Getting Intercompany Accounts Reconciled

Article Written By: Patrick Kelley

Intercompany accounts are accounts in a business's General Ledger that maintain a balance of payments due to, or from, organizations connected through common ownership or control. For example, If company "A" manufactures widgets and sells them for $100 to a sister-company, company "B", an intercompany association exists, or should exist, in the General Ledger where Organization "B" has an Intercompany Payable to Organization "A" and, conversely, Company "A" has an Intercompany Receivable from Company "B".

At the conclusion of each accounting period, the consolidated Intercompany Accounts Receivable and Intercompany Accounts Payable must have the corresponding account balances, a debit for the Intercompany A/R and a credit for Intercompany A/P.

Problem

Many organizations encounter reconciliation challenges associated with intercompany accounts. For many, these issues can result in the books to be kept open for days or weeks longer than reasonable. We are familliar with a company where it wasn't out of the ordinary to have the intercompany accounts out of balance by a few million dollars each month. Unless a company implements the proper controls to keep the balances in check, the problem will continue growing and as it multiplies, it will become thoroughly uncontrollable.

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 experience ranges from firms with just a few entities and enormous problems with balancing the accounts, to huge companies with thousands of entities which have very few issues in getting the accounts to balance.

There are seven principal drivers for out-of-balance situations 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 easliy, of course, 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 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.

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 and procedure Dispute resolution policy and 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 already have a large reconciliation mess to resolve? 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 staff members with the explicit statement that if the accounts do not balance per company policy by a given date, that a "fire team" will be set up to support the entities in the reconciliation process. This will normally be enough encouragement to get the accounts in order for most of entities, because no one wants Corporate to show up and begin helping - that is most likely 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.

About the Author

For additional help on reconciling intercompany or other accounts in the general ledger, check out John Leonard's article on Intercompany Reconciliation or visit Instant Controller

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