Elimination journal entries are used in the consolidation process to remove the effects of intercompany transactions between entities within a group, ensuring that the consolidated financial statements reflect only the transactions with external parties. These entries are crucial to avoid overstating assets, liabilities, revenues, and expenses.
Common Types of Elimination Entries
- Intercompany Sales/Revenue and Purchases/Expenses
- Eliminate sales made by one entity to another within the same group.
- Intercompany Loans and Interest
- Eliminate loans and interest between related entities.
- Intercompany Dividends
- Eliminate dividends declared by a subsidiary to its parent company.
- Unrealized Profit in Inventory
- Eliminate profit on inventory that has not yet been sold to an external party.
Example 1: Eliminating Intercompany Sales and Purchases
Company A sells goods to Company B (both are subsidiaries of the same parent company) for $50,000.
Company A’s Journal Entry (Seller):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Accounts Receivable | 50,000 | |
| 08-01-2024 | To Sales Revenue | 50,000 |
Company B’s Journal Entry (Buyer):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Inventory | 50,000 | |
| 08-01-2024 | To Accounts Payable | 50,000 |
Elimination Entry (Consolidation):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Sales Revenue | 50,000 | |
| 08-01-2024 | To Cost of Goods Sold | 50,000 |
Explanation:
- Sales Revenue will debited to eliminate the revenue recognized by Company A.
- Cost of Goods Sold will credited to eliminate the expense recognized by Company B.
Example 2: Eliminating Intercompany Loans
Company A provides a $100,000 loan to Company B within the same group.
Company A’s Journal Entry (Lender):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Loan Receivable | 100,000 | |
| 08-01-2024 | To Bank | 100,000 |
Company B’s Journal Entry (Borrower):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Bank | 100,000 | |
| 08-01-2024 | To Loan Payable | 100,000 |
Elimination Entry (Consolidation):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Loan Payable | 100,000 | |
| 08-01-2024 | To Loan Receivable | 100,000 |
Explanation:
- Loan Payable will debited to eliminate the liability recorded by Company B.
- Loan Receivable will credited to eliminate the asset recorded by Company A.
Example 3: Eliminating Intercompany Dividends
Company A (the parent company) receives a dividend of $20,000 from its subsidiary, Company B.
Company B’s Journal Entry (Dividend Declared):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Retained Earnings | 20,000 | |
| 08-01-2024 | To Dividends Payable | 20,000 |
Company A’s Journal Entry (Dividend Received):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Dividends Receivable | 20,000 | |
| 08-01-2024 | To Dividend Income | 20,000 |
Elimination Entry (Consolidation):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Dividend Income | 20,000 | |
| 08-01-2024 | To Dividends Payable | 20,000 |
Explanation:
- Dividend Income will debited to eliminate the income recognized by Company A.
- Dividends Payable will credited to eliminate the liability recognized by Company B.
Example 4: Eliminating Unrealized Profit in Inventory
Company A sells inventory to Company B for $30,000, with a cost of $20,000. Company B has not yet sold the inventory.
Company A’s Journal Entry (Seller):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Accounts Receivable | 30,000 | |
| 08-01-2024 | To Sales Revenue | 30,000 | |
| 08-01-2024 | Cost of Goods Sold | 20,000 | |
| 08-01-2024 | To Inventory | 20,000 |
Company B’s Journal Entry (Buyer):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Inventory | 30,000 | |
| 08-01-2024 | To Accounts Payable | 30,000 |
Elimination Entry (Consolidation):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Sales Revenue | 30,000 | |
| 08-01-2024 | Inventory | 10,000 | |
| 08-01-2024 | To Cost of Goods Sold | 20,000 | |
| 08-01-2024 | To Inventory | 20,000 |
Explanation:
- Sales Revenue will debited to eliminate the intercompany sale.
- Cost of Goods Sold will credited and Inventory is debited to remove the profit that has not yet been realized by the consolidated group.
Conclusion
Elimination journal entries are essential for ensuring that only external transactions are reflected in consolidated financial statements. By carefully eliminating intercompany transactions, businesses provide a clear and accurate picture of their financial position and performance.