Internal settlements

What it means

Internal settlements are the accounting for mutual work, deliveries and transfers between departments, sites or branches of the same accounting entity. Typical examples are a maintenance workshop repairing machines for production, in-house transport moving materials between warehouses, or one branch handing goods to another.

Since it is a single legal entity, it cannot have a receivable or liability towards itself. Relationships between departments are therefore tracked on special internal settlement accounts, which must balance out by the end of the accounting period and show a zero balance. The balances must not appear in the balance sheet or the profit and loss statement.

Internal settlements are closely tied to management accounting and cost centres. They make it possible to see what each department's activity costs and what it contributes, even when departments provide services to each other. The rules and internal prices are usually set out in an internal policy.

How it works in practice

When introducing them we recommend first defining cost centres and profit centres, identifying which services they provide each other and setting internal prices, for example at actual cost, standard cost or market prices. The choice affects which centre shows a profit and which a loss, so it should be transparent.

In the chart of accounts, analytical internal settlement accounts are opened for this purpose, or classes designated for management accounting are used. Each internal movement must be supported by an internal document stating the supplying and receiving centre, the type of service, quantity and valuation.

For branches that keep separate books, internal settlements are the tool by which their accounts are combined into a single set of financial statements at period end. Differences between the balances at head office and the branch must be explained and eliminated before the statements are prepared.

What to watch out for

The most common mistake is a non-zero internal settlement balance at year-end. It arises when one side is not recorded, valuations differ or timing does not match. Such a balance signals an accounting error and auditors always check it. Differences should be reconciled on an ongoing basis, not only at year-end.

Do not confuse this with transactions between related parties. If the units are separate companies in a group, these are not internal settlements but real transactions that are invoiced, subject to VAT and to transfer pricing rules. Internal prices within one company do not directly affect tax; prices between group companies do.