What are intercompany eliminations?

Financial consolidation is time-consuming, but it’s an essential process for every finance team. Every phase involves the collection, analysis, and verification of data, which can take time away from value-added tasks.

It’s even more daunting when you have multiple entities to account for. The to-do list grows quickly between a parent company and a subsidiary, and it’s tough to know where you can streamline your consolidation processes.

When preparing your consolidation, one of the first things you do is collect intercompany data between all entities. This includes intercompany transactions, and later, intercompany eliminations.

Performing eliminations is an important piece of the intercompany management puzzle. But what are they, and how do they work? Let’s dive into the details to make your next consolidation simpler.

What are intercompany transactions?

Before defining intercompany eliminations, let’s cover intercompany transactions.

In finance, the term “intercompany” refers to actions involving related companies. Intercompany transactions are financial transactions between two or more related companies. Sometimes the transactions take place between two entities under a parent company, but usually, it’s between the parent company and subsidiary.

These transactions are kept separate from external transaction recordkeeping to keep the accounting clear, and to avoid duplication when counting transactions.

Upstream transactions

An upstream transaction is when an asset or financial activity moves from a subsidiary upwards to the parent company. This is the least common of the three types of intercompany transactions.

Downstream transactions

A downstream transaction is when the asset or financial activity moves from the parent company down to the subsidiary. This is the more common transaction type, as the parent company typically has greater financial leverage.

Lateral transactions

Lateral transactions occur when the asset or financial activity is exchanged between two subsidiaries of the same parent company. Neither entity has hierarchical power over the other but may swap, purchase, or sell assets between them.

What are intercompany transaction controls?

Intercompany transaction controls are protocols that the accounting team must abide by to prove and ensure accurate reporting.

For example, suppose your organization uses specific codes or logs to identify intercompany transactions. In this case, there should be established controls over data inputs to ensure any changes to that identifying field are logged for sufficient reporting.

The controls will look different depending on your accounting processes, but they must be adhered to by everyone on the team.

What are intercompany eliminations?

Intercompany elimination is the process by which an organization removes—or zeroes— intercompany transactions. These eliminations are recorded on a balance sheet and are sometimes recorded as journal entries.

But why the need for elimination? When a business records an intercompany transaction, it cannot include the transaction as a consolidated profit or loss, as the company is essentially doing business with itself. The elimination effectively removes these transactions before producing the consolidated financial statement, to avoid inflating the data on the balance sheet.

Why are intercompany eliminations important?

Intercompany eliminations are integral for accurate financial reporting. Analysts, investors, and other stakeholders will need a clear consolidation report, and without elimination, intercompany transactions risk overstating their profits, losses, and liabilities.

When are intercompany eliminations performed?

Eliminations are completed in tandem with an organization’s consolidated financial statement. Typically, it’s performed every year, but if the consolidation happens outside the typical period, the eliminations will happen as well.

How are intercompany eliminations performed?

First, a company must identify the type of intercompany elimination they must perform. There are three types: intercompany debt, intercompany revenue and expenses, and intercompany stock ownership.

After determining the type of elimination, companies use dedicated software (ideally shared across parent companies and subsidiaries) to complete the elimination. The specific way this is done depends on the software and your current accounting processes, but the software should host the records of all intercompany transactions to help you get started.

How is ASC 810 related to intercompany eliminations?

ASC 810 is the GAAP standard for multi-entity consolidation set by the Financial Accounting Standards Board (FASB). Its primary purpose is to establish standards for organizations to meet and keep consolidations compliant.

ASC 810 sets a few basic financial consolidation principles. It states that:

1. Intercompany income remaining between parent companies and subsidiaries should be eliminated.
2. The amount to be eliminated will not be affected by a non-controlling interest (NCI).

Each parent company subsidiary must be classified as a legal entity to be included in the consolidation.

Types of intercompany eliminations

As stated earlier, the how-to process for intercompany elimination depends on the type of elimination to be performed. Some organizations will perform all three types of elimination, but some may only need to perform one or two. It depends on the nature of the business.

Let’s break down the three types further.

Intercompany debt

Intercompany debt eliminates loans made between subsidiaries, or between a parent and a subsidiary.

If a parent company purchased a building for its subsidiaries to use, for example, that would be intercompany debt. The parent company is paying for each subsidiary’s expenses, so the intercompany elimination would have to be completed to balance out the purchase.

Intercompany revenue and expenses

Sales and purchases between subsidiaries or between a parent and subsidiary are zeroed during an intercompany revenue and expense elimination.

The parent company’s consolidated net assets are unchanged when goods or services are sold between entities, so these purchases must be eliminated before consolidation.

Intercompany stock ownership

This type of elimination specifically pertains to parent companies and subsidiaries eliminating ownership interest. Without this elimination, the data for the parent company will be inaccurately inflated.

Intercompany elimination example

Intercompany transactions and eliminations are straightforward on paper, but what would it look like in practice? Let’s look at an example.

Say two subsidiaries of a parent company perform a lateral intercompany transaction.

Subsidiary A: Sells technical equipment.

Subsidiary B: Purchases the technical equipment from subsidiary A.

If subsidiary A sells the equipment for a profit, it can’t be accounted for as a profit because it’s an intercompany transaction, and not sold externally. The gain on the sale is then required to be eliminated. Additionally, the slight increase in recognized depreciation will also have to be eliminated to balance the transaction out on paper.

Another example would be if a parent company were to pay off an operations invoice for a subsidiary. This would be a downstream intercompany transaction and would have to be zeroed before completing the consolidation report.

What is eliminations accounting?

Eliminations accounting is the action of performing eliminations between entities grouped under a parent company. You could perform different types of eliminations depending on the type of transaction, and you could also choose between full or partial elimination. Ultimately, it varies depending on how exhaustive you require your consolidated financial report to be.

Why is eliminations accounting useful?

Eliminations accounting is useful because intercompany transactions can’t be applied to your financial consolidation balance sheet. Eliminations accounting effectively clears or balances these transactions to prepare an accurate report.

Who should do eliminations accounting?

Any organization that has a parent company and a subsidiary, or subsidiaries, should practice eliminations accounting. This will ensure clear financial records and will give stakeholders and investors an accurate read on the financial health of an organization.

Ideally, and depending on the size of a parent company and its subsidiaries, the organization will have a team dedicated to eliminations. These in-house subject matter experts will learn the finance software, keep accurate records, and ensure eliminations are done promptly.

How to improve your intercompany eliminations accounting

When it comes to executing eliminations accounting, there are ways to streamline your processes. You could keep spreadsheets and perform manual eliminations, but that would be tedious, and it leaves room for human error. Here’s how to automate and simplify the process.

Deploy a single company-wide consolidation system

Aligning the parent company and all subsidiaries into one consolidation system will ensure accurate record-keeping and make financial reporting much easier. If each subsidiary is using a different software or process, migrating to a unified system sooner rather than later will save a ton of time in the long term.

As your companies scale, having every team house their data in the same place, use the same tools, and adhere to the same reporting schedule will be key for transparent reporting and maintaining compliance.

Use financial consolidation software with double-entry accounting capabilities

When shopping around for your software, it’s important to look for one that covers all of your needs and more. Some software products only offer single-entry accounting, rendering them ineffective for financial consolidation. Your team will want double-entity accounting capabilities to automate the elimination process properly.

Beyond double-entry accounting, it’s also advised to seek finance software that goes above and beyond consolidation needs. If you also need a solution for things like intercompany management, business planning, and account reconciliation, you could find a tool that has everything covered within one system.

This will also cut down on your team’s expenses. Buying licenses for your team members for multiple finance tools when one does the job will increase costs and complicate processes.

Manage intercompany eliminations with a dedicated team

Because the financial consolidation process is so involved, having a specific person or team specialize in eliminations will also accelerate the process.

Challenges of intercompany eliminations

While the definition is simple and the execution seems straightforward, performing intercompany eliminations comes with its challenges. Especially if your processes aren’t consistent across all entities.

Here are some of the most common problems companies face while performing eliminations.

Poor or inconsistent record-keeping between subsidiaries

This is where aligning all related companies with one financial performance platform is key. If one subsidiary uses a simple spreadsheet, and another uses robust software, there is a risk of incorrect data, human error, and inaccurate reporting.

It’s crucial to have all teams use the same finance platform, go through the same training, and understand which controls are in place to meet compliance standards.

Exchange rate fluctuations

Not accounting for exchange rate fluctuations in intercompany transactions with different currencies will affect the elimination. If your team is using a more manual tool to log intercompany transactions, like a spreadsheet, a fluctuating exchange rate might go unnoticed.

If you opt for software that applies exchange rate fluctuations to your transactions automatically, your team won't have to worry.

Inconsistent accounting periods

Consistency is key for financial reporting, especially when it comes to consolidation. All related companies must report in the same periods, to simplify data sourcing and maintain compliance.

If they’re not already consistent, have all relevant stakeholders realign on more concrete accounting periods. This may be a bit of a disruption in the short term but will save time for all parties moving forward.

Conclusion: Streamline intercompany eliminations with Prophix One™

As you know, intercompany elimination is an intricate process. There are many challenges your team could face in the preparation and execution phases.

But with a financial performance platform, like Prophix One, your team can get your parent company and subsidiaries aligned, consistent, and prepared for smooth eliminations.

Prophix One streamlines and simplifies the key processes in the Office of the CFO, from budgeting and planning to financial close. With a platform to address your full scope of needs, your team can achieve better overall financial performance with a single source of truth.

Reach out to us for a demo. You’ll see how you can make intercompany eliminations simpler, so your team can spend more time on what matters most.