Intercompany analysis involves the analysis of accounting data pertaining to transactions involving two different entities that fall under the same parent organization.
Many businesses are owned by a larger conglomerate. For example, Gatorade and Starbucks—two internationally recognized and extremely successful companiesare owned, along with nearly two dozen other brands, by the parent company Pepsico.
The process of multiple companies coming under the same umbrella crosses many different industries. In the auto industry, for example, the Indian car company Tata Motors owns Land Rover and Jaguar. The office supply manufacturer 3M owns Scotch Tape, Post-It, Bondo, and several other manufacturers of popular office products.
In the above examples, the separate entities, companies, or units frequently conduct business with each other. Any time an exchange of financial value takes place between any of the two entities in these scenarios, the transaction must be accounted for. It cannot be overlooked or disregarded just because the two parties are related. Likewise, a parent business cannot record the transactions with one of its units as a profit or a loss. Transactions can only be considered a profit when they involve an outside entity.
Intercompany accounting is the process of tracking this financial activity, and it is necessary to make sure that the finances of the two entities and the larger parent company are accurately documented and represented. Any analysis done in this context would be considered an intercompany analysis.
Intercompany analyses can be performed in many different ways. They would be performed in the same manner as other analyses, the difference being the subject of the analysis involves two separate but related units.
For example, intercompany reconciliation is the verification of transactions that take place between two units or subsidiaries of the same parent company. It is performed much like other forms of account reconciliation. However, there are some steps that are unique to the process. Most importantly, all intercompany transactions should use a standard means of identification and data entry.
The business should also have a standard method of extracting the data for intercompany transactions. Both entities in the transaction should utilize this method to increase the efficiency of the process.
Intercompany reconciliation will look different depending on the business. For example, a large, multi-national corporation with subsidiaries around the globe will have a much different process for reconciling its intercompany transactions than a small, domestic company with one or two subsidiaries.
Intercompany analysis may also be conducted on a macro scale, looking at data in financial statements. As is the case with financial statements generally, there are many different forms of analysis that can be performed, such as an analysis of profitability, liquidity, cash flow, and growth.
An analysis may look at individual divisions, subsidiaries, or companies owned by the parent company and examine their performance compared to other outside entities in the market generally. They may conduct a historical, or “horizontal analysis,” of the individual units over time. Lastly, they may look “vertically” at the performance of those individual units in comparison to the larger parent company.
Intercompany transactions are an essential part of the business accounting process. Much of a business’s financial activity may take place between and within subsidiaries or divisions of the same parent company. This has become even more commonplace in today’s global economy.
Intercompany accounting and analysis help businesses with multiple divisions and subsidiaries prepare accurate consolidated financial statements, to provide a clear and transparent picture of its financial health and avoid disputes.
Intercompany transactions may occur in a number of different ways. They may include purchases for goods and services, loans, management fees, dividends, cost allocations, and royalties. These transactions must be recorded and reconciled just like any other transaction.
Intercompany transactions are recorded in different ways depending on the nature of the transaction. For example, if one subsidiary of a company sells inventory to another, the transaction will be recorded as an accounts receivable entry for the selling subsidiary and as an accounts payable for the purchasing subsidiary.
If a parent company makes a loan to one of its subsidiaries, it will be recorded as an asset for the parent company and as a liability for the subsidiary. In either case, the transactions will be eliminated before the consolidated financial statement is prepared.
Intercompany transactions can artificially inflate profits and liabilities in the business. Intercompany accounting operates on the principle that only transactions with outside entities can create a profit or a liability. Therefore, all intercompany transactions must cancel out to zero in the business accounting records.
Intercompany transactions occur in one of three ways:
Downstream transactions refer to transactions that originate from the parent company and are directed to one of its subsidiaries
An upstream transaction is a financial activity that is directed from the subsidiary to the parent company
Lateral transactions take place between two subsidiaries of the same parent company
Does Intercompany Accounting Only Apply to International Conglomerates?
Not all intercompany scenarios involve large, international businesses. Many are entirely domestic and operate on a smaller scale. For example, a computer company may spin off a smaller start-up to develop and sell a new software product. The start-up will act independently but is owned by and receives financing from the parent company.
Even individual businesses have multiple divisions, subsidiaries, franchises, or other units.
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