What is Intercompany Elimination?
Intercompany elimination refers to the process for removal of transactions between companies included in a group in the preparation of consolidated accounts. The process of intercompany elimination is helpful in managing eliminations of operations among companies within a single group. Besides, intercompany eliminations encourage and establish controls in multifaceted corporate environments. However, the process involves a lot of reporting and paperwork for intercompany relationships can be quite complicated.
Types of intercompany eliminations
Generally, elimination entries are made for removing the effects of intercompany transactions. There are, basically, three types of intercompany eliminations as follows:
- Elimination of intercompany stock ownership
This type of intercompany elimination transaction eliminates the assets as well as the stockholders’ equity accounts for the ownership of subsidiaries by the parent company.
- Elimination of intercompany debt
This type of elimination entry is performed when the parent company makes a loan to the subsidiary and the parent company and the subsidiary possess a note receivable and a note payable respectively. In the event of consolidation or amalgamation of two companies, the loan is merely a transfer of cash, and thus the note receivable as well as the note payable is eliminated.
- Elimination of intercompany revenue and expenses
The elimination of intercompany revenue and expenses is the third type of intercompany elimination. These intercompany revenues and expenses are eliminated as they are merely transfers of assets from one associated company to another. Moreover, it also does not have any effect on consolidated net assets. Some good examples of intercompany revenue and sales elimination can be indicated by sales to associated companies, interest expense or revenue on loans to or from associated companies, cost of goods sold as an outcome of sales to associated companies, and similar more.
Intercompany elimination entries, therefore, occur in the event of a merger, or when one company absorbs another company. During these processes, it is highly essential to clean up and consolidate the financial accounts and relationships between the two for the sake of legality as well as efficiency. Thus, it can be concluded that finances cannot be vanished. Rather, elimination entries are made indicating changes that have been brought about.