Intercompany Inventory Transactions | Consolidations | Accounting

Companies that make up a business combination frequently retain their legal identities as separate
operating centers and maintain their own record-keeping. Thus, inventory sales between these
companies trigger the independent accounting systems of both parties. The seller duly records revenue,
and the buyer simultaneously enters the purchase into its accounts. For internal reporting purposes,
recording an inventory transfer as a sale/purchase provides vital data to help measure the operational
efficiency of each enterprise.

Despite the internal information benefits of accounting for the transaction in this manner, from a
consolidated perspective neither a sale nor a purchase has occurred. An intercompany transfer is merely
the internal movement of inventory, an event that creates no net change in the financial position of the
business combination taken as a whole.

Thus, in producing consolidated financial statements, the recorded effects of these transfers are elim-
inated so that consolidated statements reflect only transactions with outside parties. Worksheet entries
serve this purpose; they adapt the financial information reported by the separate companies to the
perspective of the consolidated enterprise. The entire impact of the intercompany transactions must be
identified and then removed. Deleting the actual transfer is described here first.

The Sales and Purchases Accounts:

To account for related companies as a single economic entity requires eliminating all intercompany
sales/purchases balances. For example, if Arlington Company makes an $80,000 inventory sale to Zirkin
Company, an affiliated party within a business combination, both parties record the transfer in their
internal records as a normal sale/purchase.

The following consolidation worksheet entry is then necessary to remove the resulting balances from
the externally reported figures:
Cost of Goods Sold is reduced here under the assumption that the Purchases account usually is closed
out prior to the consolidation process.