Concept of intercompany accounting

Intercompany accounting is defined as the processing and accounting for a corporate group’s internal financial activities and events that impact multiple business units and subsidiaries (as legal entities) within its structure. Such activities and events may include sales of products and services, cost allocations, royalties, fee sharing, and financing activities. As embedded in a company’s accounting system, intercompany accounting extends into various other functions, including finance, treasury operations, and tax.

Intercompany accounting involves the recording of financial transactions between two different units or more that belong to the same parent company. The transactions may occur between the parent and its subsidiaries, or between two subsidiaries within the group. The effect of this method of accounting is the elimination of financial activity that takes place between two subsidiaries (business units) or between the parent and a subsidiary (business unit). It neutralizes the potential impact of internal transactions on a company’s bottom line, and hence the parent can prepare financial statements and filings that only reflect business activity conducted with external parties.

This can provide a clear picture of a company’s actual financial performance and reporting results, without being impacted by internal transactions that do not produce any gross or net financial gain or loss at the parent’s level. Furthermore, intercompany accounting can help an entity ensure the accuracy of tax filings as well as compliance with accounting and reporting standards.

Importance and benefits

Intercompany accounting eliminates the potential impact of internal transactions on a company’s performance, and as such helps ensure a company does not claim sales or purchases it makes to or from itself (or any services extended either way) on its financial statements submitted to tax authorities, regulators, investors, or other stakeholders. Furthermore, intercompany accounting helps a parent company:

• Clearly represent and report the financial activity between its entities (subsidiaries/ business units).
• Eliminate duplicate counting of internal financial activity between its entities.
• Ensure its financial reports are accurate and faithfully reflect its financial position, performance and cash flows.
• Ensure the accuracy of its tax filings.
• Ensure compliance with applicable accounting norms and reporting standards.

Without intercompany accounting, businesses will provide unclear financial picture to stakeholders. Such a misleading picture may also be a ground for defrauding investors, creditors, shareholders, and tax authorities. In all cases, a substantial amount of wealth might be at risk of flowing not to the rightful beneficiaries or parties in the economic cycle.