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Intercompany Accounting: Process, Challenges & Best Practices

16 December, 2022
5min read
Valerio Trinchi, Treasury Growth Initiative
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What you'll learn

  • What is intercompany accounting?
  • What is the importance of intercompany reconciliation?
  • What is the intercompany accounting process?
CONTENT
What are the types of intercompany transactions?
Why is intercompany reconciliation important?
What is the difference between intercompany and intracompany transactions?
What is the intercompany reconciliation process?
What are the challenges of intercompany accounting?
What are the best practices of intercompany accounting to overcome the challenges?
Conclusion
FAQs
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Intercompany accounting is the process of recording financial transactions between two separate legal entities within the same parent company.

Since these two entities are related, the financial transactions carried out between them cannot be termed ‘independent,’ and the profits and losses from those particular transactions cannot be shown in the financial statements.

Some common examples of intercompany accounting are the selling and purchasing of goods and services between a parent company and its subsidiaries, cost allocation, and royalty payments.

What are the types of intercompany transactions?

Primarily, there are three types of intercompany transactions: upstream, downstream, and lateral, which are explained below:

Upstream transactions

It is the flow of transactions from the subsidiary to the parent company. Here the subsidiary records the details of the transactions, such as profit and loss. An example of upstream transactions can be the transfer of a business executive to the parent company for a particular time frame who charges hourly. In this scenario, the profit and loss will be shared by the majority and minority stakeholders of the subsidiary.

Downstream transactions

It is the flow of transactions from the parent company to the subsidiary. In this kind of flow, the parent company is responsible for recording the transactions. The parent company and its stakeholders are liable to keep track of all the transactions, not the subsidiary. An example of downstream transactions is selling assets by the parent company to a subsidiary.

Lateral transactions

It is the type of intercompany transaction that takes place between two subsidiaries within the same parent organization. The two subsidiary companies hold responsibility for recording any lateral transaction along with the profit or loss. An example of lateral transactions is when one subsidiary provides IT services to another in exchange for a fee.

Why is intercompany reconciliation important?

Intercompany reconciliation is the process of restoring or collecting transactions between legal entities of a single parent company. This process is important because it ensures that all the financial statements acquired by the parent company are recorded correctly. This also helps in eliminating incorrect transactions from the statements that can cause disputes.

Intercompany reconciliation is also beneficial because it provides a consolidated report of the financial condition and status of the group, including the parent and the subsidiary company. Determining a company’s financial position helps in critical decision-making that lets you stay on top.

What is the difference between intercompany and intracompany transactions?

There are different factors that influence the business processes within a company. From the organizational point of view, a proper understanding of intercompany and intracompany operations is essential since it enables you to manage your company’s subsidiaries and employees.

Intercompany transactions Intracompany transactions
  • It is the buying and selling of assets between a company and its subsidiaries.
  • This involves different subsidiaries within a single legal entity.
  • Example- Buying a product from a company for $100, and selling the same product to their subsidiary for $120.
  • Example- Selling a product to a retailer, where both the seller and the buyer are subsidiaries of the same parent company.

What is the intercompany reconciliation process?

A typical reconciliation process of organizations is- daily, weekly, and monthly, depending on the number of transactions recorded in that period. This process eliminates intercompany transactions and ensures that the financial statements are accurate. At the weekend or month-end, the balance could be settled according to the need.

Small companies have less number of subsidiaries, thus fewer transaction records. Therefore, the month-end reconciliation option is best suited for them as it would allow them to reconcile and eliminate monthly transactions.

For larger companies, the number of transactions will be greater as compared to smaller companies, along with more potential queries and real-time analytics. To settle these transactions daily, the accounting team will need to review and reconcile these throughout the month. This process allows the workflow to be more efficient and streamlined when settling group accounts.

What are the challenges of intercompany accounting?

In this modern era of acquisitions and mergers, the issue of intercompany accounting can affect every other company, whether small or large.

Whenever an organization puts its footprint in different geographical locations, a series of intercompany transactions are generated, followed by transfer pricing, tax policies, and currency exchanges.

If these complications are not removed properly, any account can cause serious problems, including impact on financial statements, compliance issues, and lawsuits against the company’s shareholders.

What are the best practices of intercompany accounting to overcome the challenges?

The best practices to overcome intercompany accounting challenges are as follows:

Standardization of global policies across the organization

There are critical areas in an organization where global policies should be established such as data management, foreign exchange and currency, and transfer pricing.

Cash management strategy to settle transactions

Having a proper cash management strategy in place can help in reducing bank fees by providing valuable information to the company that allows them to hedge currencies.

Use third-party reconciliation software that matches transactions

Companies should start using third-party reconciliation software that can track transactions made from one legal entity to another. It can also identify a single transaction whenever required.

Conclusion

Intercompany accounting can be streamlined using modern-day technologies. An orchestrated workflow ensures that all the tasks within an organization are completed most efficiently by eliminating the need for project managers. In simple words, intercompany accounting can be eliminated using collaborative processes, which include having full visibility of account balances of the underlying transactions.

FAQs

Question: What is the journal entry for intercompany accounting?

Answer: The journal entry for intercompany accounting is made in the general accounting ledger specifically to record intercompany transactions.

Question: Why do we need intercompany transactions?

Answer: Intercompany transactions enable a company to keep track and record the reconciled transactions between a company and a group of entities.

Question: What type of account is an intercompany receivable?

Answer: Intercompany receivable is an asset account in the general ledger which is used to track money owed to a business that is currently placed at another company.

Question: Is an intercompany account asset?

Answer: An intercompany account is generally considered as assets and not collapsed into equity when concluded by a written document. It should include the principal amount, maturity date, interest rate, etc.

Question: Which intercompany transactions should be eliminated?

Answer: The intercompany profits and losses with an investee should be eliminated by an investor until those are realized through transactions with third parties.

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