The structures of large international organizations can be complex.
Many businesses, like Disney, for example, have multiple entities with the same parent company or corporate group.
The term intercompany is used to describe financial transactions, agreements, or relationships between two or more such entities.
In this article, we’ll dive into how intercompany accounting works, the challenges involved, and best practices for intercompany financial management.
What is intercompany?
Intercompany refers to financial transactions, agreements, or relationships between two or more entities within the same parent company or corporate group. These entities are legally separate but operate under common ownership or control.
Intercompany relationships can involve the transfer of funds, goods, services, or intellectual property between subsidiaries, divisions, or branches of a multinational group.
These relationships are often governed by internal agreements that aim to simulate arm’s-length pricing and ensure compliance with local regulations, particularly for tax and financial reporting.
Importance in multinational corporations
In large, multinational corporations, intercompany transactions are frequent and critical to international operations.
They enable global supply chains to function effectively, support centralized service models, and help businesses optimize tax and financial strategies across jurisdictions.
Intercompany vs. intracompany
The terms intercompany and intracompany might sound the same, but they mean very different things.
An intercompany transaction is one that occurs between separate legal entities within the same group, whereas an intracompany transaction is an activity that happens within the same legal entity, such as moving inventory between departments or business units.
Types of intercompany transactions
Most intercompany transactions are either financial in nature (such as capital being moved internally to support operations or manage liquidity) or related to the exchange of goods and services, like one company selling goods to another within the same group.
Some common examples of intercompany transactions include:
- A manufacturing subsidiary selling products to a distribution arm
- A regional office charging another entity for IT support services
- A parent company licensing intellectual property to a subsidiary for use in a local market
- A regional headquarters billing local entities for administrative support and strategic planning
- A logistics subsidiary purchasing raw materials in bulk and reselling them to other group entities at cost-plus pricing
How intercompany accounting works
Intercompany transactions require careful accounting treatment to ensure accurate reporting and regulatory compliance. If not managed properly, these internal dealings can distort a company’s financial position and performance.
Here’s a quick overview of how intercompany accounting works.
Process of recording intercompany transactions
When an intercompany transaction occurs, each entity involved must record its side of the deal.
For example, if one subsidiary sells goods to another, the seller records revenue and the buyer records an expense or an asset.
These entries are made just as if the transaction occurred with an external party, but they must be flagged as intercompany to ensure proper elimination later during consolidation.
To maintain accuracy and avoid mismatches, many organizations use centralized intercompany accounting systems or reconciliation tools. This ensures that both sides of a transaction are recorded consistently and in line with internal policies.
Impact on financial statements
At the group level, intercompany transactions have to be eliminated to prevent double-counting revenue, expenses, assets, or liabilities.
For example, if a parent company loans funds to a subsidiary, both the receivable and payable are removed from the consolidated balance sheet. Similarly, intercompany sales and the related cost of goods sold are eliminated to avoid inflating total revenue and profit.
If a company fails to eliminate these entries correctly, it can lead to misstated financials, compliance issues, or even external audits.
Role of accounting standards
Given the complexity of intercompany accounting, it's only natural that some strict standards must be in place.
U.S. GAAP and IFRS provide guidance on how to handle intercompany transactions and eliminations during consolidation.
The main requirement of these standards is transparency, consistency, and documentation of intercompany transactions, especially when such transactions have pricing implications that can impact taxable income across jurisdictions.
There are also some rules around transfer pricing, intercompany transactions have to be priced as if they occurred between unrelated parties (known as the “arm’s length” principle). This is especially important for cross-border deals that can impact tax liabilities.
Why are intercompany transactions important?
Intercompany transactions have real financial, legal, and operational consequences. As such, accurate handling is important for tax compliance, regulatory reporting, and financial consolidation.
- Implications for tax compliance. Intercompany transactions can impact how income is allocated and taxed. Businesses must document intercompany pricing using transfer pricing policies.
- Significance for regulatory reporting. Corporations using intercompany transactions are often required to provide detailed disclosures about their activities. Regulators and investors expect transparency around intercompany activity, especially when it affects financial position, performance, or risk exposure.
Challenges in intercompany accounting
Intercompany accounting can be highly complex, especially for large organizations operating across multiple entities, currencies, and tax jurisdictions. Below are some of the most common challenges businesses face.
Complexities in tracking transactions
Even a large standalone company can process thousands of transactions a month. Think about what that would look like for a company with dozens of subsidiaries. Tracking all of those transactions, as well as transactions between companies, can be difficult.
Differences in timing, currency conversion, or local accounting practices can lead to mismatches and confusion during reconciliation.
Discrepancies in reporting
When two sides of an intercompany transaction don’t match, perhaps due to timing issues, differing accounting methods between companies, or inconsistencies in documentation, discrepancies can arise.
These can delay financial close, trigger audit issues, and create a lack of confidence in reported figures.
Risk of errors and financial penalties
Manual process, lack of automation, and inconsistent data entry habits can all lead to errors in intercompany billing, reconciliation, or eliminations.
This can lead to inaccurate reporting, which can result in tax penalties, restatements, or regulatory fines, as well as harm to public reputation.
Currency conversion and exchange rate issues
Entities that operate in different countries might use different functional currencies. This is not uncommon.
Fluctuations in exchange rates can create discrepancies between when a transaction is recorded and when it's settled, meaning the records of two companies might not add up. This requires careful handling during consolidation.
Transfer pricing compliance
Ensuring all intercompany transactions follow arm’s length pricing rules requires constant monitoring and documentation. If pricing appears inconsistent or unjustified, tax authorities may challenge it. This can lead to audits, adjustments, or penalties.
Delayed reconciliations and close processes
Intercompany discrepancies can hold up month-end or year-end closing procedures.
If businesses don’t have clear, automated reconciliation processes, finance teams can spend significant amounts of time resolving variances between entities.
Inconsistent intercompany agreements
If internal services of supply agreements are poorly defined or undocumented, it can be unclear how transactions should be priced or treated from an accounting perspective.
This adds friction during audits and creates compliance risk.
Best practices for managing intercompany transactions
Managing intercompany transactions effectively requires a combination of strong internal processes, technology, and governance. Below are key best practices used by leading finance teams to improve accuracy, efficiency, and compliance.
Implement effective communication strategies
Clear communication between entities is critical for avoiding misunderstandings and discrepancies.
Align on transaction timing, documentation requirements, and responsibilities to help ensure both sides record transactions consistently and accurately.
Utilize technology for automation
By using automated intercompany accounting systems, can can:
- Reduce manual effort
- Minimize errors
- Ensure timely processing
Tools that support centralized invoice processing, real-time reconciliation, and automated eliminations can streamline operations and accelerate financial close.
Run regular audits and reconciliations
Implement routine reviews of intercompany accounts to help identify mismatches, errors, and unrecorded transactions, and rectify them before they become larger issues.
Many organizations perform monthly reconciliations and periodic internal audits to maintain integrity across entities.
Establish clear intercompany agreements
Document the terms, pricing models, and responsibilities for intercompany transactions. This is especially critical for services and intellectual property, and will help you standardize processes and ensure compliance with transfer pricing regulations.
Standardize chart of accounts and accounting policies
Using consistent accounts and policies across all entities improves transaction alignment and simplifies consolidation.
Make an agreement across the group on how to classify revenue, expenses, assets, and liabilities related to intercompany activity.
Centralize intercompany oversight
Assign responsibility for intercompany processes to a dedicated team or function. This will help ensure accountability.
This team can oversee:
- Documentation
- Pricing compliance
- Dispute resolution
- Month-end eliminations
Monitor transfer pricing compliance
Regularly review transfer pricing to ensure that international transactions follow local tax laws. Involve tax experts to reduce the risk of audits and financial penalties.
Provide training and enable cross-entity collaboration
Provide training to finance staff across all entities on intercompany processes, tools, and policies. This will help you drive consistency.
By encouraging cross-entity collaboration, you’ll help maintain alignment during complex transactions or reporting cycles.
How BILL handles intercompany finances
Managing intercompany finances is complex.
The best finance teams use powerful financial operations software like BILL to make sure nothing slips through the cracks.
BILL’s multi-entity AP solution helps accounts payable teams:
- Scale AP without adding headcount
- Improve group-wide spend visibility
- Streamline reconciliation and elimination processes
