SIC-3 (Standing Interpretations Committee Interpretation 3) provides guidance on the elimination of unrealized profits and losses on transactions with associates. An associate is an entity over which an investor has significant influence but does not control. The guidance in SIC-3 is relevant when a company prepares consolidated financial statements that include its investments in associates. In this article, we will discuss the definitions, explanations, examples, and case studies related to the elimination of unrealized profits and losses on transactions with associates as per SIC-3.
Definitions:
Associates:
Associates are entities in which an investor has significant influence, which is the power to participate in the financial and operating policy decisions of the investee, but does not control the investee.
Unrealized Profits or Losses:
Unrealized profits or losses refer to gains or losses resulting from transactions between the reporting entity and its associates that are not yet realized, i.e., not settled or converted into cash or other assets.
Explanations:
When a company prepares consolidated financial statements, it needs to eliminate the effects of transactions between the reporting entity and its associates. This is because the consolidated financial statements aim to present the financial position and results of operations of the group as a whole, including its investments in associates, as if the group were a single economic entity. The elimination of unrealized profits and losses on transactions with associates ensures that the financial statements reflect only the transactions and balances that are relevant to the consolidated group.
According to SIC-3, unrealized profits or losses arising from transactions between a company and its associates should be eliminated to the extent of the investor’s interest in the associate. The investor’s interest in the associate is usually represented by the investor’s share of the associate’s equity, which includes the investor’s share of the associate’s net assets, as determined in accordance with the relevant accounting standards.
Examples:
Sale of Inventory:
Company A sells inventory to its associate, Company B, for $10,000. The cost of the inventory to Company A is $8,000. As per SIC-3, the unrealized profit on the sale of inventory to the associate should be eliminated to the extent of the investor’s interest in the associate. If Company A owns a 60% interest in Company B, the unrealized profit of $2,000 ($10,000 – $8,000) should be eliminated by reducing the investment in Company B on the consolidated financial statements by $1,200 (60% of $2,000).
Sale of Equipment:
Company X sells equipment to its associate, Company Y, for $50,000. The carrying amount of the equipment in Company X’s books is $40,000. As per SIC-3, the unrealized profit on the sale of equipment to the associate should be eliminated to the extent of the investor’s interest in the associate. If Company X owns a 40% interest in Company Y, the unrealized profit of $10,000 ($50,000 – $40,000) should be eliminated by reducing the investment in Company Y on the consolidated financial statements by $4,000 (40% of $10,000).
Case Studies:
ABC Inc. owns a 30% interest in XYZ Ltd., an associate. ABC Inc. sells goods to XYZ Ltd. for $100,000, which cost ABC Inc. $80,000. The unrealized profit on the sale is $20,000. As per SIC-3, ABC Inc. should eliminate the unrealized profit to the extent of its interest in XYZ Ltd., which is 30%. Therefore, ABC Inc. should reduce its investment in XYZ Ltd. by $6,000 (30% of $20,000) in the consolidated financial statements.
DEF Corp. owns a 50% interest in GHI Ltd., an associate. DEF Corp. purchases a building from GHI Ltd. for $500,000, which has a carrying amount of $400,000 in GHI Ltd.’s books. The unrealized profit on the sale is $100,000. As per SIC-3, DEF Corp. should eliminate the unrealized profit to the extent of its interest in GHI Ltd., which is 50%. Therefore, DEF Corp. should reduce its investment in GHI Ltd. by $50,000 (50% of $100,000) in the consolidated financial statements.
JK Corp. owns a 20% interest in LM Ltd., an associate. LM Ltd. sells goods to JK Corp. for $200,000, which cost LM Ltd. $160,000. The unrealized profit on the sale is $40,000. As per SIC-3, JK Corp. should eliminate the unrealized profit to the extent of its interest in LM Ltd., which is 20%. However, JK Corp. assesses that the goods are overvalued and will not be sold at the original selling price. Therefore, JK Corp. adjusts the unrealized profit on the sale by recognizing a provision for the expected loss of $8,000 (20% of $40,000) in the consolidated financial statements.
In all of the above case studies, the elimination of unrealized profits and losses on transactions with associates in the consolidated financial statements ensures that the financial position and results of operations of the group as a whole are presented accurately, reflecting only the relevant transactions and balances.
In conclusion, SIC-3 provides guidance on the elimination of unrealized profits and losses on transactions with associates in consolidated financial statements. Unrealized profits or losses arising from transactions between the reporting entity and its associates should be eliminated to the extent of the investor’s interest in the associate. Examples and case studies illustrate the application of SIC-3 in different scenarios. It is important for companies to comply with SIC-3 when preparing consolidated financial statements to ensure accurate and transparent financial reporting.