Intercompany Transactions Accounting: Best Practices

In a world of increased globalization and expansion, many businesses have to bear the burden of intercompany transactions accounting. While intercompany accounting has its own fair share of nuances and need for attention to detail, it can be alleviated with the aid of financial automation solutions.

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. What are the Steps in Accounting Consolidation?

4. What to Consider When Doing Intercompany Accounting?

5. What are the Challenges of Intercompany Accounting?

6. What is the Complexity and Risk with Intercompany Accounting?

7. How to Overcome Intercompany Transaction Challenges?

8. How Automation Can Improve Intercompany Accounting?

9. 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?

They are two main types of intercompany transactions to be identified. These include:

1. Reciprocal transactions (intercos): There’s a corresponding amount in the accounts of another company within the group

• Examples: Reciprocal financing, parent royaltities, purchase/sale of goods or services

2. Non-reciprocal transactions: The corresponding amount can’t be identified in the account of another company, but still, the transaction will need to be eliminated

• Examples: Disposals of fixed assets, capital asset contributions, distribution of dividends

With the use of automated financial solutions, the system can inherently flag these types of intercompany transactions. Without software, your finance team will be tasked with manually searching, identifying, and eliminating the various kinds of intercompany transactions that take place.  

What are the Steps in Accounting Consolidation?

It’s up to the parent company to take charge of accounting consolidation to finalise 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 organisations leverage accounting automation solutions to manage the process with utmost accuracy.

What to Consider When Doing 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 prioritise 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.

What are the Challenges of 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 standardisation, then, it’s commonplace to run into trouble.

Transfer Pricing

With every territory maintaining its own set of transfer pricing rules, organisations 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.

What is the Complexity and Risk with Intercompany Accounting?

With accounting taking place in different organisations 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 to Overcome Intercompany Transaction Challenges?

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

1. Standardise 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 organise 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.

How Automation Can Improve Intercompany Accounting?

Manual accounting processes lead to bottlenecks, confusion, and the chance of error. Instead, many companies are realising 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 customisable 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.