Chapter 28: Consolidation: intragroup transactions

PRACTICE 6 SOLUTION

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 2017 for $50 000. At that date the equity of the
two entities was as follows.

At 1 July 2017, all the identifiable assets and liabilities of Matilda Ltd were recorded at fair value except for
the following.

All of the inventories were sold by December 2017. The plant and equipment had a further 5-year useful life.
Any valuation adjustments are made on consolidation.
Financial information for Zoe Ltd and Matilda Ltd for the period ended 30 June 2019 is shown below.

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Solutions manual to accompany Financial reporting by Loftus et al. .

Additional information
(a) Zoe Ltd records dividend receivable as revenue when dividends are declared.
(b) The beginning inventories of Matilda Ltd at 1 July 2018 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 2019. 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 2018, 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.

(f) The income tax rate is 30%.

Required
1. Prepare the acquisition analysis at 1 July 2017.
2. Prepare the business combination valuation entries and pre-acquisition entries at 1 July
2017.
3. Prepare the business combination valuation entries and pre-acquisition entries at 30 June
2019.
4. Prepare the consolidation worksheet journal entries to eliminate the effects of intragroup
transactions at 30 June 2019.
5. Prepare the consolidation worksheet for the preparation of the consolidated financial
statements for the period ended 30 June 2019.
6. Prepare the consolidated statement of profit or loss and other comprehensive income for the period
ended 30 June 2019.
(LO3, LO4, LO5, LO6 and LO7)
ZOE LTD – MATILDA LTD

1.

At 1 July 2017:

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 2017

Accumulated depreciation – plant and equip. Dr 20 000
Plant and equipment Cr 19 000

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Solutions manual to accompany Financial reporting by Loftus et al. .

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 2017

Retained earnings (1/7/17) 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 2019

Accumulated depreciation – plant & equip. 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 (1/7/18) Dr 200
Accumulated depreciation - plant & equip. Cr 400

Deferred tax liability Dr 120

Income tax expense Cr 60
Retained earnings (1/7/18) Cr 60

Goodwill Dr 2 150
Business combination valuation reserve Cr 2 150

(2) Pre-acquisition entries at 30 June 2019

Retained earnings (1/7/18)* 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 2019

(3) Dividend paid

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Solutions manual to accompany Financial reporting by Loftus et al. .

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 (1/7/18) 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 2018
and recognised as unrealised profit in opening inventories in this period (i.e. $2000 – $2000 /
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 (1/7/18) 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:

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Solutions manual to accompany Financial reporting by Loftus et al. .

 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 2019 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
2019. 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. $4400 - $4400 / 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 2019 by raising a Deferred Tax Asset for the tax recognised
by Matilda Ltd in advance on the unrealised intragroup profit.

(8) Sale of furniture

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Solutions manual to accompany Financial reporting by Loftus et al. .

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. $3000 -
$2500). 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 - furniture 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).

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Solutions manual to accompany Financial reporting by Loftus et al. .

5. Consolidation worksheet at 30 June 2019

Zoe Matilda Adjustments Group

Ltd Ltd Dr Cr
Sales revenue 78 000 40 000 6 5 600 108 000
7 4 400
Dividend revenue 4 400 1 600 3 2 000 1 600
4 2 400
82 400 41 600 109 600
Cost of sales 60 000 30 000 500 5 79 900
5 600 6
4 000 7
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 0 500 8 500 0
furniture
Profit before tax 11 600 7 100 13 725
Tax expense 3 000 2 200 5 150 60 1 5 028
9 8 120 7
150 8
Profit 8 600 4 900 8 697
Retained earnings 14 500 2 800 1 200 60 1 13 660
(1/7/18) 2 3 150
5 350
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 11 100 3 300 10 357
(30/6/19)

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Solutions manual to accompany Financial reporting by Loftus et al. .

6.
ZOE LTD
Consolidated Statement of Profit or Loss and Other Comprehensive Income
for the financial year ended 30 June 2019
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

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