ACT504 Chap.8 Intragroup Transactions and Unrealised Profit
Intragroup Transactions and Unrealised Profit
The group cannot make a profit by selling to itself
Consolidated statements report the group as though it were a single entity, and a single entity that moves inventory from one warehouse to another has not sold anything. Any revenue, expense, receivable, payable or profit created by an internal transfer therefore has to come back out.
The published indicative content names the cases: transfers of inventories, transfers of property plant and equipment, intragroup services, dividends and borrowings.
Two questions, asked in this order
Did the transaction leave anything inside the group that is still there at the reporting date, and if so, how much of the attached profit has since been made real by a transaction with an outsider.
The first answer decides whether an asset must be written down at all; the second decides by how much. A transfer of services leaves nothing behind, so revenue and expense are reversed and nothing else happens.
A transfer of inventory already resold outside leaves nothing unrealised, so revenue and cost of sales are reversed and the asset is untouched.
Inventory, and why the reversal is always in full
The internal sale did not happen from the group's point of view, so the whole of the recorded revenue and the whole of the recorded cost of sales come out, whatever happened afterwards.
The proportion resold outside does not scale those two lines; it only decides how much profit is still buried in the asset. In practice the entry is written with revenue at the internal selling price, the inventory credit at the unrealised profit, and cost of sales as the balancing figure.
The tax effect here is a deferred tax asset with a credit to income tax expense, because the selling entity has already paid tax on a profit the group has not yet made.
That is the opposite direction to the deferred tax liability created by a fair value uplift.
Non-current assets, where the problem lasts for years
A depreciable asset sold within the group at a profit creates two distortions at once: the asset is carried at more than the group paid, and the buyer will depreciate that inflated cost for the rest of its life.
The first is fixed by eliminating the gain against the asset. The second unwinds on its own, because each year's excess depreciation releases an equal slice of the original gain, and by the time the asset is fully depreciated the two adjustments cancel exactly.
A transfer at a loss works identically with the signs reversed, and where the seller treated the item as inventory while the buyer capitalised it, the excess depreciation adjustment still applies, because what matters is what the buyer did with it.
The transfers that leave nothing behind
Intragroup services, interest and dividends are eliminated in full and stop there.
A management fee creates revenue in one set of books and an expense in the other, and both are reversed. Interest on an internal loan is reversed, and the loan receivable and payable are removed against each other, because a group cannot owe itself money.
A dividend from a subsidiary to its parent is a movement of equity within the group rather than income, and where it is declared but unpaid the intragroup receivable and payable go too. None of these creates unrealised profit and none has a deferred tax effect.
Why direction is still worth writing down
Everything above is true whether the subsidiary is wholly owned or not.
What changes when there is a non-controlling interest is not the elimination but who bears it, and that depends entirely on which entity recorded the profit. Marking each part upstream or downstream while it makes no difference is how the habit is in place when it starts to matter.
What this chapter covers
- 01
Why an internal transfer creates nothing the group can report
- 02
Two questions that decide every part of an intragroup question
- 03
Inventory in three states, and the entry each one produces
- 04
Why revenue and cost of sales are reversed in full every time
- 05
A deferred tax asset here, against a deferred tax liability in the last chapter
- 06
Transferred depreciable assets, and profit released by excess depreciation
- 07
Services, interest, loans and dividends: full reversal and nothing else
- 08
Marking direction before it matters
Eliminate a part-sold inventory transfer with its tax effect
- 3State what the group actually holds, and at what cost.
- 4Write the elimination entry, reversing the internal amounts in full.
- 2Write the tax entry and say why it is an asset.
Key terms
- Unrealised Profit
- Profit recorded on a transfer between group members that the group has not yet made, because the item is still held inside the group rather than sold to an outside party.
- Upstream Transaction
- A sale from a subsidiary to its parent. The subsidiary recorded the profit, which is what makes the direction matter once a non-controlling interest exists.
- Downstream Transaction
- A sale from a parent to its subsidiary. The parent recorded the profit, so eliminating it changes the parent's column and leaves the subsidiary's result untouched.
- Realisation
- The point at which an internally transferred item is sold to an outside party, or consumed through depreciation, so that the profit attached to it becomes the group's own and no longer needs eliminating.
- Excess Depreciation
- Depreciation charged by the buying entity on a transfer price above the group's own cost. Reversing it each year is the mechanism by which a transfer gain becomes realised.
Intragroup Transactions and Unrealised Profit FAQ
Do we only reverse the unsold portion of an intragroup sale?
No, and this is the error that costs most marks in the topic. The internal sale did not happen at all from the group's point of view, so the full recorded revenue and the full recorded cost of sales are reversed regardless of how much has since been sold outside. What the proportion decides is only how much profit is still buried in the asset, which is the credit to inventory.
Write the revenue at the internal selling price, the inventory credit at the unrealised profit, and let cost of sales balance.
Is the deferred tax on an intragroup profit an asset or a liability?
An asset. The selling entity has already paid tax on a profit the group has not yet made, so the group has prepaid tax and recognises a deferred tax asset with a credit to income tax expense. It runs the opposite way to the deferred tax liability created by a fair value uplift on consolidation, which is why candidates who have just drilled the valuation entries often write it upside down. Ask who paid tax on what.
Why is a dividend from a subsidiary not income to the group?
Because it is a movement of equity inside the reporting entity rather than a transaction with anybody outside it. The parent's dividend revenue and the subsidiary's dividend paid or declared are removed against each other, and where the dividend is declared but unpaid the intragroup receivable and payable are removed as well. Nothing is retained inside the group, so no asset is written down and no deferred tax arises.
Exam move
Take the four transaction families and write, for each, one sentence answering whether anything is left inside the group. Then invent one example of each and write the entries without looking. The families are few enough to hold in your head, and the examination skill is sorting an unfamiliar part into the right family quickly rather than computing, because the computing is short once the family is known.
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