General rules: In order to present financial statements for the group in a consolidated format, the effect of transactions between group enterprises should be eliminated. AS 21 requires that intra-group transactions (including sales, expenses and dividends) and the resulting unrealised profits and losses be eliminated in full.
Liabilities due to one group enterprise by another will be set off against the corresponding
asset in the other group enterprise’s financial statements; sales made by one group enterprise to another should be excluded both from turnover and from cost of sales or the appropriate expense heading in the consolidated statement of profit and loss.
To the extent that the buying enterprise has further sold the goods in question to a third party, the eliminations to sales and cost of sales are all that is required, and no adjustments to consolidated profit or loss for the period, or to net assets, are needed. However, to the extent that the goods in question are still on hand at year end, they may be carried at an amount that is in excess of cost to the group and the amount of the intra-group profit must be eliminated, and assets reduced to cost to the group.
For transactions between group enterprises, unrealised profits resulting from intra-group transactions that are included in the carrying amount of assets, such as inventories and tangible fixed assets, are eliminated in full. The requirement to eliminate such profits in full applies to the transactions of all subsidiaries that are consolidated – even those in which the group’s interest is less than 100%.
Unrealised profit in inventories: Where a group enterprise sells goods to another, the selling enterprise, as a separate legal enterprise, records profits made on those sales. If these goods are still held in inventory by the buying enterprise at the year end, however, the profit recorded by the selling enterprise, when viewed from the standpoint of the group as a whole, has not yet been earned, and will not be earned until the goods are eventually sold outside the group. On consolidation, the unrealised profit on closing inventories will be eliminated from the group’s profit, and the closing inventories of the group will be recorded at cost to the group.
When the goods are sold by a parent to a subsidiary (downstream transaction), all of the profit on the transaction is eliminated, irrespective of the percentage of the shares held by the parent. In other words, the group is not permitted to take credit for the share of profit that is attributable to any minority.
Where the goods are sold by a subsidiary, in which there is a minority interest, to another group enterprise (upstream transaction), the whole of the unrealised profit should also be eliminated.
Unrealised profit on transfer or non-current assets
- Similar to the treatment described above for unrealised profits in inventories, unrealised inter-company profits arising from intra-group transfers of fixed assets are also eliminated from the consolidated financial statements.
Intra Group Transactions: The effect of any unrealised profits from inter group transactions should be eliminated from consolidated financial statement. Effect of losses from inter group transactions need not be eliminated only when the cost is not recoverable.
For example, A Ltd. sold goods for 1,25,000 to B Ltd., another subsidiary under same group at the gross profit of 20% on sales. On the date of consolidated balance sheet, B Ltd. has goods worth 25,000 as stock from the same consignment. The unrealised profits of 5,000 (25,0000 x 20%) will be deducted from the closing stock and it will be valued as 20,000 i.e. at cost to A Ltd. for the purpose of Consolidated Financial Statement.
- Reporting Date: For the purposes of preparing consolidated financial statements, the financial statements of all subsidiaries should, wherever practicable, be prepared:
To the same reporting date; and
For the same reporting period as of the parent.
- If practically it is not possible to draw up the financial statements of one or more subsidiaries to such date and, accordingly, those financial statements are drawn up to reporting dates different from the reporting date of the parent, adjustments should be made for the effects of significant transactions or other events that occur between those dates and the date of the parent’s financial statements. In any case, the difference between reporting dates should not be more than six months.
- Accounting Policies: Accounting policies followed in the preparation of the financial statements of the parent, subsidiaries and consolidated financial statement should be uniform for like transactions and other events in similar circumstances.
If accounting policies followed by different companies in the group are not uniform, then adjustments should be made in the items of the subsidiaries to bring them in line with the accounting policy of the parent. Here the figures or policies are not disturbed in respective books, but while including the items in consolidated financial statement, adequate adjustments will be made.
For example, parent company A Ltd. is valuing the stock on weighted average basis and its stock is valued as 100 lacs but its subsidiary B Ltd. is following FIFO method and its stock is valued at 20 Lacs. Stock of B Ltd. will be valued under weighted average method say, 25 lacs. Now for the purpose of consolidated financial statement, stock of B Ltd. will taken as 25 lacs and the stock disclosed in consolidated trading account on credit side and in consolidated balance sheet assets side will be 125 lacs. Hence adequate adjustments are made for this 5 lac in consolidated financial statement.
If it is not practical to make such adjustments for uniform accounting policies in preparing the consolidated financial statements, then the fact should be disclosed together with the amounts of the each items in the consolidated financial statement to which the different accounting policies have been applied.
Let us take above example, incase it is not possible practically to adjust 5 lacs in the stock of B Ltd. for the purpose of consolidated financial statement, then item will be disclosed in Consolidated Trading Account (Credit Side) and Consolidated Balance Sheet (Asset Side) as follow:
Closing Stock of A Ltd. (Weighted Average Method) 100 lacs
Closing Stock of B Ltd. (FIFO Method) 25 lacs 125 lacs
