As per previous post, consolidation subsequent to acquisition date has a few topics, mainly:
- Consolidated Statement of Comprehensive Income
- Pre and Post acquisition reserves
- Intragroup account balances
- Unrealised Intragroup Profits and Losses
- Intragroup sale of non-depreciable assets
- Intragroup sale of stock
- Intragroup sale of depreciable assets
- Intragroup charges
- Tax effect on intragroup profits and losses
- Intragroup dividend
- Other consolidation adjustments
Today, we will cover on “Intragroup account balances” and “Unrealised Intragroup Profits and Losses”
Intragroup account balances
Usually within a group, P and S would have sales and purchases from one another. This means that at P&L level, sales and purchases are inflated and needs to be cancelled off. At balance sheet side, there will be interco AR and AP that are still unpaid which will also require cancellation. Sometimes there will be complications arising from cash in transit where one side paid but is not received at the other end. Same logic applies if there’s any intercompany loans and interest where these transactions needs to be offset. Its imperative that the consolidation adjustments reflects these transactions because at group level, P and S is 1 entity and this entity cannot buy or loan money to itself.
Following is an example that demonstrates how these transactions can be cancelled out:
P acquired 80% of S for $160 3 years ago when S’s R/E was $100 and share capital was $100.
In current year, P sold to S $100 worth of goods, which represented entire group’s intra-group sales and purchase. All sales and purchased have been realised to outside parties, but only $80 have been settled by S to P. However, P only received $70 due to late bank settlement. P also provided a loan $6 to S, incurring a YTD interest expenses of $1.
| P | S | DR | CR | Consol Bal. | |
| Sales | 800 | 500 | 100 | 1200 | |
| Less: Cost of Sales | 500 | 300 | 100 | 700 | |
| Gross Profit | 300 | 200 | 500 | ||
| Interest Income | 1 | – | 1 | – | |
| Less: Distribution exp. | 66 | 59 | 125 | ||
| Less: Admin exp. | 35 | 20 | 55 | ||
| Op. Profit | 200 | 121 | 320 | ||
| Less: Interest Exp | – | 1 | 1 | – | |
| PBT | 200 | 120 | 320 | ||
| Less: Tax | 60 | 30 | 90 | ||
| PAT | 140 | 90 | 230 | ||
| Other Comp. Inc | |||||
| FV Gain | – | – | – | ||
| Reval. Surplus | – | – | – | ||
| Total Comp. Inc | 140 | 90 | 230 | ||
| PAT attributable to: | |||||
| Shareholders of P 140 + (80%* 90) | 212 | ||||
| NCI (20% * 90) | 18 | ||||
| 230 | |||||
| Total Income attributable to: | |||||
| Shareholders of P 140 + 0 (80% * (90+0) ) | 212 | ||||
| NCI (20% * (90+0) ) | 18 | ||||
| 230 |
| P | S | DR | CR | Consolidated Bal. | |
| Land | 200 | 200 | 400 | ||
| COI | 160 | – | 160 | – | |
| Stock | 200 | 100 | 300 | ||
| A/R | 140 | 70 | 20 | 180 | |
| 10 | |||||
| Loan Receivable | 6 | – | 6 | – | |
| Bank | 44 | 30 | 10 | 84 | |
| 750 | 400 | 964 | |||
| Share Capital | 500 | 100 | 80 | 500 | |
| 20 | |||||
| Retained Earnings | 160 | 230 | 80 | 264 | |
| 46 | |||||
| A/P | 90 | 60 | 20 | 130 | |
| Loan Payable | – | 10 | 6 | 4 | |
| NCI | – | – | 66 | 66 | |
| 750 | 400 | 964 |
A few important observations from above:
- Notice the PAT doesn’t change. Most consolidation entries do not affect PAT because eg. every $1 sale is cancelled against $1 of COGS. Same concept applies to elimination of Interest Income and Interest Expense.
- Similarly in balance sheet, the $20 in AP is cancelled against AR. However, do note the additional $10 for cash in transit, which is CR A/R DR Bank. The effect of this is to assume the cash has been received and the bank reconciliation will show the cash in transit. This entry will also help to match the amount outstanding shown in P’s amount owed and S’s amount owing. Similar elimination is applied to the interco loan payable and receivable.
Following is a breakdown on how the retained earnings + current year profits is being dissected:
| Pre-acquisition | Amt | P%/NCI% | P/NCI |
| Share capital | 100 | 80% | 80 |
| 20% | 20 | ||
| Retained Earnings | 100 | 80% | 80 |
| 20% | 20 | ||
| Post-acquisition (Before Current Year) | |||
| Retained Earnings (140-100) | 40 | 80% | 32 |
| 20% | 8 | ||
| Post-acquisition (Current Year) | |||
| Retained Earnings | 90 | 80% | 72 |
| 20% | 18 |
You can get the group’s R/E by adding P R/E + share of S Post R/E = 160 + 32 + 72 = 264
The 46 cancelled as NCI’s share of R/E is derived by S R/E * 20% = 230 * 20% = 46
Finally, the NCI of 66 is simply just share of S Share capital + S R/E = (100 + 230) * 20% = 66
If you can understand the above, you are almost there. Hang in there! 🙂
All that’s left to understand is to see how the P’s share of profit in P&L flows to the Statement of Equity, and hence how its matched to Balance’s Sheet ending R/E:
| P | S | DR | CR | Consolidated Bal. | |
| Opening R/E | 90 | 140 | 80 | 122 | |
| 28 | |||||
| Current Yr Profit | 140 | 90 | 18 | 212 | |
| Dividend | (70) | – | (70) | ||
| Ending R/E | 160 | 230 | 264 |
Notice that the above SOE is purely to derive Group’s R/E, which only includes P’s share of S Post acquisition R/E. This means that P’s share of pre-acquisition R/E (100 * 80%) and all NCI R/E (140 + 90) * 20% = 46 needs to removed.
Unrealised Intragroup Profits and Losses
The topic of Unrealised Intragroup Profits and Losses is a supplement to the cancellation of Sales and COGS above for P selling the goods to S for $100. However, this is based on assumption that S managed to sell away all goods bought from P to external parties, which is known in consolidation as fully realised intercompany profits. However, if the goods have not been sold out of the group at time of consolidation, it is considered unrealised and must be eliminated. To illustrate the necessity of such cancellation, here’s a flow of double entries to follow the flow of goods if its realised:
P’s double entries
| DR | Interco A/R (S) | 100 |
| CR | Sale | 100 |
| CR | Inventory | 80 |
| DR | COGS | 80 |
S’s double entries
| DR | Inventory | 100 |
| CR | Interco A/P (P) | 100 |
| DR | A/R (External) | 110 |
| CR | Sale | 110 |
| CR | Inventory | 100 |
| DR | COGS | 100 |
In the example above, because the profits are fully realised, there’s a Interco Sale and Interco COGS of $100 to cancel. However, if the profits are not realised, the last 4 lines in S’s entries are not passed and it effectively becomes just a transfer of inventory ownership from P to S and P has recognised a $20 profit margin from the transfer of ownership to S. The $20 cannot be recognised in consolidation and must be eliminated.
Such elimination comes with complications. The first complication is timing. If profits was unrealised in Year 1 but realised in Year 2, then the amount must be eliminated in Year 1 but in year 2, the same amount must be deducted from opening R/E and added to current year R/E. You may understand this as a transfer of Year 1 profit to Year 2 since the profits are only realised in Year 2.
The next complication comes from partially owned subsidiaries. In this scenario, the widely adopted practice is to differentiate between downstream profits (P sells to S) or upstream profits (S sells to P). NCI will be affected if it’s upstream but not affected if its downstream. It may not sound logical at first, but in a downstream transaction, the unrealised profits are recognised at P side and hence, no adjustment to NCI. This practice is also known as the “Full proportionate method”, summarised as per below:
- Eliminate 100% of unrealised profits or loss regardless of wholly owned or not
- Adjusting the unrealised profits against the profits of selling entity. (NCI is affected if and only if S is selling entity.
That’s not all. If you go back to the flow of accounting entries above, the original cost of inventory to P is only 80, but after the transfer of ownership to S, the inventory is recorded as 100. There’s needs to be an entry to bring the value of inventory as 80, the original value that P bought for.
Once we have adjusted for the unrealised profits and revert the asset value back to original, we have achieved a set of values that is as if there were no interco transactions for any goods that have not been sold outside of the group. That’s the guiding principal that we must be aligned to always.
There are also other complications, such as when P sells to S for $80 for goods worth $100. Is this case, should the $20 be realised or unrealised? The answer is to consider whether the $20 is real or artificial. The the goods is truly damaged and net realiseable value is only $80, then the $20 is real does not require elimination. If the $80 goods is artificial and can actually be sold for $100 to external parties, then the $20 needs to be eliminated.
This topic will be further expanded in future discussions.
All materials produced on this website, including this article, is based on author’s best interpretation of accepted accounting standards and his own experience. Any information bias, inaccuracies, misstatements, obsolesce are unintentional and should strictly not be held liable against the author. The author is not responsible for any losses, monetary or non-monetary, as a result of using these materials.
Derrick How 