5 Intercompany eliminations
5.1 Procedures for eliminating intercompany balances and transactions
5.1.1 Effect of noncontrolling interest on elimination of intercompany amounts
Consolidation — Overall Other Presentation Matters Procedures
810-10-45-18
The amount of intra-entity income or loss to be eliminated is not affected by the existence of a noncontrolling interest. The complete elimination of the intra-entity income or loss is consistent with the underlying assumption that consolidated financial statements represent the financial position and operating results of a single economic entity. The elimination of the intra-entity income or loss may be allocated between the parent and noncontrolling interests.‖
The existence of a noncontrolling interest in the consolidated group creates complexities related to the elimination of intercompany profits. ASC 810 provides guidance for preparing consolidated financial statements, including the treatment of noncontrolling interest, in ASC 810-10-45-18.
ASC 810 provides for no distinction between wholly-owned and partially-owned entities with respect to
5 Intercompany eliminations
Because individual companies in a consolidated group generally record transactions with members of the consolidated group in a manner similar to transactions with entities outside of the group, sales, cost of goods sold and profit may be recognized by the selling entity even though there has not been a transaction outside of the consolidated group. Because income cannot be recognized by the consolidated group until it has been realized in a transaction with a third party, there may be unrealized intercompany profit or loss requiring elimination.
Because noncontrolling interest is a component of equity, transfers of assets between entities in the consolidated group are accounted for as internal transfers for which no earnings are recognized until they are realized through an exchange transaction with a party outside of the consolidated group.
Unrealized intercompany income and losses are always eliminated fully in preparing consolidated financial statements. While the entire amount must be eliminated, when there is a noncontrolling interest, in certain circumstances, a determination must be made as to how that elimination should be allocated between the controlling and noncontrolling interests.
When a sale is from a parent to a subsidiary (downstream transaction), profit or loss is recognized by the parent. Accordingly, we believe the full amount of the elimination of the intercompany profit or loss should be against the controlling interest. Otherwise, the parent would continue to recognize a portion of the unrealized income or loss in income even though ASC 810-10-45-1 requires intercompany
transactions to be eliminated fully.
When a subsidiary sells to the parent (upstream transaction) and intercompany profit or loss arises, the profit or loss may be eliminated against the controlling and noncontrolling interest proportionately.
In either case, the amount of profit eliminated from the consolidated carrying amount of the asset is not affected by the existence of noncontrolling interest in the subsidiary.
Illustration 5-1: Parent sells to a majority-owned subsidiary (downstream transaction)
In a transaction in which a parent sells inventory to a majority-owned subsidiary, and some or all of the inventory remains on hand at a period-end, ASC 810 requires that the full amount of the profit arising from the intercompany transaction related to the inventory remaining on hand be eliminated against the parent’s interest and eliminated from the carrying amount of the asset. That is, because only the parent has recognized the revenues, costs of sale, and resultant profit and loss in its financial statements, no portion of these items may be allocated to noncontrolling interests.
Assumptions:
Company P owns an 80% interest in Company S.
The 1 January 20X6, beginning-of-year balance sheets for Company P and Company S are as follows (all amounts in dollars):
Company P Company S
Cash – 300,000
Inventory 200,000 50,000
Buildings and equipment, net – 150,000
Investment in Company S 400,000 –
Total assets 600,000 500,000
Current liabilities 100,000 –
Common stock 200,000 500,000
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1) During the year, Company P sells inventory to Company S, which remains in Company S’s inventory at year end. A summary of the effect of the transaction on Company P’s income statement is as follows:
Revenues $ 100,000
Cost of sales 70,000
Gross profit $ 30,000
2) The inventory sale is the only transaction between Company P and Company S during 20X6.
Further, the inventory remains on hand at Company S at year end.
3) Prior to consolidation, Company P accounts for its investment in Company S using the equity method.
Figure 5-1: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars)
Company P Company S
Figure 5-1 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows:
(1) Intercompany revenue from the downstream sale is eliminated.
(2) Intercompany cost of revenues from the downstream sale is eliminated.
(3) Net income of Company S is attributed to the noncontrolling interest ($150,000 x 20%).
Figure 5-2: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars)
Adjustments
Company P Company S Debit Credit Consolidated
Cash 200,000 450,000 650,000
Intercompany receivable 100,000 — (4) 100,000 —
Inventory 200,000 150,000 (5) 30,000 320,000
Buildings and equipment, net — 150,000 150,000
Investment in Company S 400,000 — (6) 400,000 —
Total assets 900,000 750,000 1,120,000
Current liabilities 200,000 — 200,000
Intercompany payable — 100,000 (4) 100,000 —
Total liabilities 200,000 100,000 200,000
Capital stock 200,000 500,000 (7) 500,000 200,000
Retained earnings 500,000 150,000 (8) 180,000 (9) 120,000 590,000
Total parent shareholders’
equity 700,000 650,000 790,000
Noncontrolling interest — — (10) 130,000 130,000
Total equity 700,000 650,000 920,000
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Figure 5-2 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows:
(4) Intercompany receivable and payable from the downstream sale are eliminated.
(5) Intercompany profit remaining in inventory at year end from the downstream sale is eliminated (see notes 1 and 2, under Assumptions).
(6) Company P’s investment in Company S is eliminated.
(7) Company S’s common stock is eliminated.
(8) Company S’s retained earnings balance is eliminated ($150,000) and the intercompany profit on the downstream sale is eliminated ($30,000).
(9) Company P recognizes its proportionate share (80%) of income from Company S.
(10) Noncontrolling interest is recognized at its initial balance of $100,000 ($500,000 x 20%) plus its proportionate share of income from Company S ($30,000).
Under the economic unit concept, 100% of intercompany sales, receivables, payables, purchases, cost of sales and unrealized intercompany profits and losses are eliminated. Profits and losses on downstream transactions are eliminated completely against the controlling interest.
No profit accrues to the stockholders of the selling entity under the economic unit concept because both the controlling and noncontrolling interests are owners of a single economic unit (albeit with different claims on the entity’s assets). After incorporating elimination entries, transfers of inventory are to be accounted for on the same basis as internal transfers between departments of a single entity at cost.
Illustration 5-2: Majority-owned subsidiary sells to parent (upstream transaction) Assumptions:
Same as Illustration 5-1, except for the following:
1) Rather than a downstream sale from P to S, during the year, S sells inventory to P, which remains in P’s inventory at year-end. A summary of the result of the transaction on S’s income statement is as follows:
Revenues $ 100,000
Cost of sales 70,000
Gross profit $ 30,000
Under the economic unit concept, the transfer of inventory between a subsidiary and its parent is viewed as a transfer between departments or divisions/components of a single entity. When a majority-owned subsidiary sells inventory to its parent, under ASC 810 the unrealized profit may be proportionately eliminated against the parent’s interest and the noncontrolling interest.
5 Intercompany eliminations
Figure 5-3: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars)
Company P Company S
Gross profit 300,000 170,000 440,000
Selling and administrative 100,000 20,000 120,000
Net income 200,000 150,000 320,000
Net income attributable to
noncontrolling interest — — (13) 24,000 24,000
Net income attributable to
controlling interest 200,000 150,000 296,000
Figure 5-3 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows:
(13) Net income of Company S is attributed to the noncontrolling interest, including its proportionate share of the elimination of the intercompany transaction (($150,000 — $30,000) x 20%).
For explanations of items (11) and (12), see items (1) and (2), respectively, in Figure 5-1.
Figure 5-4: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars)
Company P Company S
Adjustments
Debit Credit Consolidated
Cash 300,000 350,000 650,000
Figure 5-4 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows:
(19) Company P recognizes its proportionate share (80%) of income from Company S, including its share of the intercompany profit elimination (($150,000 — $30,000) x 80%).
(20) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($24,000, see explanation in income statement).
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The net income attributable to the controlling interest in Illustration 5-2 exceeds the net income attributable to the controlling interest in Illustration 5-1 by $6,000 because a portion of the elimination of the unrealized income, which is reflected in the subsidiary with the noncontrolling interest, has been allocated to the noncontrolling interest ($30,000 x 20% = $6,000). Net income of the consolidated entity is the same in both examples because of the requirement to fully eliminate the intercompany income or loss.
As described in Illustration 5-1, under the economic entity concept, 100% of intercompany sales, receivables, payables, purchases, cost of sales and unrealized intercompany profits and losses are eliminated. Profits and losses are eliminated in proportion to the interests in the selling entity.
No profit accrues to the stockholders of the selling entity under the economic entity concept because both the controlling and noncontrolling interests are owners of a single economic entity (albeit with different claims on the entity’s net assets). After incorporating elimination entries, transfers of inventory are to be accounted for on the same basis as internal transfers between departments of a single entity at cost.
Illustration 5-3: Parent makes an intercompany loan to a majority-owned subsidiary and the interest is expensed
Assumptions:
Same as Illustration 5-1, except for the following:
1) During the year, P makes an intercompany loan to S for $1,000,000 with an annual interest rate of 10%.
2) S expenses the current year interest on the intercompany loan and remits cash to P for the annual interest incurred on the intercompany loan.
3) The loan is the only transaction between P and S during 20X6 (that is, the intercompany sales described in Illustration 5-1 did not occur).
Figure 5-5: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars)
Company P Company S
Adjustments
Consolidated
Debit Credit
Revenues 500,000 270,000 770,000
Cost of revenues 200,000 100,000 300,000
Gross profit 300,000 170,000 470,000
Selling and administrative 100,000 20,000 120,000
Interest income 100,000 — (21) 100,000 —
Interest expense — 100,000 (21) 100,000 —
Net income 300,000 50,000 350,000
Net income attributable to
noncontrolling interest — — (22) 10,000 10,000
Net income attributable to
controlling interest 300,000 50,000 340,000
Figure 5-5 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows:
(21) Intercompany interest income and expense are eliminated.
(22) Net income of Company S is attributed to the noncontrolling interest.
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Figure 5-6: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars)
Company P Company S
Adjustments
Debit Credit Consolidated
Cash 300,000 1,350,000 1,650,000
Inventory 200,000 150,000 350,000
Buildings and equipment, net — 150,000 150,000
Intercompany loan 1,000,000 — (23) 1,000,000 —
Investment in Company S 400,000 — (24) 400,000 —
Total assets 1,900,000 1,650,000 2,150,000
Current liabilities 1,100,000 100,000 1,200,000
Intercompany loan — 1,000,000 (23) 1,000,000 —
Total liabilities 1,100,000 1,100,000 1,200,000
Capital stock 200,000 500,000 (25) 500,000 200,000
Retained earnings 600,000 50,000 (26) 50,000 (27) 40,000 640,000
Total parent shareholders’
equity 800,000 550,000 840,000
Noncontrolling interest — — (28) 110,000 110,000
Total equity 800,000 550,000 950,000
Total liabilities and equity 1,900,000 1,650,000 2,150,000
Figure 5-6 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows:
(23) Intercompany loan is eliminated.
(27) Company P recognizes its proportionate share (80%) of income from Company S ($50,000 x 80%).
(28) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($10,000).
For explanations of items (24) — (26), see items (6)-(8) in Figure 5-2.
Prior to taking into consideration the noncontrolling interest in S, the elimination of the intercompany interest income and expense has no effect on the combined net income of P and S. However, as S has absorbed an expense of $100,000, P receives the benefit of the interest to the extent of the
noncontrolling interest. This benefit is realized immediately as S recorded the full amount of the interest as a current period expense.
5 Intercompany eliminations
Illustration 5-4: Parent makes an intercompany loan to a majority-owned subsidiary and the interest is capitalized
Assumptions:
Same as Illustration 5-1, except for the following:
1) During the year, P makes an intercompany loan to S with a principal of $1,000,000 with an annual interest rate of 10%. The proceeds of the loan are used to construct a building.
2) S capitalizes the current year interest on the intercompany loan as part of the cost of the building and remits cash to P for the annual interest incurred on the intercompany loan.
3) The loan is the only transaction between P and S during 20X6 (that is, the intercompany sales described in Illustration 5-1 did not occur).
Figure 5-7: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars)
Company P Company S
Figure 5-7 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows:
(29) Interest income on the intercompany loan recognized by Company P is eliminated.
(30) Net income of Company S is attributed to the noncontrolling interest ($150,000 x 20%).
Figure 5-8: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars)
Company P Company S
Adjustments
Debit Credit Consolidated
Cash 300,000 350,000 650,000
Inventory 200,000 150,000 350,000
Buildings and equipment, net — 1,250,000 (31) 100,000 1,150,000
Intercompany loan 1,000,000 — (32) 1,000,000 —
Investment in Company S 400,000 — (33) 400,000 —
Total assets 1,900,000 1,750,000 2,150,000
Current liabilities 1,100,000 100,000 1,200,000
Intercompany loan — 1,000,000 (32) 1,000,000 —
Total liabilities 1,100,000 1,100,000 1,200,000
Capital stock 200,000 500,000 (34) 500,000 200,000
Retained earnings 600,000 150,000 (35) 250,000 (36) 120,000 620,000
Total parent shareholders’
equity 800,000 650,000 820,000
Noncontrolling interest — — (37) 130,000 130,000
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Figure 5-8 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows:
(31) Capitalized interest from outstanding intercompany loan is eliminated.
(32) The intercompany loan is eliminated.
(35) The retained earnings of Company S are eliminated ($150,000), and the interest income recognized by Company P on the intercompany loan is eliminated ($100,000).
(36) Company P recognizes its proportionate share (80%) of income from Company S ($150,000 x 80%).
(37) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($30,000).
For explanations of items (33) and (34), see items (6) and (7), respectively, in Figure 5-2.
As S has capitalized the interest expense paid by the subsidiary as part of the cost of its building, the interest has not been expensed in the income statement of S. As such, P does not receive any benefit of the interest income until the expense is recognized which will occur as the building is depreciated by S.
Year 2
In Year 2, Assume S depreciates the newly constructed building over 10 years which results in annual depreciation expense of $125,000 ($1,250,000 / 10 years = $125,000) that is included in S’s cost of revenues. Further, for simplicity, assume (1) P had no other transactions during Year 2 and (2) S does not incur any additional interest expense in Year 2.
Figure 5-9: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X7 (all amounts in dollars)
Company P Company S
Adjustments
Consolidated
Debit Credit
Revenues — 400,000 400,000
Cost of revenues — 250,000 (38) 10,000 240,000
Gross profit — 150,000 160,000
Net income — 150,000 160,000
Net income attributable to
noncontrolling interest — — (39) 30,000 30,000
Net income attributable to
controlling interest — 150,000 130,000
Figure 5-9 illustrates the elimination of intercompany transactions between Company P and Company S for the Year 2 consolidated income statement, as follows:
(38) The excess depreciation from the capitalized interest on the intercompany loan is eliminated.
(39) Net income of Company S is attributed to the noncontrolling interest ($150,000 x 20%).
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Figure 5-10: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X7 (all amounts in dollars)
Figure 5-10 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet in Year 2, as follows:
(40) Capitalized interest expense from the prior year ($100,000) less current year depreciation ($10,000) is eliminated.
(45) Retained earnings is eliminated for the prior year recognition of interest income ($100,000) by Company P.
(46) Prior year income attributable to the controlling interest ($120,000) is added to retained earnings.
(47) Company P recognizes its attributable share of income from Company S (($150,000 +
$10,000) x 80%).
(48) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S of $30,000 for both Years 1 and 2.
For explanations of items (41) — (44), see items (5)-(8) in Figure 5-2 and (32)-(35) in Figure 5-8.
Adjustments
Company P Company S Debit Credit Consolidated
Cash 300,000 625,000 925,000
Inventory 200,000 150,000 350,000
Buildings and equipment, net — 1,125,000 (40) 90,000 1,035,000
Intercompany loan 1,000,000 — (41) 1,000,000 —
Investment in Company S 400,000 — (42) 400,000 —
Total assets 1,900,000 1,900,000 2,310,000
Current liabilities 1,100,000 100,000 1,200,000
Intercompany loan — 1,000,000 (41) 1,000,000 —
Total Liabilities 1,100,000 1,100,000 1,200,000
Capital stock 200,000 500,000 (43) 500,000 200,000
Retained earnings 600,000 300,000 (44) 300,000 (46) 120,000 750,000
(45) 100,000 (47) 130,000
Total parent shareholders’
equity 800,000 800,000 950,000
Noncontrolling interest — — (48) 160,000 160,000
Total equity 800,000 800,000 1,110,000
Total liabilities and equity 1,900,000 1,900,000 2,310,000
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Illustration 5-5: Parent charges subsidiary a management fee Assumptions:
Same as Illustration 5-1, except for the following:
1) During the year, Company P charges Company S a management fee of $1,500 for its accounting and finance services.
2) The management fee is the result of a contractual arrangement negotiated between P and S.
3) The management fee is the only transaction between P and S during 20X6 (that is, the intercompany sales described in Illustration 5-1 did not occur).
Figure 5-11: Consolidating work paper to arrive at consolidated income statement, for year ended 31 December 20X6 (all amounts in dollars)
Company P Company S Figure 5-11 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated income statement, as follows:
(49) Intercompany revenue and expense resulting from the management fee of $1,500 paid to Company P are eliminated.
(50) Net income of Company S is attributed to the noncontrolling interest, including its attributable share of the management fee (($150,000 — $1,500) x 20%).
Figure 5-12: Consolidating work paper to arrive at consolidated balance sheet, 31 December 20X6 (all amounts in dollars)
Adjustments
5 Intercompany eliminations
Figure 5-12 illustrates the elimination of intercompany transactions between Company P and Company S for the consolidated balance sheet, as follows:
(54) The income recognized by Company P from the management fee is eliminated from retained earnings.
(55) Company P recognizes its attributable share of income from Company S, including the realization of the portion of the management fee attributable to the noncontrolling interest ($150,000 x 80% + $1,500 x 20%).
(56) Noncontrolling interest is recognized at its initial balance of $100,000 plus its proportionate share of income from Company S ($29,700).
For explanations of items (51) — (53), see items (6)-(8) in Figure 5-2.
Variable interest entities
Question 5.1 How should intercompany eliminations be attributed to the noncontrolling interests for consolidated variable interest entities?
The principles described above (see Section 5.1.1) and reflected in the Illustrations are equally applicable to all consolidated entities, including variable interest entities. It is common for variable interest entities to have substantive profit sharing arrangements and therefore the use of relative ownership percentages may not be appropriate. Our FRD, Consolidation of variable interest entities, provides further interpretive guidance and examples on attributing intercompany eliminations to noncontrolling interests.