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How to Reconcile Intercompany Accounts in the General Ledger

Updated on January 21, 2011

Reconciling Intercompany Accounts

Definition

Intercompany accounts are accounts in an organizations' General Ledger that represent a balance of payments due from, or to, entities related by common ownership or control. For instance, If company "A" makes widgets and sells them for $100 to a sister-company, company "B", an intercompany relationship exists, or should exist, in the General Ledger where Company "B" has an Intercompany Payable to Company "A" and, conversely, Company "A" has an Intercompany Receivable from Company "B".

At the end of each month, the consolidated Intercompany Accounts Receivable and Intercompany Accounts Payable must have the same balances, a debit for the Intercompany A/R and a credit for Intercompany A/P.

Problem

Many companies have reconciliation issues related to intercompany accounts. For many, this problem can cause the books to be kept open for days or weeks longer than necessary. I know of a company where it was not unusual to have the intercompany accounts out of balance by several million dollars every month. Unless a company institutes the appropriate controls to keep the balances in check, the problem will continue to grow and as it multiplies, it will become utterly unmanageable.

The reasons for these out-of-balance situations usually start out very small - If Company "A" from the previous section sells a widget to Company "B" for $100 and charges $10 freight, but the Purchasing Dept for Company "B" tells their Accounts Payable Dept that it's not on the Purchase Order, so we aren't paying it, the company will have an out-of-balance situation if the issue is not resolved by the end of the month. Many companies also pass an intercompany charge to their subsidiaries based upon 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 calculation, this could also cause an imbalance in the Intercompany Accounts. Any lack of clarity on the part of the entity passing the charge, or a lack of acceptance on the part of the entity receiving the charge, has the potential to cause an out-of-balance situation.

Experience

Our experience ranges from entities with only a few entities and huge 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 primary causes for out-of-balance situations with Intercompany Accounts:

  • Lack of clarity in what the receiving entity is being charged for
  • Lack 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
  • Lack of consideration by the entity passing the intercompany charge
  • Ineffective policies and/or procedures for addressing intercompany charges
  • Lack of effective course for resolution of disputes

We could, of course, break this down into four categories:

  • Lack of clarity
  • Lack of communication
  • Lack of consideration
  • Lack of support from Corporate

but I wanted to illustrate that the responsibility for both communication and clarity rests 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 researching 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. These solutions will not cause your accounts to balance, they give you the ability to enforce the process from a higher level. Enforcing the process without addressing clarity, communications, and additional corporate support, will only yield minimal, if any, results and cause an even higher level of frustration because of the investment in systems without the expected 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 organization. Some organizations may not have a person with the title of Controller, but it is usually apparent who the person is who carries out the controllership functions. In virtually all organizations, the Controller must own 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 organizations that develop intercompany issues have a matrix or semi-matrixed reporting structure. This situation has the nasty habit of splitting allegiances. It must be clear that the Corporate Controller for 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.

In the same way that the Corporate Controller owns the Balance Sheet of the organization, Division Controllers have the same responsibilities within their divisions and must be accountable to the Controller at the next level up in the organization. This responsibility chain continues to flow down to the Plant Controllers (or equivalent), who must also be accountable to the Controller(s) above them in the corporate food chain.

Resolution

Establishing an environment that has an effective intercompany reconciliation process hinges on education. The education, however, must 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 in place (and controlled), the appropriate personnel will require training, from the top of the Accounting hierarchy to the bottom. Especially when initially implemented, the policies and procedures should be reviewed frequently to ensure that they address common company-specific issues that arise during the first few months of implementation. Great care should be exercised, however, to ensure that policies aren't changed simply to ensure compliance. Each time the policies are reviewed 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 rolled-out through the organization, the issues that arise will normally deal with process or procedure issues. Remember, the policies are in place as a protection for the organization and the basis for processes and procedures that comply with the policy.

What if you're already down the road and have a huge reconciliation mess to resolve? The same laws of intercompany reconciliation still hold true. Policies, education, procedures and processes must be put into place to stop the hemorrhaging and the existing mess must be cleaned up. This should be attempted first with existing personnel with the explicit statement that if the accounts do not balance per company policy by a specified date, that a "fire team" will be assembled to assist the entities in the reconciliation process. This will usually be enough encouragement to get the accounts in order for the majority of entities, because nobody wants Corporate to show up and start helping - that is probably second only to the IRS showing up to help.

Early in this paper, it was noted that many of the technology solutions can be more cumbersome than a company's current processes. We are not saying that technology can't help, technology can help or augment 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 added to a spoiled soup.

Often, in this lean world, Corporate doesn't really have the man-hours to spare 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 ensure a reliable process for intercompany reconciliation.

For more information on intercompany or other general ledger account reconciliations please visit InstantController.com or John Leonard at John-Leonard.com.

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