Consolidation Concept in SAP:

The individual financial statements of all associated companies forms the basis of consolidation

All the financial statements from a company are reported in the consolidation chart of accounts (similar to the group’s standard chart of accounts). From a business perspective, this results in a set of aggregated financial statements that comprise the individual financial statements of all companies in the group

These aggregated financial statements contain a large number of itemized values that are merely the result of an exchange of services within the group. These values must not be included in the balance sheet, since an external third party cannot form a realistic picture of the real financial strength and performance of the group. Comparisons cannot be made with other groups until the entire group internal values have been eliminated

Example:

Consider company A and B

Company A holds 100% of the shares in company B, Eur 800was paid to company B by company A

The current assets of the company are A are consider EUR 500, Eur 100 of which can be attributed to deliveries of raw materials from company B

Company B consider reports a receivable to the amount of Eur 100 (for delivery of raw materials to company A as stated above), company A in return reports a payable to the amount of Eur 100 for the purchase of raw materials from company C

The economic unit concept, however states that the consolidated balance sheet cannot include payables and receivables from the company within the same group. The balance sheet value in the individual financial statements is due to the legal independence of the internal trading partners. The consolidation activity

“elimination of intercompany unit payables and receivables’ eliminates group internal financial relationships

The activity includes the following:

1) Down payments made, down payments received for the purchase orders2) Receivables from affiliated companies, payables to affiliated companies3) Bills of exchange receivables, bills of exchange payables to affiliated

companies4) Prepayments and accrued income/accrued expenses and deferred income

In practice the elimination of intercompany payables and receivables results in elimination differences, which are due to different valuation approaches (real elimination differences) or different posting periods (statistical elimination differences)

In the example stated above for company A and B, the receivables and payables to and from both companies should be eliminated because of intercompany transactions

Assets that fully or partially involve deliveries or services provided by the companies include in the consolidated financial statements have to be reported with the amount at which they would be reported if the internal trading partners were a single legally independent company. All intercompany profits/losses are to be adjusted.

The group production costs are calculated according to the reporting options pursuant to the international financial accounting standards

Example: company B supplies raw materials to company A. these raw materials are not consumed on the balance sheet key date and are stored in company A’s warehouse. Company B produced the raw materials at Eur 80 and sold them to partner A at a profit of Eur 20, the raw materials therefore have to be adjusted to the cost of production of Eur 80, in turn the profit from the same of raw materials is adjusted at company B.

The aggregated financial statements include the assets, liabilities, adjusting entries, and entire equity capital of the parent company and all its subsidiaries

For this reason, the aggregated balance sheet includes the company’s interest in these subsidiaries as well as the assets of the subsidiaries. From the group’s perspective, its interest in the subsidiaries and the assets that represent this are the same thing. The subsidiary’s assets and the parent company’s interest in these subsidiaries’ are two sides of same coin.

As a part of consolidation of investments, the parent company’s interest has to be offset against the subsidiaries equity. Any differences between the interest and equity first have to be checked for hidden reserves and goodwill. In general the question of whether the differential can be divided among individual complex fixed assets must be clarified.

Example: in our scenario, it is assumed that the differential cannot be divided among individual complex fixed assets. The goodwill is the price paid for the acquired customer base, the motivated employees, the market position and the propensity for innovation of subsidiary B, the equity of subsidiary company B to the amount is eliminated against parent company A’s interest.

The consolidation process results in the consolidated balance sheet

The assets and liabilities of all the affiliated internal trading partners are summarized in the consolidated balance sheet

All the service and activities exchanges between the companies in the group are eliminated

This enables external third parties to compare the group with competitors from the same industry. The group’s real financial strength and performance can be derived from the consolidated balance sheet and is not obscured by the exchange of services within the group