All forms of intercompany receivables and liabilities must be eliminated when preparing the consolidated financial statements. From the point of view of a single company, a company can not owe money. If a company owes $ 1,000 to an affiliate on account, one company will debit $ 1,000 in its separate books and the other will have to pay the same amount. When a consolidated financial statement is created, the following elimination entry is required in the consolidation worksheet:
Eliminate intercompany receivable/payable.
If there is no elimination entry, both the consolidated assets and the liabilities are overvalued in the same amount.
If the intercompany receivables/liabilities bear interest, all accounts associated with the intercompany receivable must be eliminated in the preparation of the consolidated financial statements, including the receivables/payables, interest income, interest expenses and any accrued interest on intercompany receivables. Other forms of corporate entitlements, such as bonds, are discussed in the following chapters. In all cases, failure to resolve these claims may distort the consolidated balances. As a result, the size of the debt of the merged entity may seem larger than it is, the working capital ratios may be wrong, and other types of comparisons may be distorted.