What to do with the intra-group loan note interest?

The interest expense will be cancelled against the interest income, dollar for dollar, on the consolidated statement of profit or loss Does that answer you?

OK, got it now. Thanks.

You're welcome

Sorry sir, may I ask a futher question: let's suppose the subsidiary issues 11% loan note of 4 million pounds, 2.5 million are bought by the parent. When subsidiary is drafting its own accounts one year later, does that mean the finance charge incurred to income statement will only be (4 million - 2.5 million) * 11%? Thank you.

No - so far as the subsidiary is concerned, the finance charge is $4m x 11% = $440,000 So far as the parent is concerned, the investment income is $2.5m x 11% = $275,000 But on consolidation, the investment income falls to $zero and the loan interest expense falls to $165,000 OK?

But in Q1 June 2012 exam, when we calcuate the adjusted profit of the subsidiary of Square, the profit is only adjusted by the additional depreciation of the fair value adjustment? Why the intra-group loan note interest is not an adjustment item? I ask this because NCI's attributable profit of the subsidiary is based on the post adjustment profit. Thank you.

But the Square retained earnings / profit for the year is correctly calculated! If we cancel out the intra-group interest expense from the subsidiary's profits, that will result in us giving the nci a share of an increased profit! Why should that happen? It's a consolidation adjustment. It tidies up the figures. It eliminates the situation where two pockets in the same pair of trousers have money going out of one into the other. This is an adjustment necessary when fastening the figures together for the purposes of preparing the consolidated statement of profit or loss. It has no affect on the individual financial statements of the two companies Is that better?

Can I think it like this way: There is no need of manual adjustment, because when the profits of the parent and the subsidiary are added together, the interest gain/interest expense are canceled each other other out automatically? Thank you.

Not really. You're correct in the fact that they DO cancel each other out. But that still leaves you with the nci conundrum! So far as the subsidiary is concerned, the loan interest expense is 11% on $4 million so no adjustment is necessary to the subsidiary's results So far as the parent is concerned, investment income is 11% on $2.5 million so no adjustment is necessary to the parent's results Consolidate ie effectively add across (making adjustments like pups, excess depreciation and so on) And there you have a consolidated statement of profit or loss! Oh WHOA! Hold it right there! I now have in my investment income $275,000 and in my interest expense $440,000 and, of that $440,000, $275,000 is the same money as that $275,000 investment income So reduce investment income by $275,000 and reduce interest expense by $275,000 But you'll notice that the cancelation of $275,000 investment income against $275,000 of the interest expense is done as a consolidation adjustment. It is NOT an adjustment to the results neither of the parent nor of the subsidiary Does that make it any clearer?

Is it like the sales between intra-group trade? We reduce the revenue and cost of sales by the same amount in group wise? So if we were asked to prepare the consolidated statement of profit or loss, we would have reduced the group investment income by $275,000, and reduced the group finance cost by $275,000. And since we do not reduce subsidiary revenue (in that the subsidiary is the seller) when we calculate the post-acquisition adjusted profit, we do not reduce the finance cost arised by the intra-group loan interest either? Thank you.

That's ok - if that helps to make it clearer. Got there at last!

After read the whole topic, i understood my same issue, thanks Mike and Lukayl.

You're welcome