ACCOUNTING

Intercompany Accounting: The Rising Cost of Improper or Fraudulent Practices

  • A manufacturing company faces a federal grand-jury investigation in the US involving intercompany cash transfers related to its tax planning.
  • An insurance company is forced to restate financial results stemming from its failure to eliminate certain intercompany transactions related to variable interest entities.
  • Insiders succeed in fraudulently overstating inventory because the company has weak internal controls over related-party transactions. The US Securities and Exchange Commission imposes a fine – and shareholders lodge two lawsuits.
  • Improper intercompany accounting forces an oil company to restate its financial statements. Irate investors charge that it misled them about the effectiveness of its internal controls and hale the company to court.

These are real-life cases recounted in a Deloitte report, Cleaning Up Under the Bed: Why Intercompany Accounting Is Increasing Corporate Risk. They happened in the US, but could easily occur in Asia Pacific – and in any case, some of them probably involved business units and subsidiaries in this region.

“More and more companies are running into serious problems that have real financial costs as a result of improper or insufficient intercompany accounting practices”

For companies in Asia, the issue of intercompany accounting could come to the fore pretty quickly. Tax jurisdictions across the region have begun to adopt the finalized Base Erosion and Profit Shifting (BEPS) Action Plan under the auspices of the OECD and G20 countries, which include China, India, Indonesia and Japan.

China, India and Singapore will require country-by-country reporting next year, while Hong Kong will begin automatic information exchanges with other jurisdictions by end 2018. Asian companies with group revenues of around US$820 million should expect their intercompany accounting, among other things, scrutinized more closely by various tax authorities soon after.

Holistic approach

“More and more companies are running into serious problems that have real financial costs as a result of improper or insufficient intercompany accounting practices,” writes Deloitte. “The reasons range from increased industry consolidation to growing globalization and integrated supply chains.”

It is time to address the issue – in Deloitte’s colorful words, to “clean up under the bed.” But how?

As consultants are wont to do, Deloitte recommends a sweeping solution. “What companies need,” it says, “is a holistic and preventive approach in which the primary stakeholders— accounting, tax, and treasury—work hand in hand to create a vision for the future that streamlines [intercompany accounting], from governance to reporting.”

To be fair, though, the proposed solution is sweeping because the problem could be broad and sweeping, too. After all, intercompany accounting extends beyond accounting and finance.

For example, finance may reach the financial-reporting goal of eliminating (to within a specific threshold) intercompany AR and AP transactions from the books. But this does not always mean that that exceptions and misclassifications have been addressed.

Failing to make good on this non-accounting goal could have legal implications, particularly with regards to taxation, as the increasing number of intercompany-accounting-related lawsuits suggests.

And what if a full list of approved intercompany balances cannot be produced for settlement? From finance’s point of view, unresolved intercompany positions could be accounted for as unrealized profits (or losses) in the financial statements.

But for treasury, which manages the netting and settlement of intercompany trade invoices, among others, unresolved positions can have a significant impact on real cash outflows, intercompany financing, global liquidity and foreign exchange exposures. 

Intercompany accounting framework

Deloitte’s suggestion of a holistic approach makes sense in this context. “Getting everyone working from the same playbook and equipping them to clean up the [intercompany accounting] mess calls for a single vision for the future,” it argues. “To describe that future, a company will first need a framework that provides a holistic perspective and incorporates every aspect of ICA, from governance to reporting.”

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