Consolidation Part II – Intragroup transactions PDF

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Summary of Discussion on intragroup transactions...

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Consolidation Part II – Intragroup transactions Discussion Questions 1. What is an intragroup transaction? Why is it important to make adjustments for intragroup transactions? 2. When are intragroup profits or losses realised? 3. Why is it important to identify intragroup transactions as current or prior previous period transactions? Solutions: 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. What is meant by ‘realisation of intragroup profits or losses’? Profits/losses are realised when an economic entity transacts with another external entity. For a group, this is consistent with the concept that the consolidated financial statements show only the results of transactions with external entities. The consolidated statement of profit or loss and other comprehensive income will thus show only realised profits and realised losses. Profits/losses recognised by group members on sale of assets within the group are unrealised profits/losses to the extent that the assets are still within the group. Realisation of profits/losses on intragroup transactions involving assets normally occurs when an external party gets involved. With intragroup sales of inventories, involvement of an external party, or realisation, occurs when the inventories are on-sold to an external entity. With intragroup sales of depreciable assets, realisation occurs as the asset is used up, as the benefits are received by the group as a result of use of the asset. The proportion of profits/losses realised in any one period is measured by reference to the depreciation charged on the transferred depreciable asset. 3. Why is it important to identify intragroup transactions as current or previous period transactions? Current period intragroup transactions affect different accounts than prior period transactions. For example, current period intragroup sales of inventories affect sales and cost of sales

accounts, whereas prior period sales of inventories affect retained earnings (opening balance) and, to the extent that inventories are sold externally during the current period, the cost of sales account. If the transactions are not correctly placed into a time context, then the adjustments posted in the consolidation worksheet to eliminate the effects of the intragroup transactions may be inappropriate....