What it means
When one company owns others, each member keeps its own accounts. If the parent sells goods to a subsidiary, the parent records a sale and the subsidiary records a purchase.
Added together, the group appears to have sold goods when, from the outside, nothing has left the group. Eliminating entries remove these internal transactions in the consolidated accounts.
They are made on a worksheet during consolidation, not in the individual companies' own books. The aim is for the final figures to show only dealings with outsiders such as customers, suppliers and lenders.
Several kinds of items need to be eliminated. These include sales and purchases between group members, intercompany loans and the related interest, balances owed between members, dividends paid within the group and the parent's investment in the subsidiary's equity.
Each one has a matching entry on the other side of the group, and the two cancel each other out. Unrealised profit is a subtler case.
If the parent sells goods to a subsidiary at a profit and the subsidiary still holds them in stock at the year end, the profit has not truly been earned by the group. An eliminating entry removes the profit from both the group's results and the stock value.
For people reading consolidated accounts, the takeaway is that group figures are not simply the sum of the parts. A well-run finance team keeps clean records of intercompany balances throughout the year, since mismatches between the two sides are among the most common causes of delays in preparing group accounts.
Timing differences cause practical problems. One company may record an invoice in December while the other records it in January, so the two sides do not agree at the year end.
Finance teams usually agree a cut-off date and settle disputed items before consolidation begins, which saves time during the close.
In practice
Real-world examples
Example 1
A holding company owns three trading subsidiaries. At the year end, one subsidiary owes another $150,000 for services. The consolidation team removes the receivable and the payable together, so the group balance sheet does not show a debt that the group owes to itself.
Example 2
A retail group's parent lends $1,000,000 to a subsidiary at 5% interest. The parent records $50,000 of interest income and the subsidiary records $50,000 of interest expense. The elimination removes both, so the group accounts show neither.
Example 3
A manufacturer sells components to its overseas subsidiary at a mark-up, and some are still in the subsidiary's warehouse at the year end. The accountants eliminate the profit on those components from group results and reduce stock to the original cost. This ensures the group does not report profit on goods it has not sold outside.
Think of it
Eliminating entries clean up intercompany stuff when combining statements-preventing double-counting.
Formula
Calculation
Consolidated revenue = Parent revenue + Subsidiary revenue - Intercompany sales
Suppose the parent has revenue of $5,000,000 and a subsidiary has revenue of $2,000,000. During the year the parent sold $400,000 of goods to the subsidiary, and the subsidiary resold all of them to outside customers.
Consolidated revenue = 5,000,000 + 2,000,000 - 400,000 = $6,600,000.
The matching entry removes the same $400,000 from cost of sales, so group profit is unchanged by the elimination. The journal is a debit to revenue of $400,000 and a credit to cost of sales of $400,000.Case study
Seen in the real world
Summit Peak Holdings is an illustrative, fictional group whose first consolidated accounts showed revenue 12% higher than the board expected. The finance director suspected something was wrong.
The review found that the group's trading subsidiary had billed the retail subsidiary $1,800,000 for goods, and neither side had been eliminated. Removing the intercompany sales and the matching purchases reduced group revenue by $1,800,000 and left profit unchanged.
The team then introduced a monthly matching process for intercompany balances, so differences could be resolved before the year end. The illustrative lesson is that eliminations are as much about good record keeping as about the journals themselves, and that a group with clean intercompany records closes its books faster and with fewer surprises for the auditors.
Watch out
Common mistakes
- Adding together subsidiary and parent accounts without removing intercompany sales, which overstates group revenue.
- Eliminating the revenue but not the matching cost, which distorts group profit.
- Forgetting unrealised profit on goods still held in stock by another group member.
Questions
People also ask
Why are eliminating entries necessary?
They stop the group from counting transactions between its own members as if they were dealings with outsiders.
Do eliminating entries change profit?
Eliminating intercompany sales and costs does not change profit, but eliminating unrealised profit in stock does reduce it.
Where are eliminating entries recorded?
They are recorded on the consolidation worksheet and do not appear in the individual companies' own accounts.
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