WHAT IS INTERCOMPANY TRANSACTION: Meaning, Examples & Policy

Intercompany transaction
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Exactly what are the functions of intercompany transactions? And why is proper intercompany accounting crucial to the success of your business? Intercompany transactions happen within a group of companies. To ensure the highest level of transparency, it would be a good idea to keep a separate record of these transactions. Here, we will explain the different types of intercompany transactions and the benefits of recording them in accounting. Furthermore, we’ll go through the fundamentals of intercompany transactions and reporting so that you can propel company expansion and make the most of available opportunities.

Intercompany Transaction 

An intercompany transaction is a deal between two companies that are controlled by the same person or group. This can be a parent business and a subsidiary, or it can be two subsidiaries of the same parent company. Intercompany transactions are popular in business and used for many things, such as: 

  • Moving inventory between companies
  • To divide costs between businesses
  • Paying  for running things
  • To manage risk

Intercompany transactions must be correctly recorded in both companies’ financial statements. This is because they can affect how much money each company makes. Intercompany transactions are hard to keep track of, so it’s important to talk to an accountant to make sure they are recorded properly. If the organization keeps track of intercompany transactions independently, consolidation will be much simpler. There will be greater openness as a result of the more truthful portrayal of the financial condition. 

Due to the recorded financial flows and their assignability to a consideration, documentation of intercompany transactions can also aid in resolving or clarifying conflicts. Companies with multiple domestic subsidiaries may also be affected by the need to properly document intercompany transactions, not just multinational conglomerates. Any business dealings between affiliated entities must be documented and their effect on the consolidated tax position of the enterprise must be independently confirmed. Companies with multiple domestic subsidiaries may also be affected by the need to properly document intercompany transactions, not just multinational conglomerates. Any business dealings between affiliated entities must be documented and their effect on the consolidated tax position of the enterprise must be independently confirmed.  Having subsidiaries in multiple jurisdictions with varying tax regulations might complicate the management of intercompany transactions.

To accurately assess the intercompany transactions and compile an error-free tax balance sheet, the accounting team must be well-versed in applicable tax legislation in each country.

Intercompany Transaction Example 

An intercompany transaction is one that takes place between two companies that are members of the same group. These transactions can take place for a number of purposes, including the selling of products or services, the transfer of assets, or the supply of services. A parent firm selling items to its subsidiary is an example of an intercompany transaction. In this situation, the sale would be recorded as revenue by the parent firm, while the purchase would be recorded as an expense by the subsidiary. A parent firm providing services to a subsidiary is another example of an intercompany transaction. In this situation, the cost of the services would be recorded as an expense by the parent company, but the benefit of the services would be recorded as an asset by the subsidiary.

Intercompany transactions must be tracked since they can have an impact on the financial statements of the companies involved. For example, if a parent business sells goods to its subsidiary at a price that differs from the market price, the reported profits of both companies may be affected. Intercompany transactions accounting accurately is critical in order to offer accurate financial information to investors and other stakeholders.

Example 2

A UK corporation has multiple subsidiaries. The subsidiaries pay the group annual management costs, which is an upstream transaction. The Group makes loans to its subsidiaries at better terms than a bank, allowing the companies to acquire liquid capital for expanding their operations more swiftly and without bureaucracy. These are secondary transactions. Two of the subsidiaries buy from each other on a regular basis. When company A buys certain commodities from firm B, money flows from A to B. This is an example of a lateral transaction. A lateral transaction has occurred. All of these transactions have an effect on the financial status of the companies involved, but the group makes no profit or loss. This has an effect on both the balance sheet and the tax return, thus these transactions must be reported separately.

Example 3

Here is another example of an intercompany transaction:

Company A sells inventory to Company B for $100,000. Company B pays Company A for the inventory in full. This transaction would be recorded in the financial statements of both companies as follows:

Company A:

  • Accounts receivable $100,000
  • Sales $100,000

Company B:

  • Inventory $100,000
  • Accounts payable $100,000

When the inventory is sold to a customer, Company B will record a sale and Company A will record a cost of goods sold. The intercompany transaction will have no impact on the financial results of either company.

Intercompany Transaction Accounting 

Maintaining proper accounting and reporting for a single organization requires a collaborative effort. But what if you’re in charge of reporting on the financial activities and health of several companies? You must perform intercompany accounting. Intercompany accounting is critical to the financial success of every business in your organization. It ensures that all internal transactions are tracked and correctly reflected in your financials. It is required for reporting to external stakeholders, and it can help you better understand your financial status and make educated budget and resource allocation decisions. Intercompany accounting is a way of recording transactions that occur between two connected companies, such as a parent company and a subsidiary, or two legal entities owned by the same parent company. Journal entries are used by businesses to accurately record transactions such as payments, loans, and sales and purchases. Equity transactions are also recorded in intercompany accounting. 

Intercompany accounting seeks to eliminate the financial impact of internal dealings — financial interactions between related businesses inside the same parent company — in order to provide financial statements that only represent activity with independent third parties. Intercompany accounting eliminates financial dealings between subsidiaries or between a parent and a subsidiary. Moreover, Intercompany accounting events include sales of products, services, or inventory, cost allocations, royalties, and debt financing between linked companies. Governance and policies, transfer pricing, data management, transaction management, netting and settlement, reconciliation/elimination, and reporting are all components of intercompany accounting.

Intercompany Transaction Policy and Sample

An intercompany transaction is a business deal between two or more companies that are part of the same corporate group. Intercompany transactions can take many forms, such as sales, purchases, loans, and leases. Intercompany transactions can be complex and can have a significant impact on a company’s financial statements. For this reason, it is important to have a clear and well-defined intercompany transaction policy in place.

An intercompany transaction policy should address the following issues:

  • The types of transactions that are allowed.
  • The documentation requirements for intercompany transactions.
  • The accounting treatment of intercompany transactions.
  • The procedures for monitoring and controlling intercompany transactions.

The following is a sample intercompany transaction policy:

  • Intercompany transactions must be approved by the chief financial officer or another authorized person.
  • All intercompany transactions must be supported by documentation, such as invoices, purchase orders, and shipping documents.
  • Intercompany transactions must be recorded at fair market value.
  • Intercompany receivables and payables must be reconciled on a monthly basis.
  • The chief financial officer must review all intercompany transactions on a quarterly basis.

This is just a sample intercompany transaction policy. The specific requirements for your company will depend on the nature of your business and the complexity of your intercompany transactions.

What Are Examples of Intercompany Transactions? 

Transferring resources and capital between subsidiaries, selling goods or services from one subsidiary to another, loan transfers, and payments from parent businesses to its subsidiaries are all examples of inter business transactions.

How Do You Account Intercompany Transactions? 

Depending on the nature of the deal, intercompany transactions are recorded in various ways. If one of a company’s subsidiaries sells merchandise to another, the transaction is documented as an account receivable entry for the selling subsidiary and an account payable entry for the purchasing subsidiary.

What Is the Journal Entry for Intercompany Transaction? 

An intercompany journal entry records debits and credits for deals between two subsidiaries that will be reported to ledger accounts. Intercompany journal entries are used to alter the value of any set of accounts without involving any dealing such as invoices or bills.

Is Intercompany a Debit or Credit? 

The account that receives funds in the event of an interbusiness transaction is the debit (due-from) account in the account pair. It could be either an asset or a burden. This should be different from any other receipts the corporation has issued to any other organizational units or departments. The current balance in this account is minus.

How Do You Reconcile Intercompany Transactions? 

The steps involved in intercompany reconciliation often go as follows:

  • Account balance comparisons between multiple separate systems.
  • Checking the correctness of statements and reports, as well as looking into any discrepancies that are found.
  • Taking measures to address these discovered inaccuracies

How Do You Treat Intercompany Balances? 

Businesses that deal with other businesses within the same group are required to report intercompany balances. The intercompany balances are reported on particular accounts, which are then reconciled with one another using one or more control tables that have been predefined.

Are Intercompany Transactions Assets or Liabilities? 

When accompanied by a legal agreement that details principal amounts, interest rates, maturity dates, and other pertinent information, intercompany notes and debt are often shown as assets or liabilities (i.e., not collapsed into equity).

Which Currency Should Be Entered to Record an Intercompany Transaction?

When accompanied by a legal agreement that details principal amounts, interest rates, maturity dates, and other pertinent information, intercompany notes and debt are often shown as assets or liabilities (i.e., not collapsed into equity).

Conclusion

Interbusiness transaction can help organizations make the greatest use of their assets and resources. Intercompany accounting can promote expansion, lessen the impact of market turbulence or downturns, and provide advantages that support the entities’ commercial objectives.  It is prudent corporate practice to report these transactions. In order to make better decisions and achieve better results, it also provides enterprises with the most accurate image of their financial status. You now understand the foundational elements of creating reliable intercompany reports.

  1. AFFILIATE VS SUBSIDIARY: How to Tell the Difference Easily!!!
  2. HOLDING COMPANY: How Does It Work?
  3. AFFILIATE PARTNERSHIP: Definition, Examples, and Agreement Templates.

References

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