Summary of advanced international financial reporting standards (advanced IFRS, FEM 11115) at Erasmus University. Here you can find the summaries of Lection 1-5.
-> Profits or losses resulting from intragroup transactions that are recognised in assets such as inventory and fixed assets are eliminated in full.
-> In the following examples assume Jessica Ltd owns all the share capital of Amelie LTD and that the consolidation process is being carried out on
June 30, 2016 for the year ending on that date. Assume also a tax rate of 30%.
Example 1: Intragroup sales of inventory
On 1 Jan 2016 Jessica acquired 10000 worth of inventory for cash from Amelie. The inventory had previously cost Amelie 8000.
Entry Amelie: Cash 10000
Sales Revenue 10000
Cost of sales 8000
Inventory 8000
Entry Jessica: Inventory 10000
Cash 10000
If Jessicas and Amelie's financial statements are added together for consolidated purposes sales, cost of sales and inventory will need to be adjusted
as the consolidated financial statements must show only the results of transactions with entities external to the group.
Example 2: Transferred inventory still on hand
Sales Revenue 10000
Cost of sales 8000
Inventory 2000
As no external party was involved in the transaction no sales should be shown in the consolidated financial statements.
Inventory is recorded in Jessica at 10000 but the cost to the group is however 8000. We need a credit adjustment of 2000 to reduce the inventory to
8000 which is the cost of the group.
On consolidatoin a tax effect entry is necessary when where an adjustment entry causes a difference between the carrying amount of an asset or a
liability in the records of the legal entity and the carrying amount shown in the consolidated financial statements.
The carrying amount and tax base of the inventory in Jessica is 10000 but the carrying amount in the group is 8000. This 2000 difference is a
deductible temporary difference giving rise to a deffered tax asset of 600 as well as a corresponding decrease in income tax expense. The appropriate
consolidation worksheet adjustment entry is:
Deferred tax asset 600 (2000*0.3=600)
Income tax expense 600
When the inventory is sold by Jessica in a future period this temporary difference is reversed. For example Jessica sells this incentory to an external
entity for 11000. The beforetax profit for Jessica LTd is 1000 (11000-10000) and an associated tax expense 300 (1000*0.3). From the group point of
view the profit on sale is 3000(11000-8000). The group will show current tax payable of 300 and reverse the 600 deferred tax asset and recognize
income tax expense of 900(3000*0.3).
Example 3: Transferred inventory partly sold
On January 1, 2016 Jessica acquied 10000 worth of inventory for cash from Amelie. The inventory had previously cost Amelie 8000. By the end of the
year 30 June 2016 Jessica had sold 7500 of the transferred inventory for 14000 to external parties. Thus 2500 of the inventory is on hand in Jessica
at 30 June 2016. The adjustment entry for the preparation of consolidated financial statements at 30 June 2016:
Sales 10000
Cost of sales 9500
Inventory 500
Total Sales from both entities are 24000 (Amelie = 10000 and Jessica = 14000).
Sales of the group to external entities are 14000
The consolidation adjustment is 10000 (We need to decrease sales revenue from 24000 to 14000 to eliminate sales within the group)
Total cost of sales from both entities is 15500 (Amelie = 8000 and Jessica = 7500 or 75% of 10000)
Total cost of sales to external entities is 6000 or 75% of 8000.
The consolidation adjustment is 9500 (We need to decrease cost of sales from 15500 to 6000 to eliminate cost of sales within the group.
The combined adjustment to sales and cost of sales result in a 500 (10000-9500=500) reduction in before tax profit.
The sum of profits recorded by the legals entities is 8500 (2000 Amelie and 6500 Jessica). From the groups point of view profit on sale of inventory to
external entities is only 8000 (14000-6000 which is 75% of 8000). Hence, an adjustment of 500 is necessary to reduce recorded prodit of 8500 to
group profit of 8000.
The 500 adjustment to inventory reflects the proportion of the total profit on sale of the transferred inventory that remains in the inventory on hand at
the end of the period. The adjustment entry reduces the inventory on hand from 2500 which is the recorded cost of Jessica to the group cost of 2000
(25% of 8000).
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