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Definition
Intercompany accounts are accounts in an organization's General Ledger that maintain a balance of payments due from, or to, organizations related by common ownership or control. For instance, If business "A" makes widgets and sells them for $100 to a sister-company, company "B", an intercompany association exists, or should exist, in the General Ledger where Company "B" carries an Intercompany Payable to Company "A" and, conversely, Company "A" has an Intercompany Receivable from Organization "B".
At the conclusion of each accounting period, the consolidated Intercompany Accounts Receivable and Intercompany Accounts Payable must have the identical balances, a debit for the Intercompany A/R and a credit in Intercompany A/P.
Problem
Many businesses endure reconciliation problems related to intercompany accounts. For many, this problem can lead to the books to be kept open for days or weeks longer than necessary. We are familliar with an organization where it was not unusual to have the intercompany accounts out of balance by several million dollars every month. Unless a company implements the correct controls to keep the balances in check, the problem will continue growing and as it multiplies, it will become thoroughly unmanageable.
The reasons for these out-of-balance conditions commonly begin very small - If Company "A" from the previous part sells a widget to Company "B" for $100 and charges $10 freight, but the Purchasing Dept for Company "B" tells their Accounts Payable Department that it's not on the Purchase Order, so we are not paying for it, the business will have an out-of-balance situation if the problem is not remedied by the end of the accounting period. A lot of organizations also pass an intercompany charge to their subsidiaries based on their Working Capital as an inducement to keep Working Capital as low as possible to avoid excessive intercompany charges. If there is a disagreement in the computation, this could also cause an discrepancy in the Intercompany Accounts. Any absence of clarity on the part of the entity passing the charge, or a lack of acceptance on the part of the organization receiving the charge, has the possibility to trigger an out-of-balance scenario.
Experience
Our experience ranges from companies with only a few entities and massive problems with balancing the accounts, to large companies with thousands of entities that have few issues in getting the accounts to balance.
There are seven principal reasons for out-of-balance conditions with Intercompany Accounts:
Lack of clarity in what the charges are for Absence of clarity in the calculation of an intercompany charge Lack of communication by the entity passing on an intercompany charge Lack of communication by the entity receiving the intercompany charge Absence of consideration by the entity passing the intercompany charge Ineffective policies and/or procedures for handling intercompany charges Lack of effective course for settlement of disagreements
You can obviously reorganize these into four categories:
Lack of clarity Lack of communication Absence of consideration Lack of guidance from Corporate
but I sought to show that the responsibility for both communication and clarity resides upon both the receiving entity and the passing entity; and Corporate headquarters can fail to support the reconciliation process in several ways, of which, policies, procedures and dispute resolution are the most typical.
In studying this issue, we have seen many technology-based solutions proposed and, no offence to the programmers, tend to be significantly more cumbersome than the processes they replaced. Such solutions will not cause your accounts to balance, they give you the cabability to enforce the process from a higher level. Enforcing the process without addressing clarity, communications, and additional corporate support, will only yield nominal, if any, success and cause an even greater level of frustration due to the investment in systems without the envisioned Return on Investment.
Responsibility
By definition, the responsibility for ensuring that Intercompany Accounts (or any accounts, for that matter) rests firmly with the Controller of the enterprise. Many organizations might not have a person with the title of Controller, but it's usually apparent who the person is who performs the controllership functions. In virtually all organizations, the Controller must have ownership of the Balance Sheet of the organization and be the guardian of the financial policies and procedures. By extension, as the Controller must own the Balance Sheet and support the reconciliation process, executive management i.e. CFO, CEO, Vice Presidents, etc.. must support the Controllers' authority to enforce the timely reconciliation of the Intercompany Accounts.
Many organizations that develop intercompany challenges have a matrix or semi-matrixed reporting structure. This situation has the nasty habit of splitting allegiances. It has to be clear that the Corporate Controller with the parent company is the final arbiter in the reconciliation of Intercompany Account disputes with and between subsidiaries, unless the resolution is in violation of a law.
Just as the Corporate Controller has ownership of the Balance Sheet of the organization, Division Controllers have the same responsibilities for their divisions and must be accountable to the Controller at the next level up in the organization. This responsibility chain proceeds down to the Plant Controllers (or equivalent), who must also be accountable to the Controller(s) above them in the corporate food chain.
Resolution
Setting up an environment containing an effective intercompany reconciliation process depends on education. The training, however, has to be preceded by top-down policies. These must include, but not limited to:
Responsibility for internal control Responsibility for reconciliation General process for reconciliation Specific format for reconciliation Transfer pricing policies Foreign currency policies Intercompany cut-off policies Formal confirmation policy & procedure Dispute resolution policy & procedure
After policies are established (and controlled), the appropriate staff members will require training, from the top of the financial hierarchy to the bottom. Especially when first put in place, the policies and procedures should be evaluated frequently to make sure that they deal with common company-specific challenges that arise during the first few months of implementation. Great care ought to be exercised, however, to make sure that policies aren't changed simply to ensure compliance. Every time the policies are examined due to an issue, the question should be asked as to whether the problem lies in the policy, the procedures or the process. After effective policies are established and implemented organization-wide, the issues that arise will typically deal with process or procedure issues. Bear in mind, the policies are in place as a shield for the organization and the basis for processes and procedures that are in compliance with the policy.
What if you're already down the road and have a massive reconciliation mess to deal with? The same laws of intercompany reconciliation still hold true. Policies, education, procedures and processes must be put into place to end the hemorrhaging and the existing mess must be cleaned up. This should be attempted first with current personnel with the explicit declaration that if the accounts do not balance per company policy by a specific date, that a "fire team" will be assembled to assist the entities in the reconciliation process. This will normally be sufficient encouragement to get the accounts in order for the majority of entities, because nobody wants Corporate to show up and begin helping - that is probably second only to the IRS showing up to help.
Earlier in this paper, it was mentioned that many of the technology-based solutions are often more cumbersome than a company's current processes. We are not saying that technology can't help, technology can aid or enhance if you have effective policies, but the policies must be in place, have to be effective, and must be enforced or the technology-based solution will just be more ingredients added to a spoiled soup.
Often, in this lean world, Corporate doesn't really have the time to sacrifice to address these reconciliation issues among the operating entities. In this scenario, a third party can aid in the reconciliation process or in troubleshooting the policies, procedures and processes to ensure a reliable process for intercompany reconciliation is successfully established and implemented.
Intercompany accounts are accounts in an organization's General Ledger that maintain a balance of payments due from, or to, organizations related by common ownership or control. For instance, If business "A" makes widgets and sells them for $100 to a sister-company, company "B", an intercompany association exists, or should exist, in the General Ledger where Company "B" carries an Intercompany Payable to Company "A" and, conversely, Company "A" has an Intercompany Receivable from Organization "B".
At the conclusion of each accounting period, the consolidated Intercompany Accounts Receivable and Intercompany Accounts Payable must have the identical balances, a debit for the Intercompany A/R and a credit in Intercompany A/P.
Problem
Many businesses endure reconciliation problems related to intercompany accounts. For many, this problem can lead to the books to be kept open for days or weeks longer than necessary. We are familliar with an organization where it was not unusual to have the intercompany accounts out of balance by several million dollars every month. Unless a company implements the correct controls to keep the balances in check, the problem will continue growing and as it multiplies, it will become thoroughly unmanageable.
The reasons for these out-of-balance conditions commonly begin very small - If Company "A" from the previous part sells a widget to Company "B" for $100 and charges $10 freight, but the Purchasing Dept for Company "B" tells their Accounts Payable Department that it's not on the Purchase Order, so we are not paying for it, the business will have an out-of-balance situation if the problem is not remedied by the end of the accounting period. A lot of organizations also pass an intercompany charge to their subsidiaries based on their Working Capital as an inducement to keep Working Capital as low as possible to avoid excessive intercompany charges. If there is a disagreement in the computation, this could also cause an discrepancy in the Intercompany Accounts. Any absence of clarity on the part of the entity passing the charge, or a lack of acceptance on the part of the organization receiving the charge, has the possibility to trigger an out-of-balance scenario.
Experience
Our experience ranges from companies with only a few entities and massive problems with balancing the accounts, to large companies with thousands of entities that have few issues in getting the accounts to balance.
There are seven principal reasons for out-of-balance conditions with Intercompany Accounts:
Lack of clarity in what the charges are for Absence of clarity in the calculation of an intercompany charge Lack of communication by the entity passing on an intercompany charge Lack of communication by the entity receiving the intercompany charge Absence of consideration by the entity passing the intercompany charge Ineffective policies and/or procedures for handling intercompany charges Lack of effective course for settlement of disagreements
You can obviously reorganize these into four categories:
Lack of clarity Lack of communication Absence of consideration Lack of guidance from Corporate
but I sought to show that the responsibility for both communication and clarity resides upon both the receiving entity and the passing entity; and Corporate headquarters can fail to support the reconciliation process in several ways, of which, policies, procedures and dispute resolution are the most typical.
In studying this issue, we have seen many technology-based solutions proposed and, no offence to the programmers, tend to be significantly more cumbersome than the processes they replaced. Such solutions will not cause your accounts to balance, they give you the cabability to enforce the process from a higher level. Enforcing the process without addressing clarity, communications, and additional corporate support, will only yield nominal, if any, success and cause an even greater level of frustration due to the investment in systems without the envisioned Return on Investment.
Responsibility
By definition, the responsibility for ensuring that Intercompany Accounts (or any accounts, for that matter) rests firmly with the Controller of the enterprise. Many organizations might not have a person with the title of Controller, but it's usually apparent who the person is who performs the controllership functions. In virtually all organizations, the Controller must have ownership of the Balance Sheet of the organization and be the guardian of the financial policies and procedures. By extension, as the Controller must own the Balance Sheet and support the reconciliation process, executive management i.e. CFO, CEO, Vice Presidents, etc.. must support the Controllers' authority to enforce the timely reconciliation of the Intercompany Accounts.
Many organizations that develop intercompany challenges have a matrix or semi-matrixed reporting structure. This situation has the nasty habit of splitting allegiances. It has to be clear that the Corporate Controller with the parent company is the final arbiter in the reconciliation of Intercompany Account disputes with and between subsidiaries, unless the resolution is in violation of a law.
Just as the Corporate Controller has ownership of the Balance Sheet of the organization, Division Controllers have the same responsibilities for their divisions and must be accountable to the Controller at the next level up in the organization. This responsibility chain proceeds down to the Plant Controllers (or equivalent), who must also be accountable to the Controller(s) above them in the corporate food chain.
Resolution
Setting up an environment containing an effective intercompany reconciliation process depends on education. The training, however, has to be preceded by top-down policies. These must include, but not limited to:
Responsibility for internal control Responsibility for reconciliation General process for reconciliation Specific format for reconciliation Transfer pricing policies Foreign currency policies Intercompany cut-off policies Formal confirmation policy & procedure Dispute resolution policy & procedure
After policies are established (and controlled), the appropriate staff members will require training, from the top of the financial hierarchy to the bottom. Especially when first put in place, the policies and procedures should be evaluated frequently to make sure that they deal with common company-specific challenges that arise during the first few months of implementation. Great care ought to be exercised, however, to make sure that policies aren't changed simply to ensure compliance. Every time the policies are examined due to an issue, the question should be asked as to whether the problem lies in the policy, the procedures or the process. After effective policies are established and implemented organization-wide, the issues that arise will typically deal with process or procedure issues. Bear in mind, the policies are in place as a shield for the organization and the basis for processes and procedures that are in compliance with the policy.
What if you're already down the road and have a massive reconciliation mess to deal with? The same laws of intercompany reconciliation still hold true. Policies, education, procedures and processes must be put into place to end the hemorrhaging and the existing mess must be cleaned up. This should be attempted first with current personnel with the explicit declaration that if the accounts do not balance per company policy by a specific date, that a "fire team" will be assembled to assist the entities in the reconciliation process. This will normally be sufficient encouragement to get the accounts in order for the majority of entities, because nobody wants Corporate to show up and begin helping - that is probably second only to the IRS showing up to help.
Earlier in this paper, it was mentioned that many of the technology-based solutions are often more cumbersome than a company's current processes. We are not saying that technology can't help, technology can aid or enhance if you have effective policies, but the policies must be in place, have to be effective, and must be enforced or the technology-based solution will just be more ingredients added to a spoiled soup.
Often, in this lean world, Corporate doesn't really have the time to sacrifice to address these reconciliation issues among the operating entities. In this scenario, a third party can aid in the reconciliation process or in troubleshooting the policies, procedures and processes to ensure a reliable process for intercompany reconciliation is successfully established and implemented.
About the Author:
For additional help on reconciling intercompany or other accounts in the general ledger, check out the article by John Leonard on getting your interco accounts balanced or visit John's website. Check here for free reprint license: Reconciliation of Intercompany Accounts.
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