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 groups 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 orders
2) Receivables from affiliated companies, payables to affiliated companies
3) Bills of exchange receivables, bills of exchange payables to affiliated
companies
4) 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 As
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 companys interest in
these subsidiaries as well as the assets of the subsidiaries. From the groups
perspective, its interest in the subsidiaries and the assets that represent this are the
same thing. The subsidiarys assets and the parent companys interest in these
subsidiaries are two sides of same coin.
As a part of consolidation of investments, the parent companys 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 As 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 groups 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