Intercompany profit-in-inventory reporting

June 19, 2024

A blog post by Anna Andersen and Katie Glynn

As companies become increasingly more global and complex in nature, they expand their multinational value chains and generate large volumes of intercompany (IC) transactions. Along with this expansion, higher regulation and the rise of enforcement exposes companies to more risk as they expand and grow. Within the IC accounting framework that includes the processing and accounting for internal financial activities and events that affect multiple legal entities within a company, there is an approach to the accounting for profit and profit-in-inventory that can assist in the optimization of the broader IC framework and drive the automation of the transactions reporting process for IC profit to enable overall transformation.

How can organizations approach automating the profit-in-inventory process? First, we will look at what intercompany profit and elimination encompasses. Then, we will explore automation tools, benefits, and leading practices for implementing processes that offer value across the reporting and IC accounting framework.

What is intercompany profit and profit-in-inventory?

Before exploring an approach to automating profit-in-inventory reporting, let’s first give an overview of these common intercompany accounting profit and transaction terminologies.

In essence, IC profit is allowed on any transaction between entities within the same group, but it is often deferred or eliminated in the group’s consolidated financial statements until they are realized through transactions with external parties.

Transactions can include the sale or transfer of goods, services, assets, loans, or royalties. For consolidated financial reporting, these profits are often eliminated to avoid overstatement of revenue and assets until external parties finalize the transactions. For example, if a parent company sells goods to its subsidiary, the profit from this sale is considered an IC profit, but the consolidated financial statements of the group only recognize this profit once the subsidiary sells the goods to an external customer. Generally accepted accounting principles (GAAP) requires the elimination of all IC profit as part of SEC reporting.

Profit-in-inventory refers to the difference between the cost of purchasing or producing inventory and the revenue generated from the sale—essentially the amount of money a business makes after selling its inventory and deducting the costs associated with acquiring or producing it.

What is a profit-in-inventory release?
Profit-in-inventory release refers to the recognition of profits that IC inventory transactions previously eliminated. This occurs when the inventory is sold to an external entity—an action that finalizes the transaction. In the context of consolidated financial statements, IC transactions—including profits of IC inventory sales—are eliminated to avoid double counting.

However, if the inventory is later sold to an external entity, the profit is “released” through a manual or automated process and can be recognized in the consolidated financial statements.

The intercompany profit and profit-in-inventory elimination process

Now that we understand the terminology around IC profits and profit-in-inventory, it is worth exploring the typical profit and profit-in-inventory elimination process. Profit-in-inventory elimination refers to the adjustment of profits that occur due to IC transactions affecting inventory levels across different business units or regions. The process describes the calculation and posting of elimination adjustments for these transactions. Depending on the system setup, these entries can be manual or automated. Some of the most common eliminations include IC sales or purchases, payables or receivables, loans, fixed asset transfers, dividends, equity, and unrealized profit (which includes profit-in-inventory elimination).

Now, why does this matter? For starters, it matters because of reporting accuracy. If IC profit is not properly eliminated, it can lead to an overstatement of revenue and assets in the consolidated financial statements. Without it, investors and other stakeholders may be misinformed about the company’s financial health and performance. It can also lead to regulatory compliance issues, as financial reporting standards require the elimination of IC transactions in consolidated financial statements.

Some leading practices for automating the intercompany profit process

When designing an automated profit-in-inventory model that can simplify reconciliation and reporting processes utilizing an ERP or other automated system, it is important to clearly define processes and procedures to support the model. In addition, here are some leading practices to consider in the planning, designing, and implementation process:

• Capture the current state, including IC processes, systems, and data evaluations. Make sure to include all pain points highlighted in the evaluations.
  
• Design a future-state profit-in-inventory process that both aligns with future-state requirements and addresses critical pain points.
  
• Utilize a centralized and governed IC framework to allow for better coordination with key stakeholders.
  
• Remember that detailed documentation of the IC framework is essential to streamlining processes and providing accurate and complete external reporting.
  
• Design a future state around the correct reconciliation, matching, and elimination solution, and leverage the increased capabilities of ERP and EPM solutions across the supply chain and IC activity.

If the process for automating profit-in-inventory seems overwhelming, Deloitte’s IC accounting team can help. Feel free to get in touch to learn how Deloitte’s people, process, and technology can assist you on the path to IC profit automation and IC optimization.