Advanced Accounting — Intragroup Transactions: Eliminating Unrealized Profit and Allocating to NCI

A group is a single economic entity. When the parent and a subsidiary buy and sell goods between themselves, from an outside perspective the goods have merely moved from warehouse A to warehouse B. So intragroup sales and purchases, receivables and payables, and profit not yet realized by sale outside the group are all eliminated. The basics of consolidation after acquisition were covered in chapter 3.

1. What is eliminated

Items eliminated on consolidation
Transaction	Eliminated
Sales of inventory	The full intragroup revenue and cost of sales, and unrealized profit remaining in closing inventory
Sales of PP&E	The gain or loss on disposal and the resulting difference in subsequent depreciation
Loans	Loans receivable and payable, interest income and expense
Services	Fee income and expense
Dividends	The subsidiary's dividends and the parent's dividend income

A loss on an intragroup transaction may be evidence that an asset is impaired, so impairment is considered first and the loss is eliminated only if it does not reflect impairment.

2. Downstream and upstream sales

Downstream sales: the parent sells to the subsidiary. The unrealized profit sits in the parent’s profit, so it is deducted entirely from the share of owners of the parent.
Upstream sales: the subsidiary sells to the parent. The unrealized profit sits in the subsidiary’s profit, so the subsidiary’s adjusted profit is reduced and NCI bears its percentage share.

Under K-IFRS the full amount is eliminated in both cases; the only difference is who bears the effect.

3. Intragroup inventory transactions

P holds 80% of S. In 20X1, S sold goods costing ₩4 million to P for ₩5 million (upstream), and P had not sold 40% of them outside the group by year-end. P also sold goods costing ₩2.4 million to S for ₩3 million (downstream), and S still held 50% of them.

Calculating unrealized profit (unit: ₩10,000)
Transaction	Intragroup profit	Share remaining at year-end	Unrealized profit	Borne by
S → P (upstream)	100	40%	40	Parent 32, NCI 8
P → S (downstream)	60	50%	30	Parent 30

The consolidation adjustments are:

Eliminate intragroup revenue of ₩8 million (500 + 300) and the same amount of cost of sales. Revenue and cost of sales fall together, so profit is unchanged.
Deduct the unrealized profit of ₩700,000 from closing inventory and increase cost of sales by ₩700,000.

If S’s reported profit is ₩2 million (with no fair value amortization), S’s adjusted profit is $200 - 40 = 160$ (₩10,000) and profit attributable to NCI is $160 \times 20\% = 32$ , i.e. ₩320,000. The downstream unrealized profit of ₩300,000 does not affect NCI.

A. Realization the following year

When the remaining inventory is sold outside the group in 20X2, the unrealized profit is realized. On consolidation in 20X2, cost of sales is reduced by the ₩700,000 of unrealized profit in opening inventory, restoring the profit. The upstream portion of ₩400,000 is added to S’s adjusted profit for 20X2, so NCI recovers its ₩80,000.

Subsidiary's adjusted profit with upstream sales

\text{Adjusted profit} = \text{Reported profit} - \text{Closing unrealized profit (upstream)} + \text{Opening unrealized profit realized (upstream)} - \text{Fair value amortization}

Profit attributable to NCI is this adjusted profit multiplied by the NCI percentage.

4. Intragroup PP&E transactions

At the beginning of 20X1, P sold a machine with a carrying amount of ₩2 million to S for ₩3 million (downstream). S depreciates it over its remaining five-year life with no residual value.

20X1: P’s gain on disposal of ₩1 million is eliminated. S depreciates ₩600,000 a year on ₩3 million, but from the group’s perspective the cost is ₩2 million, so only ₩400,000 a year should be depreciated. The excess depreciation of ₩200,000 is reversed.
Net effect: consolidated profit for 20X1 is adjusted by $-100 + 20 = -80$ (₩10,000). The machine’s closing carrying amount is overstated by $240 - 160 = 80$ and is reduced by that amount.
From 20X2: the excess depreciation of ₩200,000 is reversed each year, so the ₩1 million of eliminated profit is fully realized over five years.

For an upstream PP&E transaction, the same amount is eliminated, but the effect is also allocated to NCI by its percentage.

Check your understanding

W holds 60% of X. In 20X1, X sold goods costing ₩6 million to W for ₩7.5 million, and W still held one-third of them at year-end. X’s reported profit for 20X1 is ₩3 million and there are no fair value differences. What are the unrealized profit to be eliminated, X’s adjusted profit and profit attributable to NCI?

Intragroup profit is ₩1.5 million, and one-third remains, so unrealized profit is ₩500,000. As an upstream sale, X’s adjusted profit is $300 - 50 = 250$ (₩10,000), i.e. ₩2.5 million. Profit attributable to NCI is $250 \times 40\% = 100$ , i.e. ₩1 million. On consolidation, intragroup revenue and cost of sales of ₩7.5 million are eliminated, and closing inventory is reduced by ₩500,000 with cost of sales increased by ₩500,000.

References

Korea Accounting Standards Board, K-IFRS 1110 Consolidated Financial Statements (B86 consolidation procedures)
Joe Hoyle, Thomas Schaefer and Timothy Doupnik, Advanced Accounting, ch. 5–6
IASB, IFRS 10 Consolidated Financial Statements