1. Prepare the acquisition analysis at 1 January 2017 2. Prepare the business combination valuation entries and pre-acquisition entries at 1 Januart 2017 3. Prepare the business combination valuation entries and pre-acquisition entries at 31 December 2017
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WORKSHOP WEEK 8: CHAPTER 28 Consolidation: Intragroup Transactions
SUGGESTED SOLUTIONS
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Chapter 28
Comprehensive Questions
1. Why is it necessary to make adjustments for intragroup transactions?
The consolidated financial statements are the statements of the group, i.e. an economic entity consisting of a parent and its subsidiaries. These consolidated financial statements then can only contain revenues, expenses, profits, assets and liabilities that relate to parties external to the group.
Adjustments must be made for intragroup transactions as these are internal to the economic entity, and do not reflect the effects of transactions with external parties. This is consistent with the entity concept of consolidation, which defines the group as the net assets of the parent, together with the net assets of the subsidiaries. Transactions between these parties internal to the group must be adjusted in full.
2. In making consolidation worksheet adjustments, sometimes tax-effect entries are made. Why?
Obviously, not all adjustments have tax consequences. The only adjustment entries that have tax consequences are those where profits or losses are eliminated and carrying amounts of assets or liabilities are adjusted.
Accounting for tax is governed by AASB 112/IAS 12 Income Taxes. Deferred tax accounts are raised when a temporary difference arises because the tax base of an asset or liability differs from the carrying amount. Some consolidation adjustments result in changing the carrying amounts of assets and liabilities. Where this occurs, a temporary difference arises as there is no change to the tax base. In these situations, tax-effect entries requiring the recognition of deferred tax assets and liabilities are necessary.
Consider an example of an item of inventories carried at cost of $10 000 being sold by a parent to a subsidiary for $12 000, with the item still being on hand at the end of the period. The tax rate is 30%.
In the consolidation worksheet, the adjustment entry necessary to eliminate the unrealised profit of the intragroup transaction includes a credit adjustment to inventories of $2000 as the cost to the economic entity for that item differs from that to the subsidiary. In the subsidiary’s accounts, the inventories are carried at $12 000 and has a tax base of $12 000, giving rise to no temporary differences. However, from the group’s point of view, the asset has a carrying amount of $10 000, and, combined with a tax base of $12 000, gives a deductible temporary difference of $2000 (the expected future deduction is greater than the future assessable amount). As a result, a deferred tax asset exists for the group and should be recognised in a tax-effect entry. This has no effect on the amount of tax payable in the current period, but will decrease the Income Tax Expense from the perspective of the group.
Another explanation for the tax effect of the consolidation worksheet entry to eliminate the unrealised profit of the intragroup transaction can be provided as follows: as profit of $2000 is eliminated (by crediting Cost of Sales by $10 000 and debiting Sales Revenue by $12 000), the group’s profit is decreased and therefore, the Income Tax Expense (which is normally calculated as 30% of the profit) should decrease as well by 30% of $2000. Also, the entity that made the intragroup sale and recorded the profit would have paid tax on that profit; from the perspective of the group, that tax should not have been paid yet and represents a prepayment of tax in advance of the actual profit being realised by the group; this prepayment is going to be recognised by the group as a future tax benefit, a Deferred Tax Asset.
7. When are profits realised in relation to inventories transfers within the group?
Realisation occurs on involvement of an external entity, namely when the inventories are on-sold to an entity that is not a member of the group. If only a part of the inventories initially transferred intragroup is on-sold to external parties by the end of a period, only the part of the intragroup profit related to the inventories on-sold is realised. It should be noted that, as inventories are current assets which should be eventually sold to external parties, it is normally assumed, unless otherwise specified, that inventories transferred intragroup that are not sold to external parties by the end of a period are sold to external parties by the end of the next period and therefore any unrealised profit in opening inventories in one period is considered realised by the end of that period.
Exercise 28.2
Current and prior periods intragroup transfers of inventories
Charlotte Ltd owns all the share capital of Aloise Ltd. The income tax rate is 30% and all income on sale of assets is taxable and expenses are deductible.
(a) On 1 May 2016, Charlotte Ltd sold inventories to Aloise Ltd for $10 000 on credit, recording a profit of $2000. Half of the inventories were unsold by Aloise Ltd at 30 June 2016 and none at 30 June 2017. Aloise Ltd paid half the amount owed on 15 June 2016 and the rest on 1 July 2016.
(b) On 10 June 2016, Aloise Ltd sold inventories to Charlotte Ltd for $15 000 in cash. The inventories had previously cost Aloise Ltd $12 000. Half of these inventories were unsold by Charlotte Ltd at 30 June 2016 and 30% at 30 June 2017.
(c) On 1 January 2017, Aloise Ltd sold inventories costing $6000 to Charlotte Ltd at a transfer price of $7000, paid in cash. The entire inventories were sold by Charlotte Ltd to external entities by 30 June 2017.
Required
In relation to the above intragroup transactions:
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2016 and 30 June 2017.
2. Explain in detail why you made each adjusting journal entry.
1. At 30 June 2016, there will only be adjusting entries for transactions (a) and (b) as these are the only transactions related to the financial period ended on 30 June 2016. At 30 June 2017, there will be adjusting entries for all transactions.
CHARLOTTE LTD – ALOISE LTD
Inventories Cr 1 000
Cost of sales Cr 9 000
Income tax expense Cr 300
Accounts payable Dr 5 000
Accounts receivable Cr 5 000
(b) Sales revenue Dr 15 000
Cost of sales Cr 12 000
Inventories Cr 1 500
Deferred tax asset Dr 450
Income tax expense Cr 450
(a) Retained earnings (1/7/16) Dr 700
Income tax expense Dr 300
Cost of sales Cr 1000
(b) Retained earnings (1/7/16) Dr 1 500
Cost of sales Cr 600
Inventories Cr 900
Deferred tax asset Dr 270
Income tax expense Dr 180
Retained earnings (1/7/16) Cr 450
(c) Sales revenue Dr 7 000
Cost of sales Cr 7 000
2. Detailed explanations on the adjusting journal entries
30 June 2016
(a) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June 2016. As half of the inventories remain unsold at the end of the period, at 30 June 2016 half of the entire profit on the intragroup sale is unrealised and should be eliminated on consolidation by:
· Debiting Sales Revenue with an amount equal to the intragroup price – to eliminate the intragroup revenues
· Crediting Inventories with an amount equal to the unrealised profit – to decrease the value of the inventories left on hand with the group to their original cost to the group
· Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of credit to Inventories – to adjust the aggregate figure for Cost of Sales to the amount that should be recognised by the group, i.e. the original cost of the inventories sold to external parties.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit in closing inventories at 30 June 2016 by raising a Deferred Tax Asset for the tax recognised by Charlotte Ltd on the unrealised profit.
The third adjusting entry eliminates the intragroup Accounts Payable and Accounting Receivable for the amount still unpaid on the intragroup sale.
(b) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June 2016. As half of the inventories remain unsold at the end of the period, at 30 June 2016 half of the entire profit on the intragroup sale is unrealised and should be eliminated on consolidation by:
· Debiting Sales Revenue with an amount equal to the intragroup price
· Crediting Inventories with an amount equal to the unrealised profit – to decrease the value of the inventories left on hand with the group to their original cost to the group
· Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of credit to Inventories.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit in closing inventories at 30 June 2016 by raising a Deferred Tax Asset for the tax recognised by Aloise Ltd in advance on the unrealised intragroup profit.
30 June 2017
(a) In this case, the unrealised profit in closing inventories from the period ended 30 June 2016 and recognised as unrealised profit in opening inventories in this period becomes realised by the end of the current period. As such, this profit needs to be transferred from the previous period to the current period by:
· Debiting Retained Earnings (1/7/16) with an amount equal to the after-tax unrealised profit in opening inventories – this eliminates the unrealised profit from the prior period’s earnings
· Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in opening inventories – this increases the current profit as the previously unrealised profit is now realised.
As a result of this transfer of profit to the current period, the current period profit increases and a tax effect should also be recognised in the adjusting entry by:
· Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in opening inventories.
(b) In this case, a part (20%) of the inventories originally transferred intragroup in the previous period is sold during the current period to external parties, while another part (30%) is still unsold. That means that the unrealised profit in closing inventories from the period ended 30 June 2016 and recognised as unrealised profit in opening inventories in this period is only partly realised by the end of the current period. This is recognised in the first adjusting entry by:
· Debiting Retained Earnings (1/7/16) with an amount equal to the before-tax unrealised profit in opening inventories – this eliminates the unrealised profit from the prior period’s profit
· Crediting Cost of Sales with an amount equal to the unrealised profit in opening inventories that becomes realised during the current period – this increases the current profit as the previously unrealised profit is now realised
· Crediting Inventories with an amount equal to the unrealised profit in opening inventories that is still unrealised at the end of the current period – this decreases the value of the inventories still on hand to their original cost to the group.
As a result of the recognition of the part of profit that is realised in the current period, the current period profit increases and a current tax effect should also be recognised by:
· Debiting Income Tax Expense with an amount equal to the tax on the part of the unrealised profit in opening inventories that is realised by the end of the period.
As a result of the elimination of the part of the profit that is unrealised by the end of the current period, a deferred tax effect should also be recognised by:
· Debiting Deferred Tax Asset with an amount equal to the tax on the part of the unrealised profit in opening inventories that is still unrealised at the end of the period.
Given that Retained Earnings only recognises profits after tax, debiting Retained Earnings (1/7/16) in the first adjusting entry with the before-tax unrealised profit eliminated from that account more than what it should and therefore the balance of Retained Earnings (1/7/16) should be adjusted by:
· Crediting Retained Earnings (1/7/16) with an amount equal to the tax on the unrealised profit in opening inventories – this ensures that the net adjustment to Retained Earnings (1/7/16) is only for the after-tax unrealised profit.
(c) The only adjusting entry eliminates the intragroup sales revenue and the cost of sales recognised by Charlotte Ltd as the profit on the intragroup sale is entirely realised during the current period. As the inventories are sold by the end of the period to an external entity, at 30 June 2017 the entire profit on the intragroup sale is realised; however, the aggregate sales revenues and cost of sales are overstated from the group’s perspective as they include the intragroup sales revenue and the cost of sales recognised based on the price paid intragroup by Charlotte Ltd. On consolidation, this overstatement is corrected. There won’t be any tax-effect adjustment entry as the only adjusting entry posted now does not have any net effect on the profit or on the carrying amount of inventories.
Exercise 28.3
Current and prior periods intragroup transfers of non-current assets
Sophie Ltd owns all the share capital of Ruby Ltd. The following transactions relate to the period ended 30 June 2017. Assume an income tax rate of 30%.
(a) On 1 July 2016, Sophie Ltd sold a motor vehicle to Ruby Ltd for $15 000. This had a carrying amount to Sophie Ltd of $12 000. Both entities depreciate motor vehicles at a rate of 10% p.a. on cost.
(b) Ruby Ltd manufactures items of machinery which are used as property, plant and equipment by other companies, including Sophie Ltd. On 1 January 2017, Ruby Ltd sold such an item to Sophie Ltd for $62 000, its cost to Ruby Ltd being only $55 000 to manufacture. Sophie Ltd charges depreciation on these machines at 20% p.a. on the diminishing value.
(c) Sophie Ltd manufactures certain items which it then markets through Ruby Ltd. During the current period, Sophie Ltd sold for $12 000 items to Ruby Ltd at cost plus 20%. By 30 June 2017, Ruby Ltd has sold to external entities 75% of these transferred items.
(d) Ruby Ltd also sells second-hand machinery. Sophie Ltd sold one of its depreciable assets (original cost $40 000, accumulated depreciation $32 000) to Ruby Ltd for $5000 on 1 January 2017. Ruby Ltd had not resold the item by 30 June 2017.
(e) Ruby Ltd sold a depreciable asset (carrying amount of $22 000) to Sophie Ltd on 1 January 2016 for $25 000. Both entities charge depreciation in relation to these items at a rate of 10% p.a. on cost. On 31 December 2016, Sophie Ltd sold this asset to Dubbo Ltd, an external entity, for $20 000.
Required
In relation to the above intragroup transactions:
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2016 and 30 June 2017.
2. Explain in detail why you made each adjusting journal entry.
1. At 30 June 2016, there will only be adjusting entries for transaction (e) as this is the only transaction related to the financial period ended on 30 June 2016. At 30 June 2017, there will be adjusting entries for all transactions.
30 June 2016
(e) Proceeds on sale depreciable asset Dr 25 000
Carrying amount of depreciable asset sold Cr 22 000
Depreciable asset Cr 3 000
OR
Gain on sale of depreciable asset Dr 3 000
Depreciable asset Cr 3 000
Deferred tax asset Dr 900
Income tax expense Cr 900
Accumulated depreciation Dr 150
Depreciation expense Cr 150
Income tax expense Dr 45
Deferred tax asset Cr 45
30 June 2017
(a) Proceeds on sale of motor vehicle Dr 15 000
Carrying amount of motor vehicle sold Cr 12 000
Motor vehicles Cr 3 000
OR
Gain on sale of vehicles Dr 3 000
Motor vehicles Cr 3 000
Deferred tax asset Dr 900
Income tax expense Cr 900
Accumulated depreciation Dr 300
Depreciation expense Cr 300
Income tax expense Dr 90
Deferred tax asset Cr 90
Cost of sales Cr 55 000
Machinery Cr 7 000
Deferred tax asset Dr 2 100
Income tax expense Cr 2 100
Accumulated depreciation Dr 700
Depreciation expense Cr 700
Income tax expense Dr 210
Deferred tax asset Cr 210
(c) Sales revenue Dr 12 000
Cost of sales Cr 11 500
Inventories Cr 500
Deferred tax asset Dr 150
Income tax expense Cr 150
(d) Inventories Dr 3 000
Proceeds on sale of machinery Dr 5 000
Carrying amount of machinery sold Cr 8 000
OR
Inventories Dr 3 000
Loss on sale of machinery Cr 3 000
Income tax expense Dr 900
Deferred tax liability Cr 900
(e) Retained earnings (1/7/16) Dr 1 995 (unrealised gain on sale)
Income tax expense Dr 855 (30% x $2 850)
Depreciation expense Cr 150 ($1 250-$1 100)
Carrying amount at sale Cr 2 700 ($22 500-$19 800)
2. Detailed explanations on the adjusting journal entries
30 June 2016
(e) The first journal entry eliminates the proceeds on sale and the carrying amount of the depreciable asset sold recorded on the intragroup sale. If Sophie Ltd recorded the net amount as gain on sale, then in the alternative adjusting entry that gain will need to be eliminated instead of the proceeds and the carrying amount. In both cases, the adjusting entry will also bring down the balance of the asset account to reflect the original carrying amount of the asset before the intragroup sale. All of these adjustments are necessary as the asset is still on hand with the group and there was no sale involving an external entity.
The second adjusting entry is recognising the tax effect of the first entry. As the first entry eliminates the gain on sale (which decreases the current profit) and decreases the carrying amount of the asset, without any effect on its tax base, the income tax expense, normally calculated based on the current profit, needs to decrease and a deferred tax asset needs to be recognised for the deductible temporary difference created or, using another explanation, for the tax prepayment made by Sophie Ltd on the unrealised profit from on the intragroup sale.
The third adjusting entry is necessary to adjust the depreciation expense recorded after the intragroup sale by the entity that now uses the asset within the group. As this entity records the depreciation based on the price paid intragroup, while the group should recognise the depreciation based on the carrying amount of the asset at the moment of the intragroup sale, the depreciation expense is overstated and should be decreased by an amount equal to the depreciation rate multiplied by the gain on the intragroup sale. It should be noted that this adjustment to depreciation expense increases the current profit and therefore it is said to be an indication that a part of the profit on the intragroup sale is now realised.
As a part of the intragroup profit is now realised through the depreciation adjustments, the fourth adjusting entry adjusts the tax effect of the previous entry that eliminated the entire profit on the intragroup sale, basically reversing that previous tax effect entry for the part of the profit that is now realised. That is because the depreciation adjustment entry increases the carrying amount of the asset, with no effect on the tax base and therefore decreases the deductible temporary difference that was recorded in the deferred tax asset when eliminating the gain on intragroup sale.
30 June 2017
(a) The explanation for the adjusting journal entries posted now is exactly the same as for the adjusting entries at 30 June 2016 for transaction (e). In summary:
- the first adjusting entry decreases the vehicle’s value down from the price paid intragroup to the original carrying amount of the vehicle at the moment of intragroup sale and eliminates either the proceeds on sale and the carrying amount of vehicle sold or, in the alternative form, the net gain on the intragroup sale of vehicle; the second entry recognises the tax effect of the first entry by raising a deferred tax asset for the tax paid by the intragroup seller on the profit that is unrealised from the group’s perspective.
- the third adjusting entry decreases the depreciation expense recognised for the vehicle down from the depreciation recorded by the user of the vehicle (based on the intragroup price paid) to the depreciation that should be recorded by the group (based on the carrying amount of the vehicle at the moment of the intragroup sale); the forth entry recognises the tax effect of the third entry by decreasing the deferred tax asset recognised in the second entry by the tax on the profit realised through the depreciation adjustment.
(b) The explanation for the adjusting journal entries posted now is similar to that for the adjusting entries at 30 June 2016 for transaction (e). In summary:
- the first adjusting entry decreases the machine’s value down from the price paid intragroup to the original carrying amount of the machine at the moment of intragroup sale and eliminates the sales revenue and the cost of sales recognised on the intragroup sale, considering that the machine was recognised by the initial owner as inventories; the second entry recognises the tax effect of the first entry by raising a deferred tax asset for the tax paid by the intragroup seller on the profit that is unrealised from the group’s perspective.
- the third adjusting entry decreases the depreciation expense recognised for the machine down from the depreciation recorded by the user of the vehicle (based on the intragroup price paid) to the depreciation that should be recorded by the group (based on the carrying amount of the machine at the moment of the intragroup sale); the fourth entry recognises the tax effect of the third entry by decreasing the deferred tax asset recognised in the second entry by the tax on the profit realised through the depreciation adjustment.
It should be noted here that although the original classification of the asset before the intragroup sale was inventories, there won’t be any reclassification needed on consolidation as, from the group’s perspective, the asset is going to be used as a machine from the moment of the intragroup sale.
(c) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June 2017. As 25% of the inventories remain unsold at the end of the period, at 30 June 2017 a quarter of the entire profit on the intragroup sale is unrealised and should be eliminated on consolidation by:
· Debiting Sales Revenue with an amount equal to the intragroup price
· Crediting Inventories with an amount equal to the unrealised profit (i.e. 25% of ($12 000 - $12 000/1.2) – to decrease the value of the inventories left on hand with the group to their original cost to the group
· Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of credit to Inventories.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit in closing inventories at 30 June 2017 by raising a Deferred Tax Asset for the tax recognised by Sophie Ltd in advance on the unrealised intragroup profit.
(d) The first journal entry eliminates the proceeds on sale and the carrying amount of the machine sold recorded on the intragroup sale. If Ruby Ltd recorded only the net amount as loss on sale (since the proceeds were lower than the carrying amount), then in the alternative adjusting entry that loss will need to be eliminated instead of the proceeds and the carrying amount. In both cases, the adjusting entry will also bring up the balance of the asset account (now treated as inventories) to reflect the original carrying amount of the asset before the intragroup sale. All of these adjustments are necessary as the asset is still on hand with the group and there was no sale involving an external entity.
The second adjusting entry is recognising the tax effect of the first entry. As the first entry eliminates the loss on sale (which increases the current profit) and increases the carrying amount of the asset, without any effect on its tax base, the income tax expense, normally calculated based on the current profit, needs to increase and a deferred tax liability needs to be recognised for the taxable temporary difference created or, using another explanation, for the tax that should have been paid by Ruby Ltd if it wouldn’t have claimed the unrealised loss on the intragroup sale as a tax deduction.
It should be noted here that although the original classification of the asset before the intragroup sale was machinery, there won’t be any reclassification needed on consolidation as, from the group’s perspective, the asset is going to be used as inventories from the moment of the intragroup sale. As a consequence of this, there won’t be any depreciation adjustments or the related tax effect.
(e) To come up with the adjusting entries, a proper understanding of the effects of this set of transactions needs to be achieved. The effects recorded by the entities within the group are summarised below, together with what effects that should be presented by the economic entity, aka the group.
Ruby Ltd:
Carrying amount at sale (prior period) 22 000
Sales proceeds (prior period) 25 000
Gain on sale (prior period) 3 000
Sophie Ltd:
Cost of asset 25 000
Depreciation (prior period) 1 250
23 750
Depreciation (current period) 1 250
Carrying amount at sale 22 500
Sales proceeds 20 000
Loss on sale 2 500
Economic Entity:
Cost of asset 22 000
Depreciation (prior period) 1 100
20 900
Depreciation (current period) 1 100
Carrying amount at sale 19 800
Sales proceeds 20 000
Gain on sale 200
From this summary it can be observed that Ruby Ltd recorded in the previous period a profit of $3 000, while Sophie Ltd recorded a depreciation expense of $1 250. These amounts, after tax, are recorded in the Retained earnings at the beginning of the current period, meaning that the aggregate Retained earnings (1/7/16) includes a net amount of ($3 000 – $1 250) x (1 – 30%) = $1 225. However, from the group’s perspective, Retained earnings (1/7/16) should only include the depreciation expense for the group after tax, i.e. – $1 100 x (1 – 30%) = – $770. Therefore, the adjusting entry should include an adjustment to decrease Retained earnings (1/7/16) by $1 225 + $770 = $1 995. It should be noted that this amount of adjustment is actually the unrealised profit at the beginning of the current period, i.e. the profit on the intragroup sale minus for the depreciation adjustment for the previous period.
In terms of the current period, it can be observed that Sophie Ltd recorded a depreciation expense of $1250, while from the group’s perspective, the depreciation expense should only be $1 100. As such, on consolidation there is another adjustment to be posted and that is to decrease the depreciation expense by $150. Also, Sophie Ltd recorded during the current period a carrying amount at sale of $22 500, while from the group’s perspective, the carrying amount at sale should be only $19 800. Therefore, another adjustment is necessary for the current period and that is to decrease the carrying amount at sale by $2 700. It should be noted that this latter amount is actually the gain on intergroup sale that was not realised through the depreciation adjustments ($150 during the prior period and $150 during the current period), but it is realised through the sale to the external entity during the current period.
In the end, considering that the adjustments for the current period (to the depreciation expense and carrying amount at sale) increase the current profit (by the realised profit), a tax effect should be recognised as increasing the income tax expense for the current period.
Exercise 28.5
Current period intragroup transfers of inventories and non-current assets
Isolde Ltd owns all the share capital of Annabelle Ltd. The income tax rate is 30%, and all income on sale of assets is taxable and expenses are deductible. During the period ended 30 June 2017, the following intragroup transactions took place:
(a) Annabelle Ltd sold inventories costing $50 000 to Isolde Ltd. Annabelle Ltd recorded a $10 000 profit before tax on these transactions. At 30 June 2017, Isolde Ltd has none of these goods still on hand.
(b) Isolde Ltd sold inventories costing $12 000 to Annabelle Ltd for $18 000. By 30 June 2017, one-third of these were sold to Willow Ltd for $9500 and one-third to Layla Ltd for $9000; the rest are still on hand with Annabelle Ltd. Willow Ltd and Layla Ltd are external entities.
(c) On 1 January 2017, Isolde Ltd sold land for cash to Annabelle Ltd at $20 000 above cost. The land is still on hand with Annabelle Ltd.
(d) Annabelle Ltd sold a warehouse to Isolde Ltd for $100 000 on 1 July 2016. The carrying amount of this warehouse recognised by Annabelle Ltd at the time of sale was $82 000. Isolde Ltd charges depreciation at a rate of 5% p.a. on a straight-line basis.
Required
In relation to the above intragroup transactions:
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2017.
2. Explain in detail why you made each adjusting journal entry.
1.
ISOLDE LTD – ANNABELLE LTD
30 June 2017
(a) Sales revenue Dr 10 000
Cost of sales Cr 10 000
(b) Sales revenue Dr 18 000
Cost of sales Cr 16 000
Inventories Cr 2 000
Deferred tax asset Dr 600
Income tax expense Cr 600
(c) Gain on sale of land Dr 20 000
Land Cr 20 000
Deferred tax asset Dr 6 000
Income tax expense Cr 6 000
(d) Gain on sale of warehouse Dr 18 000
Warehouse Cr 18 000
Deferred tax asset Dr 5 400
Income tax expense Cr 5 400
Accumulated depreciation Dr 900
Depreciation expense Cr 900
Income tax expense Dr 270
Deferred tax asset Cr 270
2. Detailed explanations on the adjusting journal entries
30 June 2017
(a) The only adjusting entry eliminates the intragroup sales revenue recorded by Annabelle Ltd and the cost of sales recognised by Isolde Ltd as the profit on the intragroup sale is entirely realised during the current period. As the inventories are sold by the end of the period to an external entity, at 30 June 2017 the entire profit on the intragroup sale is realised; however, the aggregate sales revenues and cost of sales are overstated from the group’s perspective as they include the intragroup sales revenue and the cost of sales recognised based on the price paid intragroup by Isolde Ltd. On consolidation, this overstatement needs to be corrected. There won’t be any tax-effect adjustment entry as the only adjusting entry posted now does not have any net effect on the profit or on the carrying amount of inventories.
(b) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June 2017. As one third of the inventories remain unsold at the end of the period, at 30 June 2017 one third of the profit on the intragroup sale is unrealised and should be eliminated on consolidation by:
· Debiting Sales Revenue with an amount equal to the intragroup price – this eliminates the amount recognised by Isolde Ltd on the intragroup sale so that the consolidated figure reflects only the sales revenues generated from transactions with external parties.
· Crediting Inventories with an amount equal to the unrealised profit (i.e. one third of the profit on the intragroup sale) – this corrects the overstatement of inventories still on hand (one third of the original amount transferred intragroup) that are recorded by Annabelle Ltd based on the intragroup price, making sure that those inventories are recorded at the original cost to the group.
· Crediting Cost of Sales with an amount equal to the difference between the debit amount to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales recognised by Isolde Ltd (based on the original cost) and adjusts the Cost of Sales recognised by Annabelle Ltd (based on the intragroup price) so that the consolidated figure reflects only the cost of sales of the inventories sold to the external party based on their original cost to the group.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit in closing inventories at 30 June 2017 by raising a Deferred Tax Asset for the tax recognised by Isolde Ltd in advance on the unrealised intragroup profit.
(c) The first adjusting entry decreases the land’s value down from the price paid intragroup to the original carrying amount of the land at the moment of intragroup sale and eliminates the gain on the intragroup sale of land as it is entirely unrealised at 30 June 2017; the second entry recognises the tax effect of the first entry by raising a deferred tax asset for the tax paid by the intragroup seller on the profit that is unrealised from the group’s perspective.
(d) The first journal entry eliminates the intragroup gain on sale of the warehouse. The adjusting entry will also bring down the balance of the warehouse account to reflect the original carrying amount of the warehouse before the intragroup sale. All of these adjustments are necessary as the asset is still on hand with the group and there was no sale involving an external entity.
The second adjusting entry is recognising the tax effect of the first entry. As the first entry eliminates the gain on sale (which decreases the current profit) and decreases the carrying amount of the asset, without any effect on its tax base, the income tax expense, normally calculated based on the current profit, needs to decrease and a deferred tax asset needs to be recognised for the deductible temporary difference created or, using another explanation, for the tax prepayment made by Annabelle Ltd on the unrealised profit from the intragroup sale.
The third adjusting entry is necessary to adjust the depreciation expense recorded after the intragroup sale by the entity that now uses the asset within the group. As this entity records the depreciation based on the price paid intragroup, while the group should recognise the depreciation based on the carrying amount of the asset at the moment of the intragroup sale, the depreciation expense is overstated and should be decreased by an amount equal to the depreciation rate multiplied by the gain on the intragroup sale. It should be noted that this adjustment to depreciation expense increases the current profit and therefore it is said to be an indication that a part of the profit on the intragroup sale is now realised.
As a part of the intragroup profit is now realised through the depreciation adjustments, the fourth adjusting entry adjusts the tax effect of the previous entry that eliminated the entire profit on the intragroup sale, basically reversing that previous tax effect entry for the part of the profit that is now realised. That is because the depreciation adjustment entry increases the carrying amount of the asset, with no effect on the tax base and therefore decreases the deductible temporary difference that was recorded in the deferred tax asset when eliminating the gain on intragroup sale.
Exercise 28.6
Current and prior period intragroup services
Alice Ltd owns all the share capital of Isabella Ltd. The following intragroup transactions took place during the periods ended 30 June 2016 and 30 June 2017:
(a) Isabella Ltd paid $20 000 during the period ended 30 June 2016 and $40 000 during the period ended 30 June 2017 as management fees for services provided by Alice Ltd.
(b) Isabella Ltd rented a spare warehouse to Alice Ltd starting from 1 July 2015 for 1 year. The total charge for the rental was $30 000, and Alice Ltd paid this amount to Isabella Ltd on 1 January 2016.
(c) Isabella Ltd rented a spare warehouse from Alice Ltd for $50 000 p.a. The rental contract started at 1 January 2015, and the payments are made annually in advance on 1 January.
Required
In relation to the above intragroup transactions:
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2016 and 30 June 2017.
2. Explain in detail why you made each adjusting journal entry.
1. At 30 June 2016, there will be adjusting entries for all transactions as they are all related to the financial period ended on 30 June 2016. At 30 June 2017, there will only be adjusting entries for transactions (a) and (c); transaction (b) does not have any effects on the period ended 30 June 2017 and therefore no adjustments are necessary as the rental agreement finished before the beginning of the period.
ALICE LTD – ISABELLA LTD
30 June 2016
(a) Management fees revenues Dr 20 000
Management fee expenses Cr 20 000
(b) Rent revenues Dr 30 000
Rent expenses Cr 30 000
(c) Rent revenues Dr 50 000
Rent expenses Cr 50 000
Rent received in advance Dr 25 000
Prepaid rent Cr 25 000
30 June 2017
(a) Management fees revenues Dr 40 000
Management fee expenses Cr 40 000
(c) If the rental agreement is for 3 or more years, the adjusting entries would be:
Rent revenues Dr 50 000
Rent expenses Cr 50 000
Rent received in advance Dr 25 000
Prepaid rent Cr 25 000
If the rental agreement is only for 2 years and ends on 31 December 2016, the adjusting entries would be:
Rent revenues Dr 25 000
Rent expenses Cr 25 000
2. Detailed explanations on the adjusting journal entries
30 June 2016
(a) The adjusting entry eliminates the management fee revenue recognised by Alice Ltd and the management fee expense recognised by Isabella Ltd during the current period. As this adjusting entry does not have any net impact on the profit:
- there won’t be any tax-effect adjusting entry
- there won’t be any further adjusting entries in the next period for the management fees incurred this current period.
As the management fees were paid during the current period, there won’t be a need to eliminate any another accounts during the current period as there is no Management Fees Payable or Management Fees Receivable. Also, there were no management fees paid in advance for the next period and therefore there are no Prepaid Management Fees and Management Fees Received in Advance to eliminate.
(b) The adjusting entry eliminates the rent revenue recognised by Isabella Ltd and the rent expense recognised by Alice Ltd during the current period. As this adjusting entry does not have any net impact on the profit:
- there won’t be any tax-effect adjusting entry
- there won’t be any further adjusting entries in the next period for the rent incurred this current period.
As the rent was paid during the current period, there won’t be a need to eliminate any another accounts during the current period as there is no Rent Payable or Rent Receivable. Also, there is no rent paid in advance for the next period and therefore there is no Prepaid Rent and Rent Received in Advance to eliminate.
(c) If the rent agreement is for 3 or more years starting on 1 January 2015, it means it will end after 30 June 2017. Therefore, the current period’s rent expense and revenue is one full year rent of $50 000. The first adjusting entry will eliminate this amount. As this adjusting entry does not have any net impact on the profit:
- there won’t be any tax-effect adjusting entry
- there won’t be any further adjusting entries in the next period for the rent incurred this current period.
As the rent was paid during the current period in advance on 1 January 2016 for one year, at 30 June 2016 there will be rent paid in advance for the next period up to 31 December 2016 (6 months’ worth) and therefore the second adjustment entry will need to eliminate Prepaid Rent and Rent Received in Advance for half the yearly rent.
If the rent agreement is for 2 years starting on 1 January 2015, it means it will end on 31 December 2016. Therefore, the current period’s rent expense and revenue is only 6 months’ worth of rent, i.e. $25 000. The first adjusting entry will eliminate this amount. As this adjusting entry does not have any net impact on the profit:
- there won’t be any tax-effect adjusting entry
- there won’t be any further adjusting entries in the next period for the rent incurred this current period.
As the rent agreement ends on 31 December 2016 and the payment has been received previously, there won’t be a need to eliminate any Rent Payable or Rent Receivable. Also, there is no rent paid in advance for the next period and therefore there is no Prepaid Rent and Rent Received in Advance to eliminate.
Exercise 28.7
Current and prior period intragroup dividends
Maggie Ltd owns all the share capital of Peggy Ltd. The following intragroup transactions took place during the periods ended 30 June 2016 and 30 June 2017:
(a) During the period ended 30 June 2016, Peggy Ltd paid an interim dividend of $10 000 out of pre-acquisition profits. As a result, the investment in Peggy Ltd is considered to be impaired by $10 000.
(b) On 30 June 2016, Peggy Ltd declared a final dividend of $20 000 out of post-acquisition profits.
(c) During the period ended 30 June 2017, Peggy Ltd paid an interim dividend of $10 000 out of post-acquisition profits.
(d) On 30 June 2017, Peggy Ltd declared a final dividend of $30 000 out of post-acquisition profits.
Required
In relation to the above intragroup transactions:
1. Prepare adjusting journal entries for the consolidation worksheet at 30 June 2016 and 30 June 2017.
2. Explain in detail why you made each adjusting journal entry.
1. At 30 June 2016, there will only be adjusting entries for transactions (a) and (b) as these are the only transactions related to the financial period ended on 30 June 2016. At 30 June 2017, there will only be adjusting entries for transactions (c) and (d) as those are the only transactions related to the financial period ended on 30 June 2017. The dividend transactions from the period ended 30 June 2016 do not have any impact on the period ended 30 June 2017 that needs to be adjusted.
MAGGIE LTD – PEGGY LTD
30 June 2016
(a) Dividend revenue Dr 10 000
Interim dividend paid Cr 10 000
Accum. impairment losses – Shares in Peggy Ltd Dr 10 000
Impairment losses Cr 10 000
(b) Dividend revenue Dr 20 000
Dividend declared Cr 20 000
Dividend payable Dr 20 000
Dividend receivable Cr 20 000
30 June 2017
(c) Dividend revenue Dr 10 000
Interim dividend paid Cr 10 000
(d) Dividend revenue Dr 30 000
Dividend declared Cr 30 000
Dividend payable Dr 30 000
Dividend receivable Cr 30 000
2. Detailed explanations on the adjusting journal entries
30 June 2016
(a) The adjusting entry eliminates the dividend revenue recognised by Maggie Ltd and the dividend paid recognised by Peggy Ltd during the current period. As this adjusting entry does not have any net impact of the consolidated retained earnings there won’t be any further adjusting entries in the next period for the dividends paid this current period. Also, for dividends there are no tax effects that should be recognised or adjusted on consolidation.
As the dividends were paid during the current period, there won’t be a need to eliminate any Dividends Payable or Dividends Receivable. However, given that the dividend paid during the current period was from pre-acquisition equity and caused an impairment of the investment account that was recognised in Maggie Ltd’s accounts, this impairment will need to be eliminated on consolidation in the second adjusting entry (by reversing the entry recognising the impairment) as it is a direct effect of the intragroup transaction involving dividends.
(b) The adjusting entry eliminates the dividend revenue recognised by Maggie Ltd and the dividend declared recognised by Peggy Ltd during the current period. As this adjusting entry does not have any net impact of the consolidated retained earnings there won’t be any further adjusting entries in the next period for the dividends paid this current period. Also, for dividends there are no tax effects that should be recognised or adjusted on consolidation. As the dividends were not paid during the current period, there will be a need to eliminate Dividends Payable and Dividends Receivable in the second adjusting entry.
30 June 2017
(c) A similar explanation is used here as for the first adjusting entry at 30 June 2016 for the elimination of the intragroup dividend in (a). However, given that in this case the dividend is from post-acquisition equity, there is no need to post the second adjusting entry that reversed the impairment of the investment account caused by the dividends in (a).
(d) The same explanation is used here as for the adjusting entry at 30 June 2016 for the elimination of the intragroup dividend in (b).
Exercise 28.14
Consolidation with differences between carrying amount and fair value at acquisition date and intragroup transactions
Zoe Ltd purchased 100% of the shares of Matilda Ltd on 1 July 2014 for $50 000. At that date the equity of the two entities was as follows.
|
Zoe Ltd |
Matilda Ltd |
Asset revaluation surplus |
$25 000 |
$4 000 |
Retained earnings |
14 500 |
2 800 |
Share capital |
50 000 |
40 000 |
At 1 July 2014, all the identifiable assets and liabilities of Matilda Ltd were recorded at fair value except for the following.
|
Carrying amount |
Fair value |
Inventories |
$3 000 |
$3 500 |
Plant and equipment (cost $80 000) |
60 000 |
61 000 |
All of the inventories were sold by December 2014. The plant and equipment had a further 5-year life. Any valuation adjustments are made on consolidation.
Financial information for Zoe Ltd and Matilda Ltd for the period ended 30 June 2016 is shown below:
|
Zoe Ltd |
Matilda Ltd |
Sales revenue |
$78 000 |
$40 000 |
Dividend revenue |
4 400 |
1 600 |
Total income |
82 400 |
41 600 |
Cost of sales |
60 000 |
30 000 |
Other expenses |
10 800 |
5 000 |
Total expenses |
70 800 |
35 000 |
Gross profit |
11 600 |
6 600 |
Gain on sale of furniture |
0 |
500 |
Profit before income tax |
11 600 |
7 100 |
Income tax expense |
3 000 |
2 200 |
Profit for the period |
8 600 |
4 900 |
Retained earnings (1/7/15) |
14 500 |
2 800 |
|
23 100 |
7 700 |
Interim dividend paid |
4 000 |
2 000 |
Final dividend declared |
8 000 |
2 400 |
|
12 000 |
4 400 |
Retained earnings (30/6/16) |
11 100 |
3 300 |
Additional information
(a) Zoe Ltd records dividend receivable as revenue when dividends are declared.
(b) The beginning inventories of Matilda Ltd at 1 July 2015 included goods which cost Matilda Ltd $2000. Matilda Ltd purchased these inventories from Zoe Ltd at cost plus 33% mark-up.
(c) Intragroup sales totalled $10 000 for the period ended 30 June 2016. Sales from Zoe Ltd to Matilda Ltd, at cost plus 10% mark-up, amounted to $5600. The ending inventories of Zoe Ltd included goods which cost Zoe Ltd $4400. Zoe Ltd purchased these inventories from Matilda Ltd at cost plus 10% mark-up.
(d) On 31 December 2015, Matilda Ltd sold Zoe Ltd office furniture for $3000. This furniture originally cost Matilda Ltd $3000 and was written down to $2500 just before the intragroup sale. Zoe Ltd depreciates furniture at the rate of 10% p.a. on cost.
(e) The asset revaluation surplus relates to land. The following movements occurred in this account:
|
Zoe Ltd |
Matilda Ltd |
1 July 2014 to 30 June 2015 |
$3 000 |
$(500) |
1 July 2015 to 30 June 2016 |
2000 |
500 |
(f) The tax rate is 30%.
Required
1. Prepare the acquisition analysis at 1 July 2014.
2. Prepare the business combination valuation entries and pre-acquisition entries at 1 July 2014.
3. Prepare the business combination valuation entries and pre-acquisition entries at 30 June 2016.
4. Prepare the consolidation worksheet journal entries to eliminate the effects of intragroup transactions at 30 June 2015.
5. Prepare the consolidation worksheet journal entries to eliminate the effects of intragroup transactions at 30 June 2016.
6. Prepare the consolidation worksheet for the preparation of the consolidated financial statements for the period ended 30 June 2016.
7. Prepare the consolidated statement of profit or loss and other comprehensive income for the period ended 30 June 2016.
ZOE LTD – MATILDA LTD
1.
At 1 July 2014:
Net fair value of identifiable assets
and liabilities of Matilda Ltd = ($40 000 + $4 000 + $2 800) (equity)
+ ($3 500 – $3 000) (1 – 30%) (BCVR - inventories)
+ ($61 000 – $60 000) (1 – 30%) (BCVR - plant)
= $47 850
Consideration transferred = $50 000
Goodwill = $50 000 - $47 850
= $2 150
2.
Business combination valuation entries at 1 July 2014
Accumulated depreciation Dr 20 000
Plant and equipment Cr 19 000
Deferred tax liability Cr 300
Business combination valuation reserve Cr 700
Inventories Dr 500
Deferred tax liability Cr 150
Business combination valuation reserve Cr 350
Goodwill Dr 2 150
Business combination valuation reserve Cr 2 150
Pre-acquisition entries at 1 July 2014
Retained earnings (1/7/14) Dr 2 800
Share capital Dr 40 000
Asset revaluation surplus Dr 4 000
Business combination valuation reserve Dr 3 200
Shares in Matilda Ltd Cr 50 000
3.
(1) Business combination valuation entries at 30 June 2016
Accumulated depreciation Dr 20 000
Plant & equipment Cr 19 000
Deferred tax liability Cr 300
Business combination valuation reserve Cr 700
Depreciation expense Dr 200
Retained earnings (1/7/15) Dr 200
Accumulated depreciation Cr 400
Deferred tax liability Dr 120
Income tax expense Cr 60
Retained earnings (1/7/12) Cr 60
Goodwill Dr 2 150
Business combination valuation reserve Cr 2 150
(2) Pre-acquisition entries at 30 June 2016
Retained earnings (1/7/15)* Dr 3 150
Share capital Dr 40 000
Asset revaluation surplus Dr 4 000
Business combination valuation reserve Dr 2 850
Shares in Matilda Ltd Cr 50 000
* $2800 + $500 (1 – 30%) (BCVR - inventories)
4. Elimination of the effects of intragroup transactions at 30 June 2015
Sales of inventories from Zoe Ltd to Matilda Ltd (assuming that the inventories on hand with Matilda at 1 July 2015 were all the inventories transferred to it during the period ended 30 June 2015 from Zoe Ltd)
Sales revenue Dr 2 000
Cost of sales Cr 1 500
Inventories Cr 500
Deferred tax asset Dr 150
Income tax expense Cr 150
The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June 2015. As inventories originally transferred intragroup remain unsold at the end of the period, at 30 June 2015 the profit on the intragroup sale related to inventories still on hand (i.e. $2 000 - $2 000 / 1.33 = $500) is unrealised and should be eliminated on consolidation by:
· Debiting Sales Revenue with an amount equal to the intragroup price – this eliminates the amount recognised by Zoe Ltd on the intragroup sale so that the consolidated figure reflects only the sales revenues generated from transactions with external parties.
· Crediting Inventories with an amount equal to the unrealised profit (i.e. $500) – this corrects the overstatement of inventories still on hand that are recorded by Matilda Ltd based on the intragroup price, making sure that those inventories are recorded at the original cost to the group.
· Crediting Cost of Sales with an amount equal to the difference between the debit amount to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales recognised by Zoe Ltd (based on the original cost) so that the consolidated figure reflects only the cost of sales of the inventories sold to the external entities based on their original cost to the group.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit in closing inventories at 30 June 2015 by raising a Deferred Tax Asset for the tax recognised by Zoe Ltd in advance on the unrealised intragroup profit.
5. Elimination of the effects of intragroup transactions at 30 June 2016
(3) Dividend paid
Dividend revenue Dr 2 000
Dividend paid Cr 2 000
This adjusting entry eliminates the dividend revenue recognised by Zoe Ltd and the dividend paid recognised by Matilda Ltd during the current period (this dividend is identified by inspecting the financial statements of Matilda Ltd). As this adjusting entry does not have any net impact of the consolidated retained earnings, there won’t be any further adjusting entries in the next period for the dividends paid this current period. Also, for dividends there are no tax effects that should be recognised or adjusted on consolidation. As the dividends were paid during the current period, there won’t be a need to eliminate any Dividends Payable or Dividends Receivable.
(4) Dividend declared
Dividend revenue Dr 2 400
Dividend declared Cr 2 400
Dividend payable Dr 2 400
Dividend receivable Cr 2 400
The first adjusting entry eliminates the dividend revenue recognised by Zoe Ltd and the dividend declared recognised by Matilda Ltd during the current period (this dividend is also identified by inspecting the financial statements of Matilda Ltd). As this adjusting entry does not have any net impact of the consolidated retained earnings there won’t be any further adjusting entries in the next period for the dividends paid this current period. Also, for dividends there are no tax effects that should be recognised or adjusted on consolidation. As the dividends were not paid during the current period, there will be a need to eliminate Dividends Payable and Dividends Receivable in the second adjusting entry.
(5) Profit in beginning inventories: sales from Zoe Ltd to Matilda in the previous period
Retained earnings (1/7/15) Dr 350
Income tax expense Dr 150
Cost of sales Cr 500
In this case, the unrealised profit in closing inventories from the period ended 30 June 2015 and recognised as unrealised profit in opening inventories in this period (i.e. $2 000 – $2 000 / 1.33 = $500) is assumed to become realised by the end of the current period. As such, this profit needs to be transferred from the previous period to the current period by:
· Debiting Retained Earnings (1/7/15) with an amount equal to the after-tax unrealised profit in opening inventories ($500 x (1 – 30%)) – this eliminates the unrealised profit from the prior period’s profit
· Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in opening inventories – this increases the current profit as the previously unrealised profit is now realised.
As a result of this transfer of profit to the current period, the current period profit increases and a tax effect should also be recognised in the adjusting entry by:
· Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in opening inventories.
(6) Sales of inventories from Zoe Ltd to Matilda Ltd in the current period
Sales revenue Dr 5 600
Cost of sales Cr 5 600
The only adjusting entry eliminates the intragroup sales revenue and the cost of sales recognised by Zoe Ltd as the profit on the intragroup sale to Matilda Ltd is entirely realised during the current period. As the inventories are sold by the end of the period to an external entity, at 30 June 2016 the entire profit on the intragroup sale is realised; however, the aggregate sales revenues and cost of sales are overstated from the group’s perspective as they include the intragroup sales revenue and the cost of sales recognised based on the price paid intragroup by Matilda Ltd. On consolidation, this overstatement needs to be corrected. There won’t be any tax-effect adjustment entry as the only adjusting entry posted now does not have any net effect on the profit or on the carrying amount of inventories.
(7) Profit in ending inventories: sales from Matilda Ltd to Zoe Ltd
Sales revenue Dr 4 400
Cost of sales Cr 4 000
Inventories Cr 400
Deferred tax asset Dr 120
Income tax expense Cr 120
The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June 2016. As inventories originally transferred intragroup by Matilda Ltd remain unsold at the end of the period, at 30 June 2016 the profit on the intragroup sale related to inventories still on hand (i.e. $4 400 - $4 400 / 1.1 = $400) is unrealised and should be eliminated on consolidation by:
· Debiting Sales Revenue with an amount equal to the intragroup price – this eliminates the amount recognised by Matilda Ltd on the intragroup sale so that the consolidated figure reflects only the sales revenues generated from transactions with external parties.
· Crediting Inventories with an amount equal to the unrealised profit (i.e. $400) – this corrects the overstatement of inventories still on hand that are recorded by Zoe Ltd based on the intragroup price, making sure that those inventories are recorded at the original cost to the group.
· Crediting Cost of Sales with an amount equal to the difference between the debit amount to Sales Revenue and the credit amount to Inventories – this eliminates the Cost of Sales recognised by Matilda Ltd (based on the original cost) so that the consolidated figure reflects only the cost of sales of the inventories sold to the external party based on their original cost to the group.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit in closing inventories at 30 June 2016 by raising a Deferred Tax Asset for the tax recognised by Matilda Ltd in advance on the unrealised intragroup profit.
(8) Sale of furniture
Gain on sale of office furniture Dr 500
Office furniture Cr 500
Deferred tax asset Dr 150
Income tax expense Cr 150
The first journal entry eliminates the intragroup gain on sale of office furniture (i.e. $3 000 - $2 500). The adjusting entry will also bring down the balance of the office furniture account to reflect the original carrying amount of the asset before the intragroup sale. All of these adjustments are necessary as the asset is still on hand with the group and there was no sale involving an external entity.
The second adjusting entry is recognising the tax effect of the first entry. As the first entry eliminates the gain on sale (which decreases the current profit) and decreases the carrying amount of the asset, without any effect on its tax base, the income tax expense, normally calculated based on the current profit, needs to decrease and a deferred tax asset needs to be recognised for the deductible temporary difference created or, using another explanation, for the tax prepayment made by Matilda Ltd on the unrealised profit from the intragroup sale.
(9) Depreciation of furniture
Accumulated depreciation Dr 25
Depreciation expense Cr 25
(10% x 1/2 x $500)
Income tax expense Dr 8
Deferred tax asset Cr 8
(30% x $25 – rounded upwards)
The first adjusting entry is necessary to adjust the depreciation expense recorded after the intragroup sale by the entity that now uses the asset within the group. As this entity records the depreciation based on the price paid intragroup, while the group should recognise the depreciation based on the carrying amount of the asset at the moment of the intragroup sale, the depreciation expense is overstated and should be decreased by an amount equal to the depreciation rate multiplied by the gain on the intragroup sale but only for the 6 months since the intragroup sale. It should be noted that this adjustment to depreciation expense increases the current profit and therefore it is said to be an indication that a part of the profit on the intragroup sale is now realised.
As a part of the intragroup profit is now realised through the depreciation adjustments, the second adjusting entry adjusts the tax effect of the previous entry that eliminated the entire profit on the intragroup sale (see worksheet entry (8)), basically reversing that previous tax effect entry for the part of the profit that is now realised. That is because the depreciation adjustment entry increases the carrying amount of the asset, with no effect on the tax base and therefore decreases the deductible temporary difference that was recorded in the deferred tax asset when eliminating the gain on intragroup sale in worksheet entry (8).
6. Consolidation worksheet at 30 June 2016
|
Zoe Ltd |
Matilda Ltd |
|
Adjustments |
|
Group |
|
|
|
|
|
Dr |
Cr |
|
|
Sales revenue |
78 000 |
40 000 |
6 7 |
5 600 4 400 |
|
|
108 000 |
Dividend revenue |
4 400 |
1 600 |
3 4 |
2 000 2 400 |
|
|
1 600 |
|
82 400 |
41 600 |
|
|
|
|
109 600 |
Cost of sales |
60 000 |
30 000 |
|
|
500 5 600 4 000 |
5 6 7 |
79 900 |
Other expenses |
10 800 |
5 000 |
1 |
200 |
25 |
9 |
15 975 |
|
70 800 |
35 000 |
|
|
|
|
95 875 |
Profit from trading |
11 600 |
6 600 |
|
|
|
|
|
Gain on sale of furniture |
0 |
500 |
8 |
500 |
|
|
0 |
Profit before tax |
11 600 |
7 100 |
|
|
|
|
13 725 |
Tax expense |
3 000 |
2 200 |
5 9 |
150 8 |
60 120 150 |
1 7 8 |
5 028 |
Profit |
8 600 |
4 900 |
|
|
|
|
8 697 |
Retained earnings 1/7/12) |
14 500 |
2 800 |
1 2 5 |
200 3 150 350 |
60 |
1 |
13 660 |
|
23 100 |
7 700 |
|
|
|
|
22 357 |
Dividend paid |
4 000 |
2 000 |
|
|
2 000 |
2 |
4 000 |
Dividend declared |
8 000 |
2 400 |
|
|
2 400 |
3 |
8 000 |
|
12 000 |
4 400 |
|
|
|
|
12 000 |
Retained earnings (30/6/13) |
11 100 |
3 300 |
|
|
|
|
10 357 |
|
|
|
|
|
|
|
|
7.
ZOE LTD
Consolidated Statement of Profit or Loss and Other Comprehensive Income
for the financial year ended 30 June 2013
Revenues:
Sales revenue $108 000
Dividend revenue 1 600
$109 600
Expenses:
Cost of sales 79 900
Other expenses 15 975
95 875
Profit before income tax 13 725
Income tax expense 5 028
Profit for the period $8 697
Other comprehensive income:
Asset revaluations: Increments 2 500
Comprehensive income for the period $ 11 197
11