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 end of each month, the consolidated Intercompany Accounts Receivable and Intercompany Accounts Payable must have the corresponding account balances, a debit in the Intercompany A/R and a credit for 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 causes for these out-of-balance conditions usually begin very small – If Company „A“ from the prior section sells widgets to Company „B“ for $100 and charges $10 shipping, but the Purchasing Dept for Company „B“ tells their Accounts Payable Dept that it’s not on the Purchase Order, so we are not paying it, the organization will have an out-of-balance condition if the issue is not remedied by the end of the month. Many businesses also pass an intercompany charge to their subsidiaries based on their Working Capital as an encouragement to keep Working Capital as low as possible to avoid excessive intercompany charges. If there is a disagreement in the computation, this might also trigger an discrepancy in the Intercompany Accounts. Any lack of clarity on the part of the entity passing the charge, or a absence of acceptance on the part of the entity receiving the charge, has the capability to lead to an out-of-balance condition.

Experience

Our past experiences ranges from organizations with just a few entities and huge issues with balancing the accounts, to huge companies with hundreds of entities that have minimal issues in getting the accounts to balance.

There are seven primary causes 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

We might, certainly, reorganize these into four categories:

Lack of clarity Lack of communication Absence of consideration Lack of guidance from Corporate

however I wished to show that the responsibility for both communication and clarity sits with both the receiving entity and the passing entity; and Corporate can fail to support the reconciliation process in many ways, of which, policies, procedures and dispute resolution are the most common.

In exploring this issue, we have seen a lot of technology-related solutions on the market and, no offence to the programmers, tend to be significantly more cumbersome than the processes that they replaced. Such solutions won’t 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, is only going to yield nominal, if any, success and cause an even greater level of frustration because of the investment in systems without the expected Return on Investment.

Responsibility

By definition, the responsibility for making certain that Intercompany Accounts (or any accounts, for that matter) rests firmly with the Controller of the firm. Many firms may not have a person with the title of Controller, but it is generally evident who the person is who performs the controllership functions. In almost 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 have ownership of the Balance Sheet and support the reconciliation process, senior management i.e. CFO, CEO, Vice Presidents, etc.. must support the Controllers‘ authority to enforce the timely reconciliation of the Intercompany Accounts.

Most firms that develop intercompany issues have a matrix or semi-matrixed reporting structure. This situation comes with the unpleasant habit of splitting allegiances. It needs to be crystal 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 solution 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.

Early in this paper, it was observed that many of the technology solutions can be more cumbersome than a company’s current processes. We aren’t saying that technology can not help, technology can aid or enhance if you have effective policies, but the policies must be in place, must be effective, and must be enforced or the technology solution will just be more ingredients put in to a rotten soup.

Frequently, in this lean world, Corporate doesn’t really have the man-hours to sacrifice to address these reconciliation issues among the operating entities. In this situation, a third party can assist in the reconciliation process or in troubleshooting the policies, procedures and processes to make sure a reliable process for intercompany reconciliation is effectively established and executed.

For more in getting your intercompany accounts to balance, check out the article by John Leonard on getting your interco accounts balanced or visit John’s website