Intercompany accounting – What it is and its importance

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1. Overview: The importance and challenges of the financial close

Accurate financial information is the backbone of good business decision making, never more so given the high levels of economic volatility and shifting strategic priorities. The financial close process is fundamental to that financial visibility. It ensures the accuracy and timeliness of individual company numbers so they can be passed over to the group for consolidation and reporting and comply with regulatory reports – either internal or external.

A well-executed rapid close can both improve organizational performance and propel accounting executives from financial historians to trusted advisors. Research into the financial close conducted by analyst Hackett Group found that top performing organizations close their ledgers earlier in the month and complete the process in less time than their peer group, helping them free up resources to conduct analysis and provide financial and other company executives with support for fact-based decision-making.[1]

And yet the financial close has long been a source of frustration and pain for finance departments, with potentially significant ramifications for the organization as a whole.

Around a quarter of respondents to research into financial reporting conducted last year by FSN said they spent too much time on data collection from multiple data sources.[2]A similar proportion bemoaned the time spent cleaning and manipulating data. The analysis clearly highlighted the desire among respondents to spend more time on financial risk management and analysis and performance measurement activities.

Opportunity costs aside, a slow financial close is more than likely an indicator that your processes are cumbersome. That typically means manual and labor-intensive processes, relying on use of multiple spreadsheets. The bottom line is that a slow close will increase general and administrative (G&A) expense. It could also be an indication of underlying inefficiencies across other financial processes – such as billing, cashflow and accounts payable.

Recent years have seen a growing focus on the ‘last mile’ of the close – the most externally visible management processes that finance executives perform after the monthly, quarterly or annual close to prepare for financial reporting and disclosure. In contrast, the early stages of the financial close – the ‘first mile’ – which includes the capture of financial data and production of the preliminary trial balance and consolidations, have largely been neglected. And this is the case even though many of the problems that occur in the last mile are due to first mile issues. It is this first mile where there is the potential to make huge improvements in the efficiency, speed and accuracy of the entire record-to-report (R2R) process.

[1] Streamlining the Financial Close Process (Hackett Group, 2017)

[2] The Future of Financial Reporting (FSN, 2018)

2. The 4 key pillars of the financial close process

While the detailed financial close will undoubtedly mean different things to different people, in its broadest sense, it relates to the set of paths or workflows that must be completed in a timely manner to ensure the complete accuracy of financial reporting.

Typically condensed into a 10-day timeframe, the financial close happens every month, quarter and year to varying degrees of complexity. The financial close is the process of taking those individual entities, closing their books and rolling the numbers up to a group level where they can consolidate and produce group financial statements before the information is passed over to a reporting group for disclosure.

There are four main components of the close:

  • Close checklist – a checklist of all the processes that need to be executed along the record-to-report (R2R) journey, typically varying from 300 to 1,200. They need to occur within a tight timeframe and there are lots of dependencies, working across geographies and timeframes – requiring sophisticated project management capabilities to manage that checklist.
  • Journal entry – the process of posting journals and validating them. What you enter must be approved and controlled.
  • Intercompany – intercompany trade can represent a lot of transactions and a huge amount of work for the finance team, but you need to eliminate it from the results. Reconcile and accrue into the next month. The ideal situation is where the reconciliation is zero.
  • Balance sheet reconciliation and certification – it used to be the auditor’s job to ensure the accounts are in order and identify discrepancies, but today it’s an essential part of an organization’s financial checks and balances.

For this article we will focus on intercompany management – what it is, its role in the close and how you can tackle the challenges related to it.

3. What is the role of intercompany in the close?

An intercompany transaction occurs when one division, department or unit within an organization participates in a transaction with another division, department or unit in the same organization. These transactions might involve a parent company and a subsidiary, two or more subsidiaries, or even two or more departments within one unit. The nature of those transactions can also vary, for example from the sale of inventory from one division to another division, or sale of various services from one company or group to another company or the loan of money from a parent company to one of its subsidiaries.

Viewed in terms of a series of credits in one business mirrored by debits at another, the ultimate objective is for one to balance out another. Both entities must record the transaction and at a group consolidated level, any intercompany transaction must be eliminated so that no profit or loss is recognized until it’s realized through a transaction with an outside party.

Complexity arises because from an accounting perspective, each transaction has nuances to consider. For instance, if the transaction occurs between the parent company and a subsidiary, accountants must treat it as an arm’s length transaction.

4. The key elements of intercompany

  • Run customer open line item report/Run vendor open line item report
  • Reconcile reports and create differences list
  • Prepare accrual JV (current month)
  • Post accrual journals (JV) (current month)
  • Send notification email sharing differences list
  • Check intercompany balances

There are three main types of intercompany transactions: downstream, upstream and lateral. 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.

  • A downstream transaction flows from the parent company to a subsidiary. In this situation, the parent company records the transaction and applicable profit or loss. The transaction is transparent or visible only to the parent company and its stakeholders, not to the subsidiaries. An example of a downstream transaction is the parent company selling an asset or inventory to a subsidiary.
  • An upstream transaction flows from the subsidiary to the parent entity. In an upstream transaction, the subsidiary records the transaction and related profit or loss. For example, a subsidiary might transfer an executive to the parent company for a period of time, charging the parent by the hour for the executive’s services. In this case, majority and minority interest stakeholders can share the profit or loss because they share ownership of the subsidiary.
  • A lateral transaction occurs between two subsidiaries within the same organization. The subsidiary or subsidiaries record a lateral transaction along with the profit or loss, which is similar to accounting for an upstream transaction. An example is when one subsidiary provides IT services to another for a fee.

5. The common pitfalls and challenges of intercompany

The process of intercompany elimination is a common and widespread bottleneck to an efficient financial close. In larger organizations, and particularly global entities operating across multiple geographies and time zones, coordinating all the intercompany activities across the organization at month-end quickly becomes hugely complex and difficult to coordinate due to the sheer volume of tasks, the interdependency of those tasks and the tight deadlines at play.

Against a backdrop of pressure for organizations to close the books in as short a timeframe as possible, 40% of senior finance professionals say difficulties in reconciliations and intercompany agreement is what delays the reporting process the most, according to FSN Research and its Future of Financial Reporting report.

The increasing complexity of businesses, global expansion and the shifting sands of intercompany accounting and tax rules is only serving to further exacerbate the problem. Just getting the two entities to agree about the cost of the transaction, the currency translations and possible VAT treatments is an uphill climb.

One of the challenges of intercompany processing is that material differences often only come to light late in the close process when accounting teams find themselves under the most pressure to hit the close deadline. The adjustment process is time-consuming and prone to human error, particularly if it involves a blizzard of spreadsheets. In these circumstances it is tempting – and sometimes necessary – to simply accept any differences and postpone a full reconciliation until the next period.

The process is further complicated when only some of the entities are wholly owned. The international dimension adds further complexity; trying to reconcile intercompany transactions in different currencies and using different exchange rates and potentially subject to diverse tax implications such as VAT, can result in an out-of-balance intercompany transaction with potential tax ramifications.

Mergers and acquisitions often lead to a cobbling together of heterogeneous financial systems, charts of accounts and accounting processes. The ramifications in terms of intercompany reporting are potentially huge. Similarly, the absence of standardized processes and internal governance rules stipulating who can and can’t conduct intercompany transactions is another sticking point.

The global proliferation of accounting and tax regulations, accompanied by a rise in enforcement, exposes companies to greater risk if they fail to effectively govern their intercompany activity. In short, the challenges of performing effective and efficient intercompany accounting can be substantial, and when companies use band-aid tactics to address the problem, they only postpone the inevitable – and the mess keeps growing.

6. How can finance teams tackle the challenges of intercompany?

Remove the manual burden

Technology-enabled coordination and orchestration streamlines intercompany accounting across your entire organization. Automation removes the burden of identifying counterparties across multiple ERP systems. Integrated workflows ensure tasks are completed in the correct order and in the most efficient timeframes by removing the need for managers to waste time chasing up on their completion.
Automation allows users to collaborate more easily and resources to be deployed more efficiently. Employees previously occupied by keeping data moving are now freed to perform higher-value tasks. The result is faster resolution and timely and accurate elimination of intercompany transactions, cost savings, reduced cycle times and an accelerated close.

Streamline the intercompany process with a single view

The elimination of intercompany transactions is a collaborative process, which requires the counterparties to have full visibility of their respective balances, the difference between them and the underlying transactions. Counterparties in an intragroup trade also need shared access to a common view of their intercompany positions.

KPI monitoring gives an overview of intercompany accounting status and highlights potential delays in real time and in a visual way. Dashboards and alerts allow you to manage progress in real time, giving accounting professionals an overview of tasks that haven’t been started or completed. This visibility allows team leaders to review bottlenecks by task, individual, cost center and entity.

Eliminate intercompany mismatches early in the process

The key to minimizing delays around the agreement of intercompany differences is to start the procedure much earlier in the reporting cycle. Viewing intercompany mismatches early on in the reporting cycle allows individual companies to take remedial action and correct their positions before a consolidation is attempted.

Direct integration with ERP systems allows you to extract invoice details to help reconcile differences at a detailed level. Once the differences are resolved, adjustments can be posted directly into ERP systems through the intercompany process without the need to manually post reconciling journal entries. As such, automation effectively turns the intercompany process into a ‘preliminary close’ in advance of the normal monthly reporting cycle.

Manage intercompany risk

Eliminate endless standalone spreadsheets typically used by individuals to manage intercompany accounting with an automated system that gives you one version of the truth and an audit trail of activities detailing when they were completed and by whom. Workflows give employees ownership of each activity and lay bare the interdependencies of their tasks.

Being able to orchestrate and monitor your intercompany accounting is a fundamental part of your internal controls. Role-based security aligned with your underlying applications maintains the integrity of roles and access. At the same time, you can attach and store procedures and policy documents in task list items, which are immediately available to the individuals performing intercompany tasks.

Devise bullet-proof centralized governance and policies

Effective intercompany accounting hinges on standard global policies governing critical areas, such as data and charts of accounts, transfer pricing and allocation methods. Establishing a center of excellence with joint oversight from accounting, tax and treasury serves as a resource to address global process standardization and intercompany accounting issues.

Having a single company-wide process ensures you adhere to best practice and gives all finance stakeholders across the enterprise immediate visibility of issues, tasks and bottlenecks that need escalation and remediation. This can help you benchmark your performance, address underlying issues and facilitate post close reviews, and subsequently streamline your activities to encourage continuous process improvement and further accelerate the close.

Intercompany FAQs

What is intercompany accounting?

Intercompany accounting involves managing financial transactions between different entities within the same parent company. It is essential for ensuring accurate consolidated financial statements by recording and reconciling transactions such as intercompany loans and cost allocations among subsidiaries. This process helps maintain compliance and provides a clear view of the corporation’s financial health by preventing double-counting in financial reports. To streamline these complex processes, many companies utilize advanced accounting systems.

Redwood's advanced automation software specifically enhances these efforts by automating intercompany reconciliations and eliminating redundancies, ensuring faster and more accurate financial closes. This support not only simplifies the intricate process of managing transactions across various business units but also ensures compliance and transparency in financial reporting.

Discover five ways to identify intercompany differences earlier and drive a faster close.

What are examples of intercompany processes?

Intercompany processes involve crucial financial transactions and accounting tasks across different entities within the same multinational corporation. Examples include recording intercompany journal entries for cash or goods transfers, reconciling accounts to ensure matching transactions, consolidating financial data to produce aggregated statements, and matching transactions to eliminate discrepancies. These activities ensure accurate financial reporting and compliance, providing a transparent view of a corporation’s financial health.

Redwood significantly enhances these intercompany processes through its advanced automation capabilities. By automating reconciliations, invoice matching, and the elimination of internal transactions, Redwood ensures faster and more accurate financial closes. Its features include real-time auto-reconciliation to speed up period-end closing, multi-ERP integration for resolving intercompany differences, and robust compliance tools that prevent discrepancies by automating document creation and maintaining transparent audit trails. This comprehensive automation not only simplifies complex accounting tasks but also optimizes the financial close cycle, making it less time-consuming and more reliable.

Discover how to continuously perform intercompany accounting processes – before the close begins.

How can intercompany accounting be automated?

Redwood significantly automates and streamlines intercompany accounting by handling complex reconciliations, invoice matching, and eliminations. This automation enhances accuracy and accelerates financial closing across different entities, leading to faster and more reliable financial statements. Redwood's software simplifies these processes by identifying and eliminating internal transactions, ensuring valid consolidated reporting for legal entities, and facilitating real-time reconciliation to speed up month-end closures.

Redwood's automation features promote proactive compliance and control by generating essential documents and managing discrepancies upfront, thereby maintaining financial data integrity. It seamlessly integrates with multiple ERP systems, automating currency adjustments and streamlining elimination postings necessary for accurate consolidated financials. This comprehensive automation supports CFOs in centralizing data management, reducing manual processes, and ensuring transparency and governance in financial reporting.

Discover why auto-certification is key to faster and more accurate balance sheet reconciliation.

What does intercompany mean?

Intercompany refers to transactions or activities that occur between two or more entities within the same parent company. This includes financial transactions, resource sharing, or services exchanged between subsidiaries or divisions that may impact the consolidated financial statement preparation. Managing these transactions accurately is crucial for legal and fiscal compliance, financial consolidation, and performance analysis.