What is the purpose of intercompany accounting?

By Sigma Conso, a Prophix Company

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What we’ll be talking about:

  • Intercompany accounting provides stakeholders and decision-makers with an accurate picture of a company’s financial health after all intra-group transactions have been reconciled
  • The intercompany accounting process includes defining the scope of consolidation, identifying and compiling all intra-group transactions, and the reconciliation
  • Intercompany accounting is time-consuming and complex: errors can be very costly, and yet very few finance teams are happy with their current systems
    The right software can help streamline and accelerate intercompany accounting processes across the whole group

The need for accurate and efficient intercompany accounting has become all the more important as companies have become more and more complex. As a case in point, the United Nations Conference on Trade and Development estimates that 80% of global trade already takes place within the value chains of large international companies.

In many jurisdictions, intercompany accounting and consolidated accounts are legal and regulatory requirements. Intercompany accounting is also vital for company shareholders and directors, providing them with the best information around the company's financial position.

It is therefore essential that finance teams track, record, reconcile, and eliminate intercompany transactions accurately and in a timely fashion to avoid this necessary task becoming a drag on company efficiency.

Are you interested in discovering more about intercompany accounting software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our intercompany accounting software can do for you.

How does intercompany accounting work?

Intercompany accounting is the process of reconciling transactions between a parent company and its entities. A company with different entities or subsidiaries must ensure that all financial and commercial transactions carried out by all those entities are recorded and, if necessary, eliminated before the consolidated financial statements are completed. These transactions could include movement of assets and liabilities, plus revenue, sales, expenses, and losses.

Methods of intercompany accounting may vary slightly by company. However, for maximum efficiency and accuracy, the intercompany accounting process should be the same across the parent company and all its entities.

Consolidation scope

This is where the intercompany accounting process should begin. Drawing up a consolidation scope means ascertaining which entities need to be included in the consolidation process.

All entities controlled by the parent company are usually included. However, the key here is control. IFRS 10 defines the principle of control and establishes it as the basis for consolidation. A parent company that meets the definition of control of one or more entities must prepare consolidated financial statements. In most cases, a company which owns 50% of another business is defined as controlling it.

Some exemptions do exist under IFRS 10, but these must be considered carefully to ensure that they apply. CFOs must ensure that the company meets all the requirements under the standard for exemption.

Intra-group transactions

Once the consolidation scope has been established, finance teams must now identify and collect all the relevant data from the parent company and its entities, taking in both types reciprocal and non-reciprocal intercompany transactions.

Reciprocal transactions
: these can be matched to another amount within the group. For example, Parent Company A purchases €500 of raw materials from Entity B, which Company A controls. Company A’s accounts payable will show a debit of €500. This can be matched to the €500 on Entity B’s accounts receivable.

Non-reciprocal transactions
: these occur when a company gives goods, services, and assets from one company to another with no expectation of payment. For example, Parent Company A may sign over office space to Entity B at no cost. While Parent Company A will record the transaction, it will not appear in Entity B’s accounts.

At this point, the materiality threshold must be considered. The International Accounting Standards Board defines materiality as: Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general-purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.

It could be that some intercompany processes are not correctly recorded, for example, or the elimination process is not followed. At what point do these missing intercompany eliminations become relevant or irrelevant to the final numbers? This all depends, of course, on the company’s numbers. If €500 is not recorded correctly and turnover is €5,000, the €500 is certainly relevant to decision-makers. If, however, turnover is €500,000, it is likely not.

Reconciliation

Intercompany transaction reconciliation must be carried out to give an accurate financial picture. If intercompany transactions are not reconciled, it may appear that some companies within the group are more financially successfully than they truly are.
For example, if Parent Company A’s purchase of raw materials from Entity B is not reconciled and eliminated, it will be added to Entity B’s total turnover and therefore profit. However, there hasn’t actually been any profit: the company has simply sold something to itself. If this error is repeated, it can lead to huge discrepancies. This highlights how important it is to properly identify, match, reconcile, and eliminate intercompany transactions.

Reciprocal transactions are usually straightforward. Parent Company A’s €500 purchase of raw materials from Entity B should first be identified as an intercompany transaction. It will then be eliminated from the accounts of both companies and the total will be zero, giving an accurate picture of both company’s financial situation.

Challenges in intercompany accounting

Intercompany accounting can involve identifying, recording, and reconciling millions of transactions across many different entities, time zones, exchange rates, and jurisdictions. To make the task even harder, the subsidiary finance teams may have to use different processes and software systems, some of which may not be compatible.

Teams find themselves having to carry out tasks manually, often using insecure methods such as emailed spreadsheets to gather information on financial transactions and internal financial activities. This all increases the risk of error. A report from Deloitte found that these mismatches of ERP systems and processes directly increase corporate risk.

Time is also a key factor. Intercompany accounting can be a drag on all the company’s processes, such as the financial close. 40% of respondents to FSN Research’s Future of Financial Reporting survey claimed that the biggest delay to the financial reporting process are difficulties in reconciliations and intercompany agreement

Streamlining your intercompany accounting


Using different systems and manual processes may make the challenges of intercompany accounting seem insurmountable. In fact, a recent poll found that just nine per cent of respondents from major companies were ‘very satisfied’ with their intercompany accounting processes.

There is another way, though, with clear processes, schedules, and procedures in place across all entities – along with harnessing the most up-to-date AI and automation tools.

Today’s Best-of-Breed software can automate data collection and reconciliation. It can flag problematic transactions, allowing team members to dedicate the right time and expertise on properly investigating the issue, rather than wasting it on other, standard tasks. This software can also help streamline and accelerate financial processes, especially if deployed across the whole group.

The demands of intercompany accounting are only likely to grow. Putting the right software, global regulations, and intercompany processes in place now will help companies meet – and get ahead of – these challenges.

Are you interested in discovering more about intercompany accounting software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our intercompany accounting software can do for you.