What is Intercompany Accounting

Blog post

Large organizations often have subsidiaries that conduct business with one another. Such business activity falls outside the bounds of traditional business, and specific rules govern how such transactions are accounted for. The process is called “intercompany accounting,” and it applies not only to multinational corporations but to commercial companies as well . In this post, we’ll answer the question: what is intercompany accounting?

What is Intercompany Accounting and Why is it Important?

Intercompany accounting exists to neutralize the potential impact of internal transactions on a company’s bottom line, thereby producing financial statements and filings that only reflect business activity conducted with 3rd parties. The result is a clear picture of a company’s actual income and expenses, not a picture sullied by what are effectively internal transactions that do not produce any gross or net financial gain or loss for the company.

Think of companies with various locations or subsidiaries in terms of a family. When the father or mother gets a check from an employer, new money enters the family financial ecosystem. However, when the father or mother gives some of that money to one or more of their children that is the equivalent of an intercompany transaction because no new money has entered the family’s financial ecosystem. This is also the case if one child gives money to their sibling: one sibling will have more money and one less, but no new money has entered the family’s financial picture. It’s just the parent’s income being moved about.

In a nutshell, intercompany accounting ensures a company does not claim sales or purchases it makes to or from itself on the financial statements it provides to tax authorities, regulators, investors, or other stakeholders. Beyond keeping things on the straight and narrow, intercompany accounting helps businesses:

  • Gain a clear picture of financial activity between entities owned by the parent company.
  • Eliminate duplicate counting of intercompany financial activity.
  • Ensure the accuracy of tax filings.
  • Ensure compliance with accounting and reporting standards.

If intercompany accounting did not exist, companies could unintentionally provide an unclear financial picture to stakeholders. In the worst-case scenario, they could attempt to defraud investors, shareholders, and tax authorities by painting an inaccurate picture of company income, profit, or loss.

Risks Associated with Intercompany Transactions

If intercompany accounts are not settled in a timely fashion, it can lead to a multitude of issues including unpredictable cash flow, discrepancies during audits, and, of course, fraud. If a subsidiary is in a different tax jurisdiction than the parent, slow accounting of intercompany transactions greatly increases the risk of tax penalties and increased scrutiny by tax enforcement agencies like the IRS and HMRC. If investors or shareholders become aware of fraudulent accounting practices between companies, it may result in legal action, penalties, and a sharp decline in stock value.

On the other hand, diligent, accurate intercompany accounting can mitigate the risk of fines and lawsuits and provide company leaders with accurate information on which to base budgets and financial projections.

Principles of Intercompany Accounting

If a company with subsidiary units wants to maintain a good reputation with investors, regulators, and tax authorities, they should adhere to these three principles in its intercompany accounting:

Establish governance: Parent company policies for intercompany accounting should include oversight, clear remedial steps, and performance metrics to ensure standardization and the reduction of errors.

Ensure accountability: For effective intercompany accounting, assign tasks to specific team members and hold them accountable. Centralized control promotes consistency and prevents delays in closing.

Automate: Intercompany accounting software can help streamline the process and reduce the manual effort required by automating many of the repetitive tasks. This allows your accounting team to focus on more valuable tasks, leading to improved efficiency and accuracy in your processes.

Today, we are loading about 100,000+ records and auto-reconcile over 90% of those intercompany reconciliations, which has been a significant win for us.”

LKQ Corporation

Intercompany Accounting Best Practices

The goal of intercompany accounting should be to ensure compliance and maintain your organization’s financial reputation. Here are the intercompany accounting best practices that ensure those outcomes:

Flag transactions immediately: Labeling transactions at their inception instead of later dramatically reduces the odds that these transactions will slip through the cracks. Intercompany accounting solutions can flag intercompany activity automatically and prevent delays in the financial close process.

Eliminate intercompany transactions immediately: Once intercompany transactions are identified, software controls can be used to eliminate them automatically. Doing so further reduces the need for accountants to intervene manually and limits the number of top-side adjustments the parent company makes on its consolidated financial statements.

Settle all intercompany accounts on a monthly basis: Settling intercompany accounts at the end of each month can prevent errors, confusion, and unclear financial statements, and help company leaders make informed decisions.

Invest in intercompany accounting software: Investing in technology, such as Trintech intercompany accounting solutions, can significantly improve the entire intercompany transaction reconciliation process in terms of efficiency and accuracy.

Opt for continuous closing: Manage intercompany accounting workflows efficiently by handling closing tasks on a daily basis. This avoids delays and simplifies reconciliation by enabling accountants to investigate incidents while the details are still fresh in their minds.

Manage access and roles: In intercompany transactions, involve fewer parties and define their roles clearly to manage access efficiently.

Implement fixed asset management: Intercompany transactions often involve transferring fixed assets between units. Trintech’s intercompany accounting solutions manage fixed assets and depreciation history to ensure nothing gets overlooked during the transfer.

Conclusion

Having accurate and timely intercompany accounting is crucial in ensuring compliance and maintaining accurate financial reporting. Trintech’s intercompany accounting solutions simplify the process, reduce errors, eliminate bottlenecks during the close, and help your team generate more accurate financial statements.

To find out more how Trintech can help your intercompany accounting, click here.