Consolidation procedures and intercompany eliminations

In this lesson you will

Prepare a consolidating worksheet from parent and subsidiary trial balances
Eliminate the investment, intercompany balances and intercompany transactions
Compute and eliminate unrealized profit in ending inventory
Handle different fiscal year ends and accounting policies

What consolidation does

Consolidated statements present the parent and its subsidiaries as a single economic entity. 810-10-45-1 requires that intra-entity balances and transactions be eliminated in full, including open account balances, security holdings, sales and purchases, interest and dividends. Without the eliminations, the group would report revenue from selling to itself and receivables it owes itself.

Before the eliminations

Accounting policies. Subsidiaries should use the parent's policies, or adjustments are posted on consolidation. A subsidiary that capitalizes software development costs the group expenses needs an adjustment.
Fair value step-ups. If the subsidiary was acquired and does not apply pushdown accounting, the acquisition-date fair value adjustments, goodwill and their later depreciation and amortization are posted in the consolidation.
Reporting periods. 810-10-45-12 accepts a subsidiary with a different fiscal year end if the difference is not more than about three months. Recognize by disclosure or otherwise the effect of intervening events that materially affect financial position or results.
Foreign subsidiaries. Translate into the reporting currency under Topic 830 before consolidating.

The standard eliminations

Investment and equity. Eliminate the parent's investment account against the subsidiary's equity at acquisition, recognizing the step-ups, goodwill and noncontrolling interest. After that date, eliminate the parent's equity-method or cost-basis income from the subsidiary and dividends received.
Intercompany receivables and payables. Remove both sides. Reconcile them first: differences usually come from cash in transit, goods in transit or one side recording a charge the other has not.
Intercompany revenue and expense. Remove intercompany sales and the matching cost of sales, management fees against fee expense, and interest income against interest expense.
Unrealized profit in assets. Profit on goods or equipment sold within the group and still held at period end is not realized from the group's view. Remove it from inventory or fixed assets and from earnings. For inventory, unrealized profit equals intercompany inventory on hand times the seller's gross margin on sales. For fixed assets, remove the gain and reverse the excess depreciation over the remaining life.
Intercompany debt and dividends. Eliminate notes, accrued interest and dividends declared to group members.

Unrealized profit and noncontrolling interests

810-10-45-18 requires the intra-entity profit to be eliminated in full. When a subsidiary with a noncontrolling interest is the seller (an upstream sale), the elimination may be allocated between the parent and the noncontrolling interest. When the parent is the seller (a downstream sale), the whole elimination falls on the parent's share.

Income taxes

Eliminating unrealized profit creates a temporary difference when the group files separate tax returns. The seller has already paid tax on the profit. ASU 2016-16 requires recognition of the current and deferred tax effects of intra-entity transfers of assets other than inventory when the transfer occurs. Intra-entity inventory transfers are still an exception: the tax paid is deferred until the inventory leaves the group.

The worksheet

A consolidating worksheet lists each entity's trial balance in its own column, then an eliminations column with references to supporting schedules, then the consolidated total. Every elimination should be supported by an intercompany reconciliation signed off by both entities. The consolidation elimination workbook and the multi-entity consolidating worksheet follow this layout.

Common errors

Eliminating only one side of a mismatched intercompany balance and plugging the difference
Missing unrealized profit because the buyer does not tag inventory sourced from group members
Forgetting the prior year's unrealized profit, which reverses into the current year's cost of sales
Not eliminating intercompany transfers within cash flow statement categories

Worked example

Eliminating sales, inventory profit, balances and fees

Bayview Holdings owns 100 percent of Delta Components. During the year Delta sells parts to Bayview for $1,000,000 at a gross margin of 25 percent on sales. At year end Bayview still holds 40 percent of those parts. Bayview owes Delta $150,000 at year end. Bayview also charges Delta a $60,000 management fee. There was no intercompany inventory at the start of the year.

Elimination 1, intercompany sales: debit sales $1,000,000, credit cost of sales $1,000,000.

Elimination 2, unrealized profit: intercompany inventory on hand is 1,000,000 x 40% = $400,000. Profit in it is 400,000 x 25% = $100,000. Debit cost of sales $100,000, credit inventory $100,000.

Elimination 3, intercompany balance: debit accounts payable $150,000, credit accounts receivable $150,000.

Elimination 4, management fee: debit fee income $60,000, credit management fee expense $60,000.

Effect on consolidated pretax income: eliminations 1, 3 and 4 have no net effect. Elimination 2 reduces income by $100,000, the profit not yet earned from outside customers.

Next year, if Bayview sells the parts to outside customers, the $100,000 reverses: debit opening retained earnings $100,000, credit cost of sales $100,000.

Self-check

Answer each question before you open the answer.

A subsidiary with a 30 percent noncontrolling interest sells inventory to the parent at a profit. Must the whole unrealized profit be eliminated?
Show answer
Yes. 810-10-45-18 requires full elimination. Because the sale is upstream, the elimination may be allocated between the parent and the noncontrolling interest.
Intercompany inventory on hand is $250,000 and the selling subsidiary’s gross margin is 20 percent on sales. What is the unrealized profit?
Show answer
250,000 x 20% = $50,000.
How far apart can a subsidiary’s fiscal year end be from the parent’s?
Show answer
Not more than about three months under 810-10-45-12, with recognition by disclosure or otherwise of intervening events that materially affect the consolidated statements.
Intercompany receivables show $410,000 and payables show $395,000. What should happen before eliminating?
Show answer
Reconcile the $15,000 difference, usually cash or goods in transit or an unrecorded charge, and record the correcting entry in the right entity. Do not plug it in the elimination.

Sources

Back to the syllabus

Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error