Intercompany Accounting: Process, Challenges & Best Practices

Introduction: What is intercompany accounting?

Intercompany accounting refers to the systematic procedure of documenting financial transactions between companies within a single corporate group. This includes reconciling accounts, eliminating duplicate entries, and ensuring accurate financial reporting. 

Proper intercompany transactions accounting is crucial for maintaining transparency and compliance within a corporate group.

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 intercompany 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 intercompany 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 intercompany 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 intercompany 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 intercompany transactions is when one subsidiary provides IT services to another in exchange for a fee.

What is the difference between intracompany and intercompany 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.

What is the intercompany accounting process flow?

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 them throughout the month. This process allows the workflow to be more efficient and streamlined when settling group accounts.

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 are some examples of intercompany transactions journal entries?

An intercompany journal entry records debits and credits to be posted to ledger accounts for transactions between two subsidiaries. Intercompany journal entries adjust the value of any set of accounts without entering transactions such as invoices or bills. 

Intercompany transactions journal entries examples can vary depending on the specific transactions and accounting systems used by a company.

Here are a few examples of intercompany journal entries:

1. Sale of Inventory between Subsidiaries
   • Debit: Intercompany Receivable (Selling Subsidiary)
   • Credit: Intercompany Payable (Purchasing Subsidiary)
2. Payment of Expenses on Behalf of Subsidiary by Parent Company
   • Debit: Intercompany Payable (Parent Company)
   • Credit: Cash/Bank (Parent Company)
3. Transfer of Funds between Subsidiaries
   • Debit: Intercompany Loan Receivable (Lending Subsidiary)
   • Credit: Intercompany Loan Payable (Borrowing Subsidiary)
4. Allocation of Shared Costs
   • Debit: Intercompany Expense (Receiving Subsidiary)
   • Credit: Intercompany Revenue (Providing Subsidiary)

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 intercompany accounting best practices 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 intercompany transactions

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

Use third-party reconciliation software that matches intercompany 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

What is the journal entry for intercompany accounting?

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

Why do we need intercompany transactions?

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

What type of account is an intercompany receivable?

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.

Is an intercompany account asset?

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.

Which intercompany transactions should be eliminated?

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

What are examples of intercompany accounting?

Intercompany accounting refers to the process of managing financial transactions between companies that belong to the same corporate group. Some examples of intercompany accounting are cost allocation, royalty payments, and transferring resources and capital between subsidiaries.

How do you handle intercompany transactions?

Handling intercompany transactions can be a complex process, but you can categorize transactions by type, develop standard processes, automate transaction matching, and standardize balance sheet reconciliation.

How do you balance intercompany accounts?

Balancing intercompany accounts involves reconciling the accounts between different legal entities within the same parent company. Identifying intercompany transactions, recording intercompany transactions, reconciling intercompany accounts, and automating reconciliation are some steps you can take to balance intercompany accounts.

How is intercompany reconciliation done?

Intercompany reconciliation is the process of verifying and adjusting financial transactions between two or more companies that are part of the same parent company. Intercompany reconciliation involves comparing the balances in the intercompany accounts of each entity and making any necessary adjustments.

Is intercompany accounting difficult?

Intercompany accounting can be challenging due to the complexity of managing financial transactions between companies that belong to the same corporate group. However, using account reconciliation software for automating reconciliations and standardizing processes can help make it more efficient and less time-consuming.

What is accounting for intercompany transactions?

Accounting for intercompany transactions involves recording and managing financial transactions between companies within the same corporate group. It helps maintain transparency in financial statements, facilitating proper consolidation and evaluation of the overall financial performance.