Intercompany transactions are transfers of goods, services, or funds between two entities under common ownership, such as a parent company and a subsidiary, or two subsidiaries of the same parent. They function like ordinary transactions between two independent parties, invoices, payments, and journal entries, except both sides ultimately belong to the same overall business.
Each entity records its own side of an intercompany transaction independently, one books a sale and receivable, the other books a purchase and payable, exactly as if they were unrelated companies. When financial statements are consolidated into a single set of group results, these transactions have to be eliminated, otherwise the group's revenue and expenses would be overstated by sales the business effectively made to itself.
EXAMPLE
Subsidiary A sells $80,000 of product to Subsidiary B. Subsidiary A records $80,000 in revenue; Subsidiary B records $80,000 in inventory purchases. In the consolidated statements for the parent group, both entries are eliminated entirely, since from the group's perspective as a whole, no sale to an outside party occurred.
Both entities are recording the same underlying transaction independently, and any difference in timing, amount, or classification between the two sides creates a mismatch that has to be investigated and resolved before consolidation. Common causes include one entity recording the transaction in a different period than the other, currency translation differences for cross-border transactions, and one side applying a credit memo or adjustment the other side never received.
Unlike a discrepancy with an external supplier, an intercompany mismatch cannot be resolved by simply asking the counterparty, since both records are internal, and the process is one of comparing and reconciling two internal ledgers against each other rather than validating against an outside party's documentation.
For a business operating multiple divisions or legal entities, intercompany invoices flow through accounts payable just like external supplier invoices, but they need to be identified and coded differently, since they will be eliminated at consolidation rather than remaining as real, external cost.
A business with 25 distribution centers or multiple operating divisions generates intercompany volume as a matter of course, shared services, inventory transfers between locations, allocated corporate costs, and treating those invoices with the same validation rigor as external supplier invoices, correct entity coding, correct period, correct amount, is what keeps month-end intercompany reconciliation from becoming a recurring close bottleneck.
When intercompany transactions cross tax jurisdictions, particularly international ones, the price charged between related entities, the transfer price, has tax implications, since it affects how much profit is reported in each jurisdiction. Tax authorities generally require intercompany pricing to approximate what unrelated parties would have charged each other, the arm's length principle, to prevent shifting profit into lower-tax jurisdictions artificially.
Transfer pricing is a specialized area with its own compliance requirements and is generally handled with dedicated tax advice rather than treated as a routine AP coding decision.
