How are intercompany transactions eliminated during consolidation?

Question

AcadiFi · Accepted Answer

Intercompany elimination is essential to prevent the consolidated entity from reporting transactions with itself. The treatment depends on the direction of the sale.

**Downstream vs Upstream:**
- **Downstream:** Parent sells to subsidiary
- **Upstream:** Subsidiary sells to parent

```mermaid
flowchart LR
    subgraph Downstream
        P1["Parent"] -->|"Sells to"| S1["Subsidiary"]
        S1 --> I1["Unrealized profit allocated 100% to parent"]
    end
    subgraph Upstream
        S2["Subsidiary"] -->|"Sells to"| P2["Parent"]
        S2 --> I2["Unrealized profit shared: Parent + NCI"]
    end
```

**Scenario -- Downstream Sale:**
Westfield Corp. (parent, 80% owner of Harbor Ltd.) sells inventory to Harbor for $500,000. Westfield's cost was $350,000, so the intercompany profit is $150,000. At year-end, Harbor still holds 40% of this inventory (unsold to third parties).

**Eliminations:**
1. Eliminate intercompany revenue and COGS:
   - DR Revenue: $500,000
   - CR COGS: $500,000

2. Eliminate unrealized profit in ending inventory:
   - Unrealized profit = $150,000 x 40% = **$60,000**
   - DR COGS: $60,000
   - CR Inventory: $60,000

**Since this is downstream, the entire $60,000 unrealized profit is eliminated against the parent's income.** NCI is unaffected.

**Scenario -- Upstream Sale:**
Harbor Ltd. (subsidiary) sells inventory to Westfield (parent) for $300,000. Harbor's cost was $200,000, giving $100,000 intercompany profit. At year-end, 30% remains unsold.

**Eliminations:**
1. Eliminate intercompany revenue/COGS as above
2. Unrealized profit = $100,000 x 30% = **$30,000**

**Since this is upstream, the unrealized profit is shared:**
- Parent's share: 80% x $30,000 = $24,000 (reduces parent equity income)
- NCI's share: 20% x $30,000 = $6,000 (reduces NCI income)

**Other Common Intercompany Eliminations:**

| Transaction | Elimination |
|---|---|
| Intercompany loans | Eliminate receivable/payable and interest income/expense |
| Intercompany dividends | Eliminate dividend income and dividends paid |
| Intercompany fixed asset sale | Eliminate gain and adjust depreciation |
| Intercompany services | Eliminate service revenue and related expense |

**Exam Tip:** For CFA Level II, focus on inventory intercompany transactions. Always determine: (1) direction (upstream/downstream), (2) total intercompany profit, (3) percentage still in ending inventory, and (4) how the unrealized portion is allocated.

Practice intercompany elimination scenarios in our CFA Level II materials.

How are intercompany transactions eliminated during consolidation?

Master Level II with our CFA Course

Related Questions

Practice Questions

Transaction	Elimination
Intercompany loans	Eliminate receivable/payable and interest income/expense
Intercompany dividends	Eliminate dividend income and dividends paid
Intercompany fixed asset sale	Eliminate gain and adjust depreciation
Intercompany services	Eliminate service revenue and related expense