How to Identify Intercompany Red Flags

If done correctly, intercompany accounting—the management of financial transactions between separate legal entities that belong to the same corporate group—should be an asset, not a liability. However, due to its complexity and pervasiveness throughout multinational corporations, intercompany deficiencies can bring all kinds of problems to your business.

Identifying intercompany issues within a multi-national organization with complex processes is a major challenge. What are the indicators that an organization has intercompany issues? What red flags should senior management recognize so intercompany can be addressed before problems get out of hand?

Fortunately, it is possible to simplify the complex. By knowing what to look for, you can reduce costs and improve efficiencies. To help you achieve this goal, here is a summary of the most common intercompany red flags. 

1.     Unreconciled intercompany accounts: look to see if your organization is carrying a significant intercompany balance because intercompany counterparties cannot be readily identified

2.     A large intercompany Center of Excellence (COE): costly COE teams that are larger than necessary for the number and interoperability of corporate entities indicates an intercompany problem and an opportunity to streamline things

3.     Tax audit issues: past tax audits continuously turning up intercompany issues or internal auditors regularly tuning into intercompany vulnerabilities

4.     Transfer pricing reviews: constant reviews of transfer pricing indicate you may need to restate your accounts

5.     Disputes: if you find yourself going through disputes every month or every quarter, it’s a sign of an intercompany issue

6.     Unsettled balances: keep a close eye on balances sitting unsettled for lengthy periods of time

7.     Lack of transparency: if you don’t know which team or department is working on intercompany transactions, more than likely problems abound

Once you know to be on the lookout for intercompany red flags, you can start to make intercompany transactions easier.

In addition to those seven intercompany red flags, you should also watch out for department-specific red flags. 

To catch intercompany red flags, your treasury department is going to be taking note of what is and isn’t getting settled. They’re going to examine the different foreign exchange (FX) contracts they have and how much they’re spending. In the event they have multiple FX contracts, they need to be cognizant of where their intercompany is going, how they are transacting, and in what currencies.

Treasury also needs to examine cash flow. Where is the cash moving? Is cash not being moved? Is it getting stored in a certain area? In addition, they need to scrutinize transaction fees. How often and how much are they paying to settle invoices? Are they able to net invoices together into one payment rather than hundreds of individual payments? The answers to these questions will help your treasury team identify intercompany systems that need improvement.

Accounting will identify an intercompany issue when noticing a lot of variances while attempting to tie out multiple reports. They could also come across unreconciled accounts and variances in accounts that remain completely unresolved.

Another red flag for accounting happens when accounting sees a lot of reclassifications. When transactions are regularly corrected in the ledger, there are problems upstream. Identifying which transactions are regularly reclassified gives you an idea of where to look.

Intercompany issues typically bleed out into other areas during close, which makes them easy to spot. And, if the accounting team is spending a lot of time on calls about intercompany as close approaches, that’s another red flag.

A big red flag for the human resources team is seeing burnt-out, frustrated finance employees, working around the clock to close the books at the end of the month or quarter. HR also plays a big part in helping companies build out shared service centers. They are responsible for the planning and staffing of the shared service center, so they should have insights on how well that team is working.

The accounts payable team analyzes everything during and after the close to follow the trends. As a result, they will be impacted by intercompany problems, as well. They’re examining the tax impacts, the people impact, the costs, the cash, and anything financial, so they’re definitely going to be alerted to the impact of any intercompany issue.

It is the responsibility of the FP&A team to reach forecast targets and to ensure that whatever they estimated or budgeted for is in line. So, if your numbers are off, and you can’t explain it, they have to start digging in, which is typically a sign of intercompany gone wrong.

The nature of the intercompany process itself has the potential to trigger multiple tax red flags. Red flags for the tax team appear when they cannot defend the tax deductibility of an intercompany service transaction. Other red flags include inappropriate or inconsistent transfer-price markups and if the portion of the total invoice is not allocated proportionally to all entities involved.

Another tax red flag is caused by a lack of sufficient documentation on intercompany charges. An automated process guided by robust technology can ensure that intercompany services are detailed with more specificity, the transfer price is arrived at properly, the costs are allocated across entities appropriately, and the right indirect tax is applied and paid. In addition, automation can reduce or eliminate red flags by giving detailed and immediate insight into the cost details of the services provided and their allocation, which greatly enhances the ability to defend the tax deductibility of the charges.

Armed with an understanding of the many intercompany red flags that can affect your close better prepares you to deal with the issues as they arise and prevent them from getting out of hand.

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