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Melbourne Ltd acquired 100% of Sydney Ltd on 11 December 2016. On 1 January 2017, Sydney...

Melbourne Ltd acquired 100% of Sydney Ltd on 11 December 2016. On 1 January 2017, Sydney Ltd sold a machine to Melbourne Ltd for $80,000 and recorded a profit of $20,000. Melbourne Ltd will depreciate this machine on a straight-line basis over its useful life of 8 years. You, the group accountant, have just finished preparing the consolidated financial statements for the year ending 30 June 2020. Mrs Jones, CEO of Melbourne Ltd, is not an accountant and she doesn’t understand why you had to make some adjustments before you prepare the consolidated accounts.

Required: Write an email to Mrs Jones summarising why it is essential to adjust for this intra-group transaction before preparing the consolidated financial statements. Note: consolidation entries are not required.

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Expert Solution

Dear Mrs Jones,

I would like to draw your attention on why is it essential to adjust for this intra-group transaction before preparing the consolidated financial statements.

While consolidating the financial statements of parent and subsidiary company, all the intercompany transactions needs to be eliminated.

Consolidation means that both the entities are the same and as a general rule no one can earn profit .

If the machine has been purchased by Melbourne Ltd, then this must has been recorded as a sale in the books of the Sydney Ltd and hence the profit that has been recorded on this sale has to be removed from Sydney Ltd books.

Since both of the entities are the one, there is no sale but a transfer only. The transfer will be considered as a transfer of goods from one place to another and hence the gross profit needs to be deleted from the books.

This must be done on Sydney Ltd

Sales DR

Cost of goods sold CR

Such tradings will be included in the sales of one group company and the purchases of another.

Melbourne Ltd has a payable with Sydney Ltd, and Sydney Ltd has a receivable from Melbourne Ltd in their individual accounts.

Since both the company is one now, we cannot earn profit from ourselves, it will be loss to us only. Hence accounts needs to be reversed before preparing consolidation statements.

Regards

Accountant

ekkarill92 answered 1 year ago
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