Intercompany Journal Entry

Intercompany journal entries are entries made in the business’s accounting ledger that pertain specifically to intercompany transactions.

To better understand the specifics, it’s best to understand journal entries in general.

A journal entry is created when a business records transactions in its accounting system. Because they record all financial transactions, journal entries are the first step—and building blocks—of the business’s financial records.

Journal entries apply to all financial transactions of a business or organization, including but not limited to cash payments, deposits, interest, taxes, payroll, purchases, loans, and more.

Journal entries record a transaction for a particular account, which refers to a specific portion of the business’s overall financial records. Accounts refer to a type of financial activity, such as an asset, liability, equity, or revenue.

Many businesses have divisions, subsidiaries, franchises, or other units that act independently but are owned by a larger, parent company.

Intercompany accounting is the recording of financial transactions between two different entities that are related by the same parent company. The transactions may occur between the parent and one of its subsidiaries, or between two subsidiaries. They may also occur between groups, subdivisions, or departments within the same company.

Intercompany transactions must be recorded properly because the two entities are not completely independent, and for this reason, the parent business cannot record the transactions as a profit or loss.

A business cannot record a profit or loss by conducting business with itself. Transactions can only affect profit or loss when they involve an independent, outside entity.

Properly recorded intercompany journal entries ensure that principals of accounting are followed, and that the business maintains accurate records for its intercompany financial activities.

Many businesses have divisions, subsidiaries, franchises, or other units that act independently but are owned by the larger, parent company. For example, 3M, the office supply manufacturer, owns Scotch Tape, Post-It, Bondo, and several other manufacturers of popular office products.

In the digital world, Meta owns owns the social media platforms Facebook, Instagram and WhatsApp. The media giant, Disney, owns ABC, ESPN, National Geographic, and many others.

Not all intercompany scenarios involve large, international businesses. Many are also entirely domestic and operate on a smaller scale. For example, a lawn care company may spin off a smaller start-up to develop and sell a new line of grass seeds.

A computer manufacturer may spin-off a company to focus entirely on a new software platform that it has developed. In each case, the start-up will act independently, but is owned by and receives financing from the parent company.

Any time an exchange of financial value takes place between any of the two entities in these scenarios, the transaction must be journaled and ultimately, reconciled. It cannot be overlooked or disregarded because the two entities are related.

Intercompany journal entries will look different depending on the business. For example, a large, multi-national corporation with subsidiaries around the globe will have much different intercompany transactions than a small, domestic company with one or two subsidiaries.

Intercompany journal entries are also 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 account receivable entry for the selling subsidiary and as an account 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.

1. Downstream transactions refer to transactions that originate from the parent company and are directed to one of its subsidiaries

2. An upstream transaction is a financial activity that is directed from the subsidiary to the parent company

3. Lateral transactions take place between two subsidiaries of the same parent company

Intercompany journal entries can record a variety of transactions that are unique to the process of intercompany financial activity. They may include:

• Sales and purchases of services and goods between a parent company and its subsidiaries

• Fee sharing

• Cost allocations

• Royalties

• Financing activities, such as loans

• Centralized cash management functions

• Dividends between subsidiaries and parent company

• Leases with the parent or other subsidiaries

Intercompany journal entries face a number of challenges because of the nature of the transactions that are being recorded. All journal entries that involve an intercompany transaction should use a standard means of identification and data entry.

The terms will consistently identify the entities involved in the intercompany transaction. They will also include references to other relevant information, such as currency rates, payment amount, and the nature of the transaction.

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.