Understanding Intra-group Transactions and Why Elimination Matters

When one company within a group sells goods to another group company, that sale is real to the individual entities—but from the consolidated perspective, it is an internal movement of assets. The profit embedded in such a transfer is unrealised until the goods are sold to an external party or consumed internally.

As CA students preparing consolidated financial statements, you will need to strip out these internal profits. This ensures consolidated figures reflect only transactions with parties outside the group.

The Core Principle

Think of the group as a single economic unit. If Company A (the manufacturer) sells inventory to Company B (a subsidiary) at ₹100 per unit with a markup of 40%, and Company B holds those units unsold at year-end, the group's consolidated balance sheet should not show that ₹40 profit. The profit becomes realised only when Company B sells to an external customer.

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Step-by-Step: Eliminating Unrealised Profit on Inventory

Identifying the Transaction

Suppose Parent Ltd sells goods costing ₹60,000 to Subsidiary Ltd at ₹100,000 during the year. Subsidiary Ltd holds half the inventory unsold at year-end.

Key data:

  • Cost to Parent: ₹60,000
  • Sale price to Subsidiary: ₹100,000
  • Margin: ₹40,000 (or 40%)
  • Unsold by Subsidiary: 50% of units = ₹50,000 (cost to Subsidiary)

Calculate Unrealised Profit

The goods remaining in Subsidiary's inventory carry the selling price of ₹50,000. However, the group's cost was only 50% of ₹60,000 = ₹30,000.

Unrealised profit = ₹50,000 − ₹30,000 = ₹20,000

Alternatively:

  • Margin per unit: ₹40,000 ÷ units sold
  • Apply to units unsold

Consolidation Adjustment

You will reverse the profit in the consolidation working:

Debit: Cost of Goods Sold / Opening Inventory adjustment (₹20,000) Credit: Inventory (₹20,000)

This adjustment:

  • Reduces inventory on the consolidated balance sheet to ₹30,000 (the true group cost)
  • Increases COGS or reduces gross profit by ₹20,000 on the consolidated P&L

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Unrealised Profit and Receivables (Credit Terms)

Intra-group sales often occur on credit. The accounting for receivables follows the same principle.

Example

Parent Ltd sells goods to Subsidiary Ltd for ₹100,000 (cost ₹60,000) on credit. At year-end, Subsidiary has paid only ₹70,000.

In individual financial statements:

  • Parent shows Receivable: ₹30,000 (outstanding)
  • Subsidiary shows Payable: ₹30,000

In consolidated accounts:

  • The receivable and payable offset completely (they are internal)
  • But the unrealised profit of ₹40,000 on the total sale must still be eliminated

If Subsidiary retains all the inventory unsold, the full ₹40,000 unrealised profit is eliminated by adjusting inventory downward and COGS upward.

The Key Point

Eliminating the receivable/payable (debit Payable ₹30,000, credit Receivable ₹30,000) is a separate step from eliminating the profit (which is based on inventory unsold, not payment status).

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Effect on Consolidated Figures

Balance Sheet

  • Inventory: Reduced to actual group cost
  • Receivables: Internal amounts eliminated
  • Payables: Internal amounts eliminated
  • Retained Earnings / Reserves: Reduced by unrealised profit attributed to the group (if parent-owned subsidiary)

Profit & Loss Statement

  • Revenue: Intra-group sales eliminated entirely
  • Cost of Goods Sold: Adjusted to remove the internal margin
  • Gross Profit / Net Profit: Reflects only group-external transactions

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Partial vs. Full Unrealised Profit Elimination

When Parent Owns Subsidiary 100%

Eliminate 100% of unrealised profit against Retained Earnings (or opening P&L reserves).

When Parent Owns Subsidiary <100% (Non-controlling Interest)

Eliminate unrealised profit in proportion to group ownership. The non-controlling interest portion is deferred.

Example: Parent owns 80% of Subsidiary.

  • Unrealised profit on inventory: ₹20,000
  • Group portion (80%): ₹16,000
  • NCI portion (20%): ₹4,000

Eliminate ₹16,000 entirely; the ₹4,000 is reversed against NCI in consolidated reserves.

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Practical Consolidation Working: A Simple Worked Logic

Scenario: Parent sells ₹100 of inventory to Subsidiary at ₹150 (cost basis ₹100). Subsidiary still holds it at year-end. Parent owns 100% of Subsidiary.

| Item | Parent | Subsidiary | Elimination | Consolidated | |------|--------|-----------|-------------|---------------| | Inventory (inventory) | — | 150 | (50) | 100 | | COGS | — | 100 | 50 | 150 | | Sales | 150 | — | (150) | — |

Explanation:

  • Sales of ₹150 are removed (internal)
  • Parent's cost (₹100) added to COGS
  • Subsidiary's recorded inventory (₹150) reduced by the ₹50 profit
  • Net result: consolidated inventory at ₹100, and COGS reflects the true internal cost

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Common Pitfalls

1. Forgetting the profit exists even if payment is incomplete The profit must be eliminated if goods remain unsold—payment status is irrelevant.

2. Eliminating at wrong price Use the cost to the selling group entity, not the transfer price, as the basis.

3. Ignoring NCI adjustments If a subsidiary is partly-owned, allocate the profit elimination correctly between the group and NCI.

4. Repeating the adjustment in subsequent years Once inventory is sold externally, do not re-adjust. The adjustment is only for unsold inventory at each balance sheet date.

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FAQs

Q1: If the subsidiary pays in full, do I still eliminate the profit?

A: Yes. The profit elimination is based on whether goods remain unsold within the group, not on payment. Full payment only affects whether a receivable/payable exists; it does not change the unrealised profit adjustment.

Q2: What happens to the unrealised profit when the subsidiary later sells the goods externally?

A: In the following year, as the inventory is sold out, the unrealised profit adjustment is reversed. The profit then flows through consolidated COGS and is realised. You will adjust the opening inventory balance rather than re-eliminating the entire amount.

Q3: How do I handle goods sold at a loss?

A: If the inter-company price is below the selling entity's cost, the loss (not profit) is similarly eliminated and deferred until external sale. The principle is identical—only realise gains/losses when external parties are involved.

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Final Thought

Intra-group profit elimination is one of the most tested topics in consolidation. The logic is straightforward: remove the internal margin on unsold goods. Practise with worksheets, track inventory movements month-by-month, and always ask: "Is this inventory still within the group, unsold?" If yes, eliminate the profit.

For day-by-day guidance on mastering consolidation techniques and scenario-based practice, explore the free study planner and the consolidation case scenarios at caparveensharma.com—they will sharpen your elimination logic.