INTERCOMPANY ACCOUNTING

Intercompany Accounting indicates the financial transactions being recorded between different legal entities of the same company. 

In recent years, a growing number of businesses looking to invest more in potential niche markets overseas in the hope of expanding their global footprints. This leads to increasing demand for mergers and acquisitions popularized. According to Grant Thornton LLP, there are 30-40% of global business transactions are intercompany, equaling almost $40 trillion annually. However, organisations often underestimate or oversimplify the essence of intercompany accounting which can lead to financial loss, if not well taken care of, and reputational damage.  

Balancing intercompany accounts is a complex process, which requires the finance department to devote the utmost attention to the reconciliation process. There are 5 key elements to consider in intercompany accounting practices. 

Accounting

According to the Journey of Accountancy article, 55.7% of firms agree that accounting plays a critical role. In accounting practices, every data and figure must be recorded accurately; any out-of-balance positions can cause a huge misleading in the financial report.   

Tax

Companies must be aware of all regulatory requirements in each country before making inventory purchases or acquisitions. Staying compliant with the local tax laws can significantly minimise any possibilities of penalties, profit decrease, or loss when dealing with businesses in a particular territory.  

Treasury

When handling intercompany transactions, having detailed information on every activity between the parent companies and subsidiaries is crucial. It is to ensure the liabilities are paid on time, and all accounts are well maintained and balanced. 

Transfer pricing

Depending on the territories and tax authorities, transfer values can vary. Transfer pricing is one of the risky elements that parent organisations should be aware of before implementing intercompany practices. 

Tax policies, currencies, and transfer pricing can quickly spiral out of hand and complicate the intercompany accounting process.  If not eliminated correctly, these can negatively impact financial statements, or worse, cause compliance issues and unwanted lawsuits.   

Software systems and applications

A survey by Deloitte in 2016 revealed that 21.4% of finance professionals believed disparate software systems used in different legal entities are the biggest intercompany issues.   

Managing intercompany accounting activities is a time–consuming and highly error-prone process. Even missing one figure, the results can be irreversible. This process requires the accountants to be cautious and communicative to make sure the output is consistent and accurate.   

Comprehensive accounting software with modules dedicated to intercompany transactions can enable finance professionals to be in control, gain visibility, and standardise procedures, thus minimising and avoiding unnecessary problems.  

Financial consolidation is the process of integrating subsidiaries' financial statistics into a single financial statement under the holding company. Tracking intercompany transactions is one of the most common problems with financial consolidation.  

Intercompany eliminations (ICE) are made to remove the profit/loss arising from intercompany transactions. No intercompany receivables, payables, investments, capital, revenue, cost of sales, or profits and losses are recognised in consolidated financial statements until they are realised through a transaction with an unrelated party. 

Intercompany transactions can be divided into three main categories: 

• Downstream transaction: This is a transaction from parent to a subsidiary. 
• Upstream transaction: This is a transaction from subsidiary to parent.
• Lateral transaction: This is a transaction between two subsidiaries of the same company. 

Refer to this article for more information and examples on how to handle intercompany transactions.   

Intercompany Reconciliation (ICR) is a pain in the neck of most companies. According to BPM International, 72% of companies find ICR resource-intensive to handle, and 31% have trouble with financial close.  

There are 4 main challenges when businesses do Intercompany Reconciliation: 

Accounting software system

As previously mentioned, disparate accounting software can cause tremendous issues. As each legal entity applies its own software system and accounting process without any standardised cross-platform data management for intercompany transactions, it is a real challenge to consolidate all data stored in different formats, places, or interpretations. Add manual processes and lack of communication to the mix, and companies will have a recipe for disasters. 

Intercompany settlement

The primary function of the intercompany settlement is to ensure the net balance equals zero.  

However, issues can arise due to a variety of reasons. For instance: 

• Lack of standardisation and inadequate staff training, which leads to settlements wrongfully handled. 
• Transactions are managed and processed manually. 
• Conflicting currencies and lengthy approval processes also affect the settlement. 

Transfer pricing compliance

Each territory possesses its own transfer pricing rules and requirements that organisations must comply with. Diligently following transfer pricing practices can help companies avoid penalties from tax authorities, financial burdens, and reputational risks.  

Communications

Communication is a major issue. When handling intercompany transactions, it is crucial for the parent companies and their subsidiaries to first thoroughly discuss and agree on crucial terms and conditions. Accountants across entities are required to cautiously perform, keep contact with others regularly to ensure the accuracy of intercompany invoices, particularly when firms are still processing transactions manually to avoid costly mistakes. 

There are 3 solutions being recommended to tackle Intercompany Reconciliation issues:

Switch from monthly reconciliation to continuous close

Most companies do their reconciliation by the end of the month. The increasing amount of data makes the job becoming more difficult to approach the correct outcome. 

The suggested solution that you can apply is continuous close. Continuous close or continuous accounting is a new approach, where you practice the closing tasks on a day-to-day basis rather than an accounting period. It helps handle intercompany transactions more accurately and efficiently. 

Enhance reconciliation process clarity

Before reaching the parent company’s accounting team, the transactions first need to be recorded and categorised in the subsidiary companies. 

Additionally, the holding company definitely needs to make sure to write down the criteria of finished work, so each subsidiary can look at the list and tick the boxes. More unticked boxes, more work, less happy workers.

Use automation tools

Doing Intercompany Reconciliation manually is highly inefficient. At the same time, the miscommunications or misunderstandings between the companies while operating the task can cause bottlenecks, or worst - lead to serious issues that affect the whole company.

By adopting software that enables automation, companies can limit fraud and mistakes and shorten the intercompany reconciliation process. Additionally, automation is greatly beneficial in: 

• Reconciliation and elimination processes. 
• Intercompany pricing
• Data management 

• Transaction management 
• Netting and settlement 
• Reconciliation and elimination 
• Internal and external reporting 

Some end-to-end systems, such as ERP-based solutions, may be deployed, but they can potentially overcomplicate matters. Your company needs to adopt a dedicated system for intercompany transactions management and reconciliation such as Infor SunSystems. 

Cloud-based solutions with dedicated intercompany modules provide a mutual platform allowing everyone to instantly access the right channels of information. Plus, intercompany transactions are stored, updated, and maintained in real-time in the Cloud, which helps finance staff to significantly cut down on entry errors, improve productivity, save time and resources. 

Intercompany accounting is an all-important process that any parent company must get right. The following best practices for intercompany accounting will make this process much more straightforward and hassle-free.

Continuous closing

Continuous close is the practice of turning period-end closing tasks into day-to-day activities over an accounting period. 

Bringing those tasks closer to the point of the transaction is not without challenges, including retraining accounting staff and updating the process, but the benefits are worth the try. 

Standardised global policies for data management

It is very important to create standardised practices and policies that detail every step of your accounting process and how to collect, tag, and store transactional information. This will allow your accounting teams to organise and file your financial reports more efficiently, thus, substantially diminishing errors. 

While it is not advisable to apply across-the-board uniform policies to every accounting process, as the differences among local laws would make such policies much too vague, policies pertaining to intercompany reporting and management are much easier to be enforced across the entire organisation. 

A central intercompany accounting team

Another way to improve your intercompany accounting is to establish a cross-functional team. This team should have eyes on all transactions in the vertical chain of operations and can determine how information is inputted into the central database.

A global CMO study done by SiriusDecisions showed that 13.73% of organisations are planning to create a Centre of Excellence team as a supportive tool for tackling Intercompany issues. By establishing the Centre of Excellence, companies can better define ownership and accountability in the intercompany process while simultaneously,  combine and distribute expertise, technology, and capability efficiently among the group.

Specialised reconciliation and elimination software

Matching transactions among entities within an enterprise remains a thorny issue in intercompany accounting. As internal transactions are normally processed and stored in multiple IT systems – ERP, accounting software, procurement software, etc., a specialised tool is needed for faster intercompany reconciliation and elimination.