In addition to the basic elimination entries that are needed to eliminate the equity in subsidiary companies during consolidation, there are specific types of events that must also be eliminated. The intercompany transactions−such as sales of inventory or other assets, subsidiary stock transactions, or intercompany bond transactions−that require special attention during the consolidating process are overviewed in this module.
When preparing financial statements for a consolidated entity, elimination entries are prepared that are not recorded on the books of either the parent or the subsidiary entries. A summary of elimination entries is provided below.
Intercompany Sales of Merchandise
Intercompany sales of inventory cause there to be unrealized profit on the books of the consolidated entity. The consolidated income statement should reflect only revenues earned through transactions with parties outside of the consolidated group; profits earned through intercompany transactions are considered to be unrealized, and therefore must be eliminated when preparing consolidated financial statements. Consolidated sales, on the consolidated income statement, should include only sales to parties outside of the affiliated group; consolidated cost of sales, also on the consolidated income statement, should reflect the cost of the goods to the affiliated group; and consolidated inventory, on the consolidated balance sheet, should reflect the cost to the affiliated group (Jeter & Chaney, 2010).
Sales amongst an affiliated group can be upstream, downstream, or horizontal. Upstream sales are sales made from a subsidiary to a parent, downstream sales are sales from a parent to a subsidiary, and horizontal sales are from one subsidiary to another, within the same affiliated group (Jeter & Chaney, 2010). The intercompany profit in each of these types of transactions must be eliminated.