By Stefan Farrugia on 2018-03-02
Why are elimination entries a requirement during consolidation process?
Intercompany elimination entries are required because certain parts of the consolidated reports would show duplicated figures if you take the approach of simply consolidating every management report as it is provided.
Some entries need to be eliminated in order to reflect the true position of the group and certain transactions should not be reported because they can mislead decision-making or inflate profits.
Main types of elimination entries used by groups and why they’re needed
The main types of elimination entries pertain to intra-group sales and purchases. These cause erroneous figures in relation to stock, assets and liabilities as in reality these transactions took place within the company and therefore should not affect the stock, cost of sales or liabilities.
Which are the main elimination entries required?
Eliminating intercompany investments within the group
The group, or mother company, has a stake in every sub-company or subsidiary in the group as a shareholder. This shareholder or owner’s equity need not appear in the balance sheet for the main company. This would result in a duplicated figure for these shareholding investments. In the sub-company balance sheets, the owner’s equity section would already show the value of the mother company’s share of that company. The same amount should therefore not appear in the mother company’s balance sheet when consolidating the management accounts because it would duplicate the true figure. This entry is therefore eliminated before proceeding to the consolidated reports.
Group liabilities and group assets
When group liabilities are owed to the other companies or entities within the group, they should be struck off – this removes situations where the group is reporting on money owed to itself. So, if two sub-companies owe money to each other, this is eliminated in the intercompany consolidation process.
Intragroup sales transactions
Similar to assets and liabilities, sales transactions that occur within the group are not actual sales. From a group perspective, the goods were not sold to third parties, they were simply shifted from one part of the company to another. It is more like shifting stock from one location to another than a true sales transaction. This should be adjusted and recorded accordingly during the consolidation process. If these entries are not eliminated, cost of sales is inflated leading to incorrect profitability figures.
Consolidated reports adjustments
Consolidated financial reports are drawn from the separate financial reports of all the companies within the group or company cluster. In order for consolidated reports to offer a realistic picture of the company’s standing, it is important that all these factors are taken into account. Correct reporting is crucial because apart from being a legal requirement, it is also important in the decision-making process. Management needs to see a true picture of the overall profitability of the group and have visibility of all the levels within the company and their profitability. Without accurate data, management could be led to take erroneous decisions that might prove detrimental to the growth and stability of the group.
A clearer intercompany reporting picture
Once all these intercompany entries and intragroup transactions have been rectified, you will find that your reports are clearer and there are no details to keep in mind when reporting to the CEO. The figures appear as they should be considered. These are the figures that can be confidently used for group decision-making.