Consolidation Week 3

Inter -company transactions

TEXT CHAP 16TEXT CHAP 16

Adjustments

Previously stated that there was two major adjustments entries for consolidations :-

1) pre-acquisition entry/revaluation entry

2) eliminations of intercompany balances & transactions whereby profits or losses are made by different members of the economic entity through trading with each other

Intercompany transactions

Eliminations of intercompany transactions

Transfers of assets

� sales of inventory

� sales of depreciable assets Services Dividends (post acquisition) Borrowings

AASB 1024EFFECT OF TRANSACTIONS

BETWEEN ENTITIESSHALL BE

ELIMINATED

AASB 1024EFFECT OF TRANSACTIONS

BETWEEN ENTITIESSHALL BE

ELIMINATED

Intercompany sales of inventory

Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%.

Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000.

Closing stock adjustment

Assume that on 1 January, H Ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000. Both companies use periodic inventory system .

Assume inventory unsold by H Ltd at the end of year

Intercompany sales of inventory

Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%.

Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000.

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Intercompany sales of inventory

Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%.

Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000.

Consolidation entriesRemove internal entriesDr Sales 10 000(sales not made external to group) Cr Cost of Sales 8 000(not sold external to group) Cr Inventory 2 000(shown @ $10 000 actually only $8000)

Consolidation entriesRemove internal entriesDr Sales 10 000(sales not made external to group) Cr Cost of Sales 8 000(not sold external to group) Cr Inventory 2 000(shown @ $10 000 actually only $8000)

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Intercompany sales of inventory

Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%.

Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000.

Consider tax effect of consolidation entryReduced carrying amount of the asset :THEREFORE CREATED a DTD which leadsto a Deferred tax AssetDR Deferred Tax Asset 600 CR Tax Expense 600

Consider tax effect of consolidation entryReduced carrying amount of the asset :THEREFORE CREATED a DTD which leadsto a Deferred tax AssetDR Deferred Tax Asset 600 CR Tax Expense 600

Consolidation entriesRemove internal entriesDr Sales 10 000(sales not made external to group) Cr Cost of Sales 8 000(not sold external to group) Cr Inventory 2 000(shown @ $10 000 actually only $8000)

Consolidation entriesRemove internal entriesDr Sales 10 000(sales not made external to group) Cr Cost of Sales 8 000(not sold external to group) Cr Inventory 2 000(shown @ $10 000 actually only $8000)

Adjustment entry for unrealised profit in closing

stock

DR Sales Revenue (inter-entity sale)

CR Cost of Sales ( inter-entity cost of sales)

CR Inventory (Unrealised profits on opening inventory)

DR Deferred Tax Asset

CR Income Tax Expense

Closing stock adjustment

Assume that on 1 January, H Ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000. Both companies use periodic inventory system .

Assume half inventory unsold by H Ltd at the end of year

SAME EXAMPLESAME EXAMPLE

Intercompany sales of inventory

Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%.

Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000.

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Consolidation entriesRemove internal entriesDr Sales 10 000Cr Cost of Sales 9 000(recorded 8000+5000-4000 what it should be) Cr Inventory 1 000(unrealised profit 50%)Dr Deferred Tax Asset 300 CR Income Tax Expense 300

Consolidation entriesRemove internal entriesDr Sales 10 000Cr Cost of Sales 9 000(recorded 8000+5000-4000 what it should be) Cr Inventory 1 000(unrealised profit 50%)Dr Deferred Tax Asset 300 CR Income Tax Expense 300

Closing stock adjustment

Assume that on 1 January, H Ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000. Both companies use periodic inventory system .

Assume inventory sold by H Ltd at the end of year

SAME EXAMPLESAME EXAMPLE

Intercompany sales of inventory

Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%.

Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd . The inventory had cost S Ltd $8,000.

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Entries in S LtdDr Cash 10 000 Cr Sales 10 000Dr Cost of Sales 8 000 Cr Inventory 8 000Entries in H LtdDr Inventory 10 000 Cr Cash 10 000

Consolidation entriesRemove internal entriesDr Sales 10 000Cr Cost of Sales 10 000

No tax entry as no adjustment to carrying amount of the asset.

Consolidation entriesRemove internal entriesDr Sales 10 000Cr Cost of Sales 10 000

No tax entry as no adjustment to carrying amount of the asset.

Opening stock adjustment

Any transferred inventory unsold at the end of one period is still on hand at the beginning of the next period & because consolidation entries are not made in the books, any differences at the end of one period will still exist at the beginning of the next period.

Intercompany sales of inventory

Assume that on 1 July 2000, S Ltd has on hand inventory worth $7000 purchased from P Ltd in June 2000. The Inventory had previously been purchased for $4500.

Tax 30%

Intercompany sales of inventory

Assume that on 1 July 2000, S Ltd has on hand inventory worth $7000 purchased from P Ltd in June 2000. The Inventory had previously been purchased for $4500.

Tax 30%Consolidation entries 30 June 2000 LAST YEARDr Sales 7 000Cr Cost of Sales 4 500Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Income Tax Expense 750

Consolidation entries 30 June 2000 LAST YEARDr Sales 7 000Cr Cost of Sales 4 500Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Income Tax Expense 750

Intercompany sales of inventory

Assume that on 1 July 2000, S Ltd has on hand inventory worth $7000 purchased from P Ltd in June 2000. The Inventory had previously been purchased for $4500.

Tax 30%Consolidation entries LAST YEARDr Sales 7 000Cr Cost of Sales 4 500Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Tax Expense 750

Consolidation entries LAST YEARDr Sales 7 000Cr Cost of Sales 4 500Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Tax Expense 750

Consolidation entries THIS YEARDR Retained Profits 2 500Cr Cost of Sales 2 500 Dr Tax Expense 750 CR Retained Profits 750(Deferred tax asset is reversedas Assumed now sold)

Consolidation entries THIS YEARDR Retained Profits 2 500Cr Cost of Sales 2 500 Dr Tax Expense 750 CR Retained Profits 750(Deferred tax asset is reversedas Assumed now sold)

Opening stock adjustment

DR Retained profits ( at begin )

CR Cost of Sales

DR Income tax expense

CR Retained profits (at begin)

Intercompany sales of depreciable assets

Sale

» Intercompany profit or loss on the sale of an asset has to be eliminated - i.e. we reduce the sale price of the asset to its book value

dr Proceeds of Sale

cr Carrying Amount of Asset

cr Asset

dr Deferred Tax Asset

cr Tax expense n.b. :: entries when there is a loss dr Proceeds of Sale

cr Carrying Amount of Asset

dr Asset

drTax Expense

cr Deferred Tax Liability

Intercompany sales of depreciable assets

Consider depreciation

Depreciation should be adjusted to the depreciation on the book value - currently sale price

DR ACCUMULATED DEPRECIATION

CR DEPRECIATION

DR INCOME TAX EXPENSE

CR DEFERRED TAX ASSET

Example - depreciable asset

Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost.

Example - depreciable asset

Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost.

IN THE BOOKS ::H LTD PURCHASED $20,000DEPN (10%) 2,000B.V. $18,000

SOLD 18,500GAIN ON SALE $ 500

IN THE BOOKS ::H LTD PURCHASED $20,000DEPN (10%) 2,000B.V. $18,000

SOLD 18,500GAIN ON SALE $ 500

Example - depreciable asset

Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost.CONSOLIDATION ADJ.

DR Proceeds on Sale 18 500 CR Carrying Amt 18 000 CR M.V. 500

DR Deferred Tax Asset 150 CR Tax Expense 150

CONSOLIDATION ADJ.DR Proceeds on Sale 18 500 CR Carrying Amt 18 000 CR M.V. 500

DR Deferred Tax Asset 150 CR Tax Expense 150

Example - depreciable asset

Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost.

CONSOLIDATION ADJ.

DR Acc. Depn 30 CR Depn Exp 30(6% $500 )

DR Tax Expense 9 CR Deferred Tax Asset 9

CONSOLIDATION ADJ.

DR Acc. Depn 30 CR Depn Exp 30(6% $500 )

DR Tax Expense 9 CR Deferred Tax Asset 9

Example - depreciable asset

Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost.

CONSOLIDATION ADJ.DR Proceeds on Sale 18 500 Cr Carrying Amount 18 000 CR M.V. 500

DR Deferred Tax Asset 150 CR Tax Expense 150

DR Acc. Depn 30 CR Depn Exp 30(6% $500 )

DR Tax Expense 9 CR Deferred Tax Asset 9

CONSOLIDATION ADJ.DR Proceeds on Sale 18 500 Cr Carrying Amount 18 000 CR M.V. 500

DR Deferred Tax Asset 150 CR Tax Expense 150

DR Acc. Depn 30 CR Depn Exp 30(6% $500 )

DR Tax Expense 9 CR Deferred Tax Asset 9

SUBSEQUENT YEARDR R.P. ( Begin) 500 CR M.V. 500

DR Def Tax Asset 150 CR R.P. (Begin) 150

DR Acc. Depn 60 CR Depn Exp 30 CR R.P. (Begin) 30

DR Tax Exp 9DR R.P. (Begin) 9 CR Def Tax Asset 18RP= RETAINED PROFITS

SUBSEQUENT YEARDR R.P. ( Begin) 500 CR M.V. 500

DR Def Tax Asset 150 CR R.P. (Begin) 150

DR Acc. Depn 60 CR Depn Exp 30 CR R.P. (Begin) 30

DR Tax Exp 9DR R.P. (Begin) 9 CR Def Tax Asset 18RP= RETAINED PROFITS

Intercompany services

During the year H Ltd offered the services of a specialist employee to S Ltd in return for which S Ltd paid $25,000 to H Ltd.

Intercompany services

During the year H Ltd offered the services of a specialist employee to S Ltd in return for which S Ltd paid $25,000 to H Ltd.

ENTRY

DR SERVICES REVENUE 25,000 CR SERVICES PAID 25,000

ENTRY

DR SERVICES REVENUE 25,000 CR SERVICES PAID 25,000

Post acquisition dividends

Dividends declared but not paid

Entries in the books– Subsidiary

DR Dividend Provided (Retained Profits) 25 000

CR Provision for Dividend 25 000

– Holding Coy

Dr Dividend Receivable 25 000

Cr Dividend Revenue 25 000

Post acquisition dividends

Dividends declared but not paid

Entries in the books– Subsidiary

DR Dividend Provided (Retained Profits)

CR Provision for Dividend

– Holding Coy

Dr Dividend Receivable

Cr Dividend Revenue

CONSOLIDATION ENTRIES

DR Provision for Dividend 25,000 CR Dividend Provided 25,000DR Dividend Revenue 25,000 Cr Dividend Receivable 25,000

CONSOLIDATION ENTRIES

DR Provision for Dividend 25,000 CR Dividend Provided 25,000DR Dividend Revenue 25,000 Cr Dividend Receivable 25,000

Post acquisition dividends

Dividends declared and paid

Entries in the books– Subsidiary

DR Dividend Paid - retained profits 4 000

CR Cash 4 000

– Holding Coy

Dr Cash 4 000

Cr Dividend Revenue 4 000

Post acquisition dividends

Dividends declared and paid

Entries in the books– Subsidiary

DR Dividend Paid - retained profits 4 000

CR Cash 4 000

– Holding Coy

Dr Cash 4 000

Cr Dividend Revenue 4 000

CONSOLIDATION ENTRIES

DR Dividend Revenue 4 000 CR Dividend Paid 4 000

CONSOLIDATION ENTRIES

DR Dividend Revenue 4 000 CR Dividend Paid 4 000

Intercompany borrowings

H Ltd lends S Ltd $1,000 the latter paying $50 interest

Intercompany borrowings

H Ltd lends S Ltd $1,000, the latter paying $50 interest

ENTRY::

DR S LTD 1,000 CR H LTD 1,000

DR INT REVENUE 50 CR INT PAID 50

ENTRY::

DR S LTD 1,000 CR H LTD 1,000

DR INT REVENUE 50 CR INT PAID 50

Intercompany borrowings One type of intercompany borrowing is the issue

of debentures

Assume that on 1 January 19x0, H Ltd issues 1,000 $100 debentures having interest of 15% per annum payable on 1 January each year. S Ltd its subsidiary acquires half of the debentures issued.

Intercompany borrowings One type of intercompany borrowing is the issue

of debentures

Assume that on 1 January 19x0, H Ltd issues 1,000 $100 debentures having interest of 15% per annum payable on 1 January each year. S Ltd its subsidiary acquires half of the debentures issued.

ENTRY::

DR DEBENTURES 50,000 CR DEBENTURES IN H LTD 50,000

DR INTEREST REVENUE 7,500 CR INTEREST EXPENSE 7,500

Tutorial questions

Exercise 16.1 Exercise 16.5 Problem 16.2 Problem 16.4 Problem 16.5