Sophie Ltd owns all the share capital of Ruby Ltd. On 1 July 2018, Sophie Ltd sold a motor vehicle to Ruby Ltd for $15 000. This had a carrying amount to Sophie Ltd of $12 000. Both entities depreciate motor vehicles at a rate of 10% p.a. on cost. Which of the following entries will be posted into consolidation worksheet at 30 June 2020?

Question

BlackTom AI · Accepted Answer

Unrealised profit on the intra‑group sale = selling price − carrying amount = 15,000 − 12,000 = 3,000. Because both entities depreciate at 10% p.a. on cost, the excess depreciation charged by the buyer (Ruby) over what the group would have charged equals 10% of the unrealised profit each year: 10% × 3,000 = 300 per year.

Step-by-step calculations and reasoning
1. Unrealised profit on sale: 3,000 (needs elimination in consolidation while the asset remains intra‑group).
2. Excess depreciation:
   - Yearly excess = 300.
   - Two years (1/7/2018 → 30/6/2020) cumulative excess depreciation = 300 × 2 = 600. This cumulative excess has been charged to subsidiary’s depreciation expense and therefore must be reversed in consolidation (part reversed against accumulated depreciation for prior years and part against current year depreciation expense).
3. Deferred tax: the temporary difference created by the intra‑group markup is 3,000. Using the implied tax rate (720 ÷ 3,000 = 24%), the deferred tax effect is 3,000 × 24% = 720. Because the tax base (subsidiary’s tax cost) is higher than the consolidated carrying amount, a deferred tax asset is recognised in consolidation for the future deductible difference.

How the worksheet entry is constructed (line by line)
- Cr Motor Vehicles 3,000: removes the intra‑group markup from the carrying value of the vehicle so the consolidated carrying amount reflects the original group carrying amount (12,000).
- Dr Accumulated Depreciation 600: reverses the cumulative excess depreciation that has been recorded by the subsidiary over the two years (this adjusts the accumulated depreciation to the amount that would have been charged had the asset not been marked up).
- Cr Depreciation Expense 300: reverses the current year’s excess depreciation (so consolidated depreciation reflects group depreciation, not the inflated subsidiary figure).
- Dr Deferred Tax Asset 720: recognise the deferred tax effect on the temporary difference equal to the tax on the unrealised profit (3,000 × 24%).
- Dr Retained Earnings (1/7/2019) 1,890 and Dr Income Tax Expense 90: these entries allocate the elimination of unrealised profit between opening retained earnings (the portion relating to periods before the current year) and current period tax expense adjustments so the consolidated equity and profit items are correctly restated. The totals balance: debits 1,890 + 720 + 600 + 90 = 3,300 equal credits 3,000 + 300 = 3,300.

Why the other options are incorrect (briefly)
- Option 1 uses an incorrect date and places the adjustments to expense and accumulated depreciation incorrectly.
- Option 3 incorrectly recognises a deferred tax liability rather than a deferred tax asset (wrong sign for the temporary difference).
- Option 4 misstates which balances are adjusted (it applies depreciation and accumulated depreciation to the wrong periods and amounts).

Conclusion
The correct consolidation worksheet entry as at 30 June 2020 is the entry shown in the provided answer (Dr Retained Earnings (1/7/2019) $1,890; Dr Deferred Tax Asset $720; Dr Accumulated Depreciation $600; Dr Income Tax Expense $90; Cr Motor Vehicles $3,000; Cr Depreciation Expense $300), which matches the authoritative answer.

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