Intercompany profit elimination
Intercompany profit elimination removes intercompany transactions from the group financials. Consolidation of intercompany profits eliminates unrealized profits from selected accounts. As a result of these two processes, group statements show only external business transactions.
To eliminate and consolidate intercompany profits, these preconditions must be met:
- Entity and group parameters must be defined.
- The group ownership must be calculated.
- Entity financial data must be available.
- If any entities use local currencies that are different than the group currency, then the local currency and group currency rates must be specified on the Standard Currency Rate Maintenance page.
- Intercompany profit margins must be specified on the Profit Margin page.
To reconcile and eliminate intercompany profits, you must configure the consolidation process.
In the configuration, you define which internal sales account and internal inventory account to reconcile and how the calculated intercompany profit is posted. The elimination is then carried out according to the configuration.
The selling entity reports the margins of the intercompany sales per counter entity. The buying entity reports the intercompany inventory per counter entity. After you run the reconciliation report, those two values are matched according to the configuration and the intercompany profit is calculated.
To consolidate intercompany profits, run these consolidation processes:
- Sum Up Balance: This transfers entity values, converted into the group currency, to the group context and aggregates them in the group financials.
- Intercompany Profit Elimination: This eliminates internal profits. You can use this
process only if intercompany sales and intercompany inventory have been reported on the
intercompany accounts.Note: You can also eliminate internal profits by creating elimination journals manually.
Example
Entity A and Entity B belong to Group X. Entity A sells goods to Entity B for 10,000 EUR and books this amount as revenue in Entity A's financials. Entity B does not sell those goods to an external entity, but keeps them in its inventories. Entity B books 10,000 EUR as finished goods in its financials. There is a 20% profit margin between Entity A and Entity B. Entity A books a profit of 2,000 EUR:
10,000 EUR (revenue) * 20% (profit margin) = 2,000 EUR (profit)
This profit is an unrealized profit from the consolidated group financials' perspective.
After the Intercompany Profit Elimination process is run, this group journal is created:
| Account | Debit | Credit |
|---|---|---|
| Changes in Inventory | 2,000 EUR | |
| Finished Goods | 2,000 EUR |
By debiting the group's Changes in Inventory account with the Entity A's unrealized profit of 2,000 EUR, the group profit is reduced. By crediting the group's inventory account with the same amount, the Entity A's unrealized profit of 2,000 EUR is deducted from the group's inventory (10,000 EUR). In this way, the group's real cost of 8,000 EUR is calculated.
Deferred tax recognition as part of the standard process
A deferred tax is an income tax that is overpaid or owed because of temporary differences between the accounting income and the taxable income. After these temporary differences are reversed, a deferred tax is eliminated. This elimination is recorded as a liability or an asset in the balance sheet at the end of a year.
The standard process does not cover all use cases of deferred tax recognition. The process eliminates the selling entity's deferred taxes and uses the tax rates that have been specified on the Entity Parameter page. In this example, Entity A has an unrealized profit of 2,000 EUR. If, for example, the tax rate is 29%, then the deferred tax value of 580 EUR is recognized:
2,000 EUR (unrealized profit) * 29% (tax rate) = 580 EUR (deferred tax)
This booking is created:
| Entity | Intercompany | Account | Schedule detail | Debit | Credit |
|---|---|---|---|---|---|
| Entity A | External | Losses Carried Forward | Increases | 580 | |
| Entity A | External | Other Financial Income | 580 |
The process adheres to these settings from Business Modeling:
- For the asset account recognition: Deferred Tax - Assets account and the relevant schedule detail. For example, the Losses Carried Forward account and the Increases schedule detail.
- For the profit and loss account recognition: Deferred Tax - Revenue account and the relevant schedule detail. For example, the Other Financial Income account.