 Hello and welcome to this session in which we would look at elimination of intercompany transactions, specifically balance sheet item. This topic is covered under chapter three, which is under the consolidation of financial statements. But specifically in this topic, we're going to be looking at the balance sheet items. Now, what does that mean? Are we going to be ignoring the income statement elimination? Absolutely not. Notice chapter four, it's all devoted about income statement elimination, where we have a little bit more of advanced topic we have to cover. However, I would like to repeat myself every time I start a new recording that if you are a CPA candidate, this is a great review for you. Now, if you are a CPA candidate and you would like to dig a little bit deeper, have a higher level of understanding of these topics, please go to farhatlectures.com on my website and subscribe to my advanced accounting. Now, most likely are subscribed to my CPA material. If you want more advanced, you have access to my advanced accounting, because in this session, I do a review rather than a deep dive. But my review should be a little bit more involved than your CPA review course, but less than your advanced accounting course. I'm going to try to keep that balance. Let's go ahead and get started. Elimination of intercompany transaction balance sheet. Now, we have to remember just I know this is this is a review but also we have to remember we have a parent company and we have a sub when the parent control the sub any transaction between the parent, which is this is called the downstream of the if the parent sells to the sub or the sub sells to the parent, those are intercompany transaction and any transaction within the whole entity and this whole rectangular box looks like more like square. This whole box is within the entity. So any transaction that occur between those two entities, it's the transaction within the same entity, they will need to be eliminated. Now, if the sub sells to the outsider or if the parent company sells to the outsider, if the parent company buys from the outsider is if the sub buys from the outsider, that's a third party transaction. But any transaction within this box needs to be eliminated. And it needs to be eliminated 100%. Although the ownership is 100%. So the parent might own only 80% of the sub, but we will eliminate 100% of the transaction. So when the parent company consolidate a subsidiary, it prepare consolidated statement in which parent and subsidiaries are treated as a single entity. And this is the single entity. Therefore 100% of the intercompany transaction should be eliminated, even when the parent ownership is less than 100%. Also, the transaction are eliminated both from the balance sheet as well as the income statement. I will start with the balance sheet, because the balance sheet is easier to understand. It's the easier to understand the big picture. It doesn't mean the income statement are more difficult. Actually, the income statement could get more difficult, but for a CPA review course, you don't have to be involved with that difficulty. But if you want, you can go to my advanced accounting, but we'll explain the income statement in the next session. Let's focus on the balance sheet here. And once we know the balance sheet, we'll get the big picture. It will be a good introduction to the income statement. So balance sheet eliminate elimination consists of eliminating all the accounts that are simultaneously reported as account receivable in one entity and accounts stable in the other entity. Now in the real world or on the exam, you might see rather than account receivable, you might see something called do from and do to do from is basically the equivalent of an account receivable. So some companies, they might say do from the company do from another company or do from sub due to sub or do from parent and due to parent due to is the equivalent of accounts payable. So what's going to happen if the parent sells to the sub? So let's look at a quick, simple example. I'm going to keep everything balance sheet related. So if the parent sells the sub supplies on account, okay, the parent sells the sub, what would the sub do and what would the parent do? Okay, the sub, since they bought the supplies, they will debit supplies and they will credit accounts payable. The parent, they will debit account receivable and they will credit supplies. So notice what's going to happen. These entries simply put the supplies debit the supplies credit, they will cancel each other because when we prepare the consolidated financial statement, we increase supplies by $100, we reduce supplies by $100. What's left is accounts payable for $100 and account receivable for $100. What do you need to do? You would need to eliminate debit the accounts payable and credit the account receivable or debit due to and credit due from to eliminate the receivable and the payable. Another example of payable and receivable is dividend. When one company pays dividend to the other company, when they declare it, they will have a dividend payable. It needs to be eliminated and the company that's receiving it will have a dividend receivable which will need to be eliminated. Remember, you will debit payable to eliminate the payable and you will credit the receivable to eliminate the receivable. Those are interrelated transaction and we'll talk about dividend a little bit shortly. Also, if there is an investment in bond, let's assume the sub issued a bond's payable. You have the sub and let's keep it very simple just to illustrate the concept. The sub issued the bond at par. They will debit cash, let's assume the bond is $100,000 and they will credit bonds payable. I'm trying to keep everything balance sheet account. The parent company purchased this bond. For the parent company, they will have an investment in bonds and let's assume they bought it exactly for $100,000 and they will credit cash $100,000. Again, back to the box. When we consolidate, it's the same company debit cash, credit cash, technically cancel each other out, then we will debit this bond to get rid of the bond and credit the investment, credit the asset. Also, the same concept applies if you have any accrued interest payable or interest receivable, same concept as the payable and the receivable that we talked about here. Now, bear in mind, it's worth noting that dividend would be reported on the consolidated balance sheet is the only dividend are limited to the dividend paid by the parent company because when we consolidate, we eliminate the dividend paid by the subsidiaries are fully eliminated. So when we consolidate, the only thing that appears on the parent company is the dividend of the parent company. One more time when preparing consolidated balance sheet, if consolidated financial statement, 100% of the intercompany transaction should be eliminated, even though we own less than 100%, obviously less than 100, but more than 50. That's why when we consolidate. So you don't have, although you own less than 100, but more than 50, you eliminate 100%. Let's take a look at a quick example to familiarize ourselves with those journal entries, how they present themselves. Company Y is a wholly own subsidiary of company X. During year two, company Y declared 175,000 of dividend payable on January 3rd, year three. In addition, on December 28th, year two, before the preparation of the financial statement, the balance sheet of Y reported 220,000 account receivable from X. So we have receivable from X resulting from a sale transaction that occurred during the year. Well, what do we have to do here? Well, we have intercompany dividend, we have intercompany receivable, we have to eliminate those. So the first journal entry consists of eliminating the intercompany receivable of 220. The elimination is made by reversing these accounts. Well, if we have a receivable, guess what the other party will have? They will have a payable. Therefore, we debit the payable and credit the receivable because we have a credit of a receivable. Well, we should not have this credit. So this credit is, this account, this receivable is credited, which is reduced, and the payable is debited, which is also reduced. In other words, eliminated, eliminated. The second journal entry relate to the dividend declared of 175. The same concept applies. The dividend receivable would be credited and the dividend payable would be debited. So we're going to debit dividend payable, credit dividend receivable. Again, when dealing with dividend, I'm going to emphasize this point again, and we'll see it later on when we prepare the consolidated financial statement. The intercompany dividend are fully eliminated. Dividend paid by the parent to outsiders are reduced from retained earnings. So if there's any dividend paid to an outsider party that's that goes against retained earning, bear that in mind. Dividend paid by the subsidiary to external parties. Who are the external parties now? External parties are the NCI because if it's a subsidiary, everything practically goes to the parent and what's left, let's assume the parent owns 80%, what's left of the company, the outsider are 20, those outsiders are NCI. It goes to reduce NCI. In addition, it's worth noting that dividend would be reported on the consolidated balance sheet. I'm saying this again and again are limited to the dividend paid by the parent. Also, not only dividend, the equity accounts that are reported on the consolidated balance sheet are the equity account of the parent company, common stock, additional paid in capital, retained earnings, and dividend. Those are the only accounts that belong to the parent company that appear on the consolidated balance sheet and many CPA questions test you on that knowledge. What is the final balance on the consolidated balance sheet? And talking about CPA questions, if you are not a subscriber, go to farhatlectures.com, subscribe, work additional exercises that are similar to quasi CPA simulation to understand this topic. In the next session, I will focus on the income statement entries elimination, which is a little bit more challenging. Anyhow, read the book. If you're not a subscriber, subscribe, study hard, good luck, and of course, stay safe.