Auditing AASB 137

This report discusses the accounting requirements for investment in shares and the difference between consolidation accounting and equity accounting methods. It explores the treatment of intra-group transactions, the effect of eliminating these transactions on non-controlling interest calculation, and the changes required to ensure correct presentation of consolidated financial statements. The report also examines the impact of these changes on disclosure requirements in the annual report.

Auditing AASB 137
Module Number

Executive summary
Every organisation investing in the shares of other legal entity has to take care of the
accounting requirements attached to the investment done. The accounting of investment in
shares depends upon the ownership stake which an entity has in other legal entity. for the
ownership in the range of 20% to 50%, a significant influence of reporting entity is generated
which is required to be accounted as per the provisions of AASB 128 Investments in
Associates and Joint Ventures are followed. While, an ownership stake of 50% or more gives
a controlling stake to the reporting entity which has to be accounted as per the provisions of
AASB 3 Business Combinations. The reporting entity has to then present consolidated
financial statements as per AASB 10 Consolidated Financial Statements, AASB 127
Consolidated and Separate Financial Statements.

Table of Contents
Executive summary...............................................................................................................................1
Introduction...........................................................................................................................................1
Part A Response....................................................................................................................................1
Part B response......................................................................................................................................3
Manner in which intragroup transactions must be treated..................................................................3
Effect of elimination of intra group transactions upon the non-controlling Interest (NCI) calculation
in the subsidiary’s annual profit.........................................................................................................4
Example.............................................................................................................................................4
Part C response......................................................................................................................................5
What changes may be required to ensure that the consolidated financial statements are correctly
stated?................................................................................................................................................5
How would any required changes affect the disclosure requirements in the annual report?..............6
Conclusion.............................................................................................................................................6
References.............................................................................................................................................8

Introduction
In the provided report, the difference existent between the consolidation accounting
and equity accounting method is presented by highlighting the key difference areas. The
manner of treatment of intra group transactions, mainly the upstream transactions have been
considered. The effect of treatment of intra group transactions upon the accounting profit of
subsidiary and its apportionment in the non-controlling interests is analysed. The manner of
disclosure requirement required for non-controlling interests have also been highlighted,
along with the discussion of adjustments required to prepare the consolidated financial
statements. In the starting of this report, responses to the differences between the
consolidation method and the equity method are discussed separately. The description of the
consolidation accounting has been taken into consideration. After that, consolidation of
financial statements is done considering both the parent and subsidiary as a single economic
entity and their assets, incomes, expenses and liabilities are accumulated and application of
AASB 127 has been assessed to determine the intra group transactions and disclosure which
need to be made by the companies. Afterward, the accounting policies followed by the parent
and all of its subsidiaries has been assessed to determine whether they are following the
uniform, accounting policies or not. This helps company to avoid the possible mistakes and
issues in the reporting frameworks while preparing and filing the consolidated financial
details. This report reveals the key understanding on the AASB 127 and how company could
eliminate the intra- group transactions in its books of accounts. It helps company to eliminate
the recording issues in its financial statement.

Part A Response
The key differences between the consolidation method and the equity method are discussed
separately as follows:
Consolidation accounting
The consolidation accounting method is prescribed by the AASB 3. This method has to be
applied when the reporting entity has an ownership stake in the legal entity which is equal to
50% or exceeds 50% (D’Arcy, and Tarca, 2016).
Common names in use for this method are acquisition method or purchase method. The term
used to represent the reporting entity is parent and for the other legal entity is subsidiary.
The use of consolidation method of accounting requires the reporting organisation to prepare
the financial statements on consolidated basis. A line wise addition is made of all the assets,
liabilities, incomes and expenses to prepare the consolidated income statement and
consolidated balance sheet. The addition of the financial elements belonging to the subsidiary
is done on proportional basis (i.e. up to the percentage of ownership held by parent) (Su, and
Wells, 2018).
All the intragroup transactions whether upstream (i.e. from subsidiary to parent) and
downstream (i.e. from parent to subsidiary) are eliminated while preparing the consolidated
set of financial statements (Russell, 2017).
Example: in case JKY Ltd acquires 50% shares of FAB Ltd, then FAB Ltd shall become the
subsidiary of parent JKY Ltd. the provisions of AASB 3, AASB 10, and AASB 127 shall
start to apply. A consolidated set of financial statements shall be formed. Like for if financial
year 2018, FAB Ltd had reported revenues of $100, and JKY Ltd reports revenue of $200,
the consolidated revenue shall be:
Revenue of JKY Ltd: $200
Share of FAB Ltd.’s revenue ($100x50%): $100
Consolidated revenue for JKY Group: $300
Equity accounting

AASB 128 prescribes this method when the ownership of reporting entity varies ranges
between 20% and 50% allowing the reporting entity to exercise a significant influence over
the legal entity.
The legal entity here is often referred to as associate or affiliate (Dagwell, Wines, and
Lambert, 2015).
The financials of the reporting and legal entity are not consolidated. Rather, the investment in
the shares of the legal entity is reflected on the asset side and the income earned from them is
accounted in profit and loss account (Craswell, 2016).
No elimination of intra group transactions is done as no consolidated financial statements are
required to be prepared. Both the reporting entity and the legal entity shall prepare their own
set of financial statements. No consolidation even of any single account shall be done
(Grossi, and Pepe, 2009).
Example: if JKY holds 40% shares of FAB Ltd, it shall be said that a significant influence of
JKY Ltd exists on FAB Ltd. this shall call to apply equity method to account for investment
mad by JKY Ltd in FAB Ltd. Suppose the 40% shares have been purchased at $1000, then
the recording of this shall be reflected upon the asset side and cash shall be deducted from
JKY’s business.
Further, any dividend or any other income which shall be received from FAB Ltd. shall be
accounted as an income and the income statement shall be credited by it.
Further, the accounting entry for the purchase shall be done like this in the books of JKY
Ltd.:
Investment in shares of FAB Ltd.
Dr
Cash Cr
$1000
$1000
The above given recording of the accounting entry for the purchase has been shown with a
view to assess the income statement and balance sheet of the company.

Notes: - All the intragroup transactions whether upstream (i.e. from subsidiary to parent) and
downstream (i.e. from parent to subsidiary) are eliminated while preparing the consolidated
set of financial statements.
Part B response
In the given case JKY Ltd has a partially owned subsidiary. Some upstream transactions have
been observed. These include sale of inventory and provision of professional services. These
upstream, transactions have not been affected at cost rather the subsidiary has earned profits
upon them. There is need to apply the provisions of AASB 127 and AASB 10 in this case for
proper preparation of the Consolidated Financial Statements. The case given shows the
accounting implication of the AASB 127 for the recording and reporting of the consolidated
financial statements (Day, 2009).
Manner in which intragroup transactions must be treated
The consolidation of financial statements is done considering both the parent and subsidiary
as a single economic entity and their assets, incomes, expenses and liabilities are
accumulated. Application of AASB 127’s Paragraph 20 requires elimination of every kind of
intra group transaction while preparation of financial statements. Also as per the paragraph 21
of AASB 127, any profit or loss earned by the subsidiary in the upstream intra group
transaction shall be treated as unrealised and will be required to be eliminated in full as well.
The reasoning is an entity cannot earn profits by transacting business with itself. When the
financials of both reporting and legal entity are consolidated, they become a single economic
entity and self-profits cannot be realised. Hence, they must be eliminated (Bradbury, 2018). It
helps in assessment of the income and expenses recorded in the financial statement. It also
make the proper bifurcation in the recorded financial statement of company (AASB, 2014).
Further, any portion of asset lying with parent as a result of upstream intragroup transaction
consists of unrealised profit the portion of unrealised profit must be eliminated from the asset
along with its elimination from the annual profit of subsidiary (Barrett, and Auditor-General,
2014).

Effect of elimination of intra group transactions upon the non-controlling Interest
(NCI) calculation in the subsidiary’s annual profit
The annual profit earned by the subsidiary is divided among the parent and the non-
controlling interest in their proportionate share. Any change in the amount of annual profit of
subsidiary is bound to change the share of both parent and non-controlling interest. The
elimination of unrealised profits or unrealised losses from the annual profit of subsidiary shall
either increase or decrease the amount of annual profit of subsidiary and shall directly affect
the calculation of Non-controlling interest in subsidiary’s annual profits. However in case of
downstream transactions, the annual profit of subsidiary is not affected. And hence the
calculation of non-controlling interest in subsidiary’s annual profit is not effected (Haier,
Molchanov, and Schmutz, 2016). The main effect of eliminating the intra group transactions
would be to strengthen the transparency in the prepared financial statements of the company.
It also helps in recording of realised and unrealised profit in the separate books. The notes to
accounts also being prepared to reflects the key details of changes made in the financial
statement of company (Howieson, 2013).
Example
Suppose JKY Ltd holds 60% shares of the partially owned subsidiary of it. The cost of
provisioning of professional services to the partially owned subsidiary had been $2000, while
the cost of inventory sold by the subsidiary had been $3000. However, the services and
inventory have been sold to JKY Ltd by the partially owned subsidiary at a profit of 20% on
cost, i.e. at $2400 and at $3600 respectively. 50% of inventory at purchase price i.e. of $1800
is still present in the stock of JKY Ltd. for the same year the annual profit reported by the
partially owned subsidiary was reported at $10,000. This example shows the practical
implication of the AASV 127 and intra group transactions which needs to be recorded by the
company in the books of accounts (Ibrahim, 2008).
Transactions to be eliminated:
 The existence of unrealised profit in the inventory asset of JKY Ltd. being 50% of 600, i.e.
$300 has to be eliminated by reducing it from the inventory balance of $1800. Along with the
annual profit reported by subsidiary shall fall down by $300 becoming $9700. As only half of
the inventory remains unsold, hence only half of the unrealised profit is reversed.

 The unrealised profit upon the provision of professional services shall also be eliminated.
This is equivalent to $400. The accounting profit of subsidiary shall now be reduced to $9300
(Haqq, 2008).
Effect on accounting profit attributable to non-controlling interest
 The share of non-controlling interest in accounting profit shall be 40% of $9300, i.e. $3720.
Part C response
What changes may be required to ensure that the consolidated financial statements are
correctly stated?
As per AASB 127, the accounting policies followed by the parent and all of its subsidiaries
should be uniform, or in other words the accounting policies followed by all the group
members must be same. Situation where the accounting policies followed by any subsidiary
differ from the accounting policies of parent, an adjustment is required for the accounting
policies of the subsidiary. The parent’s accounting policies shall always be applied by every
member, and the same requirement is also provided by AASB 10 for preparation of
consolidated financial statements (Lee, Tavallali, and Lee, 2017).
In the given situation, the subsidiary of JKY Ltd reports assets in the financial statements on
the basis of historical costs. In case, JKY itself follows the revaluation model for presentation
and recording of assets in financial statements, a clash shall be observed in the accounting
policy followed by the parent JKY Ltd and its subsidiary. For preparing a consolidated
income statement and balance sheet, the adjustments shall then be required in the reporting
method of asset which the subsidiary follows to make it uniform with the revaluation model
followed by the parent (Schwarzbichler, Steiner, and Turnheim, 2018).
Hence, by adoption of assets as per revaluation model, there is a probability that a revaluation
surplus account shall be opened, which will require addition to other comprehensive income.
The share of other comprehensive income is also allocated and attributable to the non-
controlling interest. Hence, the adjustment of accounting policy shall also call adjustment in
the non-controlling interest due to a change in the amount reported as other comprehensive
income (Van Der Laan, and Dean, 2010).

Only, by incorporating all these changes, the consolidated financial statements can be
expected to be correctly stated.
How would any required changes affect the disclosure requirements in the annual
report?
When consolidated financial statements are prepared, in addition to the disclosures required
to be made in the stand alone financial statements, AASB 101, Presentation of Financial
Statements, lays some additional requirements for disclosure. These deal with the disclosure
of non-controlling interest and other adjustments made in subsidiaries to lead to correct
preparation of consolidated financial statements. In the given case, adjustment in the asset
valuation policy of the subsidiary has to be explicitly disclosed in the annual report. It must
be clarified that the adjustment has been made to bring the accounting policies of subsidiary
at par with that of JKY Ltd (Gluzová, 2016). However, notes to account related to the
adjustment made in the financial report needs to be made by company as explanatory
statement for the changes. It helps stakeholders to understand the changes which have been
made with the implication of the newly accounting standards.
The addition or the deduction of other comprehensive income as a result of adoption of the
revaluation model at subsidiary should also be reflected clearly (Pawsey, 2008).
The change in the other comprehensive income shall certainly change the amount of other
comprehensive income attributable to the non-controlling interest. Resultant, this change has
also been disclosed clearly along with the other disclosures which have been made in relation
to the non-controlling interests (Act, 2017).

Conclusion
It is considered that company uses Common names in use for this method are
acquisition method or purchase method to record the intra group transactions. All the
accounting standards discussed aforesaid have been formulated by the authorities to bring a
common accounting framework upon which every group entity shall prepare and present the
financial information. The uniformity exists because the Australian Accounting Standards
contain provisions as required by the International Financial Reporting Standards for
preparation and presentation of business and financial information. The illustrative examples
used above have extended clarity into the practical application of the different standards. The
uniformity in the application of similar provisions has extended the comparability of the
consolidated financial statements and has increased the understanding of the users. In the
elimination of the intra group transactions, it is found that change in the amount of annual
profit of subsidiary is bound to change the share of both parent and non-controlling interest.
The elimination of unrealised profits or unrealised losses from the annual profit of subsidiary
shall either increase or decrease the amount of annual profit of subsidiary and shall directly
affect the calculation of Non-controlling interest in subsidiary’s annual profits. If company is
having the subsidiaries companies then that company along with other subsidiaries company
will indulged in following the uniform reporting frameworks which will help it to strengthen
the transparency and setting up proper disclosure framework in its books of accounts.

References
AASB, C. A. S. (2014). Presentation of Financial Statements. Balance Sheet, 2(2) 68, 73.
Barrett, P., and Auditor-General, A. O. (2014). Auditing in an Evolving Environment.
Bradbury, M.E., 2018. Commentary on the Adjustments Required for Intercompany Transactions
when Equity Accounting Under IAS 28. Australian Accounting Review, 28(1), pp.140-147.
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Management, 29(4), 229-234.
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Appendix
Revenue of JKY Ltd: $200
Share of FAB Ltd.’s revenue ($100x50%): $100
Consolidated revenue for JKY Group: $300
Further, the accounting entry for the purchase shall be done like this in the books of JKY
Ltd.:
Investment in shares of FAB Ltd.
Dr
Cash Cr
$1000
$1000