When intercompany matters
Any company with multiple legal entities has intercompany transactions. Parent-subsidiary relationships. Sister subsidiaries. Holding company structures. Even simple arrangements, a parent paying for a subsidiary's software, a shared services entity billing operating entities, create intercompany activity.
Intercompany matters for three reasons: consolidation requires eliminating these transactions to avoid double-counting, tax authorities scrutinize transfer pricing, and management reporting by entity needs clean separation. Each reason has specific accounting implications.
The default reaction to intercompany is often to minimize it. In practice, this is rarely optimal. Intercompany transactions are normal and legitimate, the issue is handling them correctly, not avoiding them.
The basic mechanics
Every intercompany transaction requires matching entries in two sets of books. If Parent pays a $10K vendor on behalf of Subsidiary, Parent books: debit intercompany receivable (asset), credit cash. Subsidiary books: debit expense, credit intercompany payable (liability).
At consolidation, these matching entries net out. Parent's intercompany receivable and Subsidiary's intercompany payable cancel each other. The net effect on the consolidated balance sheet is zero, as it should be, since nothing has changed outside the group.
The mechanics seem simple. The complexity comes from getting both entries right, in the same period, in the same amount, with consistent categorization. Missing any of these produces consolidation errors that are hard to trace.
Transfer pricing
Transfer pricing is the requirement that intercompany transactions happen at arm's length prices, what unrelated parties would charge each other. Tax authorities scrutinize this because profit shifting between jurisdictions has tax implications.
The classic example: US parent licenses IP to Irish subsidiary at a low price, Irish subsidiary licenses to European customers at a high price. Profits accumulate in Ireland at lower tax rates. The IRS wants to ensure the licensing price between parent and subsidiary reflects market rates, not tax optimization.
For companies with cross-border intercompany activity, transfer pricing studies are usually required. These are done by specialized firms, document the pricing methodology, and support the tax filings. Expect to spend $15K-$50K for a study depending on complexity.
Keeping it clean
Monthly reconciliation of intercompany accounts is the foundation. Both sides of every transaction should match. Where they do not, investigate immediately rather than letting discrepancies accumulate. Intercompany accounts that have not been reconciled in months are cleanup projects waiting to happen.
Use dedicated intercompany accounts rather than mixing intercompany with other transactions. A "Due from Subsidiary A" account is cleaner than lumping intercompany into general AR. The visibility at reconciliation time is much better.
Consolidation software or a defined consolidation process. For 2-3 entities, spreadsheet consolidation works. Past that, tools like Fathom, Spotlight, or higher-end platforms (NetSuite, Sage Intacct) automate elimination entries and reduce the risk of missed intercompany items.