What are the steps of intercompany reconciliation?

By Sigma Conso

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Here’s what we’re going to talk about:

  • The basic process of intercompany reconciliation involves reconciling transactions between two entities that sit under the same parent company
  • Size, international growth, and tight deadlines add complexity and the risk of errors to the intercompany reconciliation process
  • The steps of the intercompany reconciliation process depend on the size of the company and include: open items reconciliation, accounts reconciliation, and customer/vendor open items reconciliation
  • Automation and intercompany reconciliation software can simplify and accelerate the process, while increasing the accuracy of the information

Before we go into the steps of intercompany reconciliation, let’s go through some basics. Intercompany reconciliation (ICR) is the process of reconciling transactions between two legal entities that sit under the same company umbrella. Reconciliation software can help simplify and accelerate this process. One subsidiary pays the other party, meaning a transaction takes place where one is the customer and one is the vendor.

These transactions take place within the same group and must therefore be recorded as intercompany transactions on the group-level financial statements, to show that that they represent neither revenue or a cost. They should not be included in any external financial reports.

When accountants review the financial statements at the close of the financial year, the receivables and payables of the two organisations must match, eliminating the transaction and bringing the total down to zero. The accounting team must query and check any discrepancies.

Are you interested in discovering how to improve your intercompany reconciliation process? We have a team of experts who will be happy to discuss your specific needs.

Challenges of intercompany reconciliation

With those basics in place, we can now begin to explore the complexities. For example, the more subsidiaries within an organisation, the more challenging the reconciliation process becomes.

Fast-growing organisations may find themselves with multiple subsidiaries in different countries. Each subsidiary adds to the number of intercompany transactions generated – which can run into the millions. Dealing with increasing country-specific regulation and scrutiny adds yet another layer of complexity.

Financial teams must gather and input vast amounts of data across very different systems, to tight deadlines. This puts them at risk of making mistakes or missing vital pieces of information. To make things more difficult, new and existing subsidiaries may be using legacy software and/or procedures that don’t work with those used by the majority of subsidiaries.

Manual, spreadsheet-based reconciliation is a clunky and risky process that usually leads to errors, even in the smallest of organisations. It’s a practice that rapidly becomes unsustainable as an organisation grows and needs to undertake more frequent reconciliations to satisfy not just regulatory issues but also operational demands.

This is a pressing issue: the most recent FSN Research Future of Financial Reporting report found that 43% of the 760 senior finance executives surveyed don’t even know how many business critical spreadsheets are in use across their organisation.

Companies may also have different year-ends, making matching up timings tricky. If the reconciliation is carried out centrally by the parent company, the accounts team will spend considerable time communicating with its subsidiaries to gather the necessary information for the financial close.

Types of intercompany transactions

Intercompany transactions fall under three headings: downstream transactions, upstream transactions and lateral transactions.

  • Downstream transactions are those from the parent company to the subsidiary
  • Upstream transactions move the other way, from the subsidiary to the parent company
  • Lateral transactions are those which take place between two subsidiaries

There are many reasons transactions between two subsidiaries might take place. These include: paying or receiving loans, selling or buying fixed assets, transfer of stock, paying for expenses or services, or paying dividends.

Intercompany reconciliation process

Organisations typically have regular reconciliation procedures – daily, weekly, or monthly, depending on how many transactions are taking place. This process eliminates intercompany transactions and makes sure all general ledgers match up and the balance sheet and financial statements are accurate. Balances can be settled either at month end or weekly.

For smaller companies with fewer subsidiaries and therefore fewer intercompany transactions, the monthly option is a more effective solution. This means the finance team will review, reconcile, and eliminate monthly transactions by month end, before reporting to the whole-group accounts.

For larger companies with more transactions and more potential queries, the daily, real-time option is preferable. The accounting team will settle, review, and reconcile transaction on a daily, rolling basis throughout the month. This method allows the workflow to be smoother, avoiding peaks, and allows accounting teams to settle group accounts more quickly and efficiently.

The following three processes can be applied to intercompany reconciliation:

  • G/L Open Items Reconciliation (Process 001): Suitable for reconciliation of open items: these remain open on the Open Item after the posting process if the account receivable and payables are posted to the G/L accounts.
  • G/L Account Reconciliation (Process 002): Used for reconciling documents on accounts without open time management and for profit/loss accounts.
  • Customer/Vendor Open Items Reconciliation (Process 003): This process is for the reconciliation of open items which reconciled manually). It can be used for most account receivables or payables attached to accounts of customers/vendors.

Intercompany accounts reconciliation

These accounts are those in your company’s general ledger, designated for transactions between companies within the same group.

Disney, for example, owns both Marvel Studios and Pixar. If Marvel Studies sells services worth $10,000 to Pixar, the general ledger will record Marvel as the receivable account and Pixar as the payable account.

Following the reconciliation process, both intercompany account payables and receivables should have the same balances – $10,000 debited from Pixar and credited to Marvel.

Intercompany payables and receivables

Intercompany receivables occur when one of your company's organisations incurs a payable or receivable on behalf of another subsidiary organisation. Such cases include payments such as loans, advances, and credits.

Likewise, intercompany payables are the dues that one subsidiary pays to another. These may include raw materials or products being exchanged between companies, or employees providing their services for different subsidiaries.

Improving your intercompany reconciliation

Intercompany reconciliation is already complex, and is likely to become even more so. Around 80% of global trade already takes place within the value chains of large global organisation, according to the global organisations, according to the United Nations Conference on Trade and Development.

Transferring this vast amount of data across organisations using systems that don’t match up is a tricky business. As a recent Deloitte report pointed out, improper or insufficient intercompany reconciliation practices across group companies, such as different ERP systems and differences in process, are directly responsible for increasing corporate risk.

Intercompany reconciliation is also hugely time-consuming. In fact, 40% of Deloitte’s respondents said that difficulties in reconciliations and intercompany agreement is the biggest delay to the financial reporting process.

Automation can be a vital tool in solving both these pain points. The right software can easily spot intercompany transactions, flag them, and remove them in a timely manner. Having the same system rolled out across the parent company and all its subsidiaries reduces the risk of error and differences in reporting.

This kind of best practice in intercompany accounting is the ideal solution for better communication and collaboration, and simplifies the process into easy steps. Teams across different organisations can see other accounting team tasks and actions. Again, this vastly reduces the risks of informal information-swapping over email, and prevents tasks being duplicated.

This has a beneficial, cascading effect. Freed from routine reconciliation tasks and labour-intensive processes, finance teams can spend their time working on more complex issues. It may be that some routine roles will no longer be required, enabling those team members to move to intercompany activities within which they can make a far more meaningful contribution.

However, your company must back up automation with better operational control across the board. Finance teams spend vast amounts of time gathering information and attempting to make sense of different processes across the various subsidiaries. It is vital for the CFO and senior management across the organisation to spearhead a drive to agree on a single set of processes that accounting teams can then implement globally. This will allow you and your finance team to spend the time and money saved engaged in strategic practices and thinking, which will drive company-wide success.

Are you interested in discovering how to improve your intercompany reconciliation process? We have a team of experts who will be happy to discuss your specific needs.