Each subsidiary of a parent company has its own balance sheet and, for the most part, operates as a separate legal entity.
However, when subsidiaries transact with each other or the parent company, these transactions must be handled differently from traditional transactions between two unrelated companies.
In addition, a parent company with subsidiaries must perform intercompany reconciliations at the end of each accounting period. This ensures transactions are not duplicated, missed, or erroneously entered.
In this guide, we’ll discuss what intercompany accounting is, how to create an efficient intercompany accounting process, and how you can automate many of the complexities associated with intercompany accounting and financial reporting.
Intercompany accounting is the process of recording financial transactions among parent companies and their subsidiaries and consolidating these entities’ financial statements into a single set of financial statements. This single set of financial statements then reflects the entire parent company’s performance, including its subsidiaries.
However, there's more to intercompany accounting than simply putting numbers in a spreadsheet.
For example, if subsidiaries operate in different countries, they might have to translate currencies and ensure their processes comply with local accounting standards. Accounting teams also have to reconcile their financial statements at year-end to ensure their financial statements are complete and accurate.
There are three types of intercompany transactions:
Intercompany transactions are recorded in different ways, depending on the transaction.
For example, suppose one subsidiary sells inventory to another. In this case, the transaction gets recorded as an accounts receivable entry for the selling subsidiary and accounts payable for the purchasing subsidiary.
Meanwhile, if the parent company loans to one of its subsidiaries, this loan will be recorded as an asset for the parent company and a liability for the subsidiary.
Intercompany eliminations cancel intercompany transactions that don't impact the parent company's net assets. As a result, these eliminations ensure the parent company's financial statements are accurately consolidated during the close process.
Otherwise, the parent company's balance sheet might become inflated.
However, not every intercompany transaction needs eliminating. For example, if underlying and intercompany transactions are tied together, the elimination shouldn't be performed.
Let’s say a parent company transfers cash to a subsidiary to help fund operations. In this case, an elimination doesn't need to be performed, but the transferred cash balance still needs to be recorded at the consolidated level.
The goal with intercompany eliminations is to make sure any activity that’s purely between entities is equal to zero. However, the cash did transfer in this case, so this transaction would reflect at the consolidated level.
Before consolidating entities, several key steps have to be taken to ensure the data is recorded accurately.
Here’s an overview of critical considerations during the intercompany accounting process:
There are different accounting procedures for entities depending on the percentage of each entity the parent company owns.
For example, if the parent company owns a controlling interest (more than 50%) in the subsidiary, it should be accounted for with traditional accounting methods.
However, if the parent company only owns a minority interest in the subsidiary (less than 50%), the parent should only record its gain or loss equivalent to its ownership percentage.
These conditions mean if the parent company owns 30% of an entity and the entity records a monthly gain of $10,000, the parent company should record a gain of $3,000 on its consolidated balance sheet.
Of course, you should always consult the relevant accounting standards in your jurisdiction to ensure you are recording such entries correctly.
Not all entities will have the same fiscal periods, so it’s essential to match them before producing a consolidated financial statement.
The maximum acceptable difference between the parent and subsidiary company’s reporting period is usually three months.
The calendarization process can be used if the parent and subsidiary have reporting periods more than three months apart. This process standardizes reporting periods, see below for an example.
If a subsidiary deals with multiple currencies, the subsidiary must consolidate the currencies before producing a consolidated financial statement.
Calculating currency conversions manually is often a slow and laborious process. However, with SoftLedger, this process is automated.
Executing intercompany accounting processes manually is cumbersome and can take days for your accounting team to complete.
This also means that manual errors are likely to creep into the data, and executives have to wait longer to receive financial reports.
Even if you have a modern general ledger accounting software, many processes like intercompany eliminations still have to be manually executed before the data can be consolidated. In addition, with small business accounting software, extra fees are added for different legal entities, which can get expensive.
To solve these problems, we built SoftLedger: a general ledger accounting solution that’s built specifically for multi-entity companies. It automates processes like intercompany eliminations and consolidates financial data in real-time.
It also leaves an easy-to-access, accurate audit trail for each entity. This makes accounting management more straightforward and less time-consuming.
See it in action here:
SoftLedger is also highly flexible and about 95% of the platform is fully programmable via API. You can also link your bank accounts and credit cards with just a few clicks.
Despite its robust capabilities, customers say it is super easy to navigate and only requires a week or two to onboard the team and get comfortable.
Schedule a demo today to see if SoftLedger is the best solution for you.
A CPA with more than 10 years of varied public and private accounting experience, Ben has led many complex financial projects to successful outcomes.
Ben holds a B.S. in Accounting from the University of Maryland.