Intr-group trading

Current accounts

If P and S trade with each other then this will probably be done on credit leading to:

• a receivables (current) account in one company's SoFP
• a payables (current) account in the other company's SoFP.

These amounts should not be consolidated because the group would end up with a receivable to itself and a payable to itself.

They are therefore cancelled (contra'd) against each other in the consolidated statement of financial position.

The effect of intra-group trading must be eliminated from the consolidated
income statement. Such trading will be included in the sales revenue of one group company and the purchases of another.

• Consolidated sales revenue = P's revenue + S's revenue – intra-group sales.
• Consolidated cost of sales = P's COS + S's COS – intra-group purchases

Unrealised profit

Profits made by members of a group on transactions with other group members are:

• recognised in the accounts of the individual companies concerned, but
• in terms of the group as a whole, such profits are unrealised and must be eliminated from the consolidated accounts (remember you cannot make profits if your right hand sells goods to your left!).

Such unrealised profits arise when one group company sells good to another group company and those goods have not been sold on externally by the end of the year. They are therefore known as unrealised profits held in inventory.

Intra-group trading and unrealised profit in inventory

When one group company sells goods to another a number of adjustments may be needed.

• Current accounts must be cancelled (see above).
• Where goods are still held by a group company at the reporting date, any unrealised profit must be cancelled.
• Inventory must be included at original cost to the group.

Adjustments for unrealised profit in inventory

(1)Determine the value of closing inventory still held within the group at the reporting date that are the result of intra-group trading.

(2)Use either the profit mark-up or margin to calculate how much of that value represents profit earned by the selling company. 

(3)Make one of the following adjustments:

If the seller is the parent company, the profit element is included in the holding company's accounts and relates entirely to the controlling group.

Adjustment required:

Dr Group retained earnings

Cr Group inventory

If the seller is the subsidiary, the profit element is included in the subsidiary company's accounts and relates partly to the group, partly to non-controlling interests (if any).

Adjustment required:

Dr Subsidiary cost of sales (and therefore their retained earnings in the net asset working)

Cr Group inventory