Intercompany transactions refer to the funds exchanged between separate business entities under the same parent organization.
It’s estimated that three-quarters of enterprise business transactions take place between parties that are legally affiliated with each other. Ideally, these should be seamless, easy, and error-free. But as Deloitte discovered, that’s often not the case.
Half of the companies reported a “lack of defined ownership” and struggled with visibility into their processes and key activities. Despite these challenges, 54% of companies still rely on manual intercompany processing.
Optimizing intercompany accounting is essential for the financial health of organizations, but as you can see, there’s a lot of room for improvement.
This article will cover key concepts to understand intercompany transactions, including common challenges and best practices to streamline your intercompany accounting process.
What are intercompany transactions?
Intercompany transactions are financial interactions that occur between different legal entities that belong to the same parent company. These could include transactions such as the sale or purchase of inventory, debt financing, the transfer of property, or the execution of services.
There are three main types of intercompany transactions:
- Downstream transactions: the parent company transfers money to or from a subsidiary. Intercompany accounting eliminates the subsidiary’s interest expense and the parent company’s interest income during consolidation.
- Upstream transactions: a subsidiary transfers money to or from the parent company. The gains and losses from these transactions are considered intercompany eliminations during consolidation.
- Lateral transactions: two related parties under the same parent company exchange money. Any intercompany profits would be eliminated if one subsidiary provided materials to another.
An easy way to understand how intercompany transactions work is by considering how money changes hands within a family.
When a parent gets a paycheck from their employer, that’s an independent or “arm’s length transaction.” However, when a parent gives their child an allowance for doing chores, that’s analogous to an intercompany transaction. Further, if one sibling reimburses another for dinner, that’s also like an intercompany transaction.
In these cases, money isn’t entering nor leaving the family—it’s simply being shifted around. Likewise, intercompany transactions can’t be considered earnings or profits for the parent company. However, these transactions have implications for taxes, compliance, and accounting (more on this later).
Intercompany transactions are sometimes confused with intracompany transactions, but there’s a key distinction: intracompany transactions occur between two divisions of the same legal entity (such as a warehouse or manufacturing plant) rather than separate entities.
Why is accurate intercompany accounting important?
The main benefit of accurate intercompany accounting is ensuring your company’s financials are as accurate as possible. Intercompany accounting is critical when companies merge under a parent organization.
Companies may exchange services or supply materials to simplify operations when they integrate. However, these transactions can’t be recognized as revenue. Companies may accidentally misrepresent their sales, profits, and reporting without accurate intercompany accounting.
Here are five reasons to prioritize accurate intercompany accounting:
- Intercompany accounting is essential for compliance with the Securities and Exchange Commission (SEC), Generally Accepted Accounting Principles (GAAP), and Internal Revenue Service (IRS)
- Increases visibility into the activity between related entities
- Reduces the risk of double counting transactions between entities
- Ensures compliance with tax laws and regulations across all entities
- Aids cash settlement and movement
Intercompany accounting may only seem important for large multinational corporations with multiple subsidiaries. But it’s relevant for businesses of all shapes and sizes.
For example, a retail chain with multiple locations could benefit from treating each store as a separate entity. In cases like this, intercompany accounting helps the owner properly reflect the company’s business results.
With QuickBooks Enterprise, businesses can manage multiple entities with greater visibility through seamless tracking of intercompany transactions. Intercompany transaction reports offer the ability to filter by date range to gain insight on completed transactions.
Challenges of intercompany accounting
Taking charge of your company’s intercompany accounting can help you avoid costly errors—but it comes with challenges. Here are a few roadblocks to be aware of.
Intercompany accounting requires synchronization across all entities
One of the biggest challenges organizations face is cross-matching intercompany activity across multiple entities. For example, if company A acquires company B, which has a different accounting system, this mismatch can result in discrepancies and errors.
Intercompany settlements
Transactions between parties need to be settled via accounts payable or accounts receivable to maintain accurate records. If these are settled via journal entries, the process can be tedious and get deprioritized during busy times.
Further, disputes arising between entities regarding invoices or discrepancies can waste valuable resources and weigh down accounting teams. QuickBooks Enterprise intercompany transactions enable your business to track transactions across business entities by assigning assets and liability accounts.
Transfer pricing compliance
When one entity charges another, the activity must be monitored to ensure the methods being used are consistent. This is called transfer pricing compliance, which is often handled by a CFO or CPA since there are significant tax implications. Without proper oversight, this process can result in errors with intercompany reconciliations.
5 Best practices for intercompany accounting
Accuracy and efficiency are the keys to intercompany accounting. Let’s look at five best practices to help you achieve both.
1. Use accounting software for automation
Intercompany accounting is a multidimensional process with lots of variables. Relying on legacy software or spreadsheets to manage your workflow isn’t just inefficient; it’s risky.
Investing in accounting software significantly reduces the risk of manual errors and automates tedious tasks to free up your accounting team for higher-level work.
QuickBooks Enterprise tracks intercompany transactions in real-time from a central dashboard, allowing your team to approve or reject intercompany relationships and transactions.
2. Get organizational buy-in
Getting all entities on the same page is half the battle regarding intercompany accounting. Accordingly, it’s essential to include all stakeholders in decision-making when establishing standards and policies.
This includes establishing guidelines for performance metrics, approvals, pricing, and charts of accounts.
3. Standardize transfer pricing
Tax regulations require “arms’ length” pricing between related parties, meaning intercompany pricing should reflect independent third-party pricing for products and services. There are five accepted methods to standardize transfer pricing.
4. Settle accounts monthly
It’s normal for related parties to owe each other money during intercompany activity. It’s best to settle these transactions month-end to stay consistent and avoid errors. Leaving transactions open can lead to inaccurate financial records, which creates more work in the long run.
5. Practice role-based access control
Intercompany accounting requires collaboration between multiple people across multiple organizations. That said, everyone doesn’t need access to the same information. That’s where role-based access control (RBAC) comes in.
RBAC enables organizations to grant or restrict access to information as leadership sees fit. Here are a few ways RBAC benefits intercompany accounting practices:
- Determine which users can create, approve, and report on intercompany transactions
- Decreases the risk of data breaches and leakage
- Improves cybersecurity compliance with customer data
- Facilitates scalability by creating templates to apply to current, new, or future employees
QuickBooks gives you the ability to select employees to engage in intercompany transactions.
How QuickBooks Enterprise makes intercompany transactions easier
The first step towards accurate, efficient intercompany accounting is investing in software equipped to handle your operations end-to-end. That’s where QuickBooks Enterprise comes in.
The intercompany transactions feature in QuickBooks Enterprise helps you manage multiple business entities with ease with seamless tracking. You can manage relationships between multiple parties, quickly approve or reject transactions, and reduce manual data entry with bulk transactions from a single dashboard.
Further, you can create intercompany transaction reports for clearer insight into completed historical transactions.
Final thoughts
Navigating intercompany accounting is a part of growing that many organizations simply can’t avoid. Considering its implications for taxes, compliance, and accounting, it’s certainly not something that can afford to overlook.
Fortunately, you can streamline intercompany accounting by using the right tools and following best practices. Learn how QuickBooks Enterprise gives you a clear line of sight across your growing business entities.
