Question

Maggie Ltd owns all the share capital of Taylor Ltd. The following intragroup transactions took place during the periods ended 30 June 2022 or 30 June 2023.

During the period ended 30 June 2022, Taylor Ltd paid an interim dividend of $40 000 out of pre-acquisition profits. As a result, the investment in Taylor Ltd is considered to be impaired by $40 000.

On 30 June 2022, Taylor Ltd declared a final dividend of $25 000 out of post-acquisition profits.

During the period ended 30 June 2023, Taylor Ltd paid an interim dividend of $30 000 out of post-acquisition profits.

On 30 June 2023, Taylor Ltd declared a final dividend of $50 000 out of post-acquisition profits.

In relation to the above intragroup transactions:
1) prepare adjusting journal entries for the consolidation worksheet at 30 June 2022 and 30 June 2023

2) explain in detail why you made each adjusting journal entry.

Answer 1

1)

30 june 2022

(a) sales revenue                      Dr      5000

       Cost of sales                        Cr                   4500

       Inventories                          Cr                     500

      Deffered tax asset               Dr      150

       Income tax expence           Cr                   150

       Accounts payable               Dr      2500

       Accounts recievable           Cr                   2500

(b) sales revenue                      Dr      18000

       Cost of sales                        Cr                   16000

       Inventories                          Cr                     2000

      Deffered tax asset               Dr      600

       Income tax expence           Cr                   600

30 june 2023

(a) Retained earnings             Dr   350

      Income tax expense           Dr 150

        Cost of sales                    Cr                500   

(b) Retained earnings             Dr   2000

        Cost of sales                     Cr                800

Inventories                     Cr                   1200

(c ) Sales revenue            Dr     8000

        Cost of sales              Cr                 8000

2)

Detailed explanations on the adjusting journal entries
30 June 2022:
(a) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June
2022. As half of the inventories remain unsold at the end of the period, at 30 June 2022 half
of the entire profit on the intragroup sale is unrealised and should be eliminated on
consolidation by:
• Debiting Sales Revenue with an amount equal to the intragroup price - to eliminate the
intragroup revenues
• Crediting Inventories with an amount equal to the unrealised profit - to decrease the value
of the inventories left on hand with the group to their original cost to the group
• Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of
credit to Inventories - to adjust the aggregate figure for Cost of Sales to the amount that
should be recognised by the group, i.e. the original cost of the inventories sold to external
parties.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit
in closing inventories at 30 June 2022 by raising a Deferred Tax Asset for the tax recognised
by Monica Ltd on the unrealised profit.
The third adjusting entry eliminates the intragroup Accounts Payable and Accounts
Receivable for the amount still unpaid on the intragroup sale.

(b) The first adjusting entry eliminates the unrealised profit in closing inventories at 30 June
2022. As half of the inventories remain unsold at the end of the period, at 30 June 2022 half
of the entire profit on the intragroup sale is unrealised and should be eliminated on
consolidation by:
• Debiting Sales Revenue with an amount equal to the intragroup price
• Crediting Inventories with an amount equal to the unrealised profit - to decrease the value
of the inventories left on hand with the group to their original cost to the group
• Crediting Cost of Sales with an amount equal to the intragroup price minus the amount of
credit to Inventories.
The second adjusting entry recognises the tax effect of the elimination of the unrealised profit
in closing inventories at 30 June 2022 by raising a Deferred Tax Asset for the tax recognised
by Phoebe Ltd in advance on the unrealised intragroup profit.
30 June 2023
(a) In this case, the unrealised profit in closing inventories from the period ended 30 June
2022 and recognised as unrealised profit in opening inventories in this period becomes
realised by the end of the current period. As such, this profit needs to be transferred from the
previous period to the current period by:
• Debiting Retained Earnings (1/7/22) with an amount equal to the after-tax unrealised
profit in opening inventories - this eliminates the unrealised profit from the prior period's
earnings
• Crediting Cost of Sales with an amount equal to the before-tax unrealised profit in
opening inventories - this increases the current profit as the previously unrealised profit is
now realised

As a result of this transfer of profit to the current period, the current period profit increases
and a tax effect should also be recognised in the adjusting entry by:
• Debiting Income Tax Expense with an amount equal to the tax on the unrealised profit in
opening inventories.
6) In this case, a part (20%) of the inventories originally transferred intragroup in the
previous period is sold during the current period to external parties, while another part (30%)
is still unsold. That means that the unrealised profit in closing inventories from the period
ended 30 June 2022 and recognised as unrealised profit in opening inventories in this period
is only partly realised by the end of the current period. This is recognised in the first adjusting
entry by:
• Debiting Retained Earnings (1/7/22) with an amount equal to the before-tax unrealised
profit in opening inventories -- this eliminates the unrealised profit from the prior period's
profit
• Crediting Cost of Sales with an amount equal to the unrealised profit in opening
inventories that becomes realised during the current period - this increases the current
profit as the previously unrealised profit is now realised
Crediting Inventories with an amount equal to the unrealised profit in opening inventories
that is still unrealised at the end of the current period - this decreases the value of the
inventories still on hand to their original cost to the group.
As a result of the recognition of the part of profit that is realised in the current period, the
current period profit increases and a current tax effect should also be recognised by:

• Debiting Income Tax Expense with an amount equal to the tax on the part of the
unrealised profit in opening inventories that is realised by the end of the period.
As a result of the elimination of the part of the profit that is unrealised by the end of the
current period, a deferred tax effect should also be recognised by:
Debiting Deferred Tax Asset with an amount equal to the tax on the part of the unrealised
profit in opening inventories that is still unrealised at the end of the period.
Given that Retained Earnings only recognises profits after tax, debiting Retained Earnings
(1/7/22) in the first adjusting entry with the before-tax unrealised profit eliminated from that
account more than what it should and therefore the balance of Retained Earnings (1/7/22)
should be adjusted by:
Crediting Retained Earnings (1/7/22) with an amount equal to the tax on the unrealised
profit in opening inventories - this ensures that the net adjustment to Retained Earnings
(1/7/22) is only for the after-tax unrealised profit.
(c) The only adjusting entry eliminates the intragroup sales revenue recognised by Phoebe
Ltd (on the intragroup sale) and the cost of sales recognised by Monica Ltd (on the external
sale) as the profit on the intragroup sale is entirely realised during the current period. As the
inventories are sold by the end of the period to an external entity. at 30 June 2023 the entire
profit on the intragroup sale is realised; however, the aggregate sales revenues and cost of
sales are overstated from the group's perspective as they include the intragroup sales revenue
and the cost of sales recognised based on the price paid intragroup by Monica Ltd. On
consolidation. this overstatement is corrected. There won't be any tax-effect adjustment entry
as the only adjusting entry posted now does not have any net effect on the profit or on the
carrying amount of inventories.