Lesson 29 - Advanced Accounting Course

Lesson 29: Intercompany Transactions and Eliminations

When a company owns multiple subsidiaries, they often engage in transactions between one another—such as selling goods, lending money, or charging for services. In consolidated financial statements, these intercompany transactions must be eliminated to avoid double counting and provide an accurate picture of the entire group’s financial health.

Let’s break down why this is important and how it’s done.

🤔 What Are Intercompany Transactions?

Intercompany transactions occur when one entity within a group does business with another entity in the same group. These can include:

• Sales of goods/services between subsidiaries
  
  

• Loans or advances given between companies
  
  

• Dividends paid between entities in the group
  
  

• Interest payments on loans between subsidiaries
  
  

• Transfers of assets (e.g., property, equipment)
  
  

These transactions must be removed in consolidated financial statements to avoid inflating the group’s financials.

📊 Why Eliminate Intercompany Transactions?

The goal of elimination is to avoid double counting. If we don’t eliminate them, the consolidated group would reflect:

• Higher revenues, because of sales between subsidiaries
  
  

• Higher expenses, because of purchases made by one subsidiary from another
  
  

• Unrealized profits, which could distort asset and equity values
  
  

Simply put: Eliminating intercompany transactions gives an accurate financial picture of the group as a whole.

🔑 Key Elimination Principles

The primary elimination rules are based on three key concepts:

📍 Elimination of Intercompany Sales

Let’s take an example where:

• Subsidiary A sells goods worth $100,000 to Subsidiary B.
  
  

• The cost of these goods to Subsidiary A is $60,000.
  
  

At the group level, we need to eliminate:

1. The sale between A and B (to avoid recognizing revenue twice)
   
   

2. The profit on the sale (to avoid inflating income and assets until goods are sold externally)
   
   

🧾 Example of Elimination Entries

1. Eliminate Intercompany Sales (and Purchases) If Subsidiary A sells to Subsidiary B, we eliminate the sales and purchases:

2. Eliminate Intercompany Profit in Inventory The unrealized profit in inventory is the difference between the sale price and cost price:

⚠️ Unrealized Profit in Inventory

If there are unsold goods in the inventory at year-end that were purchased from another subsidiary, the unrealized profit from those goods must be eliminated.

• Example: If Subsidiary B holds $40,000 worth of goods purchased from Subsidiary A, and those goods contain a $10,000 profit markup, we need to eliminate the profit from the consolidated balance sheet.

🧳 Eliminate Intercompany Loans and Interest

If one subsidiary provides a loan to another, both the loan payable and loan receivable must be eliminated in consolidation.

Let’s assume:

• Subsidiary A lends $50,000 to Subsidiary B, and Subsidiary B pays interest of $2,000 to Subsidiary A.
  
  

The elimination would involve removing:

1. The loan receivable and payable
   
   

2. The interest income and expense

📑 Quick Recap 

🔍 Common Pitfalls 

💡 Key Takeaways

• Elimination is needed for intercompany transactions to avoid double counting.
  
  

• Any profits from intercompany sales are considered unrealized until sold to external customers.
  
  

• Intercompany loans and interest also need to be eliminated in consolidated statements.