Provision for Unrealised Profits in PPE – Kaplan Study Text

Hi Chris.

Trust you are keeping well.

Please can you be so kind (as usual) to explain the solution to this

“On 1 April 20X7, Pauline sold an item of plant to Sonia at its agreed fair value of $5 million. Its carrying amount prior to the sale was $4 million. The estimated remaining life of the plant at the date of sale was five years.”

Pauline is the parent entity while Sonia is the subsidiary. The year end is 31 March 20X8.

My understanding of this is that a PURP will arise in Pauline’s books so the Group’s retained earning will increase by $1 million. Being an intra-group sale of a PPE, the PPE value will increase by same amount.

However I also think that, Pauline would have taken the PPE out of its books at $4 million and recognised the profit accordingly. Sonia would have recorded the PPE in its books at $5 million. So the depreciation for the year in Sonia’s books would have been $1m meaning an additional depreciation of $200,000 as depreciation prior to sale would have been $800,000.

The net effect of this would increase the Group PPE by $800,000.

However, the solution in the text was;

The carrying amount of the PPE is $4m ($5m – ($5m/5 years)). If no group transfer had happened, then the carrying amount would have been $3.2m ($4m – ($4m/5 years). PPE must therefore be reduced by $800,000 ($4m – $3.2m). Pauline is the seller so the profit impact must be adjusted against Pauline’s retained earnings. The adjusting entry is:

Dr Retained earnings
Cr PPE

Thank you in advance!

‘Wande.