As per previous post, consolidation subsequent to acquisition date has a few topics,
Today, we will cover on “Intragroup sale of non-depreciable assets” and “Intragroup sale of stock”
Before we begin however, I thought perhaps it will be good to recap some important lessons from previous learnings:
- The objective of consolidation is not just to combine the figures of multiple entities controlled under the same umbrella, but also to treat them as 1 entity by zero-ising any inter-group transactions as the combined entity cannot be buying or selling to itself.
- Goodwill is simply the difference between COI and FVNIA. Any past G/W recognized at subsidiary level should be ignored and cancelled against R/E first before calculating the new G/W.
- In consolidation under the “Acquisition method” where P holds majority but not 100% (a.k.a NCI exists),
- P’s COI is cancelled against (Subsidiary SC * Holding %) + (Subsidiary Pre-Acquisition R/E * Holding %).
- Any Subsidiary Post-Acquisition R/E * Holding % belongs to P. That’s means P’s group R/E = (P’s R/E) + (Subsidiary Post-Acquisition R/E * Holding %). This is NOT cancelled against COI.
- Therefore NCI = (Subsidiary S/C * NCI%) + (Subsidiary R/E * NCI%). For NCI, it’s not so important to distinguish between Pre-acquisition and Post-Acquisition since there’s no cancellation against COI.
- All intercompany transactions must be cancelled against one another. This includes ICO Sales/COGS, ICO interest income/expense, ICO A/P and A/R, ICO loans etc.
- Unrealised profits occurs when goods sold are sold within the group for a profit, but still have not yet left the group to external parties. Unrealised profits has 2 important considerations.
- 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.
- NCI: NCI will be affected if it’s upstream but not affected if its downstream because in a downstream transaction, the unrealised profits are recognised at P side and hence, no adjustment to NCI.
*Takes a sip of water* We are now ready to begin the most basic inter-group cancellations:
Intragroup sale of non-depreciable assets
This section will dedicated to selling of interco non-depreciable assets a.k.a land. Land is the easiest topic to start because there’s no depreciation complication and hence, we will use this opportunity to illustrate how consolidation entries differs at different points:
Lets assume P acquired 80% of S in year 2011:
In 2012, P bought a piece of land for $200
P’s double entries
| DR | Land | 200 |
| CR | Bank | 200 |
In 2013, P sold to S for $300
P’s double entries
| DR | Bank | 300 |
| CR | Land | 200 |
| CR | Profit from Land sale | 100 |
S’s double entries
| CR | Bank | 300 |
| DR | Land | 300 |
As P has recognised a profit on sale of land while S has recognised an inflated price of the land, we need to revert the figures back to original figures as if the sale never happened. Here’s how:
Consolidation entries
| CR | Land | 100 |
| DR | Profit from Land sale | 100 |
From 2014 to 2017, the land stayed on S’s balance sheet at $300. Hence, the consolidation entry needs to stay in effect to reflect the price of land as $200 instead of $300.
Consolidation entries
| CR | Land | 100 |
| DR | Opening R/E (P) | 100 |
Finally in 2018, the land was sold for $450. Here, because the land was recorded in S $300 before any consolidation adjustment, the profit at entity level is actually only $450-$300 = $150. However, let’s not forget at consolidation level, we treat it worth only $200, the original P’s purchase price. If based on P’s purchase price and not S, we have a total profit of $250, not just $150. You can also say from group’s point of view, the $100 profit was only realised in 2018 when the land was finally sold to an outsider.
S’s double entries
| DR | Bank | 450 |
| CR | Land | 300 |
| CR | Profit from Land sale | 150 |
Consolidation entries
| CR | Profit from Land sale | 100 |
| DR | Opening R/E (P) | 100 |
An important distinction here is that the CR of $100 is P’s profit, not S’s, because P sold to S and hence, the profit is P’s.
Take note also the consolidation entry to adjust the group profit to decognise the $100 unrealised profit will reduce the group profit in 2013 and increase the group profit in 2018. In between those years, as the adjustments is done against opening balance, the group profit is unaffected.
Intragroup sale of stock
With an understanding on the basis of consolidation entries, lets now tackle the issue on intragroup sale of stock.
First thing to note is Cost of Sale = OB + Purchase – CB. If function of expense is used, then any consolidation adjustment is made against Cost of Sale. If its nature of expense, then consol adj to OB and CB is made against Change in Stock figure while purchase adjustment is made against purchase figure.
Let’s kick off straight away with an example:
P owns 90% of S, where the pre-acquisition R/E is $2,000
S sells upstream to P at 25% markup.
In 2017, the annual interco sale is $300, of which $50 was still in P’s inventory at year end.
In 2018, the annual interco sale is $500, of which $35 was still in P’s inventory at year end.
Before we build the P&L and BS for 2017, lets first examine the relevant consolidation entries in 2017 and 2018 first
2017 Consolidation entries
| DR | Sales | 300 |
| CR | Cost of Sales(Purchase) | 300 |
| DR | Cost of Sale (Change in Stock) – $50 * (25%/125%) – (in S) | 10 |
| CR | Closing Inventory | 10 |
2018 Consolidation entries
| DR | Opening R/E (in S) | 10 |
| CR | Cost of Sale (Change in Stock) – $50 * (25%/125%) – (in S) | 10 |
| DR | Sales | 500 |
| CR | Cost of Sales(Purchase) | 500 |
| DR | Cost of Sale (Change in Stock) – $35 * (25%/125%) – (in S) | 7 |
| CR | Closing Inventory | 7 |
The purpose of illustrating 2018 entries is to showcase the concept of how unrealised profit consol adjustments in inventory is deemed as realised in subsequent year (adjusted against opening R/E) and then re-calculated again for current year end. This is different from the earlier discussion on sale of Land, where turnover to external party is not as fast as inventory. Other than that, the concept is the same.
Another discussion point is why adjust the unrealised profit $10 against Cost of Sale and not sale. In terms of Gross Profit, whether you DR COGS or DR Sales, the Gross Profit will still be the same, but it does goes back to the first point we made that all consol adj on inventory must be made against Cost of Sale. So, there you go.
Going back to 2017…
| P | S | DR | CR | Consol Bal. | |
| Sales | 2,800 | 5,000 | 300 | 7,500 | |
| Less: Cost of Sales | 1,500 | 3,000 | 300 | 4,210 | |
| 10 | |||||
| Gross Profit | 1,300 | 2,000 | 3,290 | ||
| Interest Income | – | – | – | ||
| Less: Distribution exp. | – | – | – | ||
| Less: Admin exp. | 300 | 800 | 1,100 | ||
| Op. Profit | 1,000 | 1,200 | 2,190 | ||
| Less: Interest Exp | – | – | – | ||
| PBT | 1,000 | 1,200 | 2,190 | ||
| Less: Tax | 300 | 400 | 700 | ||
| PAT | 700 | 800 | 1,490 | ||
| Other Comp. Inc | |||||
| FV Gain | – | – | – | ||
| Reval. Surplus | – | – | – | ||
| Total Comp. Inc | 700 | 800 | 1,490 | ||
| PAT attributable to: | |||||
| Shareholders of P 700 + (90%* [800-10]) | 1,411 | ||||
| NCI (10% * [800-10]) | 79 | ||||
| 1,490 | |||||
| Total Income attributable to: | |||||
| Shareholders of P 700 + (90%* [800-10]) | 1,411 | ||||
| NCI (10% * [800-10]) | 79 | ||||
| 1,490 |
| P | S | DR | CR | Consolidated Bal. | |
| Land | 1,000 | 500 | 1,500 | ||
| Investment | 2,700 | – | 2,700 | – | |
| Stock | 2,000 | 3,000 | 10 | 4,990 | |
| A/R | – | – | – | ||
| Loan Receivable | – | – | – | ||
| Bank | 1,300 | 1,500 | 2,800 | ||
| 7,000 | 5,000 | 9,290 | |||
| Share Capital | 5,000 | 1,000 | 900 | 5,000 | |
| 100 | |||||
| Retained Earnings | 1,800 | 3,300-10 | 1,800 | 2,961 | |
| 329 | |||||
| A/P | 200 | 700 | 900 | ||
| Loan Payable | – | – | – | ||
| NCI | – | – | 79 | 429 | |
| 350 | |||||
| 7,000 | 5,000 | 9,290 |
Following is a breakdown on how the retained earnings + current year profits is being dissected:
| Pre-acquisition | Amt | P%/NCI% | P/NCI |
| Share capital | 1,000 | 90% | 900 |
| 10% | 100 | ||
| Retained Earnings | 2,000 | 90% | 1,800 |
| 10% | 200 | ||
| Post-acquisition (Before Current Year) | |||
| Retained Earnings (3,300-2,000-800) | 500 | 90% | 450 |
| 10% | 50 | ||
| Post-acquisition (Current Year) | |||
| Retained Earnings | 800-10 | 90% | 711 |
| 10% | 79 |
You can get the group’s R/E by adding P R/E + share of S Post R/E = 1,800 + 450 + 711 = 2,961
The 329 cancelled as NCI’s share of R/E is derived by S R/E * 10% = 3290 * 10% = 329
Finally, the NCI of 429 is simply just share of S Share capital + S R/E = (1,000 + 3,290) * 10% = 429
Most importantly, this example is also a demonstration on how upstream interco transaction works compared to downstream.
If you follow the “10” highlighted in red, you can see why it is so important for distinguish whether the unrealised profit belongs to S or to P. Since the seller is S in the example for interco stock, the unrealised profit is adjusted at S side. Hence, it has the following domino effect:
- Starting with P&L, the NCI calculation is based on (S’s profit – URP) * NCI%. This reduces the NCI figure as compared to a downstream transaction, which would just be (S’s profit) * NCI%
- From the perspective of P, upstream profit is calculated as P’s profit + (S’s profit – URP) * NCI%. In downstream where P recognise the URP, and therefore when URP is reversed, P will absorb the full impact.
- At the R/E section of the balance sheet, you can also see that “10” is deducted from S side. Technically, you can also reflect this as a consolidation entry in “DR” column and the 2 columns would be balanced, but I just thought showing it under S’s R/E would make it more clear how important it is to determine whether the URP belongs to P or S. Similarly, if it was a downstream transaction, the “10” would deducted at P side and would also affect the Statement of Equity.
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 