## **Learning Outcomes**

After reading this article, you will be able to explain why intragroup balances and transactions must be eliminated in consolidated financial statements. You will understand how to identify and adjust for unrealised profits on intragroup sales, and accurately compute the required consolidation adjustments. This knowledge is essential for preparing group accounts in line with IFRS 10 as required by the ACCA SBR exam.

## **ACCA Strategic Business Reporting (SBR) Syllabus**

For ACCA Strategic Business Reporting (SBR), you are required to understand the principles and practical application of group accounting under IFRS 10. This article focuses on the following syllabus areas:

- The control principle as the basis for consolidation (IFRS 10)
- The purpose and mechanics of consolidated financial statements
- The elimination of intragroup balances and transactions
- The identification and adjustment of unrealised profits on intragroup transfers of inventory and non-current assets
- The effect of consolidation adjustments on group profit, net assets, and non-controlling interests

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the main reason for eliminating intragroup transactions in consolidated financial statements?
2. Parent X sells goods to its subsidiary Y at a 30% profit margin. At year end, Y still holds 40% of these goods in inventory. How much unrealised profit should be eliminated from the group’s profit and inventory?
3. True or false? Intragroup receivables and payables are retained in consolidated financial statements as they represent valid external liabilities.
4. When a parent sells non-current assets to a subsidiary at a gain, how should unrealised profit and excess depreciation be treated in consolidation?

## **Introduction**

Group financial statements, prepared under IFRS 10, present a parent and its subsidiaries as a single economic entity. This requires removing the effects of transactions and balances within the group to avoid overstating group performance or position. One of the most frequent consolidation adjustments involves intragroup transactions and unrealised profits—key knowledge for ACCA exams.

> **Key Term: Intragroup transactions**  
> Transfers of resources, services, or obligations between entities within the same group.
>
> **Key Term: Unrealised profit**  
> Profit arising on intragroup sales where the related asset remains within the group at the reporting date.

## **CONSOLIDATION: THE NEED FOR ELIMINATION**

When a parent controls one or more subsidiaries, consolidated statements show the group as if it were a single entity. Transactions within the group (e.g. sales, loans, asset transfers) have no effect on the group’s net position with external parties and must be eliminated.

### Elimination of Intragroup Balances

Receivables and payables between group entities do not represent assets or liabilities of the group as a whole. Similarly, intragroup loans, accrued interest, dividends payable or receivable within the group are cancelled on consolidation.

### Elimination of Intragroup Transactions

Sales of goods or assets between group companies can inflate revenue and profit if not eliminated. Only income and expenses with third parties should appear in the consolidated figures.

### Unrealised Profits on Intragroup Sales

When goods sold within the group remain in inventory at the year end, the profit on those goods is “unrealised” from the group’s standpoint. This profit cannot be recognised until the goods are sold to customers outside the group.

> **Key Term: Consolidation adjustment**  
> An entry made when preparing consolidated financial statements that removes the effects of intragroup items.

## **UNREALISED PROFITS: CALCULATION AND ADJUSTMENT**

Unrealised profits can arise on intragroup sales of trading stock (inventory) or non-current assets. They must be deducted from group profit and the value of the relevant asset in the group statement of financial position.

### Inventory Sales Within the Group

If a parent company sells inventory to a subsidiary (or vice versa) at a profit, but the inventory remains unsold outside the group at year end, the profit earned is not realised for the group.

To identify the unrealised profit:

- Calculate the profit element included in closing inventory
- Reduce both group profit (usually retained earnings of the seller) and inventory by the unrealised amount

#### Inventory Sold by Parent to Subsidiary

If the parent is the seller, the unrealised profit adjustment reduces the parent’s retained earnings. When the subsidiary is the seller, the adjustment is made against the subsidiary’s retained earnings (and thus also affects the profit attributed to the non-controlling interest).

### **Worked Example 1.1**

**Alpha Ltd (parent) sold inventory to Beta Ltd (subsidiary) for £120,000, costing Alpha £90,000. At the year end, Beta still held 25% of these goods in inventory. Calculate the group’s unrealised profit adjustment.**

> **Answer:**  
> Profit on sale = £120,000 – £90,000 = £30,000.  
> Inventory remaining: 25% × £30,000 = £7,500 unrealised profit.  
> Eliminate £7,500 from consolidated retained earnings (Alpha’s) and reduce inventory by £7,500.

### Impact of Unrealised Profit Adjustments

Eliminating unrealised profit prevents the group from presenting gains that have not been achieved in transactions with external parties. Thus, group profit and net assets are not overstated.

### **Worked Example 1.2**

**A subsidiary sells goods to its parent for £40,000 at a mark-up of 20% on cost. At year end, the parent’s inventory includes £12,000 from these goods. What is the unrealised profit to eliminate, and how?**

> **Answer:**  
> Mark-up on cost of 20% means cost per £1 of sale is £1/1.2 = £0.833. Profit in sale: £40,000 – (£40,000 / 1.2) = £6,667.  
> Unrealised profit in inventory: £12,000 / £40,000 × £6,667 = £2,000.  
> Eliminate £2,000 from subsidiary’s retained earnings and reduce group inventory by £2,000.

### Non-Current Asset Transfers

When non-current assets (like property, plant, or equipment) are sold within the group, the gain recorded by the seller is not realised from the group’s standpoint if the asset remains within the group. The consolidated statements must:

- Eliminate any profit or loss arising from the transfer
- Adjust depreciation based on the asset’s original cost to the group

### **Worked Example 1.3**

**Parent sells a machine (original cost £60,000, carrying amount £36,000) to its subsidiary for £48,000, recording a gain of £12,000. The remaining useful life is 3 years. At year end, one year of use has passed since the sale. Prepare all necessary consolidation adjustments.**

> **Answer:**
>
> - Eliminate unrealised profit in the machine: if the machine remains in group use, only £4,000 of profit has been “realised” through depreciation (£12,000 ÷ 3 years × 1 year).
> - Unrealised profit at year end: £12,000 – £4,000 = £8,000.
> - Eliminate £8,000 from consolidated profit (seller’s retained earnings) and reduce the carrying amount of plant by £8,000.
> - Depreciation adjustment: Depreciation charged by subsidiary = £48,000/2 years = £16,000 p.a. However, group depreciation should be based on original cost, so adjust depreciation expense if necessary.

### **Exam Warning**

> Failing to eliminate all intragroup transactions and unrealised profits will result in both overstatement of group income and net assets. Always identify the inventory seller and allocate the removal of unrealised profit to the correct entity’s reserves.

## **Consolidation Adjustments: Key Steps**

When preparing consolidated accounts, always:

- Cancel intragroup receivables and payables
- Remove intragroup sales, purchases, income, expenses, and dividends
- Eliminate any unrealised profit on assets remaining in the group
- Adjust depreciation for non-current asset transfers to reflect group cost
- Recognise the effect on non-controlling interests only where the seller is a subsidiary

### **Revision Tip**

> When faced with group accounts questions, always annotate your workings to show which entity is the intragroup seller and the percentage of profit remaining unrealised at the year end.

## **Summary**

Intragroup eliminations and adjustment of unrealised profits ensure that consolidated statements reflect only the group’s external results. This prevents inflation of group profits and assets as a result of internal activity. A thorough command of these adjustments is essential for ACCA exam success when preparing group financial statements under IFRS 10.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain why intragroup balances and transactions must be eliminated in consolidated financial statements
- Identify situations where unrealised profits arise within the group
- Calculate and adjust for unrealised profits in year-end inventory and non-current assets
- Adjust group retained earnings and inventory or asset balances for consolidation
- Recognise the impact of consolidation adjustments on the non-controlling interest

## **Key Terms and Concepts**

- Intragroup transactions
- Unrealised profit
- Consolidation adjustment

Control and consolidation (ifrs 10) - Intragroup eliminations and unrealised profits