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 can be significant on separate financial statements. 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, as indicated in IAS 27.9. However, there are numerous occurrences where intra-group transactions are either overtly or implicitly directed by the ultimate parent. This might be evident when the price of a good or service differs from the market price or when no consideration is given at all.
Recognition
When a reporting entity enters into a contractual agreement, it must reflect that transaction in its financial statements, recognising any resultant 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.
This decision only applies when there aren’t any IFRS requirements explicitly mandating the recognition of such a transaction or event, regardless of the reporting entity’s contractual obligations (e.g., share-based payment transactions as per IFRS 2).
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Measurement
When an entity chooses (or is left with no alternative as noted above) to recognise an intra-group transaction that hasn’t been conducted at fair value, it needs to first establish whether this transaction falls under a specific IFRS that determines the initial recognition amount. Notably, all financial instruments should be initially recognised at fair value according to IFRS 9. This is applicable to, for example, interest-free loans or those 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
- Contractual price.
For transactions that qualify as business combinations under common control, a book-value method can also be applied to acquired assets and liabilities, meaning 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 IAS 24 mandates the disclosure of such transactions, it doesn’t stipulate a specific accounting approach. It’s also worth noting that IAS 1.109 mandates that transactions involving owners in their capacity as owners should be recognised directly in the statement of changes in equity. However, this is a broad requirement, and its application to various transactions isn’t elaborated further in IFRS.
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:
| DR | CR | |
| PP&E | $3m | |
| Cash | $2m | |
| Equity | $1m |
The parent removes the PP&E from its books and records 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. Here are the accounting entries by the parent:
| DR | CR | |
| Cash | $2m | |
| Investment in subsidiary | $1m | |
| PP&E | $1.3m | |
| Gain on disposal of PP&E | $1.7m |
Approach #2: Transaction recognised at the stated transaction price
In this approach, entities record standard accounting entries based on the transaction price:
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
Now, consider a scenario where 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 value and the transaction price is treated as an equity distribution:
| DR | CR | |
| PP&E | $3m | |
| Cash | $3.5m | |
| Equity | $0.5m |
Such a distribution is often categorised as a dividend, assuming the subsidiary has adequate distributable accumulated profits.
Similarly to the earlier example, the parent removes the PP&E from its balance sheet 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 investment in the subsidiary, with no effect on P/L. The approach taken depends on the available accumulated profits in the subsidiary. Here’s a breakdown of the parent’s accounting entries:
| 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 |
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, then the credit entry would directly go to 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, as outlined in IAS 36.
Example: Distribution of inventory without consideration
A subsidiary has passed some of its inventory to its parent company without charging for it. This inventory has a carrying amount of $4m and a fair value of $5m. Typically, IFRIC 17 Distributions of Non-cash Assets to Owners would 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 enough accumulated profits, this can be recorded as a decrease in the investment in the subsidiary. Some accountants believe that assets can also be recognised at their predecessor value, which is the carrying amount shown in the subsidiary’s financial statements. However, this method is often viewed as exclusive to accounting for business combinations under common control in the consolidated financial statements.
For the subsidiary, there are two potential approaches to recording 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:
| DR | CR | |
| Inventory | $4m | |
| Equity | $4m |
Approach #2: Recognition at fair value
Following an analogy to IFRIC 17, the subsidiary recognises the dividend payable at the assets’ fair value:
| DR | CR | |
| Payable | $5m | |
| Equity | $5m |
Upon settling the dividend payable, the difference between the book value of the distributed assets and the payable amount is recognised in P/L.
| DR | CR | |
| Payable | $5m | |
| Inventory | $4m | |
| Gain on disposal of inventory | $1m |
Example: Complimentary usage of office space
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, 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 recording any expense since it isn’t contractually tied to the space.
- Recognising an expense in P/L, representing the estimated charge for the used space (e.g., $50k). With this, a corresponding credit is made to equity, indicating an equity contribution from Parent P, with A as the intermediary:
| DR | CR | |
| Rental expense | $50k | |
| Equity | $50k |
Financial guarantee contracts
If a parent issues a financial guarantee contract on behalf of its subsidiary, it must initially recognise it at its fair value as per IFRS 9.5.1.1 in its separate financial statements. The standard practice is to recognise a corresponding debit either as a P/L expense or as further investment in the subsidiary. The subsidiary doesn’t make any entries as it isn’t involved in the contract. Notably, this guarantee is eliminated from consolidated financial statements because the underlying loan already appears in the consolidated statement of financial position.
Business combinations under common control
The topic of business combinations under common control (BCUCC) is being discussed by the IASB. You can get a concise overview of the IASB’s initial views in this snapshot. For a more in-depth understanding, the Discussion Paper is a recommended read.
Disclosure
Disclosure of related party transactions and relationships are addressed in IAS 24.