Answered Essay: AASB 10 Consolidated Financial Statements: state the requirement for the full adjustment

AASB 10 Consolidated Financial Statements: state the requirement for the full adjustment for the effects of intragroup transactions.

A. Explain the need for making adjustments for intragroup transactions and describe a key point to remember in relation to the consolidated financial statements in your own words (hint: There are 5 important key points in relation to the consolidation financial statements).

B. Explain why income tax effects arise from intragroup transactions in a consolidation group and what situation must exist before the tax effects can be realised.

C. Explain how the unrealised profit on an intragroup transaction becomes realised profit. You may refer to examples in your textbook to assist you.

Expert Answer

 

  1. Explain the need for making adjustments for intragroup transactions and describe a key point to remember in relation to the consolidated financial statements in your own words (hint: There are 5 important key points in relation to the consolidation financial statements).

Answer:

The consolidated financial statements are the statements of the group, an economic entity consisting of the parent and its subsidiaries.

The consolidated financial statements then can only contain profits, assets and liabilities that relate to parties external to the group.

Adjustments must then 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 also consistent with the entity concept of consolidation, which defines the group as the net assets of the parent and the net assets of the subsidiary. Transactions between these parties must then be adjusted in full as both parties are within the economic entity.

Key Points:         Services Rent Sales of inventory Borrowings at interest or interest free Transfer of property, plant or equipment Dividends

  1. Explain why income tax effects arise from intragroup transactions in a consolidation group and what situation must exist before the tax effects can be realized.

Answer:

Accounting for tax is governed by AASB 112 Income Tax. 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, require the raising of deferred tax assets and liabilities, are necessary.

Consider an example of an item of inventory carried at cost of $10 000 being sold by a parent to a subsidiary for $12 000, the inventory still being on hand at the end of the period. The tax rate is 30%.

In the consolidation worksheet there is a credit adjustment to inventory of $2 000 as the cost to the economic entity differs from that to the subsidiary. In the subsidiary’s accounts, the inventory is carried at $12 000 and has a tax base of $12 000, giving rise to no temporary differences. From the group’s point of view, the asset has a carrying amount of $10 000, giving a temporary difference of $2 000. As the expected future deduction is greater than the assessable amount, a deferred tax asset exists for the group. This has no effect on the amount of tax payable in the current period.

  1. Explain how the unrealized profit on an intragroup transaction becomes realized profit. You may refer to examples in your textbook to assist you.

Answer:

Realization occurs on involvement of an external party in the transaction,

Or the consumption by the economic entity of the benefits of the asset containing unrealized profits.

Asset Type in Balance sheet How Realized
Inventory When Sell Inventory. In other word we expense the asset when we sell it
Land We don’t depreciate land so we will realize the asset when we sell it either as a gain / loss on sale that goes to the P&L
Buildings, motor vehicles We will realize depreciable non-current asset when:
We do depreciation entry as Dr depreciation Expense and / or
We fully depreciate asset (that is, expense it) or sell it for a gain / loss before it is fully depreciated.

Note that as the asset depreciates, the gain from the intra-group transaction is realizing.

That is, as the group uses the depreciating non-current asset until the end of the asset’s useful life, the (unrealized) gain is realized as the economic benefits from the asset are consumed in producing, for example, manufactured goods for sale.

When these goods are sold to external parties, the gain from the intra-group transfer of a depreciating non-current asset is released to income as these goods are sold.

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