Simona Catuogno » 8.Reciprocal entries

Intra-group operations

It is necessary to eliminate existing transactions between companies in the group as they represent mere resource transfers and don’t imply concrete variations within this context.

This is because the consolidated financial statement should express the result for the period and working capital of the group as a single economic entity.

Operations to rectify

The first problem that can occur is related to the incomplete correspondence of balances in the various companies in the group (reconciliation).

It is necessary to distinguish between deletions of balances that have no effect on revenue and group capital with deletions of balances that do have an effect.

The following are the ones that do not have an effect on group capital and revenue:

• credits and debts between companies to be consolidated;
• costs and expenses relating to transactions between these companies.

The following are the ones that do have an effect on group capital revenue:

• intracompany profits and losses included in elements of the actual capital (inventories and fixed assets);
• dividends from group companies.

Operations to rectify (continued)

In the scope of the methodology applied to integral purchase acquisition, the elimination of intergroup balances must be made in full regardless of participation percentages.

Elimination of intergroup credits and debts

Elimination of inter-group costs and revenues

Elimination of inter-group profits and losses

This rule is based on the general principle that an economic entity cannot generate a profit through a transaction with itself. Therefore, any gain or loss arising from exchanges of goods within the group – which are still active by the end of the purchasing company’s financial year – must be eliminated, even if the sale was made at market prices.

Exceptions to the elimination of intracompany profits

The law provides two exceptions to the general principle.

1. Profits relating to the work in progress commissioned by an external client, for the execution of which the contractor uses the work of other group companies, don’t have to be eliminated.
2. Profits and losses on intra-group transactions don’t have to be eliminated if they occur simultaneously to the following three conditions:

• If they come from current company transactions;
• If the operations are concluded in normal market conditions;
• If the elimination costs are disproportionate to the overall costs of consolidating.

Profits included in fixed assets

Issues related to the presence of the Institution of depreciation;

In the case of a transfer with registration of capital gain from the receiving party, it is necessary to eliminate profits and rectify in decline the depreciation rate calculated on a higher historical cost.

NB: the divergence problem of depreciation rates between buyer and seller.

If the transfer of goods is made for a lower amount, the loss has to be eliminated and the values of assets and depreciation must be restored (it is also possible to avoid rectifying in order to be on the safe side).

Elimination of Dividends

Corporate case study 1

Corporate case study 2

Corporate case study 3