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Module 5 - Inter- Company Transactions

Advance Accounting (New Era University)

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3. Intercompany Transactions

Intercompany transactions are transactions between the parent and its subsidiaries. As provided in PFRS 10
Consolidated Financial Statements, intragroup assets and liabilities, equity, income, expenses and cash flows
relating to transactions between entities of the group should be eliminated before consolidation.

As discussed in module 1, both parent and subsidiary are viewed as a single reporting entity for financial
reporting purposes that is why eliminating intercompany transactions is necessary. When eliminating
intercompany transactions, it is as if such transactions never occurred. The following are the common
intercompany transactions that are eliminated when preparing consolidated financial statements: a.
Intercompany sale of inventory

b. Intercompany sale of property, plant, and equipment

c. Intercompany dividends

d. Intercompany bond transactions

3.1. Intercompany sale of inventory

All profits recorded on an intercompany sale of inventory are only realized in the period in which the inventory
is resold to outsiders. Until the point of resale, all intercompany profits must be deferred. Consolidated net
income must be based on the realized income of the selling affiliate.

Intercompany sales are either:

1. Downstream

• the parent sells to the subsidiary the parent recognizes the profit.
• NCI is not affected because the profit pertains solely to the owners of the parent.

2. Upstream

• the subsidiary sells to the parent the subsidiary recognizes the profit.
• NCI is affected because the profit pertains to both the owners of the parent and the NCI

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3.2. Intercompany sale of property, plant, and equipment

Intercompany sale of property, plant, and equipment can either be:

a. Downstream → parent is the seller

b. Upstream → subsidiary is the seller. And only upstream transactions affect the NCI

Accounting procedures:

1. Any gain or loss is deferred and

a. Amortized over the asset’s remaining life, if the asset is depreciable.

b. Not amortized, if the asset is non-depreciable

2. If the asset is subsequently sold to an unrelated party or otherwise derecognized, the unamortized
balance of the deferred gain or loss is recognized in profit or loss.

3. In a downstream sale, the gain or loss is adjusted to the controlling interest only. Therefore, NCI is not
affected.

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4. In an upstream sale, the adjustments for the gain or loss are shared between the controlling interest and
NCI. Therefore, NCI is affected.

5. The unamortized balance of the deferred gain or loss is eliminated when consolidated financial
statements are prepared.

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3.3. Intercompany dividends

Investment in subsidiary either measured:

1. At cost or in accordance with PFRS 9

• Dividends received are recognized in profit or loss

2. Using equity method

• Dividends received are recognized as a reduction to the carrying

amount of the investment

In any case, dividends must be eliminated when consolidated financial statements are prepared.

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3.4. Intercompany bond transaction

Bonds acquired by the parent or the subsidiary issued by the other should be eliminated. For consolidation
purposes, both the investment in bonds and the bonds payable should be eliminated.

On the point of view of the group, the bonds payable are considered extinguished. Thus:

1. On the consolidated statement of profit or loss

• A gain or loss will be recognized for the difference between the acquisition cost of the
investment in bonds and the carrying amount of the bonds payable on the acquisition date

2. On the consolidated statement financial position

• Eliminate any interest expense and interest income recognized after the intercompany
transaction

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4. References

1. Philippine Financial Reporting Standards (PFRSs) adapted by the Financial Reporting Standards Council
based o the International
Financial Reporting Standards (IFRSs), issued by the International Accounting Standards Board, 2020

2. Zeus Vernon B. Millan – Accounting for Business Combination (Advanced Accounting 2), Bandolin
Enterprise (Publishing and Printing),
Baguio City, Philippines, 2020 edition

3. https://www.ifrsbox.com/ifrs-10-consolidated-financial-statements/

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