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The University of Sydney Page 1 ACCT3011 – Module 4

Intragroup transactions

(borrowing & inventory) The University of Sydney Page 2 Learning objectives After completing this module students should be able to: 1. Explain why consolidation worksheet adjustments are required where

there have been intragroup transactions

2. Prepare and explain worksheet adjusting entries to eliminate: • Intragroup management fees

• Intragroup borrowings

• Intragroup inventory sales, including recognition of tax effects • Unrealised profits or losses in both opening and closing inventory,

including recognition of tax effects 3. Review how all of this presents in Wesfarmers Annual Report The University of Sydney Page 3 References Textbook: • Arthur et al Chapter 4 of Arthur et al. (Pages 193 – 224, that’s is, to

end of section 4.4.

Note error on page 213; credit to Tax Expense should be $15,000

(not $50,000) Other readings:

• Wesfarmers 2023 Annual Report Accounting standards:

• AASB 10 Consolidated Financial Statements • AASB 102 Inventories

The University of Sydney Page 4 The University of Sydney Page 5 Objective 1 Explain why consolidation worksheet adjustments are required where

there have been intragroup transactions

(Arthur et al Section 4.1) The University of Sydney Page 6 Recap Part 2c in consolidation process

3 key steps in the consolidation process

STEP 1: Acquisition Analysis – compare what we paid and what we received STEP 2: Consolidation Adjusting Entries STEP 2a: Business Combination Valuation Entry – Fair Value Adjustment (Module 3) STEP 2b: Pre-acquisition Elimination Entry (and Goodwill Impairment if any) STEP 2c: Intragroup Transactions Elimination Entry (Modules 4 and 5) STEP 3: Non-controlling Interest (Module 6) The University of Sydney Page 7 Context of intragroup transactions • The Economic Entity Concept: the consolidated financial statements are the

statements of a group and are presented as those of

a single economic entity. • Thus, the consolidated financial statements should ONLY show the effects of

transactions with entities external to the economic entity. A Ltd (Parent) B Ltd (Subsidiary) A Ltd Group C Ltd (External) Upstream transaction Downstream transaction • On consolidation, ALL intragroup transactions, whether

upstream or downstream, must be eliminated in FULL

(AASB10 B86) despite ownership interest • except dividends that are eliminated to extent

paid within the group (see Module 6) • Eliminate both transactions and unrealized profit. If one entity in the group has earned profit from another

entity in the group, it is unrealized from the group’s viewpoint, until sold externally. And so that profit must

also be eliminated. • We may have transactions to eliminate and/or

unrealized profits to eliminate, in any one accounting

period – distinguish the two clearly. FLOW OF

TRANSACTION (i.e. upstream

versus downstream) look out for its

importance with

‘NCI’ in Module 6 The University of Sydney Page 8 Intra-group transactions: 3 Golden Rules 3 GOLDEN RULES from AASB 10 B86 – our consolidation adjusting entries: 1. Eliminate intragroup transactions 2. Eliminate unrealized profits 3. Recognize tax timing differences We will practice writing consolidation entries for intragroup transactions by taking a deductive approach! We will ask ourselves five questions to logically come to an answer. 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’ records, to what the

group should record? (Golden rules 1 and 2) 5. What tax effect adjusting entries must be recorded regarding the adjustments at

step 4? (Golden rule 3) The University of Sydney Page 9 Objective 2 Prepare and explain worksheet adjusting entries to eliminate: • Intragroup management fees

(Arthur et al Section4.2) The University of Sydney Page 10 Transaction a: Intragroup services – Management fees Parent Subsidiary TRANSACTION #1 The parent charges a management fee of $100 to the subsidiary and receives cash. Parent Dr Cash

Cr Management fee received Subsidiary Dr Management fee expense

Cash How should the group eliminate the

effect of this intragroup transaction? And why? Eliminate through consolidation adjusting entries. Because it is NOT a transaction with anyone outside of the group. The University of Sydney Page 11 Transaction a: Intragroup services – Management fees Parent Subsidiary TRANSACTION #1 The parent charges a management fee of $100 to the subsidiary and received cash. Parent Sub Consolidation adj Group Dr Ref Cr Cash 100 (100) Mgt fee received 100 Mgt fee expense 100 0 0 0 Natural elimination 100 100 Consolidation journal eliminate as follows:

Dr Management fee received

Cr Management fee expense

XX Note: no impact on net profit (i.e. fee/expense

are both in consolidated profit) and so no tax

effect adjustment required. Pro

forma

entry The University of Sydney Page 12 Objective 2 Prepare and explain worksheet adjusting entries to eliminate: • Intragroup borrowings

(Arthur et al Section 4.3) The University of Sydney Page 13 Transaction b: Intragroup payables/receivables balances Parent Upstream transaction: parent is

given a loan from subsidiary. Dr Cash

Cr Payable Subsidiary Dr Receivable

Cr Cash Parent Sub Consolidation adj Group Dr Ref Cr Cash 100 (100) Receivable 100 Payable 100 0 0 0 Natural elimination 100 100 Consolidation journal eliminate as follows:

Dr Payable

Cr Receivable

XX Consolidation issue: Short term finance (interest free) No tax effect, because no net profit or net

asset impact. Pro

forma

entry The University of Sydney Page 14 Transaction b: Intragroup payables/receivables balances Let’s look at a different scenario for intragroup management fees and revisit

TRANSACTION #1 The parent charges a management fee of $100 to the subsidiary. At balance date the outstanding

amount has not been paid the subsidiary.

Does this mean there are two consolidation

adjusting journal entries? Consolidation journal eliminate P&L as follows:

Dr Management fee received

Cr Management fee expense

XX Consolidation journal eliminate B&S as follows:

Dr Accrued fees payable

Cr Accrued fees receivable

XX Note the

additional

adjusting

journal entry

The University of Sydney Page 15 Transaction c: Intragroup borrowing and lending Parent Sub Consolidation adj Group Dr Ref Cr Loan receivable 800 Loan payable 800 Interest revenue 80 Interest paid 80 Cash 800+80 (800)+(80) Parent: loan to subsidiary Dr Loan rec’b

800

Cr Cash

800 Dr Cash

Cr Interest revenue

80 Subsidiary Dr Cash

800

Cr Loan payable

800

Dr Interest exp

Cr Cash

80 The subsidiary borrows $800,000 from the parent with an interest of 10% per annum. 0 0 0 Natural elimination 800 0 0 800 80 80 No external entity involved.

So all accounts

should be 0

for the group. The University of Sydney Page 16 Transaction c: Intragroup borrowing and lending Consolidation adjusting journal: Dr Loan payable

800

Cr Loan receivable

800 Dr Interest revenue

Cr Interest expense

80 Dr Interest payable

Cr Interest receivable

80 What if: the subsidiary borrows $800,000 from the parent with an interest of 10% per

annum and the interest has not yet been paid. Again, there’s no need for a tax effect adjustment. Why? No timing difference or change to consolidated net assets. The University of Sydney Page 17 Objective 2 Prepare and explain worksheet adjusting entries to eliminate: • Intragroup inventory sales, including recognition of tax effects

(Arthur et al Section 4.4) The University of Sydney Page 18 Intragroup sales of inventory Profit realisation for the group does not occur until the inventory is sold outside the group to a third party 3 GOLDEN RULES WORKSHEET ADJUSTING ENTRIES FOR

INTRAGROUP SALES OF INVENTORY 1. Eliminate intragroup transactions Eliminate the effect of intragroup sales and

purchases Eliminate any outstanding intercompany balances

at year end (finance transactions) 2. Eliminate unrealized profits Eliminate any unrealized profit held within the

carrying amount of inventory assets (consider

both closing and opening inventory) 3. Recognize tax timing differences Consider all necessary tax effect journals We also need to be clear about whether we have a PERIODIC or PERPETUAL system as

our consolidation adjustments will differ slightly. The University of Sydney Page 19 RECAP: Perpetual versus Periodic Systems of Inventory Inventory Purchased (purchased 2 units) Inventory Sold (sold 2 units) Closing Inventory (2 units left on hand??) Opening Inventory (3 units on hand) Inventory losses? PERPETUAL (continuous records) When inventory is purchased: -

Dr Inventory

Cash/Pay’b (asset)

When inventory is sold: -

Dr Cash/Receivable

Sales -

Dr COGS

Cr Inventory (asset) An annual stocktake will also be undertaken…of course – a part of good management control. A journal entry

will made to adjust for any losses. Remember this from ACCT1006? The University of Sydney Page 20 RECAP: Perpetual versus Periodic Systems of Inventory Inventory Purchased (purchased 2 units) Inventory Sold (sold 2 units) Closing Inventory (2 units left on hand??) Opening Inventory (3 units on hand) Inventory losses? PERIODIC (relies on physical count at year end) - The company maintains 3 ledger accounts that

are combined into COGS in the P&L: PERIODIC (relies on physical count at year end) When inventory is purchased: -

Dr Purchases

Cash/Pay’b (asset)

When inventory is sold: -

Dr Cash/Receivable

Sales -

Not perpetual – so no inventory entry. At year end an

annual stocktake will also be undertaken and we will: -

Inventory

Closing inventory (COGS) Opening Inventory (count) Debit +

Purchases (company records) Debit –

Closing inventory

(determined through an annual stocktake) Credit =

Inventory Sold (COGS) Debit The University of Sydney Page 21 Transaction d: Intragroup Sales of Inventories

– What are the scenarios to consider? 1. Intragroup sales of inventories in the current period a. Case 1: The inventories are all sold externally by the end of the period • So no unrealized profit in closing inventories b. Case 2: The inventories remain unsold to external entities by the end of the period • So the profit made by the selling entity is 100% unrealized from the

group’s perspective – unrealized profit in closing inventories c. Case 3: The inventories are partially sold to external entities by the end of the period • The carrying value of closing inventories includes some unrealized

profit 2. Intragroup unrealized profit at the end of the prior period • Unrealized profit in opening inventories The University of Sydney Page 22 CASE 1: Intragroup sale in current period

– all sold to an entity external to the group before the end of the year Parent Subsidiary TRANSACTION #1 External Supplier sold inventory to the parent for $500,000 on 1.6.2019 TRANSACTION #2 (INTERNAL) Parent sold that inventory to Sub for $750,000 (markup 50%) on 25.6.2019 TRANSACTION #3 Subsidiary sold all of

that inventory externally for $800,000 on 30.6.2019 – Parent 1 June 2019 (external) Dr Inventory

500

Cr Cash

500 25 June 2019 (INTERNAL) Dr Cash

750

Cr Sales

750 Dr COGS

500

Cr Inventory

500 – Subsidiary 25 June 2019 (INTERNAL) Dr Inventory

750

Cr Cash

750

30 June 2019 (external)

Dr Cash

800

Cr Sales

800 Dr COGS

750

Cr Inventory

750 Assume

perpetual

inventory

system The University of Sydney Page 23 2. Do we have to also eliminate the $250 profit? No - because inventory all sold externally $300 realized profit = $250 (parent) + $50 (subsidiary) CASE 1: Intragroup sale in current period

– all sold externally by the group before the end of the year Parent Sub Consolidation adj Group Dr

(eliminate) Ref Cr

(eliminate) Sales 750 800 COGS 500 750 800750 750 500 1. Eliminate 100% of the internal sales

Dr Sales

750

Cr COGS

750 Assume perpetual

inventory system The University of Sydney Page 24 CASE 2: Intragroup sale in current period

– all still held by the group at the end of the year Parent Subsidiary TRANSACTION #1 External Supplier sold inventory to the parent for $500,000 on 1 June 2019 TRANSACTION #2 (INTERNAL) Parent sold that inventory to Sub for $750,000 (markup of 50%) on 25.6.2019 All inventory still

held by subsidiary

at 30 June 2019 – Parent 1 June 2019 (external) Dr Inventory

500

Cr Cash

500 25 June 2019 (INTERNAL) Dr Cash

750

Cr Sales

750 Dr COGS

500

Cr Inventory (asset) 500 – Subsidiary 25 June 2019 (INTERNAL) Dr Inventory (asset)

750

Cr Cash

750

Assume

perpetual

inventory

system The University of Sydney Page 25 CASE 2: Intragroup sale in current period

– all still held by the group at the end of the year Assume perpetual

inventory system You can also combine them into one:

Dr Sales

750

Cr COGS

500

Cr Inventory

250 Parent Sub Consolidation adj Group Dr

(eliminate) Ref Cr

(eliminate) Sales 750 COGS 500 Inventory 750 0750 250 0750250 500 1. Eliminate 100% of the internal sales

Dr Sales

750

Cr COGS

750 2. Eliminate 100% of the unrealized profit

Dr COGS

250

Cr Inventory (asset)

250 The University of Sydney Page 26 CASE 2: Intragroup sale in current period

– all still held by the group at the end of the year – The tax problem – now, unlike case 1, our consolidation elimination has

changed the CV of a taxable asset. See how our journal entry reduces the

CV of Inventory…..so we need to also record a DTA – Can you also explain – why do we credit ITE? 3. Account for the tax adjustments

Dr DTA

75 (Prepayment of tax by parent on behalf of the group)

Cr ITE

75 (reduce ITE by the amount paid by parent) Parent Sub Consolidation adj Group Dr

(eliminate) Ref Cr

(eliminate) Sales 750 COGS 500 Inventory 750 0750 250 0750250 500 The University of Sydney Page 27 CASE 3:

Intragroup sale in current period

– only part still held by the group at the end of the year Parent Subsidiary TRANSACTION #1 External Supplier sold inventory to the parent for $500,000 on 1 June 2019 TRANSACTION #2 (INTERNAL) Parent sold inventory for $750,000

(markup of 50% on cost) on 25 June 2019 TRANSACTION #3 Subsidiary still holds 30%

(i.e. 70% sold externally)

by 30 June 2019 – Parent 1 June 2019 (external) Dr Inventory

500

Cr Cash

500 25 June 2019 (INTERNAL) Dr Cash

750

Cr Sales

750 Dr COGS

500

Cr Inventory

500 – Subsidiary 25 June 2019 (INTERNAL) Dr Inventory

750

Cr Cash

750

30 June 2019 (external)

Dr Cash

xxx

Cr Sales

xxx Dr COGS

525

Cr Inventory (70%*$750) 525 Assume

perpetual

inventory

system The University of Sydney Page 28 CASE 3:

Intragroup sale in current period

(markup of 50% on cost) on 25 June 2019 TRANSACTION #3 Subsidiary only held 30%

(i.e. 70% sold externally

for $xxx) of that inventory

on 30 June 2019 Assume perpetual

inventory system Parent Sub Consolidation adj Group Dr

(eliminate) Ref Cr

(eliminate) Sales 750 xxx COGS 500 525 Inventory 225 xxx750 75 35075075 150 1. Eliminate 100% of the internal sales

Dr Sales

750

Cr COGS

750 2. Only 30% of the profit is unrealized:

Dr COGS

Cr Inventory (asset)

75 500*70% sold 500*30% on hand The University of Sydney Page 29 CASE 3: Intragroup sale in current period

– only part still held by the group at the end of the year – So again, we could combine this into 3 lines of journal: – And then our tax entry: Profit on transfer 750-500 =250 x 30% = 75

Elimination of the transaction and the unrealised profit:

Dr Sales

750

Cr COGS

675

Cr Inventory

75 3. Account for the tax adjustments

Dr DTA ($75*30%)

22.5

Cr ITE

22.5

The University of Sydney Page 30 How about the periodic system? Consider case 2 again Subsidiary Parent TRANSACTION #1 External Supplier sold inventory to the subsidiary for $200,000 on 1 June 2018 TRANSACTION #2 (INTERNAL) Subsidiary sold inventory for $250,000 (markup

of 25% on cost) ON CREDIT on 25 June 2018 All inventory still

held by parent at

30 June 2018 – Subsidiary 1 June 2018 (external) Dr Purchases

200

Cr Cash

200 25 June 2018 (INTERNAL) Dr A/Receivable

250

Cr Sales

250 Year end stocktake: Dr Inventory (asset)

Cr Closing inventory (COGS)

0 – Parent 25 June 2018 (INTERNAL) Dr Purchases

250

Cr A/Payable

250 Year end stocktake: Dr Inventory (asset)

250

Cr Closing inventory (COGS)

250 Upstream transaction Assume

PERIODIC

inventory

system where

Opening Inv.

+ Purchases

–

Closing Inv.

= COGS The University of Sydney Page 31 2. Eliminate 100% of the payable/receivable

Dr Accounts payable

250

Cr Accounts receivable

250 Unrealised profit in closing inventory - Periodic inventory system 1. Eliminate 100% of the internal sales

Dr Sales

250

Cr Purchases (COGS)

250 3. Eliminate unrealized profit

Dr Closing inventory (COGS)

Cr Inventory (asset)

50 4. Tax effect

Dr Deferred tax asset

Cr Income tax expense

15 1. Eliminate 100% of the internal

sales

Dr Sales

750

Cr COGS

750 2. Eliminate 100% of the

unrealized profit

Dr COGS

250

Cr Inventory (asset)

250 3. Account for the tax adjustments

Dr DTA

Cr ITE

75 Compare to the entries under the

perpetual inventory system

(from slides 25 and 26) The University of Sydney Page 32 Parent Sub Consolidation adj Group Dr Ref Cr Sales 1 Opening Inventory +Purchases 1 - Closing Inventory 3 =COGS Income Tax Expense 4 DTA 4 Accounts Receivable 2 Inventory 3 Cash Accounts Payable 2 200 (200) 250 250 250 250 0 0250 250 250 250 250 250 50 50 15 1515 200 (200) 15 0 0 200 0 0 200 0 The University of Sydney Page 33 Summary: Current Period Transfer of Inventory- Cases 1 to 3 (Periodic) [For perpetual system, replace (1) op. inventory, (2) purchases, and (3) cl. Inventory by COGS] Case 1: all sold Case 2: unsold Case 3: partially sold (70% sold) Adjusting Entries

required on

consolidation Dr Sales 750 Cr Purchases (COGS)

750 Dr Sales 750 Cr Purchases (COGS)

750 Dr Cl. Inventory(COGS)250

Cr Inventory (asset)

250 Dr DTA

Cr ITE

75 Dr Sales 750 Cr Purchases(COGS)

750 Dr Cl. Inventory (COGS)

Cr Inventory (asset)

75 Dr DTA

22.5

Cr ITE

22.5 Unrealized Profit No unrealized profit. Entire profit on intragroup

sale is unrealized. 30% of profit on intragroup sale is unrealized. Adj. to Sales and

Purchases The adjustment to sales (purchases) is always the amount of sales (purchases) within the group (i.e. $750) Adj. to Inventory and

Closing Inventory (COGS) →Adjust unrealized

profit within the group The adjustment to inventory is always equal to the percentage of inventory still on hand within the group multiplied by the profit on the sale within the group (i.e. the unrealized profit = % of inventory still on hand * (transfer price – original cost)). 0% * ($750-$500) = $0 100% * ($750-$500) = $250 30% * ($750-$500) = $75 Adj. to Tax Effect The tax effect is always equal to the tax rate multiplied by the unrealized profit 30% * $0 = $0 30% * $250 = $75 30% * $75 = $22.5 The University of Sydney Page 34 Intragroup inventory sales Tutorial

Questions

The University of Sydney Page 35 Objective 2 Prepare and explain worksheet adjusting entries to eliminate: • Unrealised profits or losses in both opening and closing inventory,

including recognition of tax effects (Arthur et al Section 4.4) The University of Sydney Page 36 Transaction d: Intragroup Sales of Inventories

– What are the scenarios to consider? 1. Intragroup unrealized profit at the end of the prior period – An intragroup sale occurred during previous period, and all or part of the

inventory was still on hand by the end of last year – This means that last year we eliminated unrealised profit in closing

inventory. We did a journal entry to reduce profit…. (Cases 2 or 3) – And so this year we must recognise that we have unrealised profit in

opening inventory (to ensure that last period’s closing inventory = this

period’s opening inventory) 2.

Consider – if there was an intragroup transaction last year, and all of that

inventory had been on sold to an external party by the end of last year (Case 1),

there would have been no unrealised profit last year, and so no entry will be

required this year.

The University of Sydney Page 37 Intragroup sale in the prior period and remains unsold (DOC 30 June 2019) - unrealized profit in opening inventory. Assume perpetual system Subsidiary Parent TRANSACTION #1 External Supplier sold inventory to the subsidiary for $200,000 on 1 June 2018 TRANSACTION #2 (INTERNAL) Subsidiary sold inventory for $250,000 (markup

of 25% on cost) for cash on 25 June 2018 All inventory still held by

parent at 30 June 2018 and

still at 30 June 2019 – Subsidiary 1 June 2018 (external) Dr Inventory

200

Cr Cash

200 25 June 2018 (INTERNAL) Dr Cash

250

Cr Sales

250 Dr COGS

200

Cr Inventory

200 – Parent 25 June 2018 (INTERNAL) Dr Inventory

250

Cr Cash

250 Upstream transaction The University of Sydney Page 38 Unrealised profit in opening inventory

(assuming still unrealised by 30 June 2019) – Recall the journal entries we did last year (30.6.2018): – Now we need to repeat the impact of those journal entries at 30.6.2019: Account for the tax adjustments:

Dr DTA

Cr ITE

Elimination of the transaction and the unrealised profit:

Dr Sales

250

Cr COGS

250

Dr COGS

Cr Inventory (asset)

50 Op. RE (1/7/18)

Inventory (asset)

50 DTA

Op. RE (1/7/18)

15 The University of Sydney Page 39 CWS (extract) Parent Sub Consolidation adj Group 30 June 2018 Dr Ref Cr Sales COGS 0 (200) 200 Income Tax Expense Closing R/E 0 35 0 DTA 0 0 15 15 Inventory 250 0 50 200 CWS (extract) Parent Sub Consolidation adj Group 30 June 2019 Dr Ref Cr Opening R/E DTA Inventory 250 250 (15) 15 0 0250 0 0 15 15 15 050 50 200 35 We can observe that we

are effectively ‘moving’

profit from one period to

anther Closing R/E - Closing

inventory/gross profit

overstated by $50 - ITE overstated by $15 The University of Sydney Page 40 What if the unrealized profit in opening inventory

becomes realized in the current period? Subsidiary Parent TRANSACTION #1 External Supplier sold inventory to the subsidiary for $200,000 on 1 June 2018 TRANSACTION #2 (INTERNAL) Subsidiary sold inventory for $250,000 (markup

of 25% on cost) for cash on 25 June 2018 – Parent (for year ending 30 June 2019) 20 June 2019 Dr Cash

320

Cr Sales

320 Dr COGS

250

Cr Inventory

250 Upstream transaction TRANSACTION #3 Parent sold all of that

inventory externally for $320,000 on 20 June 2019 The University of Sydney Page 41 Unrealised profit in opening inventory

(realised in the current period) parent sub elim

(Dr) elim

(Cr) group Sales 320 - 320 COGS (250) - 50 (200) ITE (21) - 15 (36) Opening retained earnings - 35 50 15 0 Consolidation journals:

Op. RE (1/7/18)

COGS

Income tax expense

Op. RE (1/7/18)

15 Check:

120x 30%

= 36

The University of Sydney Page 42 Unrealised losses in inventory

(not covered in this unit) – Less common – AASB 102 requires inventory valuation at lower of cost or NRV. So write

down is more likely to have been already recorded prior to

intercompany sale. Given AASB 102 requirements, difficult to see how a

consolidation adjustment could eventuate – If there is a transfer at a loss, the effects must also be eliminated on

consolidation

– Tax effect of unrealised losses would cause DTL The University of Sydney Page 43 More notes on tax effect accounting – Textbook assumes that individual (legal) entities (that is, parent entity and

subsidiary entity) pay tax separately – Of course, the group is not a legal entity and so does not pay tax (textbook

assumes that tax consolidation does not apply) – Therefore, we would never see debits or credits to “current tax payable” as part

of our consolidation journal entries (but we would see “current tax payable”

coming into the worksheet from the individual parent and subsidiary entities) – This means that tax effect adjustments on consolidation accounting are limited to

the following accounts: – DTA

– DTL

– Income tax expense The University of Sydney Page 44 Objective 3 Understand related treatments in the Wesfarmers Annual Report (Wesfarmers 2023 Annual Report) The University of Sydney Page 45 What’s in Wesfamers consolidated financial statements? Not much! Because of course its all eliminated See page 137 The University of Sydney Page 46 Next module

Intragroup Transactions: