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Intercompany Transactions

What Are Intercompany Transactions?

Intercompany accounting is the recording of financial transactions between two different entities that fall under the same parent company. These types of transactions must be recorded properly, because the parent business can’t record the transaction as a profit or a loss. Transactions can only be considered a profit when they involve an outside entity.

Intercompany transactions occur in one of three ways:

  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 transactions are an important step in the accounting process. They allow the business to record and evaluate all financial activity thoroughly and accurately.

Not all transactions are external. Transactions that occur within or between entities within the parent company can impact its overall financial health just as much as those that involve external, client-customer transactions.

Intercompany accounting allows a business to maintain the same detailed journal entries for intercompany transactions as it would for all other financial activity.

Throughout the process, all transactions are tracked, recorded, and reconciled to avoid double entries in more than one of its subsidiaries or divisions.

The recorded information allows the company to evaluate the full monetary value of all its transactions and provide accurate financial statements. Intercompany accounting enables the business to assess all liabilities that it may incur on behalf of any of its subsidiaries, and to comply with tax regulations within different jurisdictions where its subsidiaries are located.

Without thorough and accurate intercompany accounting, companies leave themselves open to vulnerabilities, and can’t properly reconcile transactions that take place between entities or accurately assess profits and losses. This undermines the ability of the parent company to prepare accurate consolidated financial statements.

The role and contribution of each entity to the parent company’s overall performance and financial health cannot be accurately ascertained without properly recording intercompany transactions. Inadequate intercompany accounting can also lead to financial disputes between entities under the same parent company.

How Is Intercompany Accounting Used?

Intercompany transactions can involve many different scenarios. For example, a transaction may occur between the parent company and one of its subsidiaries, or between subsidiaries, divisions, or even departments.

In the age of global commerce, intercompany accounting may involve international companies with subsidiaries across the globe.

Common types of intercompany transactions include purchases for goods and services, loans, management fees, dividends, cost allocations, and royalties.

Consider, for example, the Indian car company Tata Motors, which owns both Land Rover and Jaguar. If, in the manufacturing of their vehicles, either of those two companies were to purchase car parts from the other, or if an executive of one were to spend time working on a project for the other, this would be recorded as an intercompany transaction because both are owned by the same parent company.

Intercompany accounting is a complicated and demanding process, especially when dealing with international regulations and tax laws. But it’s important to note that intercompany transactions do not just apply to international conglomerates. They can happen within subsidiaries or divisions of much smaller companies, and all within the same country.

As an example, if a digital media company were to spin off a start-up with a new line of e-commerce software, and the parent company provides working capital or a loan for the venture, this would be considered an intercompany transaction.

In another example, if a parent company pays part or all of a supplier’s invoice for one of its subsidiaries, this would also be considered an intercompany transaction.


Why Are Intercompany Transactions Important?

Intercompany transactions are an essential part of the business accounting process. For a company with subsidiaries, much of its financial activity can take place between and within subsidiaries or divisions. This has become even more commonplace in today’s global economy.

Intercompany accounting helps 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.

What Are the Basic Elements of an Intercompany Transaction?

All journal entries for intercompany transactions will share the same common elements. They will detail what kind of transaction has taken place, such as loan, purchase, or fee.

The entry will include start and end dates of the transaction and detail which entities were involved in the transaction as well as the total value of the transaction. Like any journal entry, it will also be accompanied by relevant documentation, such as invoices or loan agreements.

How Are Intercompany Transactions Recorded?

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.

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