Intercompany Transactions Accounting: Best Practices & Solutions

In today's globalized and expanding business environment, managing intercompany transactions accounting is a crucial yet complex task. With the right financial automation solutions, businesses can streamline these processes, ensuring accuracy and compliance.

Here, we’ll look at the types of intercompany transactions that may occur in your parent company. We’ll also cover the basics of what there is to know about intercompany accounting so you can ensure compliance and maintain accurate books.

Coming Up

1. What is Intercompany Accounting?

2. How to Identify Intercompany Transactions?

3. Types of Intercompany Transactions

4. Steps in Accounting Consolidation

5. Considerations for Intercompany Accounting

6. Challenges in Intercompany Accounting

7. Overcoming Intercompany Transaction Challenges

8. Complexity and Risk in Intercompany Accounting

9. How Automation Can Improve Intercompany Accounting

10. The Bottom Line

What is Intercompany Accounting?

When a parent company owns different legal entities and subsidiaries under its name, intercompany accounting is the process of recording transactions that take place between them. It is the parent company’s responsibility to eliminate the transactions occurring between its subsidiaries on its final financial statements so that the consolidated financial statements will be prepared properly.

With related entities, transactions are no longer independent. This means that there needs to be extra attention to each of the company’s financial statements.

Intercompany accounting comes into play under various scenarios, but some include: the purchase of goods and services between subsidiaries, royalty, financing activities, and cost allocations, to name a few.

How to Identify Intercompany Transactions?

Intercompany transactions are financial activities that occur between different entities within the same corporate group. Identifying these transactions is crucial for accurate accounting consolidation and financial close processes. When identifying intercompany transactions, it's important to consider two main categories:

1. Reciprocal Transactions (Intercos)

• Definition: Transactions with corresponding amounts in the accounts of another company within the group.
• Examples:
  • Reciprocal financing
  • Parent royalties
  • Purchase/sale of goods or services

2. Non-Reciprocal Transactions

• Definition: Transactions without a direct counterpart in another company’s accounts but still needing elimination.
• Examples:
  • Disposal of fixed assets
  • Capital asset contributions
  • Distribution of dividends

Proper identification of intercompany transactions is essential for:

• Accurate intercompany reconciliation
• Effective transfer pricing management
• Streamlined financial close processes

To simplify the identification process, many organizations use automated financial solutions that can inherently flag intercompany transactions. Without such software, finance teams must manually search, identify, and eliminate various types of intercompany transactions, which can be time-consuming and prone to errors.

Types of Intercompany Transactions

Understanding the different types of intercompany transactions is crucial for accurate financial reporting and compliance. These transactions can significantly impact the financial statements of the parent company and its subsidiaries. By correctly identifying and categorizing intercompany transactions, companies can ensure accurate accounting consolidation, streamline financial close processes, and maintain transparency in their financial reports.

Here are the three main types of intercompany transactions:

1. Downstream Transactions

• Flow: From the parent company to a subsidiary.
• Examples:
  • Loans from the parent to fund a subsidiary's inventory purchase
  • Sale of goods or services from the parent to a subsidiary
  • Parent company granting licenses or royalties to a subsidiary

2. Upstream Transactions

• Flow: From a subsidiary to the parent company.
• Examples:
  • Dividend payments from a subsidiary to the parent
  • Sale of goods or services from a subsidiary to the parent
  • Interest payments on loans from a subsidiary to the parent

3. Lateral Transactions

• Flow: Occur between subsidiaries within the same corporate group.
• Examples:
  • Sale of inventory between sister companies
  • Shared service arrangements between subsidiaries
  • Cross-charging of expenses between related entities

By understanding the types and categories of intercompany transactions, companies can improve their accounting consolidation practices and ensure more accurate financial reporting.

Steps in Accounting Consolidation

It’s up to the parent company to take charge of accounting consolidation to finalize its consolidated financial statements. Here’s a quick look at how parent companies can execute this process step-by-step:

1. Map Out the Scope

The process begins by defining the “consolidation scope.” The parent company defines which subsidiaries will be included based on the level of control the parent company has over the outside entities. For any subsidiary in which the parent company holds over 50% of the voting rights, the inclusion is required.

2. Draw Up Intra-Group Transaction Inventory

Next up is the data collection phase, which is of utmost importance. The parent company must collect inventory, which consists of both non-reciprocal and reciprocal transactions.

Like with audits, the parent company needs to define the materiality threshold, or the margin for error that will be considered acceptable to ensure that the corresponding financial statements can still be thought of as accurate and reliable. There are generally accepted thresholds based on each industry. They tend to be:

• 1%-3% for turnover
• 1%-5% for shareholders’ equity
• 5%-10% for current net income

3. Reconcile Accounts

Now, it’s time to reconcile accounts, in which comparative analysis takes place. To expedite and streamline this often cumbersome process, many organizations leverage accounting automation solutions to manage the process with utmost accuracy.

Considerations for Intercompany Accounting

When performed strictly manually, intercompany accounting can be burdensome and time-consuming. The help of automation solutions can take the edge off, streamline the processes, and ensure accuracy.

That being said, there are still considerations to be had when performing intercompany accounting, which include:

Accounting:

Seems obvious, but each entity, including the parent, must prioritize their accounting methods and processes to maintain accuracy of information. Every data and figure needs to be properly recorded to avoid error.

This is yet another aspect that automation solutions handle for you with the ability to collect data from disparate systems, perform transaction matching, and cleanse data in real-time.

Tax:

Tax regulations vary by state and country, so before making acquisitions or expanding, be sure that you’re aware of all tax implications.

Transfer values:

You’ll need to stay abreast of transfer values in each territory and its corresponding taxes.

Software:

Using software systems that are disconnected and work across borders and legal jurisdictions can be a center of error. That’s why it’s crucial to select accounting software that is able to handle intercompany accounting and can be programmed accordingly based on tax regulations, transfer pricing, and the like.

Automation solutions connect data from many different systems, removing error prone manual tasks such as mapping and cleansing data as well as streamlining processes such as reconciliations.

Challenges in Intercompany Accounting

The above considerations foreshadowed some of the upcoming challenges of intercompany accounting. Here’s where most companies report having trouble with the process:

Intercompany Settlement

At the end of the day, your goal is to ensure that the net balance between companies is equal to zero. But, if any of your subsidiaries suffer from conflicting currencies, time-consuming approval processes, manual work, or lack of standardization, then, it’s commonplace to run into trouble.

Transfer Pricing

With every territory maintaining its own set of transfer pricing rules, organizations have to keep track of many regulations. If they don’t, they run the risk of suffering from penalties or harming their own reputation.

Communication

With cross-border offices, parent companies and their subsidiaries need to be on the same page. This requires close communication and clearly documented standards by which to operate.

Accounting Software

If you’re subsidiaries are all working with different accounting software that can’t communicate with one another, then there’s going to be misplaced or missing cross-platform data and required information. Or, it may necessitate manual data collection, which is not a great use of time and is often rife with human error.

Impact of Currency Fluctuations

When dealing with intercompany transactions across different countries, currency fluctuations can significantly impact the accounting consolidation process. Exchange rate variations can lead to discrepancies in intercompany reconciliations and affect the overall financial close process. Companies must implement robust foreign exchange management strategies to mitigate these risks and ensure accurate reporting of intercompany transactions.

Data Management Issues

The sheer volume of intercompany transactions can lead to data management challenges. Organizations often struggle with inconsistent data formats across different entities, difficulty in tracking and reconciling historical intercompany transactions, and lack of real-time visibility into intercompany balances. Effective data management is crucial for streamlining the intercompany reconciliation process and ensuring accurate accounting consolidation.

Fraud and Compliance Risks

Intercompany transactions can be vulnerable to fraud and pose compliance risks. Challenges include detecting and preventing intentional manipulation of intercompany accounts, ensuring compliance with various international accounting standards and regulations, and maintaining proper documentation for all intercompany transactions to support audit requirements. Organizations need to implement strong internal controls and compliance frameworks to mitigate these risks and maintain the integrity of their financial reporting.

Overcoming Intercompany Transaction Challenges

To overcome the difficulties associated with intercompany accounting, try these best practices and recommendations:

1. Standardize Global Policies

It’s best to set global policies and clearly communicate them to each entity’s management and leadership. Crucial to this step is to include how companies should manage data.

This way, no matter how many different types of accounting software is involved, everything will be set up according to the standards set forth by the parent company. Be sure to also include transfer pricing policies so that tax, finance, and accounting teams are all aware of what to expect.

2. Establish Experts

Devise a center for excellence in which both automation solutions and responsible human resources are involved. The center of excellence will likely span multiple departments, including leads from IT, treasury, accounting, finance, and tax teams.

For global operations, this makes it easier for any subsidiary team to get the information they need and establish a clear line of communication that is streamlined. This team will be responsible for maintaining oversight and visibility into each entity’s practices.

3. Set up a Master Data Management Program

We’ve alluded to this fact throughout this article, but it’s vital to choose a technology solution that can help organize all your intercompany accounting considerations.

With the right automation solution in place, you can devise and carry out a master data management program that spans across various companies. This program will be aligned with the policies set forth by the parent company and ensure the proper passage of information between relevant parties.

4. Use Third Party Software

To perform intercompany reconciliation, remember that the days of manual reconciliation are long gone! Your accounting team has more important fish to fry, so empower them with an automation solution that will perform data collection and transaction matching for them. Plus, this will help to reduce compliance risk as software solutions perform reconciliations with maximum accuracy.

5. Define a Cash Management Strategy

Don’t worry, we haven’t forgotten about the King– cash. You’ll need to also define a cash management strategy for dealing with cash transactions. This will help to keep bank fees at bay and also ensure that cash won’t sit in accounts wasting away instead of being used to earn interest or hedge currencies efficiently.

6. Developing a Robust Policy Framework

Create clear, comprehensive guidelines for intercompany transactions. Align policies with international standards and local regulations. Cover key areas like documentation, approvals, and dispute resolution. A strong framework streamlines processes and reduces risks.

7. Training and Development

Invest in regular employee training on intercompany accounting practices. Cover techniques, principles, and software use. Keep staff updated on best practices and regulations. Skilled employees improve accuracy and efficiency in reconciliations and closing processes.

8. Continuous Improvement Strategies

Foster a culture of ongoing improvement. Regularly review and refine processes. Encourage feedback and use performance indicators to measure effectiveness. Leverage data analytics to identify patterns and bottlenecks. Stay adaptable by embracing new technologies and methods.

Complexity and Risk in Intercompany Accounting

With accounting taking place in different organizations and in different locations, there exist inherent risks. As the parent company, you’re tasked with reconciling a large amount of data, ensuring visibility across entities, and maintaining adequate control of many moving pieces.

You’ll need to be aware of regulations and local tax laws, as well as transfer pricing agreements. Accounting, tax, and treasury resources will be involved in an effort to mitigate risk.

The good news is that there are definitely ways to properly oversee and execute intercompany accounting. Let’s get into how it can be accomplished.

How Automation Can Improve Intercompany Accounting?

Manual accounting processes lead to bottlenecks, confusion, and the chance of error. Instead, many companies are realizing the immense benefits of finance automation software. This is especially true when it comes to intercompany accounting, as automation makes the once complex process smooth and streamlined.

With accounting automation tools, your company can work to reduce fraud and eliminate errors. At the same time, you’ll be able to benefit from:

• Internal and external reporting
• Data management
• Account reconciliation
• Transaction matching
• Intercompany pricing
• Removal of key person dependencies
• Audit trails
• Secure and accurate data

With solutions that can connect with disparate systems and even legacy systems, you can rest assured knowing that all your data will be maintained and accessible.

Additionally, parent companies can rely on increased visibility and real-time data analytics in customizable dashboards for whenever they need answers to big questions or next steps. All information is stored securely and kept up-to-date, without any human intervention.

The Bottom Line

Being a parent company is a lot like being a parent, especially when it comes to finances because the responsibility falls on your plate. You’ll have to set standards and processes that can work for your subsidiaries across borders, in different tax zones, and with various currencies in mind.

Luckily, with technology and automation solutions, you can maintain proper control and manage intercompany transactions accounting without hassle. To learn how our automation solution can simplify your intercompany accounting processes, book a demo!