Chapter 3 — Accounting Considerations Related to a Carve-Out Entity’s Statement of Comprehensive Income

3.2 Intercompany Transactions

Because the intent of carve-out financial statements is to isolate transactions related to the entity that will be carved out, preparers must (1) identify the types of intercompany transactions that have historically occurred between the carve-out entity and the remaining entities and (2) determine how those transactions and related account balances will be presented in the carve-out financial statements. Although these transactions were originally eliminated in consolidation of the parent entity’s financial statements, they generally should not be eliminated from the carve-out financial statements (unless the intercompany transactions take place within the carve-out entity).

To properly account for intercompany balances, an entity must determine when the intercompany payables and receivables will be settled (either before or after the transaction) and by what means (e.g., cash payment or via an equity transaction). For example, it is not uncommon for a parent entity to forgive certain intercompany balances (such as certain intercompany payables); such balances would therefore not result in cash settlement. Consequently, such forgiven amounts would be accounted for as equity contributions in the carve-out financial statements. Conversely, balances that are expected to be settled in cash would be reflected as “due to or from” the parent entity in the carve-out financial statements.

3.2.1 Internal Controls Over Intercompany Balances and Activities

To the extent that there are intercompany transactions between the carve-out entity and parent, management should consider whether the controls in place are sufficiently precise to cover the transactions at an intercompany level. For example, if management uses certain transaction codes to identify intercompany sales, it should consider whether there are controls over the master data inputs and changes to the transaction code field that would ensure that the identification of intercompany amounts is complete and accurate. Further emphasis should be placed on whether the transactions are appropriately reflected within and among the relevant entities so that management can evaluate whether the transactions are completely and accurately stated in the carve-out financial statements. In addition, management should consider granular transaction-level detail in the preparer’s systems of record (as opposed to “batched” information, which may not retain all detail related to certain intercompany transactions) to ascertain the nature of certain intercompany balances from a cash flow perspective (e.g., if intercompany cash transfers are recorded in a net intercompany payables account, there may be no visibility into gross borrowings and payments).

Intercompany amounts to consider include, but are not limited to, (1) receivables, payables, notes, and dividends between the remaining entities and the carve-out entity and (2) intercompany sales, costs of goods sold, royalty revenues, and management fees. Particular care must be taken to ensure that these items are properly classified and accounted for by the carve-out entity regardless of how these amounts are captured in the consolidated parent’s system (since such amounts were most likely eliminated during consolidation).