In case study 1 (page 3)

Question A. why is the cost of sales for group 1/2*12000 and not 1/2*15000?

why is the inventory 1/2*12000 also? not 1/2*15000?

Question B. why is the example using 2100? Is that an assumption or it can be derived from a certain account? If so, which?

ACC20013 Company Accounting Suggested solutions to Tutorial 7 Chapter 20 - Consolidated financial statements: intragroup transactions REVIEW QUESTIONS 1. Why is it necessary to make adjustments for intragroup transactions? 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. 2. In making consolidation worksheet adjustments, sometimes tax-effect entries are made. Why? 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. 3. Why is it important to identify transactions as current or prior period transactions? Current period transactions affect different accounts than prior period transactions. For example, current period sales of inventory affect sales and cost of sales accounts, whereas prior period sales of inventory affect retained earnings. If the transactions are not correctly placed into a time context, then the adjustments used for those transactions may be inappropriate. 4. Where an intragroup transaction involves a depreciable asset, why is depreciation expense adjusted? 1 ACC20013 Company Accounting Suggested solutions to Tutorial 7 The cost of the asset to the group is different from that recorded by the acquirer of the depreciable asset within an intragroup transaction. The acquirer records depreciation on the cost to the acquirer while in the consolidated financial statements, the group wants to show depreciation calculated on cost to the group. Hence an adjustment is necessary. If a profit is made on an intragroup sale of a depreciable asset, then the cost of the asset to the group is less than the cost recorded by the acquirer of the asset. Hence an adjustment is necessary to reduce the depreciation expense and accumulated depreciation in relation to the asset. 5. How are adjustments for post-acquisition dividends different from those for pre-acquisition dividends? Explain. There is no difference in the accounting for pre-acquisition or post-acquisition dividends. They are all accounted for as post-acquisition dividends. The adjustment is to dividend revenue recorded by the parent and dividends paid recorded by the subsidiary. The treatment of all dividends as post-acquisition dividends is hard to justify conceptually and this decision was made by the standard-setters on pragmatic grounds. Refer to AASB 127 and AASB 9 (para 5.7.6). 6. What is meant by \"realisation of profits\"? Profit is realised when an entity or an economic entity transacts with another external entity. For a group or economic entity 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. Profits recognised by group members on sale of assets within the group are unrealised profits. With transferred inventory involvement of an external party, or realisation, occurs when the inventory is on-sold to an external entity. With transferred 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 realised in any one period is measured by reference to the depreciation charged on the transferred asset. Profits recorded from intragroup services are considered to be immediately realised. 7. When are profits realised in relation to inventory transfers within the group? Realisation occurs on involvement of an external entity, namely when the inventory is on-sold to an entity that is not a member of the group. 8. When are profits realised on transfers of depreciable assets within the group? As the asset is never on-sold by a member of the group, remaining instead within the group and being consumed by use within the group, the point of realisation cannot be directly determined by reference to involvement of an external entity. Realisation is then indirectly determined by usage of the asset within the group, that is, in proportion to the consumption of the benefits from the asset within the group. Realisation of the profit/loss on sale within the group is then measured in the same proportion to the depreciation of the asset. For example, if the transferred asset is being depreciation on a straight line basis over a 10-year period, that is, at 10% per annum, then the profit on sale is realised at 10% per annum. 2 ACC20013 Company Accounting Suggested solutions to Tutorial 7 CASE STUDIES Case Study 1 Consolidation adjustments Jessica Ltd sold inventory during the current period to its wholly owned subsidiary, Amelie Ltd, for $15 000. These items previously cost Jessica Ltd $12 000. Amelie Ltd subsequently sold half the items to Ningbo Ltd for $8000. The tax rate is 30%. The group accountant for Jessica Ltd, Li Chen, maintains that the appropriate consolidation adjustment entries are as follows: Sales Cost of Sales Inventory Deferred Tax Asset Income Tax Expense Dr Cr Cr Dr Cr 15 000 13 000 2 000 300 300 Required A. Discuss whether the entries suggested by Li Chen are correct, explaining on a line-by-line basis the correct adjustment entries. B. Determine the consolidation worksheet entries in the following year, assuming the inventory is on-sold, and explain the adjustments on a line-by-line basis. A. The correct entry is: Sales Cost of sales Inventory Deferred tax asset Income tax expense Dr Cr Cr Dr Cr 15 000 13 500 1 500 450 450 Sales: Recorded sales = $15 000 + $8 000 = $23 000 Group sales = $8 000 [external entity sales only] Adjustment = $15 000 Cost of sales: Recorded = $12 000 + x $15 000 = $19 500 Group = x $12 000 = $6 000 Adjustment = $13 500 Inventory: Recorded = x $15 000 = $7 500 Group = x $12 000 = $6 000 Adjustment = $1 500 DTA: As inventory in the first adjustment is reduced by $1 500, this changes the carrying amount of the asset. A change in the carrying amount creates a temporary difference between it and the tax base giving rise to a deferred tax benefit which will be reversed on sale of the asset to an external entity. 3 ACC20013 Company Accounting Suggested solutions to Tutorial 7 B. Assuming the inventory is on-sold, the entry in the following year is: Retained earnings (op bal) Income tax expense Cost of sales Dr Dr Cr 1 050 450 1 500 Retained earnings (op bal): In the prior period, Jessica Ltd recorded an after tax profit of $2 100 on sale of inventory to Amelie Ltd. Half of this inventory was on-sold to an external entity, leaving half the profit, $1 050, unrealised. Hence prior period profit is reduced by $1 050. Income tax expense: In the prior period, the group raised a deferred tax asset of $450. When the inventory is on-sold this year the account is reversed effectively crediting the deferred tax asset account and debiting the income tax expense. Cost of sales: Recorded = x $15 000 = $7 500 Group = x $12 000 = $6 000 Adjustment = $1 500 Case Study 2 Depreciation expense At the beginning of the current period, Jessica Ltd sold a used depreciable asset to its wholly owned subsidiary, Amelie Ltd, for $80 000. Jessica Ltd had originally paid $200 000 for this asset, and at time of sale to Amelie Ltd had charged depreciation of $150 000. This asset is used differently in Amelie Ltd from how it was used in Jessica Ltd; thus, whereas Jessica Ltd used a 10% p.a. straight-line depreciation method, Amelie Ltd uses a 20% straight-line depreciation method. In calculating the depreciation expense for the consolidated group (as opposed to that recorded by Amelie Ltd), the group accountant, RuiFen Xue, is unsure of which amount the depreciation rate should be applied to ($200 000, $50 000 or $80 000) and which depreciation rate to use (10% or 20%). Required Provide a detailed response, explaining which depreciation rate should be used and to what amount it should be applied. For the group, depreciation is based on the cost of the asset to the group and the depreciation rate is that applied by the entity using the asset. The asset has been transferred within the group. Note that consolidation adjustments are not based on reversing intragroup transactions. The purpose of the adjustments made is to remove the effects of the transactions so that the group position in relation to external entities is reported. As the usage of the asset in the group has changed as a result of transfer within the group, then the depreciation rate used by the group must reflect the actual consumption of benefits within the group. In this example, the cost of the asset to the group is the carrying amount at time of transfer, namely $50 000. The asset is being used by Amelie Ltd which applies a 20% depreciation rate. This is then the rate used by the group. 4 ACC20013 Company Accounting Suggested solutions to Tutorial 7 PRACTICE QUESTIONS Question 20.1 Intragroup transactions Koala Ltd owns all of the shares of Kangaroo Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) In April 2016, Koala Ltd sells inventory to Kangaroo Ltd for $12 000. This inventory had previously cost Koala Ltd $8000, and it remains unsold by Kangaroo Ltd at the end of the period. (b) All the inventory in (a) is sold to Cockatoo Ltd, an external party, for $16 500 on 19 June 2016. (c) Half the inventory in (a) is sold to Galah Ltd, an external party, for $7200 on 20 June 2016. The remainder is still unsold at the end of the period. (d) Koala Ltd, in January 2016, sold inventory for $8000. This inventory had been sold to it by Kangaroo Ltd in the previous year. It had originally cost Kangaroo Ltd $4800, and was sold to Koala Ltd for $9600. (a) (b) (c) (d) Sales revenue Cost of sales Inventory Dr Cr Cr 12 000 Deferred tax asset Income tax expense (30% x $4 000) Dr Cr 1 200 Sales revenue Cost of sales Dr Cr 12 000 Sales revenue Cost of sales Inventory Dr Cr Cr 12 000 Deferred tax asset Income tax expense (30% x $2 000) Dr Cr 600 Retained earnings (1/7/15) Income tax expense Cost of sales Dr Dr Cr 3 360 1 440 5 8 000 4 000 1 200 12 000 10 000 2 000 600 4 800 ACC20013 Company Accounting Suggested solutions to Tutorial 7 Question 20.2 Intragroup transactions Numbat Ltd owns all of the shares of Goanna Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) On 1 July 2015, Numbat Ltd sold an item of plant costing $15 000 to Goanna Ltd for $18 000. Numbat Ltd had not charged any depreciation on the plant before the sale. Both entities depreciate assets at 10% p.a. on cost. (b) On 1 January 2014, Goanna Ltd sold a new tractor to Numbat Ltd for $30 000. This had cost Goanna Ltd $24 000 on that day. Both entities charged depreciation at the rate of 10% p.a. on cost. (c) Ignore this part - On 1 July 2015, Numbat Ltd sold an item of machinery to Goanna Ltd for $9000. This item had cost Numbat Ltd $6000. Numbat Ltd regarded this item as inventory whereas Goanna Ltd intended to use it as a non-current asset. Goanna Ltd charges depreciation at the rate of 10% p.a. on cost. (d) In February 2015, Numbat Ltd sold inventory to Goanna Ltd for $9000, at a mark-up of 20% on cost. One-quarter of this inventory was unsold by Goanna Ltd at 30 June 2015. (e) Goanna Ltd sold land to Numbat Ltd in December 2015. The land had originally cost Goanna Ltd $20 000, but was sold to Numbat Ltd for only $16 000. To help Numbat Ltd pay for the land, Goanna Ltd gave Numbat Ltd an interest-free loan of $9000, and the balance was paid in cash. Numbat Ltd has as yet made no repayments on the loan. (f) On 1 July 2014, Goanna Ltd rented a spare warehouse to be used jointly by Numbat Ltd and Galah Ltd with each company paying half the agreed rent to Goanna Ltd. The rent paid to Goanna Ltd in the 2014-15 year was $300 while the rent paid in the 2015-16 year was $350. (a) Proceeds on sale of plant Carrying amount of asset sold Asset Dr Cr Cr 18 000 Gain on sale of plant Asset Dr Cr 3 000 Deferred tax asset Income tax expense Dr Cr 900 Accumulated depreciation Depreciation expense (10% x $3000 p.a.) Dr Cr 300 Income tax expense Deferred tax asset Dr Cr 90 Retained earnings (1/7/15) Deferred tax asset Tractors Dr Dr Cr 4 200 1 800 Accumulated depreciation Depreciation expense Retained earnings (1/7/15) Dr Cr Cr 1 500 15 000 3 000 OR (b) 6 3000 900 300 90 6 000 600 900 ACC20013 Company Accounting Suggested solutions to Tutorial 7 (10% x $6000 p.a. for 2.5 years) (c) (d) (e) Income tax expense Retained earnings (1/7/15) Deferred tax asset Dr Dr Cr 180 270 Sales revenue Cost of sales Machinery Dr Cr Cr 9 000 Deferred tax asset Income tax expense Dr Cr 900 Accumulated depreciation Depreciation expense (10% x $3000 p.a.) Dr Cr 300 Income tax expense Deferred tax asset Dr Cr 90 Retained earnings (1/7/12) Income tax expense Cost of sales Dr Dr Cr Proceeds on sale of land Land Carrying amount of land sold Dr Dr Cr 16 000 4 000 Land Dr Cr 4 000 Income tax expense Deferred tax liability (30% x $4 000) Dr Cr 1 200 Loan from Goanna Ltd Loan to Numbat Ltd Dr Cr 9 000 Rent revenue Rent expense Dr Cr 175 450 6 000 3 000 900 300 90 262.5 112.5 375 20 000 OR Loss on sale of land (f) 7 4 000 1 200 9 000 175 ACC20013 Company Accounting Suggested solutions to Tutorial 7 Question 20.3 Intragroup transactions Dingo Ltd owns all of the shares of Bilby Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) On 1 January 2015, Dingo Ltd sold inventory costing $6000 to Bilby Ltd at a transfer price of $8000. On 1 September 2015, Bilby Ltd sold half these items of inventory back to Dingo Ltd, receiving $3000 from Dingo Ltd. Of the remaining inventory kept by Bilby Ltd, half was sold in January 2016 to Goanna Ltd at a loss of $200. (b) On 1 January 2016, Bilby Ltd sold an item of plant to Dingo Ltd for $2000. Immediately before the sale, Bilby Ltd had the item of plant on its accounts for $3000. Bilby Ltd depreciated items at 5% p.a. on the diminishing balance and Dingo Ltd used the straightline method over 10 years. (c) On 1 July 2015, Dingo Ltd sold a motor vehicle to Bilby Ltd for $12 000. This had a carrying amount to Dingo Ltd of $9600. Both entities depreciate motor vehicles at a rate of 10% p.a. on cost. (d) During the 2014-15 period, Dingo Ltd sold inventory to Bilby Ltd for $9000, recording a before-tax profit of $1800. Half this inventory was unsold by Bilby Ltd at 30 June 2015. Lecturer's Note: Assume the inventory is sold in 2016. (e) Bilby Ltd sells second-hand machinery. Dingo Ltd sold one of its depreciable assets (original cost $80 000, accumulated depreciation $64 000) to Bilby Ltd for $10 000 on 1 January 2016. Bilby Ltd had not resold the item by 30 June 2016. Lecturer's Note: IF we assume Bilby Ltd takes this machine as its inventory hence no depreciation is needed. (f) On 1 May 2016, Bilby Ltd sold inventory costing $300 to Dingo Ltd for $360 on credit. On 30 June 2016, only half of these goods had been sold by Dingo Ltd, but Dingo Ltd had paid $280 back to Bilby Ltd. (a) (b) Retained earnings (1/7/15) Income tax expense Sales revenue Cost of sales (4000 + 500) Inventory (1/4 x 2000) Dr Dr Dr Cr Cr 1 400 600 3 000 Deferred tax asset Income tax expense Dr Cr 150 Plant Proceeds on sale of plant Carrying amount of plant sold Dr Dr Cr 1 000 2 000 Plant Dr Cr 1 000 Loss on sale of plant Income tax expense Deferred tax liability Dr Cr 300 Depreciation expense Accumulated depreciation (10% x $1000 x year) Dr Cr 50 Deferred tax liability Dr 15 4 500 500 150 3 000 OR 8 1 000 300 50 ACC20013 Company Accounting Suggested solutions to Tutorial 7 Income tax expense (c) Cr 15 Proceeds on sale of motor vehicle Carrying amount of motor vehicle sold Motor vehicles Dr Cr Cr 12 000 Gain on sale of vehicles Motor vehicles Dr Cr 2 400 Deferred tax asset Income tax expense Dr Cr 720 Accumulated depreciation Depreciation expense (10% x 2 400 p.a.) Dr Cr 240 Income tax expense Deferred tax asset Dr Cr 72 Retained earnings (1/7/15) Income tax expense Cost of sales Dr Dr Cr 630 270 Inventory Proceeds on sale of machinery Carrying amount of machinery sold Dr Dr Cr 6 000 10 000 Inventory Loss on sale of machinery Dr Cr 6 000 Income tax expense Deferred tax liability Dr Cr 1 800 Sales revenue Cost of sales Inventory Dr Cr Cr 360 Deferred tax asset Income tax expense Dr Cr 9 Accounts payable Accounts receivable Dr Cr 80 9 600 2 400 OR (d) (e) 2 400 720 240 72 900 16 000 OR (f) 9 6 000 1 800 330 30 9 80 ACC20013 Company Accounting Suggested solutions to Tutorial 7 Question 20.4 Intragroup transactions Emu Ltd owns all of the shares of Cassowary Ltd. In relation to the following intragroup transactions, all parts of which are independent unless specified, prepare the consolidation worksheet adjusting entries for preparation of the consolidated financial statements as at 30 June 2016. Assume an income tax rate of 30%. (a) Emu Ltd sold inventory to Cassowary Ltd on 1 September 2015 for $27 000. This inventory had cost Emu Ltd $18 000. One-third of the inventory was sold by Cassowary Ltd to Goanna Ltd for $13 000 and one-third to Galah Ltd for $13 200. (b) Emu Ltd manufactures certain items which it then markets through Cassowary Ltd. During the current period, Emu Ltd sold items for $18 000 to Cassowary Ltd at cost plus 20%. Cassowary Ltd has sold 75% of these transferred items at 30 June 2016. (c) During June 2016, Cassowary Ltd declared a $2000 dividend. The dividend was paid in August 2017. (d) In January 2016, Cassowary Ltd paid a $4500 interim dividend. (e) Emu Ltd sold a warehouse to Cassowary Ltd for $150 000. This had originally cost Emu Ltd $123 000. The transaction took place on 1 January 2015. Cassowary Ltd charges depreciation at 5% p.a. on a straight-line basis. (a) (b) (c) (d) (e) Sales revenue Cost of sales Inventory Dr Cr Cr 27 000 Deferred tax asset Income tax expense Dr Cr 900 Sales revenue Cost of sales Inventory Dr Cr Cr 18 000 Deferred tax asset Income tax expense Dr Cr 225 Dividend payable Dividend declared Dr Cr 2 000 Dividend revenue Dividend receivable Dr Cr 2 000 Dividend revenue Dividend paid Dr Cr 4 500 Retained earnings (1/7/15) Deferred tax asset Warehouse Dr Dr Cr 18 900 8 100 Accumulated depreciation Depreciation expense Retained earnings (1/7/12) (5% x $27 000 p.a. for 1.5 yrs) Dr Cr Cr 2025 10 24 000 3 000 900 17 250 750 225 2 000 2 000 4 500 27 000 1350 675 ACC20013 Company Accounting Suggested solutions to Tutorial 7 Income tax expense Retained earnings (1/7/15) Deferred tax asset Dr Dr Cr - 11 End - 405.0 202.5 607.5