When groups scale across entities, countries, or business units, intercompany transactions become unavoidable. But these internal transactions often introduce a hidden distortion: unrealized profit embedded in intercompany markups.
If not identified and eliminated properly, this hidden profit inflates margins, misstates inventory values, and produces misleading consolidated results — even if every entity’s own books are correct.
This guide breaks down how intercompany markups work, why unrealized profit exists, how it affects group reporting, and what the finance team must do to ensure true group performance.
1. What Are Intercompany Markups?
Intercompany markups arise whenever one entity within a group sells goods or services to another group entity at a price higher than cost.
Examples include:
- Manufacturing entity sells at cost + 20% to a distribution entity
- Shared service centers charging administrative fees
- Regional hubs adding margin when reselling inventory
- IT entities charging cost-plus for internal development work
These markups are completely normal — they help measure performance at the entity level and follow tax-transfer pricing requirements.
But from a group perspective, the markup is internal.
The group hasn’t made a profit until the goods or services are sold to an external customer.
This is where unrealized profit appears.
2. What Is Unrealized Profit?
Unrealized profit is the portion of intercompany markup that sits inside:
- Inventory
- WIP
- Assets produced internally
- Service prepayments or accruals
In other words:
👉 It is profit recognized within the group but not yet realized externally.
Example (simplified):
- Manufacturing entity makes a product for $100
- Sells it to a distribution entity for $130
- The distribution entity still holds the product in inventory at period end
The group has not yet earned the $30 markup.
It is unrealized and must be removed in consolidation.
3. Why Unrealized Profit Distorts Group Margins
At the individual entity level, the numbers are fine.
But at the group level, failing to eliminate unrealized profit leads to:
1. Inflated Consolidated Gross Margin
Profit appears before a real external sale.
2. Overstated Inventory
Inventory still contains the markup — not at true group cost.
3. Misleading Performance Between Entities
Trading entities look artificially profitable.
Producing entities look healthier than they are.
4. Incorrect Net Profit and Equity
Unrealized profit artificially boosts retained earnings.
These distortions make group performance appear better (or worse) than reality — creating challenges for CFOs, auditors, and external stakeholders.
4. Where Unrealized Profit Is Typically Found
Unrealized profit can appear in several places depending on the nature of the intercompany transaction.
1. Inventory
This is the most common case.
Any markup embedded in unsold internal inventory must be reversed.
2. Capitalized Assets
If one entity builds equipment or software and charges another entity cost-plus, markup may sit inside PPE or intangible assets.
3. Services
For project-based or cost allocation service transactions, markup may affect WIP or deferred cost balances.
4. Transfer-Priced Goods
Manufacturing hubs, regional hubs, and distribution centers often use mandated cost-plus structures, leaving unrealized profit in stock lines.
Understanding where unrealized profit hides is essential before building an elimination process.
5. How Unrealized Profit Should Be Eliminated in Consolidation
Unrealized profit eliminations follow a consistent logic:
Step 1: Identify Intercompany Transactions With Markups
Review which entities:
- Sell to other entities
- Use transfer-pricing rules
- Charge fees or services with a margin
- Are part of a manufacturing or trading chain
Not all intercompany activities require unrealized profit eliminations — only those containing markups.
Step 2: Determine the Portion of Inventory or Assets Still Unsold
Only the unsold portion contains unrealized profit.
Example:
If 40% of intercompany purchases remain in inventory, then 40% of markup is unrealized.
Step 3: Calculate the Markup Included
Markup can be calculated using:
- Cost-plus percentage
- Gross margin percentage
- Actual profit embedded in intercompany invoices
Example:
Cost = $100
Markup = 30%
Intercompany price = $130
Embedded profit = $30
If 50% still in inventory → Unrealized = $15
Step 4: Record the Consolidation Adjustment
Adjust two areas:
- Inventory / asset value
- Cost of sales (or relevant expense)
This brings group results back to true economic cost.
Step 5: Reverse the Elimination When Sold Externally
When the inventory is sold to customers, the previously unrealized profit becomes realized — and the elimination reverses.
This ensures correct timing of profit recognition at the group level.
6. Common Challenges (and How to Solve Them)
Challenge 1: Markup percentages vary across entities
Some entities use cost-plus 10%, others use 20%, and some use margin-based pricing.
Solution:
Create a central markup matrix—ideally stored in the reporting system—for consistent calculations across the group.
Challenge 2: Hard to identify which inventory is intercompany
Inventory blending or mixing destroys traceability.
Solution:
Require trading entities to tag intercompany stock or track by SKU batch, or use system-level matching where available.
Challenge 3: Manual spreadsheets are slow and error-prone
Managing 10+ entities and thousands of SKUs manually guarantees mistakes.
Solution:
Automate calculation logic using a consolidation system that:
- Identifies intercompany transactions
- Computes markup percentages
- Matches remaining inventory
- Automatically reverses at time of sale
Challenge 4: Unrealized profit in assets is often ignored
Service markups and internally built assets are commonly overlooked.
Solution:
Document all internal cost-plus activities and periodically review which accounts require unrealized profit tracking.
Challenge 5: Timing differences cause mismatched calculations
Receiving entity’s period-end inventory doesn’t align with selling entity’s invoicing.
Solution:
Use system matching based on invoice number, shipment date, or transaction pairs to ensure accuracy.
Conclusion: Understanding True Group Performance Starts With Removing Internal Profit
Intercompany markups serve a real purpose — entity-level measurement, tax transfer pricing, and accountability.
But without proper elimination, they distort group results and mislead decision-makers.
By identifying where unrealized profit hides, calculating it correctly, and eliminating it systematically, finance teams ensure:
- True consolidated margins
- Accurate inventory valuation
- Reliable profit reporting
- Reduced audit rework
- Greater confidence in management insights
And with automation from systems like BrizoSystem, this process becomes faster, cleaner, and far more reliable.