Question

1. Why is it necessary to make consolidation adjustments for intragroup transactions? In making consolidation worksheet adjustments, sometimes tax-effect entries are made, why? Give an example about the tax-effect of intragroup transactions in catering services for airline industries.

Answer 1

When preparing consolidated financial statements under GAAP, one of the final steps in finalizing the financial reports is to process the Consolidating Entries. The Consolidating Entries are designed to eliminate any unrealized profit from intra-company transactions.

It is necessary to make adjustments for intra-group transactions because it would otherwise lead to Double-Counting the effect of a transaction.

For instance, if one company sells goods to its subsidiary for a 100% markup with a gross profit of $50,000, the company essentially increased profit by $50,000 out of thin air since the transaction is a sale for the parent and an inventory purchase for the subsidiary. This is obviously not representative and thus these transactions must be eliminated if the goods have not been sold to a third party.

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 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 $20 000 being sold by a parent company(ABC Airlines) to a subsidiary(EFG) for $24 000, 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 $4 000 as the cost to the economic entity differs from that to the subsidiary.

In the subsidiary’s(EFG) accounts, the inventory is carried at $24 000 and has a tax base of $24,000, giving rise to no temporary differences.

From the ABC Airlines point of view, the asset has a carrying amount of $20,000, giving a temporary difference of $4 000. 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.