Cleaning up the mess under the bed
Why intercompany accounting is increasing corporate risk
It’s an unsettling trend: More and more companies are experiencing serious problems and real financial costs as a result of improper or insufficient intercompany accounting (ICA) practices. Chalk it up, in part, to increased industry consolidation, growing globalization, and integrated supply chains. But the problems are also a product of continued denial and neglect. For years, the issue has been swept under the bed. Now it’s time to address the mess.
- Download the report
- The root of the problem
- No function is an island
- Getting out the broom and dustpan
- Meet the authors
More than 3,800 professionals participated in a May 2016 Deloitte Dbriefs webcast, “Cleaning up intercompany accounting: Driving efficiency while managing risk.” When polled, they told us that insufficient accounting of transactions between various legal entities within an organization can lead to inaccurate financial reporting, yet only about nine percent of respondents said their organizations have holistic, efficient, and well-communicated intercompany accounting frameworks. Learn more here.
Cleaning up the mess: Now is the time
Countless organizations struggle with the time-intensive requirements of managing an ICA program that is often inefficient due to processes and systems that have been pieced together and neglected over time. But denial will only lead to a growing mess, including serious risk exposures. As the complexity of ICA continues to rise, and the consequences for getting it wrong become increasingly apparent, financial executives need a strong and fresh approach to this long-ignored problem. The time has come to clean up the mess under the bed.
The root of the problem
Today’s organizations are far more complex than they were a mere decade or so ago. Many companies have significantly expanded their global footprints, which can generate an enormous volume of intercompany transactions and introduce the need for compliance with country-specific regulations and tax policies. Companies are also facing increased competition as well as greater regulatory scrutiny.
As if that weren’t enough, ICA has been further complicated by:
- Industry consolidation, where stronger players snap up weaker competitors, frequently inheriting heterogeneous financial systems, charts of accounts, and accounting processes with each new acquisition
- Company growth, which often introduces centralized business service centers that increase the number of intercompany transactions processed
- Increased enforcement of global accounting and tax regulations, exposing companies to greater risk if they fail to streamline their intercompany transactions
- Mounting pressure for companies to achieve a more efficient financial close in order to support filing deadlines and internal control assertions.
The challenges of performing effective and efficient ICA are substantial. What companies need is a holistic and preventive approach in which the primary stakeholders work hand in hand to create a vision for the future that streamlines ICA, from governance to reporting.
Intercompany accounting refers to the processing and accounting for internal financial activities and events that impact multiple legal entities within a company. ICA can include sales of products and services, fee sharing, cost allocations, royalties, and financing activities.
No function is an island
The effects of improper ICA extend beyond the accounting function, a fact that may not be fully appreciated in many organizations. For example, a company may succeed at eliminating intercompany accounts receivable and accounts payable transactions from their books (within a specific tolerance threshold,) thus achieving an important financial reporting goal. Yet at the legal-entity level, exceptions, and misclassifications may still remain—with certain tax implications. If addressing a specific issue for the accounting department has negative repercussions for the tax department, the mess under the bed just gets shuffled around but not cleaned up.
There are three major functions impacted by ICA:
- Accounting: Financial misstatements can impact the company’s reputation, stock price, and shareholder value. Weaknesses in internal controls may surface during an audit. And insufficient ICA transparency and control provide the opportunity for misappropriation of assets, making it easier to hide assets flowing out of the organization to fictitious vendors or accounts
- Tax: Transactions between countries are subject to specific tax laws. Misclassified profits between countries can result in tax penalties, interest, and reputational damage. Tax organizations of large multinationals have been particularly impacted by new requirements for country-by-country reporting in the European Union.
- Treasury: The treasury organization receives details of intercompany trade transactions and manages the netting and settlement of intercompany trade invoices. It also manages intercompany financing and global liquidity and foreign exchange exposures.
Getting out the broom and dustpan
Persuading everyone working from the same playbook and equipping them to clean up the ICA mess calls for a single vision for the future. To describe that future, a company will first need a framework that provides a holistic perspective and incorporates every aspect of ICA, from governance to reporting. A framework can help visualize ICA as an interconnected, interdependent, end-to-end process, while breaking it into manageable pieces. Then, to address each component of the process, a company needs an approach that embeds both leading practices and a roadmap for adopting them.
Deloitte Advisory uses a framework that is divided into seven components, representing the relevant accounting, treasury, tax, legal, and business considerations associated with intercompany transactions.
Based on extensive research of ICA practices in a wide range of companies, we have identified a set of leading practices for each component of this framework.
These practices, which address the common challenges of ICA, include:
- Governance and policies
- Intercompany pricing
- Data management
- Transaction management
- Netting and settlement
- Reconciliation and elimination
- Internal and external reporting
Despite the emphasis on systems that automate and integrate ICA processes, technology alone is not the answer. Designing an approach that is cross-functional, that assigns ownership and accountability, and that is based on well-delineated processes is critical to the success of ICA initiatives.