What is Intercompany Reconciliation?
Intercompany reconciliation is the verification of transactions that take place between two units or subsidiaries of the same parent company.
Many businesses have divisions, subsidiaries, franchises, or other units that act independently but are owned by a larger parent company. For example, Gatorade and Quaker Foods, two internationally recognized and extremely successful brands, are owned, along with nearly two dozen others, by the parent company Pepsico.
Not all intercompany scenarios involve international businesses. Many are also 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.
Any time an exchange of financial value takes place between any of the two entities in these scenarios, the transaction must be accounted for and ultimately reconciled. It cannot be overlooked or disregarded because the two entities 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 most importantly, the larger parent company, are accurately documented and represented.
Much like account reconciliation ensures the validity and accuracy of business accounting in general, intercompany reconciliation is the process of verifying the records of intercompany accounting, specifically.
Intercompany transactions 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.
How Is Intercompany Reconciliation Performed?
Intercompany reconciliation faces several challenges because of the nature of the transactions that are being reconciled. These may include poor record keeping, such as invoicing errors and inconsistent account period recording. Exchange rate differences can also be an issue for international companies.
Intercompany reconciliation is performed much like other forms of account reconciliation. However, there are some steps that are unique to the process.
To begin, all intercompany transactions must be identified. To do this properly, 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.
Using these standard data parameters will greatly increase the efficiency of the reconciliation process, by eliminating or reducing the need to search and find data pertaining to intercompany transactions. This process is often referred to as master data management. The term describes the process by which a business takes steps throughout the enterprise to ensure the uniformity, accuracy, and consistency of all its data.
The business should also have a standard method of extracting the data for intercompany transactions. Both entities in the transaction should use this method to increase the efficiency of the process.
Finally, the business will benefit from having a centralized means of reconciling all intercompany transactions once they have been gathered. Automated software solutions will make this process much easier.
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.
Why Is Intercompany Reconciliation Important?
Intercompany transactions are an important step in the business accounting process. They allow the business to record and evaluate all manner of financial activity thoroughly and accurately.
Intercompany reconciliation allows a business to maintain the same level of accuracy for its intercompany transactions that it does for all other forms of financial activity.
An effective intercompany reconciliation process helps the business avoid double entries in more than one of its subsidiaries or divisions. It allows the company to evaluate the full monetary value of all its transactions, to provide accurate financial statements, and to avoid disputes.
Are There Any Calculations Involved in Intercompany Reconciliation?
If not done properly, 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.
For example, if a subsidiary purchases supplies from another, it will record a $1,000 transaction in its purchase account. At the same time, the entity that sold the supplies will record the transaction for the same amount in its sales account. Intercompany reconciliation will make sure that these two transactions are properly recorded in the ledgers for both subsidiaries, and that they ultimately cancel out, or equal zero, and do not appear in the consolidated financial statement for the parent business.