IFRSs offer limited guidance on how to account for intra-group transactions specifically in separate financial statements. While the effects of these transactions are eliminated during the preparation of consolidated financial statements, their impact on separate financial statements can be significant. Moreover, an intra-group transaction might affect the consolidated financial statements of a sub-group when the related party is under the control of the same ultimate parent but isn’t part of the sub-group.
The prevailing principle is that IFRS requirements apply uniformly to both consolidated and separate financial statements (IAS 27.9). However, there may be instances in which intra-group transactions are either overtly or implicitly directed by the ultimate parent. This will be particularly evident when the price of a good or service differs from the market price, or when no consideration is given at all.
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Recognition
When a reporting entity enters into a contractual agreement, it must reflect that transaction in its financial statements and recognise any resulting rights or obligations, even if no consideration is involved.
However, if the reporting entity is not involved in a contract, it has two accounting policy choices:
- Recognise the transaction as detailed in the ‘Measurement’ section below; or
- Not recognise the transaction at all, except for group share-based payment arrangements.
Measurement
When an entity recognises an intra-group transaction that hasn’t been conducted on market terms, it first needs to establish whether the transaction falls under a specific IFRS that determines the initial recognition amount. For example, all financial instruments should be initially measured at fair value. This applies to, for example, intra-group interest-free loans or loans at below-market interest rates.
If no specific IFRS requirements exist for the initial recognition amount, the entity has the option to measure the transaction at:
- Fair value; or
- The contractual price.
For business combinations under common control, a book-value method can also be applied to the acquired assets and liabilities, in which case the predecessor values are used.
If a transaction is recognised at fair value, the difference between the fair value and the contractual price is recognised as an equity transaction. It’s important to note that IFRSs neither specifically mandate nor prohibit separate recognition of an off-market element of an intra-group transaction.
While IFRS 18 / IAS 1 require transactions involving owners in their capacity as owners to be recognised directly in the statement of changes in equity, this is a broad requirement, and its application to various transactions isn’t elaborated further.
Examples
Example: Sale of PP&E for less than fair value
Suppose a parent company sells an item of PP&E to its subsidiary for $2m. In the parent’s books, the PP&E’s carrying amount is $1.3m, while its fair value is estimated at $3m.
Approach #1: Transaction recognised at fair value
The subsidiary recognises the PP&E at its fair value of $3m. The difference between this fair value and the $2m transaction price is treated as an equity contribution from the parent:
The parent derecognises the PP&E from its books and recognises a gain on disposal. This gain is calculated as the difference between the PP&E’s fair value and its carrying amount. The difference between the PP&E’s fair value and the transaction price is accounted for as an equity contribution to the subsidiary, increasing the cost of the investment. The parent’s accounting entries are:
Approach #2: Transaction recognised at the stated transaction price
In this approach, entities recognise standard accounting entries based on the transaction price:
Subsidiary:
Parent:
Example: Sale of PP&E for more than fair value
Now consider a scenario in which the parent sells PP&E to its subsidiary for $3.5m, which is higher than its fair value. The PP&E’s carrying amount in the parent’s books is still $1.3m, and its fair value remains $3m.
Approach #1: Transaction recognised at fair value
The subsidiary recognises the PP&E at its fair value of $3m. The difference between this fair value and the transaction price is treated as an equity distribution:
Such a distribution is often classified as a dividend, assuming the subsidiary has adequate distributable accumulated profits.
As in the earlier example, the parent derecognises the PP&E from its statement of financial position and recognises a gain on disposal. This gain is the difference between the PP&E’s fair value and its carrying amount. The difference between the PP&E’s fair value and the transaction price can be recognised as dividend income in P/L or as a partial repayment of the cost of the investment in the subsidiary, with no P/L impact. The approach taken depends on the available accumulated profits in the subsidiary. The parent’s accounting entries are:
It’s worth noting that the $0.5m credit entry cannot be recognised directly in equity, as it isn’t a transaction with owners from the parent’s viewpoint. However, if this transaction took place between fellow subsidiaries, the credit entry would be recognised directly in equity, representing a contribution by a parent through another subsidiary.
Approach #2: Transaction recognised at the stated transaction price
As in the first example, entities use standard accounting entries. However, the subsidiary must ensure that the acquired asset isn’t carried above its recoverable amount.
Example: Distribution of inventory without consideration
Suppose a subsidiary has transferred some of its inventory to its parent company without charging consideration. This inventory has a carrying amount of $4m and a fair value of $5m. IFRIC 17 Distributions of Non-cash Assets to Owners would typically be relevant here. However, it doesn’t apply if the non-cash asset remains under the ultimate control of the same party both before and after the distribution (IFRIC 17.5).
The parent company typically recognises the received assets at their fair value. The corresponding entry would be a credit to dividend income in P/L. If the subsidiary doesn’t have sufficient accumulated profits, this can be recognised as a decrease in the investment in the subsidiary. Some accountants believe that the assets can also be recognised at their predecessor value, which is the carrying amount shown in the subsidiary’s financial statements. However, in my opinion, this method is restricted to accounting for business combinations under common control.
For the subsidiary, there are two potential approaches to recognising this transaction:
Approach #1: Recognition at book value
Here, the subsidiary recognises the distribution based on the carrying amount of the distributed assets, without any impact on P/L:
Approach #2: Recognition at fair value
By analogy to IFRIC 17, the subsidiary recognises the dividend payable at the assets’ fair value:
On settling the dividend payable, the difference between the book value of the distributed assets and the payable amount is recognised in P/L:
Example: Complimentary use of office space
In this scenario, Subsidiaries A and B are both controlled by Parent P. A leases 1,000 sq m of office space from an external party. B’s employees use 200 sq m of this space, even though B isn’t named on the lease. Moreover, Subsidiary A doesn’t charge Subsidiary B for this space.
Given this, Subsidiary B has two choices:
- Not recognising any expense, since it isn’t contractually entitled to use the space.
- Recognising an expense in P/L, representing the estimated charge for the space used, for example, $50k. In this case, a corresponding credit is made to equity, representing an equity contribution from Parent P, with A as the intermediary:
Financial guarantee contracts
If a parent issues a financial guarantee contract on behalf of its subsidiary, it must initially recognise it at fair value in its separate financial statements (IFRS 9.5.1.1). The standard practice is to recognise a corresponding debit either as an expense in P/L or as an increase in the carrying amount of the investment in the subsidiary. The subsidiary doesn’t make any entries, as it isn’t involved in the contract. Importantly, this guarantee is eliminated from consolidated financial statements because the underlying loan already appears in the consolidated statement of financial position.
Disclosure
Disclosures of related party transactions and relationships are addressed in IAS 24.