Intercompany transaction
A transaction between two companies in the same group, such as a sale, a loan or a shared cost, which must be eliminated when the group reports as one.
In short
- Each entity records it in its own books; consolidation removes it from group results.
- Both sides must record the same amount in the same period, or the elimination won't balance.
- Pricing between related companies across borders is subject to transfer pricing rules.
An intercompany transaction happens between entities under common control: a parent and its subsidiary, or two subsidiaries of the same parent. Common examples are one company selling goods to another, charging a management fee, lending money or paying a shared expense on the other's behalf.
Why they need special handling
Each company is a separate legal entity with its own books. Each records its side: one a sale and a receivable, the other a purchase and a payable. But from the group's point of view, nothing happened with the outside world. When the group prepares consolidated statements, intercompany balances and transactions are eliminated. The group does not report revenue from selling to itself.
Where it goes wrong
- One side records the transaction and the other doesn't, or does so in a different month.
- The two sides use different amounts, often because of exchange rates or tax.
- Unrealized profit on intercompany inventory is not removed.
These mismatches are one of the most common causes of a slow close in multi-entity groups. Agreeing intercompany balances between entities before month end, with a standard process and cut-off date, avoids most of them.
Tax
When related companies are in different countries, the prices they charge each other must be at arm's length, the price unrelated parties would agree. Tax authorities, including the CRA, can adjust transfer prices that don't meet that standard.
Worked example
A management fee
A holding company charges its operating subsidiary a $20,000 monthly management fee. The holding company records $20,000 of revenue and a receivable; the subsidiary records $20,000 of expense and a payable. On consolidation, the revenue and expense cancel, as do the receivable and payable. Group profit is unchanged.