Intercompany Eliminations
for Construction

IFRS 10 intercompany eliminations for Construction

Construction groups organise their entities around specialist capabilities. A holding company sits at the top, with subsidiaries covering civil engineering, building construction, mechanical and electrical services, plant hire, and property development. Projects frequently involve multiple group entities working on the same contract, with one entity acting as main contractor and others as subcontractors. Each internal subcontract generates intercompany revenue in the subcontracting entity and intercompany cost in the main contractor entity. Under IFRS 15, both entities recognise revenue over time based on their respective performance obligations. At consolidation, the intragroup subcontract revenue and cost eliminate under IFRS 10.B86, leaving only the group's revenue from the external client and the group's actual costs.

The intercompany transactions in construction groups cluster around project-related flows and group overhead charges. Project-related flows include intragroup subcontracting (the largest category by value), internal plant hire charges from the plant entity to project entities, project management or design fees charged by specialist entities, and material transfers from a central procurement entity. Group overhead charges include management fees, shared IT and finance services, and insurance cost allocations. Construction groups also use intercompany loans to fund working capital on large projects (construction contracts often have payment terms of 60-90 days from certification, creating cash flow gaps that the parent or treasury entity bridges with internal financing). The plant hire entity is a common source of intercompany complexity because it charges hourly or daily rates to project entities for equipment use. If the rate includes a margin, any plant hire charges capitalised into work-in-progress on uncompleted contracts represent unrealised profit at the reporting date.

IFRS 15 revenue recognition over time creates a specific elimination challenge in construction. When a subsidiary subcontractor recognises revenue over time on an intragroup contract, it front-loads profit recognition relative to the project timeline. The main contractor entity recognises corresponding cost over time. At any reporting date before the intragroup subcontract completes, the subcontractor has recognised cumulative revenue and profit that the main contractor has recognised as cost. The intercompany revenue and cost eliminate, but the cumulative profit recognised by the subcontractor on the incomplete contract is unrealised from the group's perspective (the group hasn't earned it from the external client yet, proportionate to where it appears in the subcontractor's accounts). Auditors need to calculate the unrealised element by comparing the subcontractor's profit margin on the intragroup contract with the group's overall margin on the external contract. This is frequently missed because auditors focus on eliminating the income and expense but forget the profit element embedded in the stage of completion.

Start by obtaining a schedule of all projects that involve more than one group entity. For each project, identify the main contractor, all intragroup subcontractors, the internal subcontract values, the stage of completion at the reporting date, and the margin each entity has recognised. Calculate the group's overall margin on the external contract and compare it to the sum of margins recognised by individual entities. The difference (after eliminating intercompany revenue and cost) represents unrealised profit that needs adjustment. For internal plant hire, verify the rate charged and identify the margin element. Calculate unrealised profit on plant hire charges capitalised into work-in-progress on uncompleted contracts. For intercompany material transfers, apply the standard inventory unrealised profit calculation to materials held on site at the reporting date.