Each year, commonly controlled business must prepare a combined or consolidated financial statement for tax and reporting purposes. The intercompany accounting process is an important process for parent companies with subsidiaries or companies split by location. Intercompany transactions must be eliminated through reconciliation to avoid double-counting, once on the books of the parent company and again on the books of the subsidiary. Intercompany reconciliation solves the problem of reporting inaccurate information on the income statement and helps to avoid misrepresentation of a firm's financial position.
Intercompany accounting, or reconciliation, is the process of balancing the accounts between two branches of the same company to bring the balances to zero in the general ledger. The company branches are usually in different locations and offer different products and services. Common scenarios are reconciling intercompany receivables and payables, and intercompany sales and purchases between a parent company and its subsidiaries. Intercompany accounts are typically electronic and reciprocal, so records between companies are easily accessed and balanced.
In a typical processing scenario between Company A and its affiliate Company B, Company A receives a $100 invoice for supplies that are used by both Company A and Company B. Company A makes a journal entry for $100 in the general ledger under accounts payable and splits the expense with Company B, resulting in journal entries under expenses of $50 apiece. Company A has a liability of $100 and an expense of $50. Company B has $50 in expenses and zero liability. At this point, Company A’s books are out of balance and must be reconciled through intercompany journal entries. Company A makes a journal entry under intercompany receivables of $50 and another of the same amount for Company B under intercompany payables. The liability is shifted, a net balance is achieved and the intercompany books are closed for this expense.
Implementing a fat and accurate electronic intercompany reconciliation system is highly recommended for commonly controlled businesses. The centralized system will promote intercompany synergies and help smooth the closing process at the end of an accounting cycle. When a company needs to create a report or file a tax return, the information will be accurate and easily at hand. This system facilitates filing a tax return with the IRS and may help thwart an IRS audit, saving time and money. For example, when filing IRS form 1120, the U.S. Corporation Income Tax Return, line eight will not have any “Adjustment to Eliminations of Transactions between Includible Entities…” which, if entered, may raise some red flags and trigger an audit.
Hiring an outside firm to control intercompany accounting may be a good choice for your small business. Many reputable accounting firms offer intercompany reconciliation services. Performing a cost-to-benefit analysis can help you decide what your firm needs and what its budget can accommodate. Keep in mind that intercompany reconciliation benefits can far outweigh costs in terms of your company’s accountability and credibility.
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