intra group trading assignment

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CHAPTER ONE
INTRODUCTION
1.1 Introduction
Sometimes a company is acquired on the basis that the parent company trades with it
regularly. It is therefore sensible to bring that company into the group so that the supply of goods
or services can be secured and controlled.
Where this situation arises it is important to remember that each company is a legal entity
in its own right that will record transactions in their own way. However, when the two
companies are brought together in the consolidated financial statements, adjustments will need to
be made to reflect the single economic entity.

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CHAPTER TWO
INTRA GROUP TRADING
2.1 Introduction
There may be transactions between companies within a group. In other words, a company
may trade with another company in a group. This is known as intra group trading or intra group
transaction. Intra group trading simply means trading between companies within the group. For
example, A Ltd (Parent company) sells goods on credit to B Ltd (Subsidiary). Here A Ltd and B
Ltd trade with each other.
2.2 Types of Intra Group Trading
 Sale and purchase of goods on credit .
 Loans held by one company in the other and interest on such loans
 Sale of non-current assets
 Intra group dividends
 Intra group investment in debentures
2.2.1 Sale and Purchase of Goods on Credit
One company, may sell goods on credit to another company in the group. In other words, one
company may buy goods on credit from another company within the group. For example, P Ltd
(parent company) sells goods for ? 1,00,000 to 8 Ltd (subsidiary company) on credit. This
trading will be included in the sales revenue of P Ltd and purchases of S Ltd. The effect of this
intra group trading must be eliminated from the consolidated statement of profit or loss. '
Consolidated sales revenue = P’s sales revenue + S’s sales revenue Intra group sales
Consolidated cost of sale = P’s cost of sale + S’s cost of sale Intra group sales.
In short, intra group sale or purchase must be deducted from the sales of P Ltd and purchases
of S Ltd.

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The sale and purchase of goods on credit within the group lead to the following potential
problem areas:
a) Unrealised profit on inventory
b) Mutual indebtedness or mutual owings
a) Unrealised Profit on Inventory
When goods are sold or purchased within the group at cost (i.e., profit is not included)' then
there will be no further problem. Suppose the goods are sold by P Ltd at a profit of 20% on
selling price. This means that P Ltd has made a profit of T 20,000 (1.9,,1,00,000 x 20%) on
goods sold to S Ltd. If S Ltd could sell the entire goods bought from P Ltd, there is no further
problem. This is because S Ltd could realise the entire profit on this transaction. This means that
there is no question of unrealised profit. But if goods (or a part of such goods) remain unsold and
are included in the stock of S Ltd at the end of the year, the profit of T 20,000 charged by P Ltd
(or a part of T 20,000) remains unrealised. Such stock will include profit because inventories are
valued at cost plus profit, i.e., at the amount at which they were purchased from P Ltd. The profit
included in the inventory (stock) is called unrealised profit. In the above example, the unrealised
profit is T 20,000 (If the entire goods received from P Ltd remain in stock). If only half of the
goods remains in stock, the unrealised profit is T 10,000.
The inventory appearing in the balance sheet of 8 Ltd includes T 1,00,000 (if the entire goods
remain unsold). P Ltd records a profit of T 20,000 (included in the retained earnings) in its
individual accounts. This means profit made by members of a group on transactions with other
members are recognised in their individual accounts. However, from the group’s point of view,
the cost is T 80,000 (external sales nil) and closing inventory at cost is T 80,000 and profit or
loss is nil. In a consolidated balance sheet, the Only profits recognised should be those earned by
the group in providing goods or services to outsiders. Similarly, inyentory should be valued (in
the consolidated balance Sheet) at cost to the group.
In the individual balance sheet of P Ltd., the retained earnings are overstated by T 20,000
(unrealised). Similarly, in the individual balance sheet of 8 Ltd the inventory is ?Verstated by T

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20,000 (because T 20,000 profit which is unrealised is included in the 1nVentory). But from the
group’s point of view, the cost of inventory is T 80,000 and profit realised is nil (unrealised
profit is T 20,000). Therefore, an adjustment is needed in the consolidated balance sheet. The
adjusting entry (for provision for unrealised profit) is 3
Group retained earnings Dr. (with the amount of profit unrealised by the group
To Group inventory
In other Words, a reserve is created, equivalent to the unrealised profit. This is ed provision
for unrealised profit. If a portion of the goods has been sold by S Ltd, a proPortionate provision
should be created for unrealised profit on unsold goods. The
provision is created to eliminate the unrealised profit. In short, Rs 20,000 should be deducted
from retained earnings and also from inventory in the consolidated balance sheet. Suppose three-
fourth of the goods ate sold by S Ltd. Now the unrealised profit is Then Rs 5,000 (one-fourth of
the goods remains in stock). Then Rs 5,000 should be deducted from the retained earnings as
well as from the inventory.
b) Mutual Indebtedness or Mutual Owings
The intra group trading leads to mutual indebtedness or mutual owings. When one of the
members of the group sells or purchases goods on credit, mutual owings Will arise. For example,
when P Ltd sells goods for Rs1,00,000 to S Ltd on credit, it is a trade receivable for P Ltd and
trade payable for 5 Ltd. This means that Rs 1,00,000 is. due from S Ltd to P Ltd or 5 Ltd owes
Rs 1,00,000 to P Ltd. This is mutual owings. This is included in the trade receivables of P Ltd
and trade payables of S Ltd. This intra group owings should be eliminated in the consolidated
balance sheet. Hence, while preparing consolidated balance sheet, the mutual owings should be
deducted from the trade receivables and also from the trade payables.
In respect of the gdods sold on credit by one of the group members to another member,
the company which has sold goods may draw a bill of exchange on the company which has
purchased goods. For example, of Rs 1,00,000 goods sold by P Ltd to S Ltd, P Ltd has drawn a

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bill for Rs 75,000 on 3 Ltd. In this case the bills receivable of P Ltd will include Rs 75,000
drawn on 8 Ltd. and the bills payable of S Ltd will include Rs 75,000 accepted by S Ltd. This is
a mutual owing. All mutual owingsshould be eliminated in the consolidated statements. Hence,
Rs 75,000 should be deducted from bills receivable and also from bills payable in the
consolidated balance sheet.
2.2.2 Loans held by One Company in the Other and Interest on such Loans
Sometimes one company in the group grants loans to another in the group. For example,
P Ltd gives a loan of Rs 1,00,000 to S Ltd. For P Ltd this is an asset, while for S Ltd this is a
liability. Both asset and liability must be eliminated while preparing consolidated balance sheet.
P Ltd shall get interest on loan granted to S Ltd. At the sar'ne time, S Ltd has to pay
interest on loan taken from P Ltd. The loan interest received must be eliminated from the
consolidated statement of profit or loss. The interest should be deducted from group investment
income and group finance costs.
2.2.3 Intra Group Sales of Non-current Assets
Sometimes sale of non-current assets takes place between companies within the MP. The
company selling the fixed asset may make a profit, while the buying company
Would record the fixed asset at the cost at which it purchased the fixed asset. This Cost
Will include the profit charged by the selling company. Following adjustments should be done in
the consolidated balance sheet.
a) Unrealised profit on sale of fixed assets : The profit recorded by the selling company should
be treated as an unrealised profit in the eyes of the group. This is because the buying company
would not usually resell the fixed asset to outside
customers. The amount of such unrealised profit must be eliminated from the group profit as well
as from the group’s cost of .fixed asset.
b) Depreciation on inflated costs : The company buying the fixed asset would provide

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depreciation based on its costs. This cost is an inflated value because this includes the unrealised
profits of the selling company. Thus, the depreciation charged is high. This amount of excessive
depreciation should be deducted from the unrealised profit. Only
the balance of unrealised profit should be deducted from the group retained earnings
as well as from the group’s fixed asset. The adjusting entries are as follows
a) If the fixed asset is sold by parent company
Group retained earnings Dr. (with profit on sale less the additional or excess depreciation) .
To Non-current or fixed asset
Thus, the adjustment is that the profit on sale less additional or excess depreciation
should be deducted from group retained earnings. The same amount should be deducted from the
fixed asset also. '
b) If-the fixed asset is sold by subsidiary company
Group retained earnings Dr. (parent’s share in subsidiary)
Non-controlling interest Dr. (non controlling share holders’ share)
To Non-current or fixed asset
Thus, the adjustment is that the profit on sale less additional depreciation (parent’s share
only) should be deducted from group retained earnings and the share of non controlling
shareholders should be deducted from NCI. The total profit on sale less additiohal depreciation
should be deducted from the asset.
2.2.4 Intra Group Dividends
So far we have assumed that the subsidiary company retains all of its after tax profit.
However, the subsidiary company shall distribute some of its profits as dividends. In other words,

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dividends may be received by the parent company from the subsidmry company on the shares
held by the parent company. Such dividend is called intra group dividend. Dividend may be
received by the parent either out of pre-acquisition profit or out of post-acquisition profit.
 Dividends received by Parent Company out of Pre-acquisition Profits of the
subsidiary
A subsidiary company can pay dividends out of past profit earned before the parent
company acquired shares in the subsidiary (i.e., out of pre-acquisition profits): This usually
happens when thr I arent company buys shares ’cum dividend’. It may do so in the current year
or any future year. For the parent company, any dividends received out of pre-acquisition profits
represent a reduction in its Cost of acquisition (’Non-current Investment in Subsidiary’
appearing under the assets in its balance sheet). This is a decrease in the price paid for the shares
of the subsidiary. Accordingly, parent company should pass the following entry in its books on
receiving dividends.
Cash A/c Dr.
To Investment in Subsidiary
The effect of this entry is that the cost of investment in subsidiary is reduced (because it is
credited). In the meantime parent company’s share in the pre-acquisition profit of subsidiary is
reduced by an equal amount (because dividend is paid out of it). Therefore, dividend received by
parent company out of the pre-acquisition profits of the subsidiary has no effect on the amount of
goodwill or bargain purchase gain.
To determine whether the dividend received is declared out of pre-acquisition profits or post
acquisition profits, the period for which dividend is declared is relevant and not the date of
declaration of dividend.
 Rectificaton of Error Relating to Dividend Receivedfrom Subsidiary

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Sometimes the parent company may credit its profit and loss statement When it receives
dividend from subsidiary out of pre-acquisition profit. This is an error. This should be corrected
while preparing consolidated balance sheet. Similarly, the parent company may omit to record
the dividend received. This omission should be corrected by means of a journal entry. The
following procedure may be adopted:
a) Consider the total dividend paid while calculating the current year profit of the subsidiary.
b) Deduct the share of parent company in the dividehd'from the cost of investment in the
subsidiary (instead of crediting profit or loss statement, cost of investment in subsidiary should
be credited).
c) Deduct the share of parent company in the dividend, from the profit of the parent company
(i.e., debit the profit or loss statement to correct the wrong credit given to profit or loss
statement).
Thus, the rectification entry is:
Profit or Loss Dr.
To Shares in Subsidiary or Investment in Subsidiary
 Dvidend Receivedby Parent Company out of Post-acquisition Profit of Subsidiary
If the subsidiary has already paid dividends out of post-acquisition profits, the matter should
be regarded as closed and nothing more needs to be done about this
When the subsidiary paid dividends, it would have debited the amount to its Statement ofpor
L (or Reserve and Surplus) and credited to Cash Account. As parent Company has already
received cash, it would have credited its Profit and Loss Statement and debited Cash Account.
The non-controlling interest in this regard has also been satisfied. Thus, there is no intra group
liability to be eliminated while preparing consolidated balance sheet. Hence, there is no need for
any consolidation adjustment (simply ignore it).

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 Interim Dividend Receivedfrom Subsidiary
The parent company may receive interim dividend from the subsidiary. Interim dividend is
usually declared and paid in the middle of the year. Interim dividend is to be apportioned
between pre-acquisition period and post-acquisition period on the basis of time ratio on the
assumption that interim dividend is earned equally throughout the year. This is because we
assume that interim dividend is paid for full year and out of Current year profit, irrespective of its
date of declaration and payment.
Interim dividend should be taken into consideration while calculating pre-acquisition Profit
and post-acquisition profit. While calculating pre-acquisition profit, interim dividend ' relating to
pre-acquisition period should be deducted. Likewise, while calculating pre acquisition profit, the
interim dividend relating to post-acquisition period should be deducted. Thereafter, the interim
dividend relating to post-acquisition period should be ignored (reason 13 already given) Then
interim dividend relating to pre-acquisition Period should be taken into consideration while
preparing consolidated balance sheet. tis deducted from cost of investment (price paid) while
calculating goodwill / bargain purchase (capital loss is reduced or gain is increased). Thus, asset
is reduced. In the Wondated balance sheet, it should be deducted from retained earnings / surplus
of parent company. Thus, liability is reduced. In this way balance sheet will get tallied.
 Proposed Dividend out of Post-acquisition Profits
Usually dividends are proposed by the subsidiary out of post acquisition profits. The basic
rule is that if a subsidiary has not yet paid a dividend (but declared or proposed) on the equity
capital, this appropriation shall be ignored in consolidation. The full amount of revenue profit
(Without deducting the proposed dividend) attributable to parent company’s share in the
subsidiary is taken in the consolidated balance sheet as usual. However, if the parent company
has already recorded its share of proposed dividend from subsidiary as income in its profit and
loss statement and as an asset (dividend receivable) in its balance. sheet, then the intra group
indebtedness due to the pending dividends has to be cancelled or eliminated. This is because an
organisation (group) cannot owe money to itself. As already stated all intra group liabilities and
indebtedness must be eliminated While preparing the consolidated balance sheet. To eliminate

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the proposed intra group dividend in the consolidated balance sheet, the following journal entry
is to be passed :
Proposed Dividend (S Ltd) Dr.
To Dividend Receivable (P Ltd)
Minority’s portion (amount due to non-controlling shareholders) of the dividend pr0posed
by the subsidiary is payable to parties outside the group within a short period Of time. Hence, it
should be shown as current liability in the consolidated balance sheet. If P’s share (in the post
acquisition profit) is based on profit after deducting dividend, then P’s share in the proposed
dividend is added to retained earnings while calculating group retained earnings.
2.2.5 Intra Group Intrestment in Debentures
The parent company and its subsidiary may often buy each other’s debentures or bonds. If
the parent company has invested in the debentures of the subsidiary it is shown as ’investment in
debentures of subsidiary’ (asset) in the balance sheet of the parent company. In the subsidiary’s
individual balance sheet, it is shown as debentures issued (liability). Both asset and liability
should be eliminated in the consolidated balance sheet.
If debenture interest has already been paid on mutual debts at the date of consolidated
balance sheet, no cancelling adjustment is necessary. However, if on the date of consolidation,
any interest is outstanding on intra group debt (shown as payable in the balance sheet of the
company that issued debentures and as a receivable in the balance sheet of the company that
made the investment), it should be eliminated. Thus, the intra group account payable and
receivable are cancelled.
 Parent Company which has Two Subsidiaries

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Sometimes a parent company may have two subsidiaries.Then the parent and its two
subsidiaries constitute a group. In suchcases, the preparation of consolidated balance sheet is
somewhat difficult
 Consolidated Statement of Profit or Loss
In addition to the consolidated balance sheet, the group is required to prepare the
consolidated statement of profit or loss and other comprehensive income. There are two options.
One option is to prepare two separate statements : (a) Statement of profit or loss, and (b)
statement of other comprehensive income. The other option is to prepare only one statement
(combined) Statement of profit or loss and other comprehensive income.
 Impact of Intra-group Trading on Consolidated Statement of Profit or Loss
When one company in a group sells goods (on credit) to another, the sax‘ne amount is added
to the sales revenue of the first company (seller) and to the cost of sales to the second company
(buyer). The consolidated figures for sales revenue and cost of sales should represent sales to,
and purchases from, outsiders. Therefore, an adjustment is necessary to reduce the sales revenue
and cost of sales figures by the amount of intragroup transaction. This means that such intra-
group transaction should be cancelled in the consolidated statement of profit or loss.
The goods sold at a profit within the group may remain in stock of the purchasing company
at the year end. Then unrealised profit included in such inventory should be ' excluded from the
figure of group profits. The best way to deal with this is to calculate the unrealised profit on
unsold stock at the year end and add this amount back to cost of sales, thereby reducing gross
profit.

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CHAPTER THREE
CONCLUSION
Where this situation arises it is important to remember that each company is a legal entity
in its own right that will record transactions in their own way. However, when the two
companies are brought together in the consolidated financial statements, adjustments will need to
be made to reflect the single economic entity.
There may be transactions between companies within a group. In other words, a company
may trade with another company in a group. This is known as intra group trading or intra group
transaction. Intra group trading simply means trading between companies within the group.

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BIBLIOGRAPHY
 Articles
Intra group: Meaning, Advantages and Disadvantages-Article shared by: HIMANSHI
JESWANI- 8/8/1999
 Web sites
https://economictimes.indiatimes.com/definition/intragroupdivident
http://www.yourarticlelibrary.com/accounting/share/sebi-guidelines-of-a-company/46870