Unrealized profit on Property, Plant and Equipment
Where one company sells an item of PPE to the other company in the group then, this will lead to two main problems.
a) The selling company will report on unrealized profit because the item of PPE is still used within the group. Whereas the PPE of the buying company will be overstated by the unrealized profit.
An entry is thus required to reverse the unrealized profit and the overstatement. Relevant entries
i) If the holding company made the sale
DR. Group retained profits
CR. Group PPE
(With the full unrealized profit)
ii) If the subsidiary company made the sale,
DR. Group retained profits (with holding company’s share of unrealized profit)
DR Minority interest (With unrealized profit)
CR. Group PPE (With the full unrealized profit)
b) The buying company will charge excess depreciation due to the inflated price of PPE (excess depreciation is the difference between charged to date based on the actual cost of PPE)
This means, that the profits of the buying company are understated and PPE is also understated due to the excess depreciation.
An entry is thus required to write back the depreciation and also the reserve the understatement of the PPE. The following entries are relevant:
If the holding company made the sale and thus the subsidiary company is charging the excess depreciation.
DR Group PPE (With the full excess depreciation)
CR. Group retained profits (with holding company share of excess depreciation)
CR M2 (With the minority’s share of excess depreciation)
If subsidiary company made the sale and thus holding company is charging the excess depreciation,
DR Group PPE
CR Group retained profits
(With the full excess depreciation)