Intercompany accounting: What do global SMBs need to know?

If you're running a business with multiple entities or subsidiaries, you've probably felt the headache of managing financial flows between them. Welcome to intercompany accounting — a world where every transaction between your companies needs tracking, recording, and eventually eliminating from your consolidated reports.

Getting this wrong can mean regulatory trouble, inaccurate financial statements, and confused investors. Getting it right means clear visibility into your group's true financial health.

What is intercompany accounting?

Intercompany accounting tracks all financial transactions between separate legal entities that belong to the same parent company, then eliminates these internal flows when creating consolidated financial statements.

For example, when your UK subsidiary sells products to your German subsidiary, that's an intercompany transaction. Both companies record it on their books — one as revenue, the other as an expense. When you create your group's consolidated financial statements, you need to eliminate this internal sale so it doesn't inflate your overall revenue numbers.

This intercompany accounting process involves two main activities:

• Recording all transactions between your entities throughout the year
• Eliminating these flows during consolidation to show your group's true financial position to the outside world

Why is intercompany accounting important for SMBs?

Intercompany accounting becomes mandatory once your business reaches a certain size and has subsidiaries or external entities.

In most jurisdictions, companies above specific thresholds must produce consolidated accounts that comply with strict accounting standards. This means reviewing and eliminating both reciprocal transactions (where amounts appear on both sides) and non-reciprocal transactions (where elimination affects only one entity).

The consolidation process combines accounts from your parent company and all subsidiaries into a single, accurate financial picture. This consolidated view shows investors, lenders, and regulators your group's true financial situation — without the distortion of internal transactions inflating your numbers.

As your group grows larger, this process becomes increasingly complex. International companies must follow global standards like the International Financial Reporting Standards (IFRS), established by the International Accounting Standards Board in London.

What's the difference between intercompany and intracompany accounting?

The difference between intercompany and intracompany transactions comes down to how the legal entities involved in the transaction are connected.

• Intercompany transactions happen between separate legal entities within your group.
• Intracompany transactions occur within the same legal entity.

If your parent company sells products to its subsidiary (two separate legal entities), that's an intercompany transaction. If two divisions within the same subsidiary work together, that's an intracompany transaction.

Both types need to be tracked, but only intercompany transactions require elimination during consolidation. This is because intracompany transactions stay within the same legal entity and don't create the double-counting problem that intercompany transactions do.

Reciprocal vs non-reciprocal transactions

There are two types of intra-group transactions:

• Reciprocal transactions (intercompany transactions or intercos): A corresponding amount exists in the accounts of another company within the group.
• Non-reciprocal transactions: A corresponding amount is not identifiable in the accounts of another company within the group, but the transaction still needs to be eliminated.

The following are the most frequently observed intra-group transactions:

The elimination of reciprocal transactions (or intercos) is theoretically straightforward as the amount identified as a receivable in the accounts of one company within the group is treated as a debt in the accounts of another. The consolidated income statement does not change after the elimination process.

The elimination of non-reciprocal transactions is distinct because a corresponding amount is not identifiable in the accounts of another company within the group. The consolidated income statement is therefore modified after the elimination process.

But how to identify the transactions involved? Where does the consolidation process begin? What methods can be used to ensure the account statements are reliable?

Common challenges and discrepancies that can arise when handling intercompany transactions

Despite adhering to strict accounting rules and standards, discrepancies can arise during the period of account reconciliation. The most common reasons for these accounting discrepancies are:

• Increasingly short closing lead times, which can vary from one subsidiary to another.
• The need to identify non-reciprocal transactions between the parent company and its subsidiaries, sometimes a tedious process.
• Subsidiaries located abroad record their transactions in their local currency, which can complicate the reconciliation process.
• Different dates for recording relevant accounting data from one subsidiary to the next.
• Intercompany transactions in foreign currencies, with an exchange rate that fluctuates between the date of transaction and the date of reconciliation.

In light of these obstacles, CFOs, treasurers and other accounting professionals need to adopt accounting best practices and solutions to simplify consolidation efforts. This can mean standardising accounting procedures across the group's various subsidiaries and digitally transforming the group's financial and accounting functions.

Tackling currency risk is one action that falls squarely within the common procedures to smooth the intercompany accounting process.

How to effectively consolidate and reconcile intercompany transactions

Accounting consolidation begins with the mapping out of a “consolidation scope”. This refers to the entities within a group to be included when establishing the group’s consolidated financial statements. Its range is determined by the parent company’s control over its subsidiaries.

Once the scope has been defined, an inventory of the reciprocal transactions to be eliminated must then be drawn up and, lastly, the accounts must be reconciled in order to ascertain the veracity and compliance of all the transactions made.

Step 1: Map out the financial consolidation scope

The inclusion of subsidiaries in the consolidation scope depends on the level of control the parent company has over the external entity. If it maintains more than 50% of the voting rights in a company, then this company’s inclusion in the consolidation scope is a must. This is because such voting rights attribute the parent company with overall responsibility for the subsidiary’s financial and operational policies.

Step 2: Draw up an inventory of intra-group transactions

The inventory — the second phase of accounting consolidation — consists of collecting all data on reciprocal and non-reciprocal intra-group transactions. The inventory – the second phase of accounting consolidation – consists of collecting all data on reciprocal and non-reciprocal intra-group transactions. This is the first step to cancelling them out. At this point, it is also essential to establish the materiality threshold, below which any reporting errors do not compromise the reliability of the corresponding financial statements.

The materiality threshold is governed by a set of professional standards and a series of best practices. While it may vary from industry to industry, the thresholds generally considered to be material are:

• Between 1% and 3% for turnover
• Between 1% and 5% for shareholders’ equity
• Between 5% and 10% for current net income
  
  

Step 3: Reconcile the accounts

Accounting consolidation also requires the completion of a reporting package. This lists the various transactions undertaken by companies within the group, making it possible to conduct a comparative analysis and reconcile the accounts. The latter refers to a comparison between two reciprocal accounts, or an assessment of non-reciprocal flows, with the ultimate goal of ascertaining the veracity and compliance of the amounts identified.

Reconciling intercompany flows can be tiresome and time-consuming. To do it right, the accounting professionals in each of the group’s different subsidiaries must work closely with their counterparts, in accordance with a series of preordained group-wide processes. During the reconciliation phase, it is important to establish:

• Precise methods for exchanging relevant accounting data
• A strict schedule for exchanging relevant accounting data
• Clear procedures for identifying and resolving any discrepancies

Centralising processes is simpler in smaller groups and becomes infinitely more complex when there is a high level of intra-group transactions. When it comes to the latter, rigorous management in each subsidiary is required.

Intercompany accounting best practices to avoid inaccurate financial reporting

Messy processes lead to messy reporting. When your subsidiaries all handle intercompany transactions differently, you end up with numbers that don't match and explanations that don't exist.

The best practices below attack the root problems — inconsistent data, timing disasters and currency headaches that turn month-end into a scramble.

Standardise accounting processes across entities

Your London team books intercompany loans one way. Berlin does it completely differently. By the time you're trying to reconcile everything, you're playing detective instead of thinking strategically about your accounting at large.

Build one playbook that everyone uses:

• Same transaction codes
• Same timing rules
• Same chart of accounts.

Your templates need enough detail to eliminate confusion, but they can't be so rigid that local teams can't actually follow them. This works when you create policies at the top and make sure each subsidiary can execute them. No exceptions, no "we've always done it this way" excuses.

Set a clear materiality threshold group-wide so teams focus on discrepancies that truly impact reporting accuracy

You don't want your team spending hours investigating a £200 discrepancy while there's a far more important £20,000 error next up in the queue.

Along the process standardisation line, define thresholds for what's worth investigated. Set group-wide materiality thresholds based on your turnover, equity or net income — typically 1-3% for revenue. Document these clearly so every subsidiary knows when to dig deeper and when to move on.

This keeps your reconciliation focused on discrepancies that genuinely affect your consolidated financials, instead of chasing pennies at the risk of letting massive discrepancies slip through.

Use automated accounting software to make reconciliation less painful

Matching intercompany transactions by hand across multiple entities and currencies? You're setting yourself up for errors and late nights.

When building out your finance technology stack, look for tools that can help with reconciliation. For example, look for a platform that can auto-match entries and flag discrepancies before they become problems. Everyone gets shared visibility into transaction status, and you catch issues early instead of discovering them at month-end.

Manage foreign exchange risk proactively

Exchange rates shift between transaction dates and reconciliation. For example, a €100,000 intercompany loan recorded in January can create a €3,000 variance by March — just from exchange rate movement.

One tool you can put to work right away are FX forward payment contracts. Forward payments let you lock in exchange rates in advance for intra-group transactions, meaning no more rate-driven surprises during consolidation.

For SMBs working across multiple currencies, this turns unpredictable consolidation into something you can actually plan for. Your FX risk management strategy can protect both your margins and your reporting accuracy.

Get intercompany accounting right from the start

Ultimately, the accounting processes used by a group depend on a number of factors, from the group’s geographical location to the number of companies involved. For groups with subsidiaries whose accounting currency differs from the consolidation currency, currency risk management solutions are certainly worth exploring, as they help process intra-group transactions in a simpler manner and contribute to the optimisation of multicurrency cash flows.