For most businesses, merging or acquiring companies that can complement or add value to their solutions portfolio is part of their growth strategy. Just in the first quarter of this year, mergers and acquisitions (M&As) involving companies in Asia Pacific (Apac) and Japan saw a deal value of US$233 billion ($323.3 billion), according to Refinitiv, a provider of financial markets data and infrastructure.
M&As, however, present challenges such as intercompany accounting. Intercompany accounting involves recording financial transactions between different legal entities within the same parent company. As those entities are related, the transactions between them are not independent, which means companies cannot include a profit or loss from these transactions on consolidated financial statements.
Examples of intercompany accounting transactions include sales and purchases of goods and services between a parent company and its subsidiaries, centralised cash management functions, and leases with the parent or other subsidiaries.
“Intercompany accounting is used to eliminate such transactions between subsidiaries. When transactions occur internally, they must be removed so that they do not appear in the parent company’s financial statements. Otherwise, it will appear as an open balance which will be questioned by auditors,” explains Victor Ng, regional vice president for Asia at BlackLine, a provider of cloud-based finance and accounting tools.
But he warns that intercompany accounting can become complex, especially when each company records its finances differently. “Complications may also arise in international businesses due to systemic differences in regulation, taxation, foreign exchange rates and compliance, to name a few,” he adds.
In an interview with DigitalEdge Singapore, Ng shares more about the complexities of intercompany accounting and how automation can help Apac businesses navigate those challenges for post-merger success.
What are the common issues Apac businesses face in intercompany accounting and cash flow management?
Most businesses, including those in Apac, face similar challenges with intercompany accounting, regardless of their size. In fact, intercompany accounting is increasingly challenging due to complexities arising from local tax policies, currencies, transfer pricing, as well as different systems and applications.
The main challenge that companies face when it comes to intercompany accounting is the lack of integration among systems, such as enterprise resource planning systems. Entities within a company often make their own decisions on the systems and tools they run on.
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A Deloitte survey of over 4,000 accounting professionals revealed that nearly 80% experienced challenges with intercompany accounting around disparate software systems within and across business units and divisions. Without standardisation, they often face issues with integration, resulting in a loss of needed supporting information.
Disputes are also commonplace, especially between subsidiaries. For instance, a subsidiary may claim that it did not engage a particular service, or the amount reflected in the transaction is incorrect. Reaching a mutual agreement on eliminating the balances then becomes a challenge.
Also, businesses that trade across borders face the challenge of managing operations and compliance across tax jurisdictions.
Other challenges include more stringent documentation requirements, growing tax and audit scrutiny, growth in the volume and value of variances, and increasing regulatory hurdles.
With data from different companies being highly distributed, it takes time and effort to reconcile large volumes of data and trace back errors to mitigate risk. Limited cross-entity visibility makes this process even more difficult.
When not eliminated correctly, out-of-balance accounts can adversely impact financial statements, leading to financial, compliance and reputation risks. It is clear that intercompany accounting requires a structured end-to-end process, given large transaction volumes, multiple stakeholders, complicated entity agreements and increased regulatory scrutiny.
What are some of the intercompany red flags before they affect the business?
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Given its complexity and pervasiveness throughout a company, identifying intercompany issues remains a major challenge for multinational organisations. Fortunately, there are several intercompany red flags that organisations can look out for before these issues get out of hand, such as:
- Unreconciled intercompany accounts – Check if your organisation is carrying a significant intercompany balance as this is indicative of intercompany counterparties not being readily identifiable.
- Large intercompany Center of Excellence (COE) – A bloated and costly COE team indicates an intercompany problem and an opportunity to streamline things.
- Tax audit issues – Past tax audits continuously flagging issues could signal intercompany vulnerabilities.
- Transfer pricing reviews – Check if your organisation constantly reviews its transfer pricing as it may indicate the need to restart your accounts.
- Disputes – If you find yourself dealing with disputes every month or quarter, chances are that it is an intercompany issue.
- Unsettled balances – Check if you have balances that are left unsettled for prolonged periods.
- Lack of transparency – If you do not have a clear understanding of which team or department is working on intercompany transactions, it is more than likely that problems will arise.
How can automating the intercompany accounting process help with post-merger success?
The complex nature of the intercompany accounting process makes it hard for companies to record financial transactions between different entities within the same parent company. When set against a backdrop of global trade, M&As and ever-changing tax regulations, it becomes more evident that the automation of intercompany accounting is key to a company’s post-merger success.
Automation can help reduce the intercompany accounting risks and complexity that arise from the merger of organisations and ensure the company is compliant with local laws and regulations. Automation can also help simplify the intercompany accounting process and make it more intuitive. This reduces the time and effort spent reconciling accounts across various data sources, freeing employees to focus on more important tasks such as analysing figures to develop actionable insights for stakeholders.
Can you share some best practices to achieve intercompany accounting excellence?
Automating the intercompany accounting process is critical and should be done first. This helps reduce the risk of human error and frees up the finance team’s time to focus on analysing the numbers instead.
The importance of automation is evident in these four main areas that organisations can look at when it comes to intercompany accounting best practices:
Organisations should ensure that there are proper trading rules and agreements between the various entities so that they can automate the transfer pricing workflow to standardise the process. There should be automation in terms of posting across the different ledgers as well.
Balancing and substantiating
A real-life scenario like this could unfold if we use a manual approach for intercompany accounting: All the substantiation is done on email or in a document, which is then filed in a folder. During the yearly audit, the finance team will have to locate the said folder to explain any discrepancies found.
This takes up time, which could be spent on doing more strategic work. Hence, organisations should find a way to automate the whole process of balancing their accounts receivable and accounts payable postings with automated exception handling. That way, they can ensure there is proper documentation to substantiate those postings for better efficiency.
Netting and settlement
Automation is key here to help create an advanced netting and settlement process where you are able to get real-time updates on gains and losses of exchange rates, for example.
Consolidation and elimination
If balances are not eliminated correctly, it will appear as an unbalanced number in the corporate books and will be a red flag during audits. Automating postings of elimination entries ensures that the system will be able to handle topside adjustments wherever needed.
By leveraging BlackLine’s solutions to automate the intercompany accounting process, one of our customers managed to reduce intercompany imbalances from US$30 million to less than US$1 million per month, with a 93% automatic matching ratio of intercompany transactions. The customer also managed to strengthen controls and compliance in its processes, as well as dramatically reduce the manual work and effort involved.
Any other tips that you would like to share?
It can be rather tempting to want to do everything at once when companies want to transform their intercompany accounting practices. But it is important for companies and especially CFOs to think about where the company is at the moment, what would be a realistic target in the next six months to a year, and what benefits can be reaped from the transformation. Bearing in mind that there could be resource constraints or variables to consider, identify the top two or three priorities and start from there.