6.3 Intra-Entity Profit
ASC 830-30
45-10 The elimination of intra-entity profits that are attributable to sales or other transfers between entities that are consolidated, combined, or accounted for by the equity method in the reporting entity’s financial statements shall be based on the exchange rates at the dates of the sales or transfers. The use of reasonable approximations or averages is permitted.
As noted in the guidance above, intra-entity profits resulting from “sales or other transfers between entities that are consolidated, combined, or accounted for by the equity method” should be translated by using the exchange rate on the transaction date (or another appropriate alternative). For example, in the case of an intra-entity sale of inventory, any profit recognized by the selling entity would also be included in the inventory balance on the books of the purchasing entity and should be eliminated in consolidation until the inventory is sold to an outside party. Subsequent exchange rate fluctuations should not affect the intra-entity profit being eliminated.
Accordingly, an entity should track the portion of the inventory balance attributable to the intra-entity profit that originated on the transaction date and the portion attributable to the underlying cost of the inventory (i.e., the selling entity’s cost basis). As noted above, the portion attributable to the intra-entity profit should be translated at the historical rate in effect on the date of the intra-entity sale. The portion attributable to the underlying cost component should be translated at the current exchange rate.
Example 6-2
Intra-Entity Profit Elimination
Company B, a U.S. company, has a wholly
owned foreign subsidiary, W, which has identified the EUR as
its functional currency. On September 18, 20X1, B sells
inventory to W for $500,000 (the inventory costs $350,000).
As a result of the sale, B realizes intercompany profit of
$150,000 ($500,000 – $350,000). The exchange rate on the
date of the sale was $1 = €1.30. Subsidiary W records the
inventory at €650,000 ($500,000 × [€1.30 ÷ $1]). As of
September 30, 20X1, the inventory has not yet been sold and
the exchange rate is $1 = €1.40.
The €650,000 inventory balance recorded by W
as of September 30, 20X1, consists of the following:
-
Intra-entity profit: €195,000 ($150,000 × [€1.30 ÷ $1]).
-
Cost of the inventory: €455,000 ($350,000 × [€1.30 ÷ $1]).
The intra-entity profit of €195,000 is
translated at the historical rate in effect on September 18,
20X1, the date of the intra-entity sale (i.e., €1.30 ÷ $1).
As a result, the intra-entity profit would be $150,000,
which equals the intercompany profit amount recognized by B,
the U.S. parent. These two balances are then fully
eliminated in consolidation until the sale is realized
outside of the consolidated group.
The cost of the inventory, €455,000, is
translated at the current exchange rate as of September 30,
20X1. Accordingly, an inventory amount of $325,000 (€455,000
÷ [€1.40 ÷ $1]) is recognized on B’s consolidated balance
sheet.
Therefore, as of September 30, 20X1, B will
recognize a CTA loss of $25,000 ($350,000 – $325,000)
associated with the inventory on hand held by W.
Connecting the Dots
The application of the requirements from ASC 830 that are illustrated in the above example may be unduly burdensome for some entities. ASC 830 therefore provides an expedient under which an entity uses an appropriate rate that is expected to yield a result similar to that achieved by using the exchange rate on each date of recognition (see Section 3.2 for information about selecting exchange rates).