Intercompany accounting is prone to errors and omissions. If accounts don't balance, it could be because something's been overlooked or because different entities record transactions at different times. The best way to reconcile the accounts is automation, although consistent accounting practices and regular reviews of the balances will reduce mismatches.
The short version
- Intercompany accounting can be enormously time-consuming – and even become a full-time job.
- When intercompany balances don't match, it can be because something's been overlooked or because of a time lag between different sides of a transaction being recorded.
- There could also be errors in coding transactions or allocating them to the right entities.
- Errors will always crop up in a manual system – but consistent coding, clear processes and regular reviews will help.
Intercompany accounting can be so horrendously time-consuming that it can become, literally, a full-time job.
"I used to know a family-owned business with 300 companies in the group. They employed someone just to do the consolidation, even though it only happened once a year," says Guy Burton, iplicit's Technical Solutions Consultant. "He spent his entire year preparing and updating spreadsheets, getting everything ready for the auditors."
The size and complexity of the job depends on how many entities there are to deal with and how often consolidation is necessary. Some, like that 300-entity family business, only consolidate at year-end for statutory reasons, while others need the job done monthly for their own management purposes. Either way, for many organisations, the job is about pulling together trial balances from multiple entities and entering it into spreadsheets.
The process tends to be painstaking and error-prone. At The Recruitment Group, "everyone would be scratching their heads" when it came to month-end reconciliation before FD Narinder Uppal introduced a system that could automate multi-entity accounting.
In the second part of a series about multi-entity consolidation, we look at some practical steps you can take to minimise mismatches.
What an intercompany elimination is and why it's necessary
Different entities in the same group often do business with each other – for example, by selling one another goods or services, lending money or splitting shared costs. Transactions like these don't affect the profit and loss of the group – but that's exactly why they have to be carefully recorded and removed from the consolidated accounts.
If Company A sells something to its sister company, Company B, for £10,000, that money will show up as a credit in Company A's books and a debit in Company B's ledger, yet the group won't have become any richer or poorer. If these transactions weren't stripped out of the group accounts, you would be overstating revenue and expenses and possibly inflating group profit.
Why intercompany balances don't match
While the principle might not be hard to grasp, the work involved in intercompany accounting presents almost endless scope for mistakes and omissions. The moment of truth tends to come when the finance team pulls together trial balances from all the relevant entities and finds something doesn't match. The reason is usually one of the following.
Someone's forgotten to record something
The fallibility of human memory is at the root of many mismatches. "If you're not on a consolidated system like iplicit and there's a sale of goods from Company A to Company B, someone has to remember to raise a sales invoice in one company and a purchase invoice in the other," says Guy Burton. The whole process can be derailed if someone is interrupted at the wrong moment and doesn't get back to the task. And the risks are multiplied if different teams handle the opposite ends of the transaction.
Timing differences
The two sides of an intercompany transaction might be handled by different people at different times. You might find yourself raising an intercompany sales invoice today and crossing your fingers that your opposite number in another entity generates the corresponding purchase invoice at the end of the month.
"That's where intercompany balances can get out of sync," says Guy Burton. "One set of accounts has the transaction in it and the other doesn't yet, so someone has to track down exactly where the missing entries are and make the adjustments needed for the consolidated accounts. The reason intercompany balances don't match often comes down to those time differences."
Coding and counterparty errors
Often, transactions aren't allocated to the correct entity or the correct account code when they're entered into the system. Allocating a sum to the wrong entity (aka counterparty) can occur because an incoming bill needs to be split between entities. (It doesn't help that, sometimes, the incoming invoice isn't addressed to the right entity in the first place.)
For example, an invoice for a £100,000 audit fee might be addressed to one party in the group but require splitting between entities. This one multi-company purchase invoice necessitates a whole string of adjustments and reconciliations – and a mistake in any one of them can cause serious confusion.
When it comes to coding, different entities of the group might have a different chart of accounts because they work differently, requiring a more or less detailed breakdown of transactions in a particular area. Any errors or inconsistencies can be immensely complicated to clear up when the data is mapped across to the consolidated accounts.
Examples: What does reconciliation and elimination look like in practice?
Example 1: Subsidiary A sells a supply of widgets to its parent company, Parent B, for £10,000.
Subsidiary A has thereby generated £10,000 of revenue, while Parent B has incurred a £10,000 expense. But the group overall hasn't seen any extra revenue from this transaction or incurred any extra costs, so the two sides of the transaction need to be matched and eliminated when the group's consolidated accounts are prepared.
The example becomes more complex if Subsidiary A is entering the transaction right now but Parent B's finance team won't get to it until the end of the month. So between now and then, the accounts won't be neatly reconciled.
Example 2: Let's take that £100,000 audit fee we mentioned earlier. Parent B receives the invoice and settles the bill. However, that bill needs to be split unequally between several entities, so Parent B charges £10,000 to Subsidiary A, £5,000 to Subsidiary C and so on. All these transactions have to be carefully entered and eliminated when the group accounts are prepared.
Reducing mismatches before they happen
As long as human beings are keying in figures and making calculations, there will be some degree of error and omission in a process as complicated as intercompany accounting. But there are practical steps you can take to reduce those errors.
Apply consistent coding across entities. It's not always possible but it does lessen the opportunity for error. It also reduces the work that has to be done to map everything across to the consolidated accounts.
Have clear processes. It helps to be scrupulously precise about how entity-to-entity transactions are recorded on both sides – and when.
Review balances regularly. Checking the intercompany balances more than once a month helps, so that discrepancies can be identified before memories have faded and a landslide of further data has entered the system.
Where the process remains manual
For many organisations, almost everything about consolidation is manual. You take the trial balances from each entity's accounting system and enter each of those balances into a spreadsheet. Then you start investigating the figures that don't tally.
Danielle Disley, Group Finance Manager at the Abbey Group of companies, remembers doing intercompany work with multiple versions of Sage 50 software. "Making sure you raised an intercompany invoice, and that it was all reconciled correctly, was a nightmare – especially when you might get a bill to split between seven companies," she says. "Logging in and out of different companies was time consuming – and you could easily find yourself in the wrong company."
Besa Lane, Head of Finance at the charity ellenor, faced a similar challenge, using spreadsheets to reconcile accounts for the main charity, a lottery trading company and a retail trading entity. "The spreadsheets were prone to so many mistakes, with formula after formula, all linked to each other so if something was wrong it would affect a spreadsheet in another workbook," she says.
Automating the intercompany transactions is essential for any substantial organisation that wants to see real-time group information. That's not to say there will never be a case that requires human intervention – when an unusual requirement for a refund between companies comes up, for example. But the role of the finance team can become one of reviewing and overseeing rather than handling every transaction individually.
Where iplicit comes in
Automating intercompany tasks is impossible when different parts of a group are using different instances of the finance software – or even using different systems altogether for operational reasons or because the group has grown through acquisition.
With a unified system, intercompany adjustments are done at the point the data is entered. The group picture is always available because eliminations happen at the push of a button.
Danielle Disley of Abbey Group achieved this real-time group picture when the organisation moved to iplicit. "You put a rental invoice for the group in the system, for example, and it does everything else for you, including carrying out the recharge straight away. You know it's in all the companies' accounts."
Besa Lane of ellenor says: "The accounts are ready instantaneously. Once the month-end is closed, we just need to check them."
The bottom line: from error-spotting to strategy
Overhauling your systems so the intercompany accounts balance first time will make working life a lot calmer and less frustrating. But it can also alter the role of the finance team. With less manual work and fewer errors to hunt down, the team can contribute more to the direction of the company, delivering real-time data for the whole group.
As Besa Lane says: "Before, I was spending a lot of time in spreadsheets, trying to get things right and eliminate mistakes. But now we have more valuable reporting that helps strategic decision making, so I'm spending more time on risk management and strategic analysis."
See for yourself
Ready to see how iplicit can help your multi-entity organisation automate the grind and produce accurate group accounts? Take a three-minute tour or book a demo to see how it would work for you.
What is an intercompany elimination?
An intercompany elimination removes the internal transactions between entities in the same group, such as sales or loans between subsidiaries, when preparing consolidated accounts. Because these transactions cancel out at group level, leaving them in would overstate revenue, expenses and profit.
Why don't intercompany balances match?
Intercompany balances usually fail to match because of missed entries, timing differences between when each entity records its side of a transaction, or errors coding a transaction to the wrong entity or account. Manual processes make all three more likely.
How can you reduce intercompany mismatches?
Apply consistent coding across all entities, keep clear processes for recording both sides of a transaction and review balances more than once a month so discrepancies emerge before memories fade and more data piles on top. Automation removes most of this manual risk entirely.
What's the difference between manual and automated intercompany reconciliation?
Manual reconciliation means pulling trial balances from each entity into spreadsheets and investigating the mismatches by hand, which is slow, repetitive and error-prone. Automated systems like iplicit apply eliminations the moment data is entered, so the group picture stays accurate and available in real time.
