Eliminating intercompany transactions with associates under the equity method

One of the most common questions we get by groups that have associates in them is whether we should eliminate intercompany transactions with associates.

Firstly, it’s important to point out that associates and joint ventures consolidated using the equity method do not form part of the group according to IFRS 10 as group is defined as a parent and its subsidiaries.

Subsidiaries are consolidated by combining 100% of the holding company with 100% of the subsidiary. Which means when we process our intercompany eliminations, we process 100% of the transaction value and allocate the eliminations to the actual line items where they originate.

But when it comes to associates, we only have two line items, being the “Investment in associate” on the balance sheet and “Income from associate” on the profit and loss. To add to that we only bring in our percentage of the income.

We also don’t control the associate so would it even be appropriate to eliminate intercompany transactions?

The answer is that it depends.

You can follow this handy decision tree and example we’ve put together on what you should do with more details explanations below.

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Transactions not involving assets

When consulting IFRS 28, no firm guidance exists one eliminating intercompany transactions with associates for transactions that do not involve assets. For example, intercompany transactions involving consulting work or management fees.

The community is split and the choice to eliminate these is entirely up to you, although the majority of accountants choose not to.

If you do decide to eliminate these transactions, remember that you only eliminate the profit and loss elements at the percentage holding in that associate.

Remember to

- Eliminate the percentage held only of the transaction value

- Only eliminate income statement values (do not eliminate balance sheet receivables/payables like you would with subsidiaries on consolidation)

Transactions involving assets (upstream and downstream)

Downstream (when investor sells to associate)

This could be for instances where the investor sells inventory to the associate.

- Calculate unrealised profit or loss in the asset held by the associate at year end

- Investor reduces each line item in their income statement relating to the sale

          o  Revenue x 20%

           o  Cost of sales x 20%

- The balance is allocated to the “Investment in associates” line item

- The above journals must reverse when the asset is sold by the associate

Remember the tax in these journals (deferred tax)

Upstream (when associate sells to investor)

This could be for instances where the associate sells inventory to the investor.

You have two acceptable approaches that you can follow based on your preference.

Approach 1

- Reduce the asset value (e.g. inventory)purchased by the unrealised profit x shareholding percentage. Remember we have the investor’s inventory line item available in the financial statements, which means we can adjust it.

- Reduce Income from associate line by the same amount. We don’t have the associate’s revenue and cost of sales line items in our consolidated financials, hence we only adjust the Income from associate line item.

- Reverse these entries once the asset is sold in subsequent periods

Approach 2

- Reduce the Investment in associate line by the unrealised profit x shareholding percentage

- Reduce Income from associate line by the same amount

- Reverse these entries once the asset is sold in subsequent periods

Dividends

Dividends are always eliminated between associates and the investor. By distributing dividends, the associate is reducing its value of “net assets” and therefore reduces the value of the investment the Investor holds.

- Reduce Investment in associate (BS) by dividend received amount

- Reduce dividend income (P&L) by the dividend received amount

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Conclusion

Equity accounting and eliminations are interesting, for the simple reason that you’re not bringing in everything of the associate like you would with a subsidiary, so you have a limited number of line items to work with. And that’s the key that will help unlock these eliminations.

You can only eliminate against the line items that are available, primarily Income from Associates (P&L) and Investment in Associates (BS), unless you have a downstream transaction where you can eliminate against the Investor’s line items like Revenue and Inventory for example.

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