Intercompany Transactions: Meaning, Types & Examples

Intercompany transactions are a core part of how multinational corporations operate. Financial activities don’t just occur with external parties; they also take place within an organization itself. These internal exchanges fall under intercompany accounting. An organization needs to handle these transactions properly to ensure accurate financial reporting and regulatory compliance.

In this blog we will cover:

• What intercompany transactions are and why they matter.
• The different types and how they work.
• Best practices for managing them effectively.

What Are Intercompany Transactions?

Intercompany transactions are financial exchanges between two legal entities under the same ownership. These transactions can be monetary or non-monetary, covering everything from goods and services to loans, royalties, assets, debt, dividends, and cost allocations.

The best way to understand intercompany transactions is to see them in action.

For example, a paycheck from an employer is new money coming into the household. But when a parent pays their child an allowance for chores, money is just moving around internally. This internal transfer is the perfect example of an intercompany transaction.

Common activities between a parent company and its subsidiaries

Parent companies and subsidiaries create many types of intercompany activities. Some common examples of these intercompany activities include:

• Sales of goods or services between entities
• Loans and advances between group members
• Shared costs like IT support or HR
• Payment of dividends
• Royalties for intellectual property use
• Management fees

Difference between Intercompany and Intracompany Transactions

Intercompany and intracompany transactions may sound similar, but there is one main difference that separates them from each other.

Intercompany transactions happen between entities under the same organization, but intracompany transactions happen within a single company between various departments and business units.

Types Of Intercompany Transactions

Intercompany transactions can be categorized into three types based on how money flows between related entities. Organizations need this understanding to record, track, and eliminate these transactions during consolidation.

Downstream Transactions

Money flows from a parent company to its subsidiary in downstream transactions. The parent company starts the transaction and takes responsibility for recording and tracking all related documents.

The parent company records any profit or loss from these transactions. These transactions remain visible only to the parent company's stakeholders, not to the subsidiaries.

Common examples of downstream transactions include:

• Loans provided by the parent to subsidiaries at favorable rates
• Sale of assets or securities from parent to subsidiary
• Distribution of dividends from parent company profits
• Funding transfers to support subsidiary operations

Upstream Transactions

Money moves from a subsidiary to its parent company in upstream transactions. The subsidiary must keep records and document any profit or loss from the transaction.

Both the parent company and the subsidiaries' stakeholders can see upstream transactions. 

Common examples of upstream transactions include:

• Sales of products from manufacturing subsidiary to parent
• Transfer of equipment or property to parent company
• Temporary assignment of subsidiary employees to parent operations
• Royalty payments for intellectual property use

Lateral Transactions

Lateral transactions happen between two subsidiaries under the same parent company. These exchanges occur between entities at the same level within the corporate structure.

Both participating subsidiaries must record transaction details and any profit or loss. This shared responsibility will give proper documentation from both sides of the exchange.

Common examples of lateral transactions include:

• Exchange of inventory or supplies between subsidiaries
• Provision of specialized services between sister companies
• Transfers of equipment or technology between related entities
• Joint project collaborations between subsidiaries

Intercompany Transactions Examples

Intercompany transactions can occur in different ways between entities. Here are the most common business examples:

1. Sale of Inventory 

A parent company sells inventory to its subsidiary for $100,000, which includes a $20,000 internal profit. The subsidiary then sells the inventory to an outside customer.

• What happens? For the consolidated financial statements, that $20,000 internal profit is not recognized until the final sale to the external party is complete. An elimination entry is required to remove the internal sale and unrealized profit.

2. Intercompany Loans 

A parent company lends $500,000 to its subsidiary. The interest paid by the subsidiary becomes interest income for the parent company.

• What happens? From the group's perspective, no new money was earned. The interest income and interest expense cancel each other out during consolidation to avoid artificially inflating the company's financial performance.

3. Shared Resources and Services 

This occurs when a parent company pays vendor bills on behalf of its subsidiary or when different divisions share resources, like a restaurant supplying ingredients to its food truck.

• What happens? These actions create intercompany receivables and payables—internal debts that must be tracked and eliminated from the consolidated balance sheet.

Benefits Of Intercompany Transactions

Intercompany transactions allow businesses to work better across different entities. These transactions speed things up and provide finance teams with a better understanding of how the business is doing. Some of the main advantages are:

• Financial accuracy: Intercompany transactions improve the accuracy of recording and removing entries during consolidation. This keeps group-level financials clear and builds trust with auditors, creditors, and investors.

• Resource optimization: Subsidiaries share assets, services, and products within the group. This helps in improving the efficiency of the entities.

• Cost reduction: Standardized intercompany processes save time on manual reconciliation, prevent duplicate work, and decrease transaction processing expenses.

• Better decisions: These transactions provide detailed insights about intercompany activities and balances. This helps businesses plan strategies and improve profitability.

How To Manage Intercompany Transactions Effectively

Managing intercompany transactions well just needs good planning and hands-on execution. Companies face growing challenges as global tax rules change and digital transformation speeds up.

These complex financial exchanges can work better with proven practices:

• Your organization needs standardized global policies. These policies must cover key areas like data management, transfer pricing, foreign exchange, and settlement procedures. 

• A master data management program ensures new accounts match company policies. The program helps intercompany transactions follow standardized rules. This approach maintains accurate identification of intercompany activities in different platforms.

• Automation technologies like multi-entity ERP software or third-party reconciliation tools match transactions across multiple systems.

How Can HighRadius Help?

Intercompany transactions can be complex, specifically for businesses with multiple entities or subsidiaries. Common challenges include reconciliation errors, delayed approvals, inconsistent policies across entities, lack of real-time visibility into financial data, and manual processes that consume significant time and resources. These issues can lead to inaccurate reporting, compliance risks, and slower decision-making, ultimately affecting the company’s financial efficiency and strategic planning.

Our cloud-based Record to Report Solution brings together close management, reconciliations, intercompany accounting, consolidation, and reporting, empowering businesses to overcome these challenges. Key capabilities of the software include:

• Automated Intercompany Matching & Elimination: Instantly identify and eliminate intercompany balances using intelligent matching logic, even across multiple currencies and subsidiaries.

• Entity-Level Close Management: Orchestrate local close tasks with entity-specific checklists and approval workflows, while maintaining centralized visibility across the group.

• Integrated GL Reconciliation: Validate intercompany transactions at the GL level using pre-configured templates and auto-certification, reducing the risk of discrepancies during consolidation.

FAQs On Intercompany Transactions

1. Why are intercompany transactions important?

Intercompany transactions are very important of multinational corporations as they allow companies to improve efficiency, allocate capital for growth, share resources, and manage global tax liabilities across all parties.

2. What is the journal entry for intercompany transactions?

Each company records the transaction individually, then a separate elimination entry is posted during consolidation. This reverses the internal transaction to prevent double-counting profits.

3. How are intercompany transactions reconciled?

Finance teams match each entity’s balances like receivables vs payables and fix any differences before consolidation, ensuring accurate group financials.