Intercompany transactions & Reconciliation

Intercompany reconciliation is the verification of transactions that take place between two units or subsidiaries of the same parent company. Many businesses have divisions, subsidiaries, franchises, or other units that act independently but are owned by a larger parent company.? Intercompany transactions can be

·???????? Reconciliation of downstream transactions | When a parent company sells to its subsidiary.

·???????? Reconciliation of upstream transactions | When a subsidiary sells to its parent company.

·???????? Reconciliation of lateral transactions | When two subsidiaries of the same parent company sell to each other.

It's important to understand how each of these is recorded in the respective unit's books, the impact of the transaction, and how to adjust the consolidated financials. Companies use journal entries to accurately record transactions such as payments, loans, or sales and purchases.

Whether an intercompany transaction is recorded as a debit or credit depends on the nature of the transaction. For example, if Company A sells goods to Company B, Company A's account will be credited in Company B’s books, and Company B's account will be debited in Company A’s books to reflect the transfer of goods.

Intercompany reconciliation is a crucial step in the intercompany accounting process and for preparing a consolidated statement for financial reporting. Intercompany accounting is significantly more complicated than standard accounting since it requires balancing multiple ledgers, tracking internal / external transactions, forex conversion, performing intercompany eliminations and settlements, and preparing a consolidated financial statement.

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What is Intercompany Accounting and why this is done?

Intercompany accounting is based on the simple concept that transactions between group companies are irrelevant when accounts of all entities of the group are consolidated. A company can’t profit or lose by doing business with itself, and thus, ‘intercompany transactions’ are canceled out from consolidated financial statements.

Intercompany accounting process can be divided into below steps

1.?????? Data collection – Subsidiary company’s ledger sent to parent company for verification with all details of invoices, receipt, payments, etc.

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2.?????? Reconciliation – Transaction details received by subsidiary are matched and reconciled with details in their sub-ledger and an account is considered reconciled when all the internal transactions can cancel out each other. A company's transactions are first segregated into intercompany and external transactions. The intercompany transactions are matched with the general ledger of the respective companies

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3.?????? Netting & Settlement - This involves the actual cash transfers based on intercompany accounts receivables & payables. The outstanding balances are cleared out, and the companies can reflect this in their sub-ledgers.

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4.?????? Elimination and consolidation - transactions like purchasing goods from Subsidiaries can be eliminated and removed from the statement. However, intercompany transactions that affect the consolidated financials are not eliminated. This can be investments or transactions with partially owned subsidiaries. After reconciliation and elimination, the finalized consolidated statement is prepared.

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Why Intercompany reconciliation is important?

Intercompany reconciliation is an important and necessary accounting step for enterprises or even small businesses with different entities.

·???????? Identify Accounting Errors: Transactions can be incorrectly reported in one or both of the ledgers due to errors. Reconciliation will help align the two sub-ledgers.

·???????? Tax Compliance: Group companies must prepare a consolidated financial statement adjusted by Generally Accepted Accounting Principles (GAAP) or another accounting standard. The internal transactions are subject to different tax rules, making it essential to report them correctly.

·???????? Investor relations: Public companies are obligated to present a consolidated financial statement to their investors. Misrepresenting financials can lead to scrutiny from the SEC.

·???????? Financial Planning: Get an overall understanding of the business with a consolidated statement. This can help you better understand the expenses & income of each company.

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Intercompany Reconciliation Process – Steps

1.?????? Identification of Transactions – compile a comprehensive list of all transactions that occurred between the different entities of the company within a specific timeframe. No transactions shall be over looked

2.?????? Verification of Data – cross-verification to confirm the accuracy of the data and ensure that all entities are aligned on the transactions listed.

3.?????? Rectification of Discrepancies – the involved entities collaborate to investigate and rectify these issues

4.?????? Review and Approval – Once all transactions have been verified and any discrepancies corrected, the reconciled list undergoes a final review by senior management. This review serves as a quality check before the reconciliation is formally approved, ensuring accountability and accuracy in the financial records.

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Challenges in Intercompany Reconciliation

1.?????? Complex transactions - The business world isn't always straightforward. Sometimes we can get transactions that are like puzzles, with multiple layers and components. These complex transactions aren't just a challenge to carry out; they're also difficult to reconcile

2.?????? Inconsistent data - Different subsidiaries may use various accounting methods. This lack of uniformity can make it tough to reconcile transactions across the board

3.?????? Human error - A misplaced decimal or a forgotten entry could lead to discrepancies that take time and effort to resolve, impacting both the accuracy and efficiency of the entire reconciliation process.

4.?????? Time consuming - for large corporations with subsidiaries scattered across the globe, the reconciliation process can take up a considerable chunk of time. This extended timeline not only delays other vital financial tasks but also incurs additional operational costs.

5.?????? Regulatory change - Regulations, laws, and accounting standards are always evolving, and companies have to scramble to keep up. The challenge is that these changes often require alterations in the reconciliation process itself, demanding continuous education and updates for the team responsible for reconciliation.

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Best practices in Intercompany reconciliation

To overcome these challenges, certain best practices can be super helpful:

1.?????? Standardization of accounting policies & procedures by using the same accounting methods across all divisions

2.?????? Automation - Not only does this save time, but it also enhances accuracy, allowing you to focus on more strategic tasks

3.?????? Regular Audits act as an additional layer of oversight, ensuring that the reconciliation process is not just functional but effective; identifies any weaknesses or areas for improvement, allowing for timely course correction.

4.?????? Training - well-trained and up-to-date staff with knowledge of the latest accounting standards and company-specific procedures

5.?????? Early Reconciliation allows for more time to resolve any discrepancies, ensuring that the financial records are accurate

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Summary / key takeaways

·???????? Intercompany reconciliation is done between companies with the same parent entity.

·???????? Reconciliation helps remove duplicate entries and rectify errors. This is essential for financial reporting and tax compliance.

·???????? Determine the scope of the work and gather documents like general ledger/invoice/bank statements, etc.

·???????? Match the documents using document ID or amount/date combo. Continue this process till all transactions are matched.

·???????? Resolve discrepancies by verifying the details using supporting documents in coordination with affected business units.

·???????? Streamline your intercompany reconciliation by standardizing tools, rules & processes.

·???????? Automate reconciliation to improve accuracy and save time & cost.

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