Accounting

How To Calculate Unrealised Profit In Inventory Consolidation

Do all transactions require adjustment entries for NCI? No, not all transactions require an adjustment entry for the Non-Controlling Interest (NCI) or Minority Interest calculation. Calculating Unrealised profit on inventory is a consolidation adjustment. The accounting adjusting entries for NCI require for those transactions which have the following characteristics:

• After the transaction, the other party to the transaction (for two-company structures this is the parent) must have on hand an asset (e.g. inventory) on which the unrealised profit is accrued.

• The transaction must result in the subsidiary recording a profit or a loss.

• The initial consolidation adjustment for the transaction should affect both the statement of financial position and the statement of profit or loss and other comprehensive income (including appropriations of retained earnings), unlike payments of debenture interest, which affect only the statement of profit or loss and other comprehensive income.

In determining the transactions requiring an adjusting entry for the Non-Controlling Interest (NCI), it is important to work out which transactions involve unrealised profit. The test for realisation is the involvement of a party external to the group, based on the concept that the consolidated financial statements report the affairs of the group in terms of its dealings with entities external to the group.

Consolidated profits are therefore realised profits as they result from dealing with entities external to the group. Profits made by transacting within the group are unrealised because no external entity is involved.

Once the profits or losses on an intra-group transaction become realised, the NCI share of equity no longer needs to be adjusted for the effects of an intra-group transaction because the profits or losses recorded by the subsidiary are all realised profits.

In this section, I would discuss on why and how to calculate unrealised profit in inventory consolidation:

In case of inventory, realization occurs when the acquiring entity sells the inventory to an entity outside the group. Consolidation adjustments for inventory are based on the profit or loss remaining in inventory on hand at the end of a financial period.

If inventory is sold in the current period by the subsidiary to the parent at a profit, giving the Non-Controlling Interest (NCI) a share of the recorded profit will overstate the NCI share of consolidated equity. This is  because the group does not recognize the profit until the inventory is sold outside the group.

Hence, whenever consolidated adjustments are made for profit remaining in inventory on hand at the end of the period, an NCI / Minority Interest adjustment is necessary to reduce the NCI share of current period profit and the Non-Controlling Interest (NCI) total.

If there is inventory on hand at the beginning of the current period, the NCI share of the previous period’s profit must be reduced as the subsidiary’s previous year’s recorded profit contains unrealized profit.

As the group realizes the profit in the current period when the inventory is sold to external parties, the NCI share of the current period profit must be increased.

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