6.2 Intra-Entity Transactions Arising in the Normal Course of Business
ASC 830-20
35-1 A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally shall be included in determining net income for the period in which the exchange rate changes.
35-2 At each balance sheet
date, recorded balances that are denominated in a
currency other than the functional currency of the
recording entity shall be adjusted to reflect the
current exchange rate. At a subsequent balance
sheet date, the current rate is that rate at which
the related receivable or payable could be settled
at that date. Paragraphs 830-20-30-2 through 30-3
provide more information about exchange rates.
Entities often regularly transact with other entities (e.g., the parent entity
or other subsidiaries) within their consolidated group (e.g.,
through the sale or purchase of inventory). When the entities that
are party to such transactions have different functional currencies,
transaction gains and losses may result, just as they do when
similar transactions are entered into with outside parties (see
Chapter
4). Under ASC 830-20-35-1 and 35-2, transaction
gains and losses associated with transactions that are denominated
in a currency other than the entity’s functional currency should be
included in earnings unless they meet any of the criteria in ASC
830-20-35-3, one of which is discussed in more detail in Section
6.4. Although the related intra-entity payable or
receivable will be eliminated upon consolidation, the transaction
gain or loss “survives” consolidation because it results in (or will
result in) actual changes to the entity’s cash flows.
For example, in the preparation of the foreign entity’s functional-currency financial results, intra-entity transactions between a parent entity and a foreign entity that are denominated in the parent’s functional currency are subject to the measurement guidance in ASC 830-20; as a result, a transaction gain or loss may be recognized in the foreign entity’s earnings. However, upon consolidation, the foreign entity’s financial results would be subject to ASC 830-30 and translated, with the resulting translation adjustment reflected in the consolidated entity’s CTA. In such situations, the transaction gain or loss recognized by the foreign entity would not be eliminated upon consolidation. This would also be the case when an intra-entity transaction is denominated in the foreign entity’s functional currency, resulting in the recognition by the parent (instead of the foreign entity investee) of a transaction gain or loss that would not be eliminated upon consolidation.
Example 6-1
Foreign-Currency-Denominated Intra-Entity
Payables Arising in the Normal Course of
Business
Company J, an entity whose
functional currency is the USD, has a wholly owned
Mexican subsidiary, M. Management of M previously
determined that the MXN is its functional
currency, primarily because M’s sales to third
parties, as well as its labor costs, are
denominated in this currency. Purchases of raw
materials from J are denominated in USD, and the
related intra-entity payables to J are therefore
denominated in USD as well.
In the absence of
contemporaneous evidence to the contrary, payables
arising through the ordinary course of business
are expected to be settled in the foreseeable
future. Therefore, such balances should be
accounted for in the same manner as similar
transactions with outside parties (as discussed in
Example 4-2).
Upon consolidation, the
intra-entity payable (on M’s books) and receivable
(on J’s books) would be eliminated. However, any
exchange rate fluctuations that result in
transaction gains and losses on M’s books in
connection with the USD-denominated payables would
not be eliminated but would “survive”
consolidation and be reflected in earnings.
However, if M negotiates a
long-term advance with its parent, J, for which
repayment is neither planned nor anticipated in
the foreseeable future, gains or losses resulting
from future foreign currency fluctuations may be
accounted for prospectively from the date of the
negotiated advance or note payable in a manner
similar to translation adjustments. See Section
6.4 for a discussion related to
intra-entity accounts that are long-term in
nature.
6.2.1 Unsettled Intra-Entity Transactions When Multiple Exchange Rates Exist
ASC 830-30
45-7 If unsettled intra-entity transactions are subject to and translated using preference or penalty rates, translation of foreign currency statements at the rate applicable to dividend remittances may cause a difference between intra-entity receivables and payables. Until that difference is eliminated by settlement of the intra-entity transaction, the difference shall be treated as a receivable or payable in the reporting entity’s financial statements.
Generally, a foreign entity’s financial statements should be translated by using the exchange rate that applies to dividend remittances (see Chapter 3). However, there may be different preference or penalty rates that apply to unsettled intercompany transactions. Differences between the dividend remittance rate and the preference or penalty rate could result in a receivable or payable (that survives consolidation) until the intra-entity balance is ultimately settled (and the differences are therefore eliminated).