Intercompany transactions often carry unique legal and financial challenges for the parent company and its subsidiaries that may benefit from the cash or assets exchanged. Even if both companies do everything “by the books,” with a clear record of transactions, lenders may not look favorably upon intercompany transactions. These types of transactions can also muddy the waters for investors and can create complications at tax time. A remote work environment created an added layer of complications, which include cybersecurity concerns and too many hands on data files.
But intercompany transactions also have a myriad of uses and benefits that executives and accounting departments should not ignore. It’s not necessary to steer clear of intercompany transactions, but it is important to make sure all your bases are covered before executing such a deal.
What Is an Intercompany Transaction?
Intercompany transactions are any transactions between a parent company and subsidiaries or related entities, most often start-ups that may need a cash infusion or that can take advantage of the parent company’s infrastructure to reduce operational costs.
Companies can also buy and sell goods or inventory between each other. In some cases, a parent company can transfer cash to a start-up, but all transactions must be recorded clearly by the accounting department.
Common Types of Intercompany Transactions
Parent companies may provide operational infrastructure, such as shared office space, supplies or equipment, or staff to subsidiaries, especially in the case of start-ups. The business can often take a tax loss on the new company, which may not show a profit in the first year or two. But if sharing resources increases expenses for the parent company, the parent company may show reduced profits. This can cause issues, especially in the case of publicly held companies where shareholders pay attention to profitability each quarter, or if the parent company is seeking investment funding or a bank loan.
A larger company may also decide to choose to purchase goods or materials from its subsidiary to reap the profits. It’s important to make sure these intercompany transactions are logged just as if the materials had been purchased from an outside vendor. Similarly, a parent company can leverage existing vendor relationships to purchase materials for its subsidiary in order to reap the benefits of better terms or bulk discounts. The parent company could even choose to transfer these items to the subsidiary at no cost, which can lead to inaccurate bookkeeping and inflated expenses for the parent company.
Intercompany sales can go in either direction; the parent company can sell to the subsidiary or buy from the subsidiary. In either case, this type of transaction makes it difficult to determine either company’s profitability accurately. Likewise, if personnel spend time working on both businesses, time must be logged accurately in order to attribute those payroll expenses to the right company.
What Can Go Wrong with Intercompany Transactions?
Intercompany transactions can carry many complications, whether the companies are exchanging goods, raw materials or cash, or sharing operational expenses or human capital resources. These transactions can be confusing for bookkeepers, especially if the business owner just does what’s necessary to meet the needs of the business in the moment and fails to report a transaction, such as a wire transfer.
Large amounts of cash being exchanged between the two companies can raise red flags to investors completing due diligence or to bankers reviewing financial statements in consideration of a business loan. These transactions would also need to be clearly documented at tax time, and could potentially trigger an IRS audit.
Similarly, if a company is sharing administrative and operational expenses with a subsidiary, it can create cash flow issues and reduced profitability. Publicly held companies, especially, want to be acutely aware of their bottom line, as investors are investing in the parent company, not the start-up.
Intercompany Transactions and Cybersecurity Concerns
The remote work era creates another level of challenges with intercompany transactions. Not only must the business owner offer full transparency about transactions with the bookkeeping team, and rely on the accounting department to log those transactions correctly, but the company must also ensure all files are safe and tamper-proof.
With multiple personnel accessing files, it’s important to maintain a log of changes. Investment firms and loan officers conducting due diligence may also need access to view files that record intercompany transactions, which means now these files are being exposed to people outside the organization, increasing cybersecurity risks.
Intercompany Accounting in the Era of Mergers and Acquisitions
Intercompany transactions are not always between a parent company and a start-up or subsidiary. As companies in similar industries merge or acquire other businesses in the same industry, intercompany transactions become more common — and more complicated.
Research firm Deloitte refers to intercompany accounting as “the mess under the bed.” One way to eliminate that mess is to pull it out into the open. By ensuring that all relevant personnel understand intercompany transactions, the reasons they occurred, and where the assets went, you can simplify the process and reduce the chance of additional scrutiny from investors or even a tax audit.
How a VDR Can Help with Enhanced Security, Efficiency and Compliance
Virtual data rooms (VDRs) can eliminate some of the common pain points associated with intercompany transactions. While they can’t ensure that the people logging the transaction do the right thing or include all the necessary details, VDRs can create an audit trail of who logged into the documents and made changes. A VDR can also provide a secure avenue to share files, including accounting spreadsheets and invoices, with outside investors, shareholders and lenders.
Look for enterprise-level VDR capabilities that include easy enhanced digital rights management to share and revoke files with outside parties at any time, and that can integrate easily with your company’s productivity software suite. By using a VDR, you can create a powerful “risk buffer” so that your company doesn’t have to shoulder the full responsibility of cybersecurity.
Caplinked offers risk mitigation with industry-recognized security protocols, digital rights management, easy document tracking and more. Learn more about using a VDR to help manage your intercompany transactions and start your free trial today.
Dawn Allcot is a full-time freelance writer and content marketing expert specializing in technology, business and finance.
B2BCFO – Intercompany Transactions
Deloitte – Intercompany accounting and M&A challenges
Froehling Anderson Accountants – Audit Procedures with Related Party Transactions