Sales and Purchases

Sales and Purchases

Where there are mutual dealings-sales and purchases-between the companies in the group, transfers of goods between the companies may take place at a transfer value which is higher than cost. The point of this is to split the income earned on the completed transaction between the supplying company and the company which eventually sells the product outside the group. In preparing a consolidated income statement it will be necessary to eliminate such inter-company dealings from the total of group sales and purchases, so that no double counting occurs. A problem arises where one of the companies is at the financial year-end holding goods in inventory supplied by another company in the group at a price in excess of original cost. Such inventory will be included in the holder's books and inventory sheets at cost price to the buying company, which is cost price plus a profit margin from the group viewpoint, and in compiling group accounts it will be necessary to deal with the unrealized income. If the inventory of S Ltd includes goods received from P Ltd, at a cost of £2200 but the cost to P Ltd was £2000, from the group point of view, the inventory of S Ltd carries an unrealized income of £200. This would be adjusted on consolidation:

Credit - Consolidated income statement £200 Debit - Consolidated inventory £200

i.e., both the group income and the group inventory is reduced by £200. Where the subsidiary is wholly owned by its parent, it is clear that it is proper to remove from the group accounts the full amount of the unrealized income. If a minority is involved the position is a little more complicated. Where the inventory is held by a partly owned subsidiary the usual practice is to provide for the whole of the unrealized income, as above, so that inventory appears at its cost price in the consolidated balance sheet. Where the subsidiary is the supplying company and there is a minority shareholding in the subsidiary, the inter-company income has been earned from the point of view of the minority, and the view may be advanced that the minority should not be debited with its proportion of the unrealized income i.e., the minority should be entitled to its proportion of the income for the year before adjustment. But from a group point of view the income is not yet made and it can be argued that the adjustment should be made in proportion to the shares in the income of the subsidiary company e.g.:

Consolidated income statement £150

Minority interest £50

Consolidated inventory £200

Other treatments are also possible, but in most cases the amounts involved are not material and some variety in practice is permissible.

Much the same sort of situation arises in dealing with inter-group income arising on a sale or transfer of fixed assets between companies in the same group. Assume that P Ltd sells an item of plant which stood in its own books at £7000 to its wholly owned subsidiary for £8000 and that group policy is for each company to provide depreciation on this type of asset at a rate of 20 per cent per annum.


Learn More About Short-run Tactical Decisions

Read on: Subsidiaries Acquired During An Accounting Period

Subsidiaries acquired during an accounting period

It will be rare in practice for a subsidiary to be taken over on the same day as the first day of the financial year of the parent company so that the two accounting periods coincide. It is a requirement that the financial year-ends coincide after takeover. In the usual case of a subsidiary taken over during its financial year either proper final accounts can be specially prepared at the date of acquisition so that pre- and post-acquisition income can be distinguished or an apportionment can be made on a time or some other rational basis to determine... see: Subsidiaries Acquired During An Accounting Period