Mergers Lead to Intercompany Accounting Risks

Mergers and acquisitions are prompting companies to take risky accounting maneuvers, warns a new report from Deloitte.

The report, “Cleaning up the mess under the bed – Why intercompany accounting is increasing corporate risk,” discusses the impact of “intercompany accounting,” or ICA, the processing and accounting for internal financial activities and events that affect multiple legal entities within a company. ICA can include sales of products and services, fee sharing, cost allocations, royalties, and financing activities. It’s a broad area that, while rooted in accounting, has extensions into various functions, including tax, treasury, and finance.

Intercompany accounting also faces pressures from increased regulation in the areas of accounting and tax around the world. Recent investigations have exposed the use of inadequate “Band-Aid” tactics by multinationals to streamline their transactions. The report urges organizations to pay extra attention to cleaning up any missteps they have made in the past by adopting a preventive approach comprising the accounting, tax and treasury functions. Companies that don’t take action could be exposed to steep corporate risks, including costly lawsuits, regulatory investigations and loss of brand reputation and investor confidence.

The report cites some examples such as an unnamed manufacturing company facing a federal grand-jury investigation involving intercompany cash transfers related to its tax planning, and an insurance company forced to restate financial results because it failed to eliminate certain intercompany transactions related to variable-interest entities. An oil company’s improper intercompany accounting resulted in a restatement of its financial statements followed by a lawsuit accusing the company of misleading investors about the effectiveness of its internal controls. Another unnamed company’s weak internal controls over related-party transactions allowed insiders to fraudulently overstate inventory, leading not only to Securities and Exchange Commission-imposed fines but to two lawsuits.

“One of the greatest issues facing ICA settlement is the institutional knowledge needed to clean up the historical unreconciled balances,” said the report. “As time goes by and people move, or as companies undergo mergers and acquisitions, it’s often extremely hard to close these out, especially when the issues have persisted for years.”

To access the report, click here.