EstatePass

Financial Reporting · Module 5: Business combinations and group accounting

The Profit That Isn't There Yet

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Chapters

  1. Case
  2. Rule
  3. Entry
  4. Recap

In short

When a parent sells inventory to its subsidiary, consolidation eliminates the whole intragroup sale and defers the profit still in closing inventory. If $100,000 of stock is sold at a $25,000 profit and 30% is unsold, the group removes $7,500 of unrealized profit and recognizes a $2,250 deferred tax asset at a 30% tax rate.

  • Eliminate intragroup sales and cost of sales in full.
  • Reduce closing inventory by the profit not yet sold outside the group.
  • Tax-effect the adjustment: debit deferred tax asset, credit income tax expense.

Transcript

Case

Platypus sells $100,000 of stock to Wombat. Wombat is a company Platypus owns outright. Platypus books a $25,000 profit. But for the group, the stock just moved shelves. So how much of that profit is real?

Rule

Consolidated statements show the group as one economic entity. And one entity can't make a profit selling to itself. So AASB 10 says: eliminate intragroup sales in full, and remove any profit still sitting in the group's inventory. Here are the facts. Cost $75,000, sold for $100,000. At year end, Wombat still holds 30%. Tax is 30%.

Entry

Step one: take out the whole sale. Debit sales revenue, $100,000. A common mistake is to eliminate only the profit. The group never sold anything, so the full sale goes. Pause here. How much profit is still unrealized? 70% was sold to outside customers. That profit is real. 30% is still on Wombat's shelves. $25,000 times 30% is $7,500. Credit inventory, $7,500. Cost of sales is the balancing figure: $92,500. Check it. The two companies recorded $145,000. The group only sold 70% of stock that cost $75,000. That's $52,500. The difference is exactly our credit. One more step. The group now carries that stock at $22,500. For tax, it's still $30,000. That gap is a deductible temporary difference. So debit a deferred tax asset of $2,250, and credit income tax expense by the same amount.

Recap

Debits and credits both total $102,250. Group profit after tax falls by $5,250. Three moves: eliminate the whole sale, defer the profit still held, then tax-effect it. Next time: the stock gets sold, and that profit comes back. Subscribe so you catch it.

Sources

  • AASB 10 Consolidated Financial Statements, para B86(c)
  • AASB 112 Income Taxes

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