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Eliminating IC Profits in Inventory: The Challenge of IFRS 10 - B86(c)

 

 

Introduction

IFRS 10:B86, covering the topic of “Consolidation Procedures”, can probably be described as a brief summary of the core functionality that consolidation software solutions like Tagetik CPM offer:

 

  • B86 (a) combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries.
  • B86 (b) eliminate the carrying amount of the parent’s investment in each subsidiary and the parent’s portion of equity of each subsidiary.
  • B86 (c) eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group.

 

Apparently, the third consolidation procedure IFRS 10:B86(c) needed some additional explanation, as the IASB added to B86(c) between brackets: “(profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full)”.

 

 2016-11-17-ic-eliminations-dgi

 

 

Challenge

Eliminating profits on intragroup transactions that are recognized in inventory can be a real challenge to the office of finance. This is especially challenging in those situations where a corporation has vertically integrated in the value chain and intercompany deliveries are plenty. The challenge of eliminating profits on intragroup transactions that are recognized in inventory only appears at consolidated (sub-)level; it is not an issue in the single company financial statements. The question is how a consolidation software solution can be utilized to address this challenge.

 


Solution

Instead of pushing the challenges to the corporate head office (and often inconveniently at the end of the closing process), we have chosen at DGI to embed a pragmatic solution in our consolidation process in Tagetik, shifting responsibility to local contributors whilst acting purely as process coordinator at corporate head office.
The interesting thing is that the actual elimination of profit included in inventory is dependent on input from 2 entities:

 

  1. First of all, input is needed from the supplying entity regarding the intercompany revenue and corresponding gross margin per counterparty. This input is to be provided in the first step (intercompany balances/transactions) in our consolidation process.
  2. Secondly, input is needed from the receiving entity in order to calculate the amount of profit that is included in inventory. For that purpose, the intercompany revenue and corresponding gross margin declared by the supplying entity are used as inflow in a movement schedule at the receiving entity. The input that the receiving entity is required to provide is limited to a declaration of the consumption of the supplied goods. As a result, an ending balance (opening balance in next period) will remain of both Intercompany Revenue and corresponding Gross Margin. The ending balance of the Gross Margin represents the mentioned profit resulting from intragroup transactions that are recognized in assets and will be eliminated in full.

 


Concluding remarks

A push down of challenges from corporate head office to local contributors comes with a risk of endless additional data requirements. In order to make sure that the designed solution would not overcomplicate data entry and intercompany balancing efforts at entity level within the Group, we decided to work with total intercompany revenue per period by counterparty against an average gross margin instead of detailing the information up to transactional level.


As mentioned before, we have chosen to embed the described solution in our consolidation process in Tagetik. In the first step in the consolidation process all intercompany balances/transactions are recorded and matched. The deadline of submission in our case is day 2 and local contributors are responsible for the intercompany matching. Corporate head office plays the vital role of process coordinator by making sure that the deadline for intercompany matching is met by all contributors. Actually, the process coordinator role of corporate head office won’t stop at this point. On the contrary, we continue to make sure that the next deadline for the monthly close is met. And since the mentioned solution is embedded in the consolidation process, along the way the challenge of IFRS 10:B86(c) is addressed as well.

 

 

Consolidation

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