Intercompany Transactions – Explanation

Intercompany transactions

What are intercompany transactions?

All of the transactions between the affiliated companies are called intercompany transactions. Intercompany transactions may result in reciprocal account balances on the books of the affiliates. For example, intercompany sales transactions produce reciprocal sales and purchases (or cost of goods sold) balances, as well as reciprocal balances for intercompany receivables and payables. Intercompany loan transactions produce reciprocal notes receivable and payable balances, as well as reciprocal interest income and expense balances. These intercompany transactions are intracompany transactions from the viewpoint of the consolidated entity; therefore, we eliminate their effects in the consolidation process (while making consolidated financial statements).

GAAP concisely summarizes consolidation procedures

In the preparation of consolidated financial statements, intercompany balances and transactions shall be eliminated. This includes intercompany open account balances, security holdings, sales and purchases, interest, dividends, etc. As consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity, such statements should not include gain or loss on transactions among the entities in the consolidated group. Accordingly, any intercompany income or loss on assets remaining within the consolidated group shall be eliminated; the concept usually applied for this purpose is profit or loss.

  1. Intercompany Inventory Transactions: Affiliated consolidated entities are a combination of different companies. The financial statements required for each affiliate are aggregated into a single financial statement that represents the financial position and operating results of the entity as if it were a single entity.
  2. Intercompany Transfers of Noncurrent Assets and Services: Transactions between affiliates for sales and purchases of non-current assets result in unrealized gains and losses for the consolidated entity. The consolidated company eliminates such gains and losses in reporting on the results of operations and the financial position when preparing consolidated financial statements.

    Intra-group transfers of long-term assets and services are much less common than intragroup transfers. They are most likely to occur in mergers as part of a reorganization of the merged companies.

  3. Intercompany Indebtedness