dividend has not been recognised in the accounts of Nat or Midget as at 30 June 2009. The payment of a dividend out of pre-acquisition earnings will have no impact on goodwill as there will be a corresponding decrease in the cost of the investment, and the share of pre-acquisition capital and reserves of the subsidiary. For example, without the dividend the investment would be recorded at $1.5 million and the pre-acquisition capital and reserves would be $1.35m, giving goodwill of $150,000. After the dividend, the investment will be reduced by the amount of the dividend from pre-acquisition reserves, and the pre-acquisition reserves of Midget will be decreased. Goodwill will still be $150,000


and will be the calculated as $900,000 less $$750,000 (which is the share capital of $600,000 plus the remaining retained earnings of $150,000).

At this point in time there is no need to make an adjustment for the dividend paid after the time the 30 June 2009 accounts were prepared.

Dr Share capital 600Dr Retained earnings 750Dr Goodwill 150Cr Investment in Midget Ltd 1,500

29.12Jacko Jackson


Company Company Dr Cr statement$000 $000 $000 $000 $000

Income statementSales revenue 4 200 1 400 7002 4 900Less: cost of goods sold (1 750) (490) 1403 7002 (1 680)Less: other expenses (210) (105) 356 (350)Other revenue 245 87.5 1405 192.5Profit 2 485 892.5 3062.5Tax expense 700 350 46.24 1003.8Profit after tax 1 785 542.5 2 058.7Retained earnings 30 June 2004 3 500 1 400 1 4001 3 500

5 285 1 942.5 5 558.7Dividends paid 700 140 1405 700

Balance sheetShareholders’ equityRetained earnings 30 June 2005 4 585 1 802.5 4 858.7Share capital 14 000 1 750 1 7501 14 000

Current liabilitiesAccounts payable 350 297.5 647.5

Non-current liabilitiesLoans 2 100 875 2 975

21 035 4 725 22 481.2

Current assets

Cash 875 87.5 962.5Accounts receivable 525 612.5 1 137.5Inventory 2 100 1 050 1403 3 010

Non-current assetsLand 5 040 1 400 6 440Plant 8 645 1 400 10 045


Investment in Jackson Ltd 3 500 — 3 5001 —Deferred tax asset 350 175 46.24 571.2Goodwill — — 350 1 35 6 315

21 035 4 725 4 561.2 4 561.2 22 481.2


1. Dr Share capital 1 750 000Dr Retained earnings 1 400 000Dr Goodwill 350 000Cr Investment in Jackson 3 500 000

To eliminate the investment in Jackson Ltd.

2. Dr Sales revenue 700 000Cr Cost of goods sold 700 000

To eliminate inter-company transaction.

3. Dr Cost of goods sold 140 000Cr Inventory 140 000

To eliminate unrealised profit in closing inventory.140 000 = (700 000 – 420 000) × 0.5. From the economic entity’s perspective the cost of goods sold should be the cost to the entity of producing the goods that were sold externally, and this would be $210 000 (half of $420 000). The total cost of goods sold in the separate accounts of the legal entities would be $770 000, which would be represented by $420 000 in the accounts of Jackson, and $350 000 in the accounts of Jacko. Hence, on consolidation we need to reduce cost of goods sold by $560 000 (which is $770 000 less $210 000). The above two journal entries provide this net result.

4. Dr Deferred tax asset 46 200Cr Income tax expense 46 200

To adjust tax expense by the unrealised profit.46 200 = 140 000 × 33%.

5. Dr Dividend revenue 140 000Cr Dividend paid 140 000

To eliminate dividend paid by Jackson to Jacko.

6. Dr Goodwill impairment loss 35 000Cr Goodwill 35 000

Goodwill impairment loss recognised for the year.


10.13 Please note, in the first print run of the 5th Edition of this text there was an error in the question as the ‘Dividends paid’ by the 100 percent owned subsidiary (Irons Ltd) does not equal the ‘Dividends received from Irons Ltd’ in the accounts of Andy Ltd (the parent entity). Obviously these two amounts should be the same. Apologies for this. Before commencing this question please make the following changes in the accounts of Andy Ltd. Please change ‘Dividends received from Irons Ltd’ to $116 250 (from $93 000), and please change ‘Sales revenue’ in the accounts of Andy Ltd to $839 250 (from $862,500). This mistake was fixed in subsequent print runs of the 5th Edition of the text.

Elimination of the investment in Irons Ltd and the recognition of goodwill on consolidation

Irons Ltd$

Share capital at acquisition date - 1 July 2002 250 000Retained earnings at acquisition date - 1 July 2002 200 000

450 000Investment in Irons Ltd 500 000Goodwill on consolidation 50 000

As shown above, the net assets of Irons Ltd are $450 000 at acquisition date. As $500 000 is paid for the investment, the goodwill amounts to $50 000.The consolidation entry to eliminate the investment is:

(a)Dr Share capital 250 000Dr Retained earnings 200 000Dr Goodwill 50 000Cr Investment in Irons Ltd 500 000

Elimination of intercompany salesWe need to eliminate the intragroup sales because, from the perspective of the economic entity, no sales have in fact occurred. This will ensure that we do not overstate the turnover of the economic entity.

Sale of inventory from Irons Ltd to Andy Ltd(b) Dr Sales 65 000

Cr Cost of goods sold 65 000Under the periodic inventory system, the above credit entry would be to purchases, which would ultimately lead to a reduction in cost of goods sold. (Cost of goods sold equals opening inventory plus purchases less closing inventory, so any reduction in purchases leads to a reduction in cost of goods sold.)


Elimination of the unrealised profit in the closing inventory of Andy LtdIn this case, the unrealised profit in closing amounts to $7 000. In accordance with AASB 102 ‘Inventories’, we must value the inventory at the lower of cost and net realisable value. Therefore on consolidation we must reduce the value of recorded inventory as the amount shown in the accounts of Andy Ltd exceeds what the inventory cost the economic entity.

(c)Dr Cost of goods sold 7 000Cr Inventory 7 000Under the periodic inventory system, the above debit entry would be to closing inventory—profit and loss. We increase cost of goods sold by the unrealised profit in closing inventory because reducing closing inventory effectively increases cost of goods sold. (Remember, cost of goods sold equals opening inventory plus purchases less closing inventory.) The effect of the above entries is to adjust the value of inventory so that it reflects the cost of the inventory to the group.

Consideration of the tax paid or payable on the sale of inventory that is still held within the groupFrom the group’s perspective, $7 000 has not been earned. However, from Irons Ltd’s individual perspective (as a separate legal entity), the full amount of the sale has been earned. This will attract a tax liability in Irons Ltd’s accounts of $2100 (30 per cent of $7000). However, from the group’s perspective some of this will represent a prepayment of tax as the full amount has not been earned by the group even if Irons Ltd is obliged to pay the tax.

(d) Dr Deferred tax asset 2 100Cr Income tax expense 2 100($7000 x 30 per cent)

Sale of inventory from Andy Ltd to Irons LtdDuring the current financial period Andy Ltd sold inventory to Irons Ltd at a price of $81 250. The unrealised profit component is $3000.

(e) Dr Sales 81 250 Cr Cost of goods sold 81 250

Elimination of unrealised profits in the closing inventory of Irons Ltd(f) Dr Cost of goods sold 3 000

Cr Inventory 3 000

(g) Dr Deferred tax asset 900Cr Income tax expense 900($3 000 x 30 per cent)

Unrealised profit in opening inventoryAt the end of the preceding financial year, Andy Ltd had $52 500 of inventory on hand, which had been purchased from Irons Ltd. The inventory had cost Irons Ltd $43 750 to produce. Assume that the inventory has been sold to an external party in the current period and is therefore realised<em>so there is no need to adjust the closing balance of inventory.

(h) Dr Retained earnings - 30 June 2008 6 125Dr Income tax expense 2 625


Cr Cost of sales 8 750

Adjustments for intragroup sale of plantOn 1 July 2008 Andy Ltd sold an item of plant to Irons Ltd for $145 000 when its carrying value in Irons Ltd’s accounts was $101 250 (cost of $168 750 and accumulated depreciation of $67 500). This item of plant was being depreciated over a further six years from acquisition date, with no expected residual value.

Reversal of profit recognised on sale of asset and reinstatement of cost and accumulated depreciationThe result of the sale of the item of plant to Irons Ltd is that the profit of $43 750 - the difference between the sales proceeds of $145 000 and the carrying amount of $101 250 - will be shown in Andy Ltd’s financial statements. However, from the economic entity’s perspective there has been no sale and, therefore, no gain on sale given that there has been no transaction with a party external to the group. The following entry is necessary for the accounts to reflect the balances that would have applied had the intragroup sale not occurred.

(i) Dr Profit on sale of plant 43 750 Dr Plant 23 750Cr Accumulated depreciation 67 500

The result of this entry is that the intragroup profit is removed and the asset and accumulated depreciation accounts revert to reflecting no sales transaction. The profit of $43 750 will be recognised progressively in the consolidated financial report of the economic entity by adjustments to the amounts of depreciation charged by Irons Ltd in its accounts. As the service potential or economic benefits embodied in the asset are consumed, the $43 750 profit will be progressively recognised from the economic entity’s perspective. This is shown in journal entry k.

Effect of tax on profit on sale of item of plantFrom Andy Ltd’s individual perspective it would have made a profit of $43 750 on the sale of the plant and this gain would have been taxable. At a tax rate of 30 percent, $13 125 would then be payable by Andy Ltd. However, from the economic entity’s perspective, no gain has been made, which means that the related ‘tax expense’ must be reversed and a related deferred tax benefit be recognised. A deferred tax asset is recognised because, from the economic entity’s perspective, the amount paid to the Tax Office represents a prepayment of tax.

(j)Dr Deferred tax asset 13 125Cr Income tax expense 13 125

Reinstating accumulated depreciation in the balance sheetIrons Ltd would be depreciating the asset on the basis of the cost it incurred to acquire the asset. Its depreciation charge would be $145 000 ÷ 6 = $24 167. From the economic entity’s perspective, the asset had a carrying value of $101 250, which was to be allocated over the next six years, giving a depreciation charge of $101 250 ÷ 6 = $ 16 875. An adjustment of $7 292 is therefore required.

(k) Dr Accumulated depreciation 7 292Cr Depreciation expense 7 292

Consideration of the tax effect of the reduction in depreciation expense


The increase in the tax expense from the perspective of the economic entity is due to the reduction in the depreciation expense. The additional tax expense is $2 188, which is $7 292 x 30 per cent. This entry represents a partial reversal of the deferred tax asset of $13 125 recognised in an earlier entry. After six years the balance of the deferred tax asset relating to the sale of the item of plant will be $nil.

(l) Dr Income tax expense 2 188Cr Deferred tax asset 2 188

Impairment of goodwill (m)Dr Retained earnings 20 000

Dr Impairment loss - goodwill 3 750Cr Accumulated impairment losses - goodwill 23 750

Elimination of intragroup transactions - management feesAll of the management fees paid within the group will need to be eliminated on consolidation.

(n) Dr Management fee revenue 33 125Cr Management fee expense 33 125

Dividends paidWe eliminate dividends paid within the group. Only dividends paid to parties outside the entity (minority interests and shareholders of the parent entity) are to be shown in the consolidated accounts.

(o) Dr Dividend revenue 116 250Cr Dividend paid 116 250

We can now post the consolidation journal entries to the consolidation worksheet.


Eliminations and adjustments

ConsolidatedAndy Ltd Irons Ltd Dr Cr statements

($000) ($000) ($000) ($000) ($000) Detailed reconciliation of opening and closing retained earningsSales revenue 839.25 725 65(b) 1418

81.25(e)Cost of goods sold (580) (297.5) 7(c) 65(b) 732.5

3(f) 81.25(e)8.75(h)

Gross profit 259.25 427.5 685.5Other revenue - Dividends received from Irons Ltd 116.25 - 116.25(o) -Management fee revenue 33.125 33.125(n) -Profit on sale of plant 43.75 43.75(i) -ExpensesAdministrative expenses (38.5) (48.375) (86.875)Depreciation (30.625) (71) 7.292(k) (94.333)Management fee expense - (33.125) 33.125(n) -Other expenses (126.375) (96.25) 3.75(m) (226.375)

Profit before tax 256.875 178.75 277.917

Tax expense 76.875 52.75 2.625(h) 2.1(d) 118.313

2.188 (l) 0.9(g)

13.125(j)

Profit for the year 180 126 159.604

Retained earnings - 30 June 2008 399.25 299 200(a) 472.1256.125(h)

20(m)

579.25 425 631.729Dividends paid (171.75) (116.25) 116.25(o) (171.75)

Retained earnings-30 June 2009 407.5 308.75 459.979

Balance sheet Shareholders’ equity Retained earnings 407.5 308.75 459.979Share capital 437.5 250 250(a) 437.5

Current liabilities Accounts payable 57.875 57.875Tax payable 100 31.25 131.25

Non-current liabilities Loans 236 145 381

1 181 792 875 1467.604

Current assets Accounts receivable 74.25 77.875 152.125Inventory 115 36.250 7(c) 141.25

3(f)

Non-current assets Deferred tax asset 2.1(d) 2.188(l) 13.937

0.9(g)13.125(j)

Land and buildings 198.75 407.5 606.25Plant at cost 400 444.75 23.75(i) 868.5Accumulated depreciation (107) (173.5) 7.292(k) 67.5(i) (340.708)Investment in Irons Ltd 500 – 500(a) -Goodwill 50(a) 50Accumulated amortisation 23.75(m) (23.75)

1 181 792.875 931.23 931.23 1467.604

The next step would be to present the consolidated financial statements. A suggested format for the consolidated accounts would be as follows (prior year comparatives for the accounts of the parent entity, both of which would be required in practice, have not been provided):


Consolidated income statement of Andy Ltd and its subsidiariesfor the year ended 30 June 2010

$Sales 1 418 000Cost of good sold 732 500Gross profit 685 500Administrative expenses (86 875)Depreciation (94 333)Other expenses (226 375)Profit before income tax expense 277 917Income tax expense 118 313Profit after income tax expense 159 604

Consolidated balance sheet of Andy Ltd and its subsidiariesas at 30 June 2009

$Current assetsAccounts receivable 152 125Inventory 141 250

293 375Non-current assetsLand and buildings 606 250Plant 868 500less Accumulated depreciation (340 708)Goodwill 50 000less Accumulated impairment loss (23 750)Deferred tax asset 13 937

1 174 229Total assets 1 467 604

Current liabilitiesAccounts payable 57 875Tax payable 131 250

189 125

Non-current liabilitiesLoan 381 000Total liabilities 570 125

Shareholders’ equityShare capital 437 500Retained profits - 30 June 2009 (x) 459 979Total shareholders’ equity 897 479Total equities 1 467 604

Notes to and forming part of the consolidated accounts

Consolidated$

Note x: Retained profitsRetained profits - 1 July 2008 472 125Profit after income tax 159 604Final dividend (171 750)Retained profits - 30 June 2009 459 979


10.14 Please note, in the first print run of the 5th Edition of this text there was an error in the question as the ‘Dividends paid’ by the 100 percent owned subsidiary (Parko Ltd) does not equal the ‘Dividends received from Parko Ltd’ in the accounts of Joel Ltd (the parent entity). Obviously these two amounts should be the same. Apologies for this. Before commencing this question please make the following changes in the accounts of Andy Ltd. Please change ‘Dividends received from Parko Ltd’ to $93 000 (from $74 400), and please change ‘Sales revenue’ in the accounts of Joel Ltd to $671 400 (from $690 000). This mistake was fixed in subsequent print runs of the 5th Edition of the text.

Elimination of the investment in Parko Ltd and the recognition of goodwill on consolidation

Parko Ltd

$Share capital at acquisition date - 1 July 2004 200 000Retained earnings at acquisition date - 1 July 2004 180 000

380 000Investment in Parko Ltd 356 000Surplus on consolidation 24 000

As shown above, the net assets of Parko Ltd are $380 000 at acquisition date. As $356 000 is paid for the investment, there has been a discount, or excess, on acquisition. Where an entity is acquired at a discount, paragraph 56 of AASB 3 requires that:

If the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities recognised exceeds the cost of the business combination, the acquirer shall:(a) reassess the identification and measurement of the acquiree’s identifiable assets,

liabilities and contingent liabilities and the measurement of the cost of the combination; and

(b) recognise immediately in profit or loss any excess remaining after that reassessment.

The above requirement to reassess the value of assets acquired in the business combination is consistent with an assumption that an excess on acquisition - which in the past has been referred to as a ‘discount’ - usually results from measurement errors and seldom constitutes a real gain to the acquirer. The acquirer should therefore, in the presence of an excess, reassess the fair values of the identifiable assets, liabilities and contingent liabilities. However, if the excess remains after reassessing the fair values of both the amount paid for the subsidiary and the net assets acquired, it is to be recognised immediately as a gain.(a)Dr Share capital 200 000

Dr Retained earnings 180 000Dr Gain on acquisition of subsidiary 24 000Cr Investment in Parko Ltd 356 000

Elimination of intercompany salesWe need to eliminate the intragroup sales because, from the perspective of the economic entity, no sales have in fact occurred. This will ensure that we do not overstate the turnover of the economic entity.

Sale of inventory from Parko Ltd to Joel Ltd(b) Dr Sales 50 000

Cr Cost of goods sold 50 000


Under the periodic inventory system, the above credit entry would be to purchases, which would ultimately lead to a reduction in cost of goods sold. (Cost of goods sold equals opening inventory plus purchases less closing inventory, so any reduction in purchases leads to a reduction in cost of goods sold.)

Elimination of the unrealised profit in the closing inventory of Joel LtdIn this case, the unrealised profit in closing amounts to $5 000. In accordance with AASB 102 ‘Inventories’, we must value the inventory at the lower of cost and net realisable value. Therefore on consolidation we must reduce the value of recorded inventory as the amount shown in the accounts of Joel Ltd exceeds what the inventory cost the economic entity.

(c)Dr Cost of goods sold 5 000Cr Inventory 5 000Under the periodic inventory system, the above debit entry would be to closing inventory - profit and loss. We increase cost of goods sold by the unrealised profit in closing inventory because reducing closing inventory effectively increases cost of goods sold. (Remember, cost of goods sold equals opening inventory plus purchases less closing inventory.) The effect of the above entries is to adjust the value of inventory so that it reflects the cost of the inventory to the group.

Consideration of the tax paid or payable on the sale of inventory that is still held within the groupFrom the group’s perspective, $5000 has not been earned. However, from Parko Ltd’s individual perspective (as a separate legal entity), the full amount of the sale has been earned. This will attract a tax liability in Parko Ltd’s accounts of $1500 (30 per cent of $5000). However, from the group’s perspective some of this will represent a prepayment of tax as the full amount has not been earned by the group even if Parko Ltd is obliged to pay the tax.

(d) Dr Deferred tax asset 1 500Cr Income tax expense 1500($5000 x 30 per cent)

Sale of inventory from Joel Ltd to Parko LtdDuring the current financial period Joel Ltd sold inventory to Parko Ltd at a price of $60 000. The unrealised profit component is $2000.

(e) Dr Sales 60 000 Cr Cost of goods sold 60 000

Elimination of unrealised profits in the closing inventory of Parko Ltd(f) Dr Cost of goods sold 2 000

Cr Inventory 2 000

(g) Dr Deferred tax asset 600Cr Income tax expense 600($2000 x 30 per cent)

Unrealised profit in opening inventoryAt the end of the preceding financial year, Joel Ltd had $40 000 of inventory on hand, which had been purchased from Parko Ltd. The inventory had cost Parko Ltd $30 000 to produce. Assume that the inventory has been sold to an external party in the current period and is therefore realised<em>so there is no need to adjust the closing balance of inventory.


(h) Dr Retained earnings - 30 June 2008 7 000Dr Income tax expense 3 000Cr Cost of sales 10 000

Adjustments for intragroup sale of plantOn 1 July 2008 Parko Ltd sold an item of plant to Joel Ltd for $116 000 when its carrying value in Parko Ltd’s accounts was $81 000 (cost of $135 000 and accumulated depreciation of $54 000). This item of plant was being depreciated over a further six years from acquisition date, with no expected residual value.

Reversal of profit recognised on sale of asset and reinstatement of cost and accumulated depreciationThe result of the sale of the item of plant to Joel Ltd is that the profit of $35 000 - the difference between the sales proceeds of $116 000 and the carrying amount of $81 000 - will be shown in Parko Ltd’s financial statements. However, from the economic entity’s perspective there has been no sale and, therefore, no gain on sale given that there has been no transaction with a party external to the group. The following entry is necessary for the accounts to reflect the balances that would have applied had the intragroup sale not occurred.

(i) Dr Profit on sale of plant 35 000Dr Plant 19 000Cr Accumulated depreciation 54 000

The result of this entry is that the intragroup profit is removed and the asset and accumulated depreciation accounts revert to reflecting no sales transaction. The profit of $35 000 will be recognised progressively in the consolidated financial report of the economic entity by adjustments to the amounts of depreciation charged by Joel Ltd in its accounts. As the service potential or economic benefits embodied in the asset are consumed, the $35 000 profit will be progressively recognised from the economic entity’s perspective. This is shown in journal entry k.

Effect of tax on profit on sale of item of plantFrom Parko Ltd’s individual perspective it would have made a profit of $35 000 on the sale of the plant and this gain would have been taxable. At a tax rate of 30 per cent, $10 500 would then be payable by Parko Ltd. However, from the economic entity’s perspective, no gain has been made, which means that the related ‘tax expense’ must be reversed and a related deferred tax benefit be recognised. A deferred tax asset is recognised because, from the economic entity’s perspective, the amount paid to the Tax Office represents a prepayment of tax.

(j) Dr Deferred tax asset 10 500Cr Income tax expense 10 500

Reinstating accumulated depreciation in the balance sheetJoel Ltd would be depreciating the asset on the basis of the cost it incurred to acquire the asset. Its depreciation charge would be $116 000 ÷ 6 = $19 333. From the economic entity’s perspective, the asset had a carrying value of $81 000, which was to be allocated over the next six years, giving a depreciation charge of $81 000 ÷ 6 = $ 13 500. An adjustment of $5 833 is therefore required.

(k) Dr Accumulated depreciation 5 833Cr Depreciation expense 5 833


Consideration of the tax effect of the reduction in depreciation expenseThe increase in the tax expense from the perspective of the economic entity is due to the reduction in the depreciation expense. The additional tax expense is $1750, which is $5 833 x 30 per cent. This entry represents a partial reversal of the deferred tax asset of $10 500 recognised in an earlier entry. After six years the balance of the deferred tax asset relating to the sale of the item of plant will be $nil.

(l) Dr Income tax expense 1 750Cr Deferred tax asset 1 750

Elimination of intragroup transactions - management feesAll of the management fees paid within the group will need to be eliminated on consolidation.

(m) Dr Management fee revenue 26 500 Cr Management fee expense 26 500

Dividends paidWe eliminate dividends paid within the group. Only dividends paid to parties outside the entity (minority interests) are to be shown in the consolidated accounts.

(n) Dr Dividend revenue 93 000Cr Dividend paid 93 000

We can now post the consolidation journal entries to the consolidation worksheet.


Eliminations and adjustments

ConsolidatedJoel Ltd Parko Ltd Dr Cr statements

($000) ($000) ($000) ($000) ($000) Detailed reconciliation of opening and closing retained earningsSales revenue 671.4 540 50(b) 1101.4

60(e)Cost of goods sold (464) (238) 5(c) 50(b) 589

2(f) 60(e)10(h)

Gross profit 226 302 512.4Other revenue - Dividends received from Parko Ltd 93 - 93(n) -Management fee revenue 26.5 26.5(m) -Profit on sale of plant 40 35 35(i) 40Gain on acquisition of subsidiary 24(a) 24ExpensesAdministrative expenses (30.8) (38.7) (69.5)Depreciation (29.5) (56.8) 5.833(k) (80.467)Management fee expense - (26.5) 26.5(m) -Other expenses (101.1) (72) (173.1)

Profit before tax 205.5 143 253.333

Tax expense 61.5 42.2 3(h) 1.5(d) 95.85

1.75 (l) 0.6(g)

10.5(j)

Profit for the year 144 100.8 157.483

Retained earnings- 30 June 2008 319.4 239.2 180(a) 371.67(h)

463.4 340 529.083Dividends paid (137.4) (93) 93(n) (137.4)

Retained earnings- 30 June 2009 326 247 391.683

Balance sheet Shareholders’ equity Retained earnings 326 247 391.683Share capital 350 200 200(a) 350

Current liabilities Accounts payable 54.7 46.3 101Tax payable 41.3 25 66.3

Non-current liabilities Loans 173.5 116 289.5

945.5 634.3 1198.483

Current assets Accounts receivable 59.4 62.3 121.7Inventory 92 29 5(c) 114

2(f)

Non-current assets Deferred tax asset 1.5(d) 1.75(l) 10.85

0.6(g)10.5(j)

Land and buildings 224 326 550Plant at cost 299.85 355.8 19(i) 674.65Accumulated depreciation (85.75) (138.8) 5.833(k) 54(i) (272.717)Investment in Parko Ltd 356 – 356(a) -

945.5 634.3 700.683 700.683 1198.483

The next step would be to present the consolidated financial statements. A suggested format for the consolidated accounts would be as follows (prior year comparatives for the accounts of the parent entity, both of which would be required in practice, have not been provided):


Consolidated income statement of Joel Ltd and its subsidiariesfor the year ended 30 June 2010

$Sales 1 101 400Cost of good sold 589 000Gross profit 512 400Profit on sale of plant 40 000Gain on acquisition of subsidiary 24 000Administrative expenses (69 500)Depreciation (80 467)Other expenses (173 100)Profit before income tax expense 253 333Income tax expense 95 850Profit after income tax expense 157 483

Consolidated balance sheet of Joel Ltd and its subsidiariesas at 30 June 2009

$Current assetsAccounts receivable 121 700Inventory 114 000

235 700Non-current assetsLand and buildings 550 000Plant and equipment 674 650less Accumulated depreciation (272 717)Deferred tax asset 10 850

962 783Total assets 1 198 483

Current liabilitiesAccounts payable 101 000Tax payable 66 300

167 300

Non-current liabilitiesLoans 289 500Total liabilities 456 800

Shareholders’ equityShare capital 350 000Retained earnings - 30 June 2009 (x) 391 683Total shareholders’ equity 741 683Total equities 1 198 483

Notes to and forming part of the consolidated accounts

Consolidated$

Note x: Retained earningsRetained earnings - 1 July 2008 371 600Profit after income tax 157 483Dividends paid (137 400)Retained earnings - 30 June 2009 391 683


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