Question

Do you think that intra-entity asset entries have the potential to overstate the financial performance of the organization in the short-term? please explain.

Answer 1

The answer is yes. Intra entity transactions has huge effect on standalone financials of the entity.

Its better to understand with an example, let assume a soft drink manufacturing company has three different entity,

1. A - where the drink production is done

2. B - where bottle are manufactured and sold to company A

3. C - Which is handling marketing and advertising.

In the above scenario, If company A is in loss then one can show the selling price of bottles sold by B at a lower rate and also decreased the price of marketing and advertising services availed by A which would result in lower loss or higher profit in company A and Company B and C would be in higher loss or lower profit.

This would help to Company A to window dress its account on the basis of its influence over company B and C and would lead to incorrect information for investors.

Same way, if there is huge profit in company A then it might increase price of bottles and marketing services resulting in higher profit in B and C and lower profit in A and might pay lower tax based on the tax policy of the concerned nations.

In nutshell, intra-entity entries are very crucial to analyse as they have the potentials to over or under state the financial performance. To overcome this there are accounting standard which requires disclosure of all such entries with related parties. At the same time, auditors are also required to mention such transaction b/w two related party which are not at market price, however one must note that market price is very subjective in nature hence its generally difficult to establish the real price/value of a product or service.