IFRS contain very limited guidance on accounting for intra-group transactions that would apply specifically to separate financial statements. Although effects of such transactions are eliminated in the course of preparation of consolidated financial statements, they may have a material impact on separate financial statements. Furthermore, an intra-group transaction may also impact consolidated financial statements of a sub-group, if the related party is controlled by the same ultimate parent, but doesn’t belong to the sub-group.
The general rule is that the requirements set out in IFRS apply equally to consolidated and separate financial statements (IAS 27.9). However, there are many instances of intra-group transactions being (more or less explicitly) directed or influenced by the ultimate parent. In particular, the price paid for a good or service may differ from the market price, or there may be no consideration at all.
Recognition
If the reporting entity is a party to a contractual relationship, it should recognise the intra-group transaction in its financial statements to reflect the rights or obligations arising from it, even if there is no consideration involved.
If the reporting entity isn’t a party to a contract, it has an accounting policy choice:
- to recognise the transaction as discussed in the ‘Measurement’ section below; or
- not recognise the transaction at all.
This choice is available only if there are no IFRS requirements specifically requiring recognition of such a transaction or event irrespective of contractual commitments of the reporting entity (e.g. share-based payment under IFRS 2).
Measurement
If an entity decides (or has no other option – see ‘Recognition’ above) to recognise an intra-group transaction that was not carried out at fair value, it must first determine whether this transaction is in the scope of a specific IFRS that prescribes the initial recognition amount. In particular, all financial instruments should be initially recognised at fair value as determined in IFRS 9 (for example, see Interest-free loans or loans at below-market interest rate).
Provided that there are no IFRS requirements prescribing the initial recognition amount, the entity can choose to measure the transaction at:
- fair value; or
- stated contractual price.
When the transaction constitutes a business combination under common control (read more), it is also possible to apply a book-value method to received assets and liabilities, i.e. use the predecessor amounts.
If the transaction is measured at fair value, the difference between fair value and stated contractual price is recognised as an equity transaction. It’s worth noting that separate recognition of an off-market component of an intra-group transaction is neither explicitly required nor prohibited in IFRS. IAS 24 requires disclosure of intra-group transactions but doesn’t prescribe any distinct accounting treatment. It’s true that IAS 1.109 requires transactions with owners in their capacity as owners to be reported directly in the statement of changes in equity. This is however a very broad requirement and it’s application to transactions is not discussed further in IFRS.
Examples
Example – Sale of PP&E for less than fair value
Parent sells an item of PP&E to its subsidiary for $2m. The carrying amount of PP&E in parent’s books amounts to $1.3m while the fair value is estimated at $3m.
Approach #1 Transaction is recognised at fair value.
The subsidiary recognises the item of PP&E at fair value of $3m with an implied contribution to equity by the parent measured as the difference between the fair value of PP&E and the contractual price:
| DR | CR | |
| PP&E | $3m | |
| Cash | $2m | |
| Equity | $1m |
The parent derecognises the item of PP&E and recognises a gain on disposal measured as the difference between the fair value of PP&E and its carrying amount. The difference between the fair value of PP&E and the contractual price is recognised as an equity contribution to the subsidiary (hence increasing the cost of the investment). Entries recognised by the parent are as follows:
| DR | CR | |
| Cash | $2m | |
| Investment in subsidiary | $1m | |
| PP&E | $1.3m | |
| Gain on disposal of PP&E | $1.7m |
Approach #2 Transaction is recognised at the stated transaction price.
When a transaction is recognised at the stated transaction price, entities recognise typical accounting entries:
Subsidiary:
| DR | CR | |
| PP&E | $2m | |
| Cash | $2m |
Parent:
| DR | CR | |
| Cash | $2m | |
| PP&E | $1.3m | |
| Gain on disposal of PP&E | $0.7m |
Example – Sale of PP&E for more than fair value
Let’s now assume that the parent sells an item of PP&E to its subsidiary for $3.5m, i.e. above its fair value. As in previous example, the carrying amount in parent’s books amounts to $1.3m while the fair value is estimated at $3m.
Approach #1 Transaction is recognised at fair value.
The subsidiary recognises the item of PP&E at fair value of $3m with an implied distribution from equity measured as the difference between the fair value of PP&E and the transaction price:
| DR | CR | |
| PP&E | $3m | |
| Cash | $3.5m | |
| Equity | $0.5m |
Such a distribution is usually classified as a dividend provided that there are sufficient distributable accumulated profits available in the subsidiary.
As in previous example, the parent derecognises the item of PP&E and recognises a gain on disposal measured as the difference between the fair value of PP&E and its carrying amount. The difference between the fair value of PP&E and transaction price is recognised either as a dividend income in P/L or as partial repayment of the cost of the investment in subsidiary without any impact on P/L. The treatment depends on whether there are sufficient accumulated profits available in the subsidiary. Entries recognised by the parent are as follows:
| DR | CR | |
| Cash | $3.5m | |
| PP&E | $1.3m | |
| Gain on disposal of PP&E | $1.7m | |
| Dividend income or Investment in subsidiary | $0.5m |
Note that the credit entry of $0.5m cannot be recognised directly in equity because it is not a transaction with owners from parent’s perspective. If, however, this transaction was carried out between fellow subsidiaries, then the credit entry would go directly to equity as it would represent a contribution made by a parent via another subsidiary.
Approach #2 Transaction is recognised at the stated transaction price.
When a transaction is recognised at the stated transaction price, entities recognise typical accounting entries as in the previous example. However, the subsidiary must ensure that the asset acquired is not carried above its recoverable amount as determined in IAS 36.
Example – Distribution of inventory for no consideration
A subsidiary distributes some of the inventory to its parent for no consideration. The carrying amount of the inventory is $4m while the fair value amounts to $5m. Normally, IFRIC 17 Distributions of Non-cash Assets to Owners would apply to such distributions. However, this interpretation does not apply to a distribution of a non-cash asset that is ultimately controlled by the same party or parties before and after the distribution (IFRIC 17.5).
The parent would usually recognise the assets received at fair value with a corresponding credit entry to dividend income in P/L or, if there aren’t sufficient accumulated profits available in the subsidiary, as a reduction of the investment in the subsidiary. Some accounting professionals also argue that the assets received can be recognised at the predecessor value, i.e. carrying amount as reported in the financial statements of the subsidiary, instead of fair value. However, this approach is often thought to be reserved for business combinations under common control only (read more).
The subsidiary has a policy choice and can account for the transaction using the carrying amount of the inventory given or by applying IFRIC 17 by analogy (i.e. at fair value). These two approaches are illustrated below.
Approach #1 Recognition at carrying amount
Under this approach, the subsidiary recognises the distribution at the carrying amount of assets being distributed, without recognising any P/L impact:
| DR | CR | |
| Inventory | $4m | |
| Equity | $4m |
Approach #2 Recognition at fair value
Under this approach, per analogy to IFRIC 17, the subsidiary measures the dividend (distribution) payable at the fair value of the assets to be distributed:
| DR | CR | |
| Payable | $5m | |
| Equity | $5m |
Then, when settling the dividend (distribution) payable, it recognises the difference between the carrying amount of the assets distributed and the carrying amount of the payable in P/L:
| DR | CR | |
| Payable | $5m | |
| Inventory | $4m | |
| Gain on disposal of inventory | $1m |
Example – Provision of office space for free
Subsidiaries A and B are ultimately controlled by Parent P. Subsidiary A leases 1,000 sq m of office space from a third party. Employees of Subsidiary B are allowed to use 200 sq m of this space without Subsidiary B being a party to the lease contract. Furthermore, Subsidiary A does not recharge any costs to Subsidiary B.
In this scenario, Subsidiary B can elect not to recognise any expense as it isn’t a party to a contractual relationship. Alternatively, Subsidiary B can recognise an expense in P/L representing the implied charge for the office space used (say, $50k). Under the second approach, a corresponding credit entry goes to equity to represent an equity contribution made by Parent P with Subsidiary A acting as an intermediary:
| DR | CR | |
| Rental expense | $50k | |
| Equity | $50k |
Financial guarantee contracts
When a parent issues a financial guarantee contract on behalf of its subsidiary, it must recognise it initially (in its separate financial statements) at fair value in accordance with IFRS 9.5.1.1. It is a generally accepted practice to recognise a corresponding debit entry either as an expense in P/L or an additional investment in the subsidiary. The subsidiary, in turn, does not recognise anything in its separate financial statements as it is not a party to a contractual relationship.
It’s worth noting that such a guarantee should be eliminated from consolidated financial statements since the underlying borrowing is already shown in the consolidated statement of financial position.
Other points
Business combinations under common control (‘BCUCC’) are currently on the agenda of the IASB. See this useful snapshot summarising IASB’s preliminary views. If you want to dig deeper, I highly recommend reading the Discussion Paper.
Disclosure
Disclosures of related party transactions are related party relationships are covered in IAS 24 Related Party Disclosures.