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This document discusses intercompany transactions, which occur between units of the same entity. Intercompany transactions can include dividend declarations, asset transfers, and lending between parent companies and subsidiaries or between subsidiaries. Regardless of the type of transaction, intercompany transactions must be eliminated from consolidated financial statements to accurately represent the financial position of the consolidated entity. The document presents a framework for evaluating intercompany transactions and provides examples of downstream and upstream transactions to demonstrate how to apply the framework.

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Diane Roallos
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75 views

Buscom Inco

This document discusses intercompany transactions, which occur between units of the same entity. Intercompany transactions can include dividend declarations, asset transfers, and lending between parent companies and subsidiaries or between subsidiaries. Regardless of the type of transaction, intercompany transactions must be eliminated from consolidated financial statements to accurately represent the financial position of the consolidated entity. The document presents a framework for evaluating intercompany transactions and provides examples of downstream and upstream transactions to demonstrate how to apply the framework.

Uploaded by

Diane Roallos
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Most economic transactions involve two unrelated entities, although transactions may occur between

units of one entity (intercompany transactions). Intercompany transactions may involve such items as
the declaration and payment of dividends, the purchase and sale of assets such as inventory or plant
assets, and borrowing and lending. Regardless of the type of transaction, the occurrence of an
intercompany transaction, if not removed (eliminated) from the consolidated financial statements, will
often result in a misrepresentation of the consolidated entity’s financial position. This chapter presents a
framework for evaluating intercompany transactions. The next section presents a theoretical discussion
of intercompany transactions. The subsequent section presents a framework for interpreting such
transactions, including two-year examples of downstream (parent-to-subsidiary) transactions to assist in
applying the framework to specific situations. The examples in this section are simplified in that each
intercompany transaction occurs at, or near, year-end. This is followed by examples where the
simplifying assumption is relaxed. The chapter then presents how upstream (subsidiary-to-parent)
intercompany transactions differ from downstream transactions.

BASIC CONCEPTS

An intercompany transaction occurs when one unit of an entity is involved in a transaction with another
unit of the same entity. While these transactions can occur for a variety of reasons, they often occur as a
result of the normal business relationships that exist between the units of the entity. These units may be
the parent and a subsidiary, two

139

INTERCOMPANY TRANSACTIONS CHAPTER4

Intercompany transaction: a transaction that occurs between two units of the same entity

139-210.ch04rev.qxd 12/2/03 2:57 PM Page 139

subsidiaries, two divisions, or two departments of one entity. It is common for vertically integrated
organizations to transfer inventory among the units of the consolidated entity. On the other hand, a
plant asset may be transferred between organizational units to take advantage of changes in demand
across product lines. An intercompany transaction is recognized in the financial records of both units of
the entity as if it were an arm’s-length transaction with an unrelated party. From the consolidated
entity’s perspective, the transaction is initially unrealized because unrelated parties are not involved;
therefore, the intercompany transaction needs to be interpreted differently than it was by either of the
participating units. The difference in interpretation generally results in the elimination of certain account
balances from the consolidated financial statements. Transactions between units of an entity can take
several forms and can occur between any units of the entity. Figure 4-1 illustrates possible directions of
intercompany transactions. Transactions flowing from the parent to the subsidiary are commonly called
downstream transactions, transactions from the subsidiary to the parent are commonly called upstream
transactions,and transactions between subsidiaries are commonly called lateral transactions. The
volume of intercompany transactions eliminated from the financial records of many large conglomerate
organizations is significant. For example, Exxon Mobil Corporation reported the elimination of
intercompany revenue of $98.1 billion, $113.4 billion, and $136.6 billion for 2000, 2001, and 2002,
respectively.1 These amounts represented 29.7 percent, 34.8 percent, and 40.0 percent of the entity’s
total sales and other revenue before eliminating intercompany transactions for the three years,
respectively. The views developed in ARB No. 51 have long served as the basic philosophy of the
accounting profession toward consolidations and intercompany transactions. In stating the purpose of
consolidated financial statements, ARB No. 51 provides a justification for the elimination of
intercompany transactions. Regardless of the direction, the intercompany transaction must be removed
when preparing the consolidated entity’s financial statements because, as discussed in ARB No. 51: The
purpose of consolidated statements is to present, primarily for the benefit of the shareholders and
creditors of the parent company, the results of operations and the financial position of a parent company
and its subsidiaries essentially as if the group were a single company with one or more branches or
divisions.2

140 CHAPTER 4 INTERCOMPANY TRANSACTION

Downstream transaction: an intercompany transaction flowing from the parent to the subsidiary

Upstream transaction: an intercompany transaction flowing from the subsidiary to theparent

Lateral transaction: an intercompany transaction flowing from one subsidiary to another subsidiary

FIGURE 4-1 Directions of Intercompany Transaction

Parent Company

Downstream

Lateral

Subsidiary BSubsidiary A

UpstreamUpstream

1 Exxon Mobil Corporation, 2002 10-K. 2 Accounting Research Bulletin, No. 51, “Consolidated Financial
Statements” (New York:American Institute

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