Phew! Last post was lengthy isn’t it? 🙂
Today, we will cover on “Intragroup sale of depreciable assets” and “Intragroup charges”
Without further delay, let’s jump straight into first topic.
Intragroup sale of depreciable assets
This topic is complicated in the sense that subsequent depreciation is treated as gradual realisation of unrealised profit (URP). This is because the PPE depreciates faster so long as the PPE was sold with profit. The faster speed in depreciation must be equalised back to the same depreciation rate as if the sale never happened together with reversal on initial profit from sale of PPE.
Let’s visualise this with an example:
P acquired 60% of S in 2012. In Dec 2015, S sold machinery to P for $400. The machinery was bought in Jan 2011 for $600 and had accumulated depreciation of $300 when it was sold to P. Group’s policy was to depreciate this over 10 years on straight line and to provide full year depreciation whenever it has been in used for more than 6 months.
At this point, it is important to note that the asset has exactly reached the halfway point of its life before it was sold to P.
P’s double entries (Buyer)
| DR | PPE(Cost) | 400 |
| CR | Bank | 400 |
S’s double entries (Seller)
| DR | Bank | 400 |
| CR | PPE (Cost) | 600 |
| DR | PPE (Acc. Dep) | 300 |
| CR | Gain on Sale of PPE | 100 |
Hence at end of 2015, year of the sale from S to P, the following consol entries will revert back to the state as if the transaction never occured:
2015 Consolidation entry
| DR | Gain on Sale of PPE | 100 |
| DR | PPE (Cost) | 200 |
| CR | PPE (Acc. Dep) | 300 |
The entry above is pretty straightforward. The objective was just to de-recognise the URP and transform the cost and depreciation back to 600-300. In 2016 and 2017 however, because of the difference in depreciation rate if the sale happened and if it didn’t happen, we need to adjust for the difference.
| If sale didn’t happen | If sale happened | |
| Cost | 600 | 400 |
| No. of Years | 10 | 5 |
| Depreciation/Year | 60 | 80 |
As you can see from above, the interco sale caused an acceleration of depreciation by 20 every year, which should be adjusted for:
2016 Consolidation entry
| DR | Opening R/E | 100 |
| DR | PPE (Cost) | 200 |
| CR | PPE (Acc. Dep) | 300 |
| DR | PPE (Acc. Dep) | 20 |
| CR | Depreciation Expense | 20 |
In 2017, the entries repeats itself, except with additional adjustments for the accelerated depreciation:
2017 Consolidation entries
| DR | Opening R/E | 100 |
| DR | PPE (Cost) | 200 |
| CR | PPE (Acc. Dep) | 300 |
| DR | PPE (Acc. Dep) | 40 |
| CR | Opening R/E | 20 |
| CR | Depreciation Expense | 20 |
Another way to see the $20 adjustment/year is to see it as gradual realisation of sale to outside party given the fact that the $100 profit on sale of PPE gradually decrease over 5 years at $20/year from the increase in depreciation at entity level. Hence, from that logic, both the $100 profit and $20/year adjustment belongs to the seller S. Another way to prove that both $100 and $20/year belongs to seller S is to assume the PPE stayed with group until the end without selling to external vendor. The the consol adjustment in the final year would look like this:
2020 Consolidation entries
| DR | Opening R/E | 100 |
| DR | PPE (Cost) | 200 |
| CR | PPE (Acc. Dep) | 300 |
| DR | PPE (Acc. Dep) | 100 |
| CR | Opening R/E | 80 |
| CR | Depreciation Expense | 20 |
If you observe the entries above, they actually net off each and hence are exactly the same. (So technically, in the last year, no consol adjustment is required lah…)
Let’s now take a look what happens if P sells off the asset in 1st day of 2018 for $250. Again, we need to do a comparison of what happens if the sale happened and if the sale didn’t happen:
| If sale didn’t happen | If sale happened | |
| Sale Proceed | 250 | 250 |
| – Cost | 600 | 400 |
| – Acc. Dep | 420 ($600 * 7/10 years) | 160 ($400 * 2/5 years) |
| Book Value | 180 | 240 |
| Profit | 70 | 10 |
So if you take the difference of 70 – 10, you get 60, which should always tie to 2017 ending R/E (DR 100 CR 20 CR 20). This 60 should always be 60, regardless of selling price. Henceforth, we consider the URP realised and pass the following entry in 2018:
2018 Consolidation entries upon sale to external party
| DR | Opening R/E | 60 |
| CR | Profit on sale of PPE | 60 |
Let’s now assume S’s R/E was $200 and the PPE is still with P (not realised) when it was acquired and we are ready to build the 2018 consolidated statements:
| DR | Opening R/E | 100 |
| DR | PPE (Cost) | 200 |
| CR | PPE (Acc. Dep) | 300 |
| DR | PPE (Acc. Dep) | 60 |
| CR | Opening R/E – 2 Yrs * 20 | 40 |
| CR | Depreciation Expense | 20 |
| P | S | DR | CR | Consol Bal. | |
| Sales | 800 | 500 | 1,300 | ||
| Less: Cost of Sales | 500 | 150 | 650 | ||
| Gross Profit | 300 | 350 | 650 | ||
| Interest Income | – | – | – | ||
| Less: Distribution exp. | – | – | – | ||
| Less: Admin exp. | 200 | 100 | 20 | 280 | |
| Op. Profit | 100 | 250 | 370 | ||
| Less: Interest Exp | – | – | – | ||
| PBT | 100 | 250 | 370 | ||
| Less: Tax | 30 | 70 | 100 | ||
| PAT | 70 | 180 | 270 | ||
| Other Comp. Inc | |||||
| FV Gain | – | – | – | ||
| Reval. Surplus | – | – | – | ||
| Total Comp. Inc | 70 | 180 | 270 | ||
| PAT attributable to: | |||||
| Shareholders of P 70 + (60%* [180+20]) | 190 | ||||
| NCI (40% * [180+20]) | 80 | ||||
| 270 | |||||
| Total Income attributable to: | |||||
| Shareholders of P 70 + (60%* [180+20]) | 190 | ||||
| NCI (40% * [180+20]) | 80 | ||||
| 270 |
| P | S | DR | CR | Consolidated Bal. | |
| Land | 300 | 500 | 800 | ||
| PPE (cost) | 400 | – | 200 | 600 | |
| PPE (Acc. Dep) | (240) | – | 60 | 300 | (480) |
| Investment | 180 | – | 180 | – | |
| Stock | – | – | – | ||
| A/R | – | – | – | ||
| Loan Receivable | – | – | – | ||
| Bank | 160 | 200 | 360 | ||
| 800 | 700 | 1,280 | |||
| Share Capital | 500 | 100 | 60 | 500 | |
| 40 | |||||
| Retained Earnings | 200 | 530-100+40+20 | 120 | 374 | |
| 196 | |||||
| A/P | 100 | 70 | 170 | ||
| Loan Payable | – | – | – | ||
| NCI | – | – | 40 | 236 | |
| 196 | |||||
| 800 | 700 | 1,280 |
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 | 60% | 60 |
| 40% | 40 | ||
| Retained Earnings | 200 | 60% | 120 |
| 40% | 80 | ||
| Post-acquisition (Before Current Year) | |||
| Retained Earnings (530-200-180)-100+40 | 90 | 60% | 54 |
| 40% | 36 | ||
| Post-acquisition (Current Year) | |||
| Retained Earnings | 180+20 | 60% | 120 |
| 40% | 80 |
You can get the group’s R/E by adding P R/E + share of S Post R/E = 200 + 54 + 120 = 374
The 196 cancelled as NCI’s share of R/E is derived by S R/E * 40% = (530-100+40+20) * 40% = 196
Finally, the NCI of 236 is simply just share of S Share capital + S R/E = (100 + 530-100+40+20) * 40% = 236
Most importantly, I want you to follow the figures in red and see that we need to assign BOTH the initial $100 profit and subsequent $20/year depreciation to S and understand that the assignment of profit is applicable not just to current year profits, but also to the opening balance. You can understand it as a permanent assignment.
Intragroup charges
This is a very short discussion for scenario where P’s interco transaction is in P&L while S capitalise it in balance sheet. A good example is FRS 23 that governs construction financing, which give rise to 3 possible scenarios
- P loans S. P recognise interest income in P&L while S recognise in balance sheet. From group’s perspective, this loan never happened.
| DR | Loan Payable |
| DR | Interest income |
| CR | Loan Receivable |
| CR | Asset in Construction (Interest amount) |
- P borrows from bank and then loans to S. P recognise interest income in P&L with A/P to bank and loan A/R from S while S capitalise the interest as per FRS 23. From group’s perspective, the underlying nature of this transaction is bank financing and FRS 23 is in effect. This is not a loan from P. Hence, the capitalised interest will stay capitalised.
| DR | Loan Payable |
| DR | Interest income |
| CR | Loan Receivable |
| CR | Interest Expense |
- Same situation as above except P charge a higher interest to S compared to the interest it pays the bank. In this case, the interest recognised should be pegged to the bank’s and an additional leg is required to reversed out the inflated portion of the interest out from the Asset in Construction
| DR | Loan Payable |
| DR | Interest income |
| CR | Loan Receivable |
| CR | Interest Expense |
| CR | Asset in Construction |
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 