Question

Question Two Peter Chou is the general manager of Madari Ltd. He believes that intragroup transactions can be included within consolidated financial statements as long as the transaction represents fair value. That is, the value of the transaction is equivalent to an ‘arm’s length’ transaction.  

Required Prepare a persuasive, but concise (no more than 350 words), response to Peter Chou. Mr. Chou is not an accountant so ensure that your explanation is understandable to a nonaccountant.

Answer 1

In case of accounting of group companies(joint ventures,subsidiaries,associates etc.),transactions entered into between the companies existing within group need to be eliminated in preparing consolidated financial requirements.(even if they are at fair value or arm length price)

the reason behind the same is that company cannot recognize revenue from sales or cost of production to itself ; all sales or costs must be to external entities.

suppose a company made sales to its subsidiary at markup of 5% (lower than the the usual of 10%)of goods costing 100 at 105(with markup).The parent should have recorded it as sales and subsidiary at purchase.Assume the goods are not sold and lying with inventory of subsidiary.

At consolidation the position would be

PARTICULARS	AMOUNT	PARTICULARS	AMOUNT
PURCHASE	105	COGS	100
		LOSS	5

Seems like we are selling to ourselves on loss.(look from parents point of view)

now look at position at year end

PARTICULARS	AMOUNT	PARTICULARS	AMOUNT
		CLOSING STOCK	105

In the consolidated books we are actually having goods that infact we sold.(look from parents point of view)

thus,it is clear now why we eliminate inter company transactions

*guidance provided by ind as 110