Question

L Ltd acquired 100% of M Ltd in 20x5. At the date of acquisition, M Ltd had a piece of machinery carried in its book at an amount lower than its fair value. This piece of machinery was used by M Ltd for 10 years from 20x2. For the 20x8 consolidation, the following consolidation journal entry was shown

Dr Depreciation expense

Cr Accumulated depreciation: Machinery

Required: briefly explain the purpose of the above CJE

In 20x5, P Ltd sold a piece of machinery to its subsidiary, Q Ltd, at an amount higher than its carrying amount. The machinery was to be used by Q Ltd for the next 5 years. For the 20x8 consolidation, the following consolidation journal entry was shown

Dr Accumulated depreciation: Machinery

Cr Depreciation expense

Required: briefly explain the purpose of the above CJE

Answer 1

Answer:-

1)

In M’s books, depreciation is charged based on an amountlower thanfair value.

In CFS, the machinery isrestatedto fair value and depreciation ischarged based on fair value (higher than M’s records)

Need to account for theadditional depreciationarising from fair valueadjustment on consolidation.

Eg. M carried the machinery at 150,000. Fair value is 200,000.Annual depreciation in M’s books:

Dr Depreciation expense15,000

Cr Accumulated depreciation15,000

Annual depreciation in group’s books:

Dr Depreciation expense20,000

Cr Accumulated depreciation20,000

Adjusting entry:

Dr Depreciation expense5,000

Cr Accumulated depreciation5,000

2)

If there wasno intragroup sale, P ltd should have anannualdepreciation chargeof (original cost / useful life).

In Q Ltd’s books, the annual increment to the accumulateddepreciation is higher since P sold the machinery to Q at anamount higher than its carrying amount.

accumulateddepreciation account is overstated, thus need to reverse thedepreciation expense journal entry by the overstated amountGradual realizationof unrealized profit arising from inter-company sale of machinery.

The unrealized inter-companyprofit is to be realized through the depreciation process.