Examples of consolidation elimination entries

What we’re going to talk about:

- The right consolidation software can automate the process, but it remains important to understand the logic behind this intercompany elimination process

- Two main methods of consolidation are the equity method, when an investor does not have full control, and the consolidation method, when a parent has full control of a subsidiary

- There are three main types of elimination entries: elimination of equity, of debt, and of transactions including revenue and expenses

- Automation ensures that these intercompany transactions are correctly identified, eliminated, and recorded on the consolidated balance sheet, allowing more time for strategic thinking, and lessening the risk of error

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In today’s corporate landscape, parent companies and its subsidiaries need to consolidate and eliminate their intra-group transactions to ensure that the company as a whole complies with all relevant laws and regulations. Quick, accurate, and efficient intercompany elimination and consolidation should therefore be a key part of all these entities’ financial processes.

It is also essential that decision-makers and shareholders be provided with a balance sheet that shows the rightcashflow liabilities, profit, and loss, thus giving an accurate picture of the company’s financial status.

While the right intercompany accounting software can automate these processes – vastly reducing the risk of error and saving considerable time – it’s equally important to understand exactly what elimination and consolidation are, and why they are so important.

Are you interested in discovering more about financial consolidation software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our financial consolidation software can do for you.

Consolidation methods: an overview

There are three consolidation methods, with the consolidation and equity methods being the most common:

  • The consolidation method incorporates the whole impact of subsidiaries into group accounts. This means that a subsidiary’s assets, loans, liabilities, and equity are all transferred to the parent company’s balance sheet, and its revenues and expenses to the parent company’s income statement. This method is generally used when the the parent company is defined as having control over the subsidiary.

  • The equity method does not use the conventional consolidation process and applies more when an investor holds significant influence over an investee but does not have control over it. Here, the investor calculates its proportionate share of the investee’s equity and reports it as an investment. That investment account is affected by the investee’s profit and loss: it rises and falls proportionally to the investor’s shares.
  • The proportional consolidation method records an entity’s liabilities and assets on the parent company’s balance sheet in proportion to the parent’s participation in the entity. For example: Parent A has 50% controlling interest over Entity B. So, Parent Ltd records its investment as 50% of Entity Ltd’s liabilities, assets, revenues, and expenses.

However, in 2013 the International Accounting Standards Board (IASB) abandoned proportional consolidation and IFRS11 now requires the equity method when an investor does not have control.

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Types of elimination entries

Using the consolidation method, intercompany transactions between parent and subsidiary companies must be identified, reconciled and eliminated in order to ensure that the parent company’s financial records correctly reflect the company’s financial position. The following are examples of common elimination entries.

Elimination of equity ownership in the subsidiary companies

Ms B founds a UK-based fintech company, PoundX, using £100,000 of her own capital. Three months later, she invests £50,000 in a new company, RandX, which will operate in South Africa. PoundX is defined as having control of RandX, thereby making it the parent company.

PoundX must now ensure that its equity ownership in RandX is eliminated. To do so, PoundX reports its investment as an asset. Meanwhile, RandX – the subsidiary - must report it as equity owned by the parent.

The two entries must then be consolidated, and an elimination entry made. This will ensure that this £50,000 is not double counted in the consolidated financial records.

Elimination of intercompany debt

To extend the above example, RandX is about to develop a forecasting tool for small businesses. For this new project, it needs funds. PoundX therefore lends £10,000 to RandX. With this loan, the parent company and the subsidiary now have a note receivable and a note payable respectively.

For elimination purposes, the loan is treated as a cash transfer and is generally eliminated as per revenue transactions, with both the payable and receivable notes being eliminated.

Elimination of intercompany revenue, sales, expenses, assets, and liabilities

All intercompany revenue, sales, expenses, assets, and liabilities must all be correctly identified, eliminated, and consolidated. If PoundX agrees to sell specialist computer equipment costing £10,000 to RandX, for example, the money involved in the sale stays within the company. The consolidated financial statements must reflect this to avoid incorrectly inflating PoundX’s profits and showing the wrong amount of income.

PoundX’s accounts receivable statement will therefore show £10,000, and RandX’s accounts payable will show £10,000. The two transactions must be matched, reconciled, and eliminated so that the final balance is zero.

Consolidation elimination entries example

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Elimination entries: Going beyond automation

As multi-subsidiary companies continue to grow, so do the challenges around consolidation and elimination. In fact, FSN Research’s Future of Financial Reporting report found that 40% of respondents said their difficulties in reconciliation and intercompany elimination were the biggest delay to their financial reporting process.

This increased volume and complexity of intercompany transactions arrives alongside an increasingly regulation-heavy landscape, creating a perfect storm for CFOs who must ensure their consolidation and elimination processes are both rapid and accurate.

Automation, which enables transactions such as debt, sales, purchases, assets, equity and liabilities to be correctly recorded, identified, and eliminated, is clearly the way forward. It eliminates the high risk of error associated with manual entry onto spreadsheets – it is estimated that 90% of all spreadsheets contain errors.

It also saves your accounting team valuable time, allowing them to concentrate on more strategic thinking, and gives the C-suite the data they need to make the right decisions to maximise your company’s performance.

However, automation by itself is not enough: the human factor is equally important. Understanding how consolidation and elimination works enables CFOs and their teams to be smarter than their software. It allows them to identify not just the right software for your company’s needs, but also the right people, and to smooth out those pain points in the process where a human touch is needed. Automation is a fantastic tool – but it’s not the only one in the toolbox.

Are you interested in discovering more about financial consolidation software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our financial consolidation software can do for you.