An intercompany transaction is when a sale occurs between two divisions, units, or entities within the same organization. There are many instances where modern companies must make these types of transactions. For example, a parent company might loan money to one of its subsidiaries or a department might transfer inventory to another unit.
At this point you may be wondering, how do you account for these types of transactions? This blog will answer some of the most commonly asked questions about intercompany accounting.
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Intercompany accounting comprises all financial and commercial transactions documented between separate legal entities belonging to the same parent company. These types of transactions may occur between:
An intercompany journal entry is a financial record in the accounting ledger that specifically relates to intercompany transactions. Anytime a transaction occurs between two related entities, the exchange must be recorded and reconciled. A few examples of intercompany journal entries include:
Intercompany journal entries enable companies to meet the same standards of detailed accounting that are expected of all other financial activities. A transaction may only impact a business’ profit and loss statement when it involves an independent, external entity.
Since the entities involved in an intercompany transaction are related, they are not independent, and therefore it would be wrong for the parent company to record a profit or loss. However, by reviewing intercompany journal entries, companies can evaluate the full monetary value of their collective transactions and cultivate a nuanced understanding of their overall financial health.
Accurate financial records of intercompany transactions are vital to strict adherence to regulatory compliance. Accounting principles like ASC 810 and IFRS 10 provide the requirements for preparation and presentation of consolidated financial statements.
Intercompany accounting has become a staple of everyday business, increasingly companies must develop protocols to mitigate the risk posed by handling high volumes of transactions between related entities. The five core intercompany accounting challenges multi-entities face include:
To reduce the complications introduced by intercompany accounting, companies of all sizes must adopt rigorous policies and implement robust processes. Without a proper financial backbone, companies risk non-compliance and hours of lost time as their systems buckle from expansion. Below lists five intercompany accounting best practices all multi-companies can take advantage of:
A downstream transaction occurs when the parent company sells to its subsidiary. In this case, the parent company is responsible for recording the transaction and any profit or loss. The transaction is not transparent to the subsidiaries, only the parent company and its stakeholders.
An upstream transaction occurs when a subsidiary sells to its parent company. In this type of transaction, the subsidiary is responsible for record-keeping and documenting any profit or loss. Not only is the transaction visible to minority and majority interest stakeholders, but they can also share the profit or loss because they share ownership of the subsidiary.
A lateral transaction occurs when two subsidiaries belonging to the same parent company sell to each other. Similar to an upstream transaction, either or both subsidiaries may record the transaction and applicable profit or loss.
The intercompany eliminations process involves deleting transactions made between related entities from the financial statements. This process is essential to mitigate the effects of intercompany transactions on the bottom line and present clear, consolidated financial statements that explicitly show third party transactions.
Further reading: The complete guide to financial consolidation
Transactions involving sales or interest payments between affiliated companies are referred to as intercompany revenues and expenses. These transactions are disregarded by the accounting team because a business cannot record sales of goods to itself as revenue, and the company’s consolidated net assets are unaffected by the removal of linked revenue, cost of goods sold, and profits.
When intercompany stock ownership is eliminated, the assets and stakeholders’ equity accounts for the parent company’s ownership of the subsidiaries are eliminated. The accounting team must create an intercompany elimination to take the profit out of retained earnings.
Intercompany debt is eliminated when a parent firm lends money to a subsidiary, and each party has a note payable and a note receivable. The loan is reduced to a simple cash exchange when the two companies are consolidated; therefore, the accounting team must cancel both the payment and the receivable.
Determining how to manage your intercompany transactions and maintain accurate multi-entity financial records can be a daunting task, but it’s well worth it to develop efficient and effective reporting protocols so that leadership can make data-driven decisions that maximize your company’s resources.
Implement the following eight best practices to streamline financial consolidation and master intercompany accounting:
A robust financial management solution, like Multi-Entity Management (MEM), provides a secure, centralized environment for intercompany accounting and empowers your company to gain better insights with real-time consolidated reporting. Directly embedded in Dynamics GP and Dynamics 365 Business Central, complete your intercompany transactions from end to end within a single database or instance while protecting your data with a scalable security setup customized to your organizational structure.
Recent years have seen a rise in the number of transactions taking place between related companies. Intercompany accounting has become a fact of everyday business, yet, despite this, many remain unaware of the best practices for managing intercompany transaction challenges or have a plan in place to mitigate the risks that can arise when handling high volumes of transactions between related organizations.
If you’re new to intercompany accounting, then take a moment before we jump into the challenges of handling intercompany transactions and check out this short primer on the FAQs. If you’re already up to speed, then let’s jump straight into the core issues multi-companies are trying to overcome through automation.
Handling intercompany accounting involves tracking, settling, eliminating, and reconciling all intercompany transactions between entities. It involves numerous steps, transaction types, and scenarios that need to be worked through for parent companies to produce an accurate consolidated financial statement.
As companies grow and these transactions increase, finance faces an immense backlog of unprocessed data, improvising manual processes to try and meet deadlines, and error-riddled reports that are effectively useless. All these issues can exist as well as the problem of having the entire team tackling the task of trying to fix them, leaving little time for the many other duties on the average finance department’s plate.
If everyone is busy inputting data manually, rectifying errors and scrambling to get month-ends complete, what happens to the strategic elements of finance? How can your team grow operations if you are already struggling to keep up with the pace of intercompany transactions?
A lack of documentation may not seem like the most pressing concern if you currently face a bottleneck of intercompany transactions. However, every minute spent defining processes and standardizing the approach to intercompany accounting will save you hours in the long run.
Often, parent companies adjust for all subsidiaries to produce a consolidated financial statement. Yet, there’s no reason individual subsidiaries can’t complete the bulk of this work with the proper guidance. One problem that regularly occurs is different approaches from different teams and little communication from the parent company regarding accounting expectations.
When acquiring new branches or expanding, companies need to sit down and consider every stage of the intercompany process. Building out policies for handling every transaction type, ensuring teams have adequate tools, establishing a global chart of accounts, and communicating changes to existing policies through continuous training and documentation.
Accurate reporting already costs intercompany accounting teams a lot of time and energy without the additional stress of dealing with errors. Most companies will likely spend most of their time researching discrepancies between reports and rectifying errors on month-ends. Often transactions queried at the end of a month will be weeks old, and parent companies may have to go through multiple departments in a subsidiary to get answers as to what went wrong.
Rectifying errors can cost teams more time than it should take to process an intercompany transaction end-to-end. Wasting time in this manner can impact team productivity and morale, as strategy takes a backseat, and accountants figure out inconsistencies across multiple reports and teams.
The biggest roadblock for accounting professionals is the lack of good tools to handle intercompany transactions challenges. Deloitte polled 4,217 accountants facing intercompany hurdles and found that the most common challenge was decentralized accounting systems.
Far too many multi-entity companies operate from disparate accounting systems, with teams handling finance in silos, importing, and exporting reports, and updating records manually. This scenario is an administrative nightmare and a recipe for financial disaster. It
is worth noting that transferring sensitive financial information in this way is a process vulnerable to security breaches and data manipulation. In the worst cases, it can lead to issues with filing taxes, the loss of essential documents, and reporting that fails to meet compliance requirements.
Finance needs to convince leadership teams of the cost of non-compliance and alert them to the amount of time and money commonly saved by investing in the right tools. Financial transformation often doesn’t begin until it’s long overdue, and when it comes to multi-companies, it should be a top priority before problems start to arise.
Non-compliance is a risk most multi-companies should not be willing to take, yet it’s a risk that many take every day when they postpone financial transformation. Global accounting standards like IFRS 10 and ASC 810 are non-negotiable, and teams must work to keep intercompany transactions in line with the expectations in these guidelines.
Often companies have developed high-level strategies to tackle compliance issues, but the real work happens at the line-item level. Creating smooth workflows involves implementing global policies and frameworks that meet the growing demands of governing bodies.
Although several solutions exist for each issue, automation is at the heart of each. Postponing the inevitable and trying to manually address the rising tide of intercompany transactions in your company will only lead to stressed teams without the tools to properly manage the issues.
Suitable ERPs will allow your team to manage end-to-end intercompany processes without headaches so that you can focus on growing operations through strategic initiatives. If you’re in the market for multi-entity management software, check out this blog on the features to look for in financial consolidation ERPs.