Intragroup transactions and eliminations

Intragroup eliminations: how are intercompany sales cancelled?

A parent sells goods costing 80 to its subsidiary for 100. Group revenue and cost of sales would both be overstated by 100, so the intercompany transactions are cancelled: Dr Revenue 100, Cr Cost of sales 100. That entry alone does not change profit; the next one does.

How is unrealised profit in inventory removed?

At year end the subsidiary still holds 25% of the goods. The group has made no profit on those items yet, because they have not been sold outside the group. The unrealised profit is 25% of the parent's 20 margin, so 5. Inventory is reduced to its cost to the group: Dr Cost of sales 5, Cr Inventory 5.

How are intragroup balances eliminated?

The subsidiary owes the parent 20 for goods bought on credit. The parent's receivable and the subsidiary's payable cancel: Dr Payables 20, Cr Receivables 20. If the two balances do not agree, because of cash or goods in transit, the difference is investigated and adjusted before eliminating, for example by recognising the cash in transit in the group's cash.

How are intercompany balances reconciled?

Before each close, group companies confirm their balances with each other. Differences usually come from cash in transit, goods in transit, invoices booked in different periods, or exchange rates. Many groups set a cut-off date and a matching tool so that differences are resolved before consolidation rather than forced into a suspense account.

What about intragroup loans and interest?

The lender's receivable and the borrower's payable are eliminated, and so are the interest income and interest expense. Exchange differences on intragroup loans between companies with different functional currencies do not eliminate fully and remain in group profit or loss, unless the loan forms part of a net investment in a foreign operation.

How are intragroup dividends treated?

If the subsidiary pays a dividend of 40, of which the parent receives 32 for its 80%, the parent's dividend income of 32 is eliminated against the subsidiary's dividend, and the remaining 8 paid to the non-controlling shareholders reduces the non-controlling interest. Group profit does not include dividends from subsidiaries.

What is the difference between downstream and upstream sales?

• Downstream (parent to subsidiary): the parent made the profit, so the whole unrealised profit adjustment reduces the parent's share of retained earnings.
• Upstream (subsidiary to parent): the subsidiary made the profit, so the adjustment reduces the subsidiary's profit and is shared between the parent and the non-controlling interest in proportion to their holdings. With an 80% holding, 4 of a 5 adjustment falls to the parent and 1 to the NCI.

What about intragroup transfers of property, plant and equipment?

If one group company sells equipment to another at a profit, the gain is eliminated and the asset restated to its original carrying amount in the group; the extra depreciation the buyer charges on the higher price is also reversed each year until the asset is fully depreciated or sold outside the group.

Is there a deferred tax effect?

Yes. Eliminating unrealised profit reduces the carrying amount of inventory in the group while its tax base, in the buyer's hands, stays at the price paid, creating a deductible temporary difference and usually a deferred tax asset. See temporary differences. All of these entries appear in the consolidation example, and the Consolidation worksheet (Excel) generates them. See also IFRS 10 explained.

This guide is general information. It is not tax or legal advice for your situation.