Intercompany eliminations explained
Intercompany eliminations remove transactions and balances between companies of the same group, such as fees, loans, interest, shares and amounts owed, so the group statements show only dealings with outsiders. Both sides are removed, because each company's books hold one side and the group would otherwise count the same item twice.
A group is a set of companies owned together. When one of them sells to, lends to or invests in another, each company records its own side. The group has not sold anything, borrowed anything or earned anything from an outsider. Eliminating those items is the step that makes the group figures mean what they say.
What counts as intercompany
Anything that two companies of the group record against each other. Four kinds cover most groups.
| Kind | One company records | The other records | Removed from the group |
|---|---|---|---|
| Sales and fees | Revenue | Cost or purchase | Revenue and costs |
| Loans and interest | Loan receivable, interest income | Loan payable, interest expense | The receivable and payable, the income and expense |
| Investments and share capital | Investment in the subsidiary | Share capital of the subsidiary | The investment against the subsidiary's equity |
| Balances owed | Receivable | Payable | Both |
Dividends paid from a subsidiary to the parent follow the same logic: income for one company, a reduction of equity for the other, and neither belongs in the group profit.
Investments and share capital
When a parent buys shares in a subsidiary, the parent shows an investment and the subsidiary shows share capital. In the group, the parent does not own an investment in itself, so the investment is removed against the subsidiary's equity on the day of acquisition. If the parent paid more than the share of equity it bought, the difference is dealt with in an acquisition adjustment, usually as goodwill. This elimination is made once, at acquisition, and carried forward. The monthly ones are the fees, the loans and the balances.
Why both sides are removed
Each side is true in its own company's books. Together, inside the group, they cancel. Take the fees in the example below: removing only the revenue would leave the costs in the group profit and understate it by that amount. Removing only the cost would overstate profit by the same amount. Removing both leaves profit where it was, and the revenue and costs lines now describe business with outsiders.
The same holds on the balance sheet. A loan between two companies is an asset in one set of books and a liability in the other. Remove one and the group balance sheet no longer balances.
A worked example: the 420 of fees
Zenvara Technologies bills Zenvara Inc. for software services. In Technologies' books, in rupees, the fees are 35,070 thousand in revenue. Translated at 83.50 rupees to the dollar, that is 420 thousand dollars. In Inc.'s books they are 420 thousand dollars of costs. The two sides agree, so 420 is eliminated from each.
| Companies added together | Elimination | Group | |
|---|---|---|---|
| Revenue | 6,376 | (420) | 5,956 |
| Costs | 5,360 | (420) | 4,940 |
| Net profit | 1,016 | 0 | 1,016 |
The entry is a debit to group revenue of 420 and a credit to group costs of 420. Profit is 1,016 before and after, but the group no longer claims 420 of revenue it did not earn from anyone outside.
Try it: eliminate an intercompany balance
Starts with the fees owed between Zenvara Technologies and Zenvara Inc., in US dollars in thousands. The smaller side is eliminated.
Zenvara Technologies holds 20.00 more. That amount stays in the statements and on the list until it is resolved.
General information, not accounting advice.
When the two sides do not agree
In practice the two sides often differ at the month end. The usual causes are:
- Timing. One company booked the invoice in September and the other books it in October.
- Currency. The invoice is in a third currency, or each company translated it at a different rate.
- A missing or double entry. One company has not booked the item, or has booked it twice.
- A different amount. Tax, a discount or a short payment was treated differently on each side.
The right response is to find the cause and fix it in the company that is wrong, then eliminate. When that cannot be done before the close, eliminate the smaller of the two sides and leave the difference visible. Suppose Inc. had booked only 400 of the 420 by month end. Eliminate 400 from each side. The remaining 20 of revenue stays in the group figures, and group profit is 20 too high until Inc. books the missing 20. A difference that stays visible gets chased. One that is hidden in another account is found a year later.
Finconsol compares what each company holds against the other, pair by pair, every month. The smaller side is eliminated by default, by an entry in Finconsol, apart from the companies' books. Whatever is not eliminated stays in the statements and on the list until it is resolved.
Do it every month
Intercompany differences do not correct themselves. A small mismatch left in March is still there in December, joined by a dozen others, and by then nobody remembers which invoice caused it. Comparing every pair of companies every month keeps each difference small, recent and cheap to explain.
Foreign currency adds its own difference. If a loan between a rupee company and a dollar company is revalued by one of them at month end and not by the other, the two sides differ by the exchange movement until both are revalued. Agree in advance which company carries the exchange difference, and use the same month-end rate on both sides.
Habits that keep eliminations small
- Give each intercompany relationship its own accounts in every company, so the items can be found.
- Have each pair of companies agree their balance before either closes.
- Settle in one agreed currency where possible, and use the same rate on both sides.
- Review the list of unresolved differences at every close, not once a year.
The steps around this one are in how to consolidate financial statements, and the effect of rates on foreign companies is in currency translation in consolidation.
General information about consolidation, not accounting or legal advice for your group.