Chapter 6 — Intra-Entity Transactions
Chapter 6 — Intra-Entity Transactions
6.1 Overview
Intra-entity foreign currency transactions can have unique effects on an entity’s financial statements, including the (1) creation and transfer of foreign currency risk from one entity in a consolidated group to another, (2) creation of transaction gains and losses that “survive” consolidation, and (3) application of exceptions to the general rules outlined in ASC 830. This chapter discusses the accounting effects of intra-entity transactions.
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).
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).
6.4 Long-Term Intra-Entity Transactions
ASC 830-20
35-3 Gains and losses on the
following foreign currency transactions shall not be
included in determining net income but shall be reported in
the same manner as translation adjustments: . . .
b. Intra-entity foreign currency transactions that
are of a long-term-investment nature (that is,
settlement is not planned or anticipated in the
foreseeable future), when the entities to the
transaction are consolidated, combined, or accounted
for by the equity method in the reporting entity’s
financial statements.
35-4 Intra-entity transactions and
balances for which settlement is not planned or anticipated
in the foreseeable future are considered to be part of the
net investment. This might include balances that take the
form of an advance or a demand note payable provided that
payment is not planned or anticipated in the foreseeable
future.
A consolidated entity should pay particular attention to long-term
intra-entity transactions, since the facts and circumstances associated with such
transactions may result in an accounting treatment for the consolidated entity that
is inconsistent with the general principles in ASC 830.
6.4.1 Meaning of “Foreseeable Future”
ASC 830-20-35-3(b) contains an exception that allows entities to
recognize exchange rate gains or losses as a CTA within OCI for intra-entity
transactions that are “of a long-term investment nature” (i.e., the settlement
of such transactions “is not planned or anticipated in the foreseeable future”).
Whether repayment is planned is a key factor in applying this exception.
The FASB 52 Implementation Group discussed this issue at its
December 1981 meeting, concluding that the term “foreseeable future” does not
imply a specific period but is an intent-based indicator. Specifically, the
group noted that an intra-entity transaction may qualify for the ASC
830-20-35-3(b) exception if:
-
There are no planned or anticipated repayments.1
-
Management, having the appropriate authority, represents that (1) it does not intend to require repayment of an intra-entity account and (2) the parent company’s management views the intra-entity account as part of its investment in the foreign subsidiary.
If the criteria for the exception are met, the exchange rate
gains and losses are recorded through the CTA as if they were part of the net
investment.
Example 6-3
Short-Term Intra-Entity Debt
Company C is a wholly owned U.S.
subsidiary (whose functional currency is the USD) of
Company D, a Swiss-based holding company. Company C has
notes due to D that are denominated in EUR. The notes
have stated maturities ranging from six months to one
year. Although the notes are short-term by contract, D
represents each year that it will not demand payment for
that year; historically, the notes have been renewed
each year.
In this case, the short-term notes would
not qualify for the exception in ASC 830-20-35-3(b).
Company D only represents that it will not require
payment in the current year on the rolled-over
short-term notes; it does not represent that it will not
demand payment on the notes in the foreseeable future
(i.e., the timing of the repayment appears uncertain).
In other words, because D (the parent)
cannot assert that repayment will not be required in the
anticipated or foreseeable future, it is inappropriate
for D to apply the exception in ASC 830-20-35-3(b).
Further, the FASB 52 Implementation Group concluded that
rolling- or minimum-balance intra-entity accounts do not
qualify for this exception (see Example
6-5).
As demonstrated in the example above, uncertainty regarding the
timing of a repayment is not a criterion under which a transaction can be
considered long-term in nature. For an entity to apply the exception in ASC
830-20-35-3(b), there must not be a planned or anticipated repayment in the
foreseeable future. Conversely, an intra-entity loan or advance may have a
stated maturity or be due on demand, but if the lending entity does not intend
to demand repayment despite the maturity date (i.e., management has stated its
intentions to renew the loan or advance), it may be acceptable to apply the
exception. The appropriate accounting in such cases will depend on management’s
specific, stated intentions. In the example below, an intra-entity loan may seem
to be long-term in nature given management’s intentions but does not, in fact,
qualify for the exception.
Example 6-4
Determining Whether Linked Transactions Can Be
Accounted for as Long-Term in Nature
Company A, which uses its local currency
(EUR) as its functional currency, is a subsidiary of a
U.S. parent company, P. Bank B has loaned A $100 million
USD that is due in 20X4. Company A currently makes
interest-only payments. The debt with B is
collateralized in full with a letter of credit from P.
Company A will most likely not be able to make its
balloon payment (and possibly not its interest payments)
under the existing agreement and will not be able to
obtain alternative financing. Therefore, B is expected
to convert the letter of credit in full payment of the
debt as soon as A defaults. After default, P will have
the third-party B debt and a USD-denominated
intra-entity receivable from A. Company A will have a
USD-denominated intra-entity payable to P.
In accordance with ASC 830-20-35-3(b),
it is not acceptable for A to currently account for its
debt to B as an intra-entity foreign currency
transaction that is “of a long-term-investment nature”
even though there is a high probability of default and
conversion to an intra-entity payable is expected.
Company P’s settlement of A’s debt with
B is anticipated in the near future with the creation of
a new debt instrument also from P (its obligation under
the letter of credit), and A will have an intra-entity
payable to P. The settlement of A’s existing debt with
B, the borrowing under the letter of credit, and the
intra-entity transaction are not seen as one continuous
transaction under ASC 830. Therefore, A’s debt to B does
not currently meet the criteria to be reported in the
same manner as a translation adjustment.
Because A currently makes
USD-denominated interest payments to B, its functional
currency cash flows are affected by changes in the
foreign currency exchange rate. Changes in the foreign
currency exchange rate affect A’s actual and expected
functional currency cash flows. Therefore, the exchange
rate gains and losses on such borrowings should continue
to be accounted for as transaction gains and losses to
be included in the determination of net income.
Management should also consider factors other than its intent in
determining whether a transaction qualifies as long-term in nature. For
instance, management should consider its history with similar instruments for
which the intention was not to repay. If the entity, despite management’s
intention, has historically been unable to maintain the long-term nature of
similar instruments (e.g., repayments were necessary as a result of cash flow
constraints), the entity may conclude that the instrument does not meet the
“foreseeable future” criterion and that it cannot apply the exception. Other
factors for an entity to consider in determining whether it qualifies for the
exception are (1) its ability to control whether and, if so, when repayment will
occur (e.g., if repayment is contingent on the occurrence of a certain event or
transaction) and (2) whether there is a legitimate business purpose for not
settling the intra-entity account. Further, when applying this exception,
management should ensure that its intentions related to long-term intra-entity
accounts are consistent with assertions being made for other purposes (e.g.,
indefinite reinvestment assertions for income tax purposes).
Connecting the Dots
The amounts subject to these long-term intra-entity
transactions are often large enough that board approval is needed. An
entity should therefore ensure that management personnel with the
appropriate level of authority have approved the fact that the loans
will not be repaid in the foreseeable future.
In addition, management should look for contradictory
evidence regarding the assertion that the loans will not be repaid in
the foreseeable future. For example, often these loans are created to
generate an interest expense deduction in a high-tax-rate jurisdiction.
Many tax jurisdictions require that an entity repay the loan at some
point in time to receive the tax deduction.2 Accordingly, management will need to determine whether the
assertion made for tax purposes (i.e., the intention to receive the
deduction) contradicts the assertion made for financial reporting
purposes (i.e., the settlement of such a transaction “is not planned or
anticipated in the foreseeable future”). If the two assertions are
contradictory, management will need to evaluate whether the deferral of
foreign currency transaction gains and losses is appropriate or whether
an uncertain tax position should be established for the interest
deduction. See Deloitte’s Roadmap Income Taxes for additional
information on the tax accounting impacts of these types of
transactions.
The long-term-nature exception discussed above applies only to
the consolidated entity’s financial statements. If an individual entity in the
intra-entity transaction (e.g., a subsidiary) compiles stand-alone financial
statements, the general rules in ASC 830 would apply and the transaction gains
and losses associated with such accounts would be recorded in earnings.
Similarly, if an ultimate parent entity enters into an intra-entity advance or
loan with a third-tier subsidiary that is consolidated into an intermediary
subsidiary, the accounting for the transaction in the intermediary’s
stand-alone, consolidated financial statements would not qualify for the
exception because the transaction is between the intermediary’s subsidiary and
an entity outside its stand-alone, consolidated group (i.e., its ultimate
parent). The image below illustrates this concept.
Accounts that are not determined to be long-term in nature (and
are therefore subject to the same accounting treatment as similar accounts with
third parties) will expose the entity to foreign currency exchange rate
fluctuations since the effects of such fluctuations are reported in
earnings.
6.4.2 Intra-Entity Debt With Interest Payments
If an intra-entity debt instrument is determined to be long-term
in nature in accordance with the guidance discussed above, any related interest
receivable or payable would not qualify for the same exception as the debt
instrument itself when periodic interest payments are required. Rather, any
transaction gains or losses related to the interest receivable or payable would
be recorded in earnings (and would not be reclassified into a CTA upon
consolidation). Such gains and losses would survive consolidation in a manner
consistent with those that occur in the normal course of business (as discussed
in Section 6.2).
6.4.3 Rolling or Minimum Balances
Many parent entities will maintain a minimum balance when
managing intra-entity receivable or payable accounts. Management often views
this minimum balance as a component in its financing of the subsidiary; however,
rolling-balance and minimum-balance intra-entity accounts generally do not
qualify for the exception for long-term investments under ASC 830.
Example 6-5
Rolling or Minimum Balances Viewed as Long-Term
Investments
Company A, whose functional currency is
the USD, advances EUR to its foreign subsidiary, AB,
which has identified the EUR as its functional currency.
Subsidiary AB may repay some of the advances; generally,
however, they are replaced with new advances within a
short time frame (i.e., three to five days). In total,
AB has 50 million EUR advances outstanding at all
times.
The advances from A to AB do not qualify
as a long-term investment under ASC 830-20-35-3(b).
Company A should therefore recognize transaction gains
or losses related to such advances in earnings.
The FASB 52 Implementation Group addressed a similar question at
its December 1981 meeting, concluding that the “aggregate balance of trade
receivables or payables (each open invoice will be settled) cannot qualify as a
long-term investment.” The group further concluded that intra-entity
transactions must be evaluated individually, not on an aggregate or net basis
(i.e., even if all intra-entity balances are aggregated in one general ledger
account, an entity must consider the transactions individually to determine
which ones qualify as long-term in nature).
6.4.4 Parent’s Guarantee of a Foreign Subsidiary’s Debt
Like the linked transaction in Example 6-4, a parent company’s guarantee
of a subsidiary’s debt (either through contribution of equity or intra-entity
lending) does not qualify for the long-term investment exception in ASC
830-20-35-3(b). Consider the following example:
Example 6-6
Parent’s Guarantee of Foreign Subsidiary’s
Debt
Company AA, a U.S. company, has a
Mexican subsidiary, BB, whose functional currency is the
MXN. Subsidiary BB borrows USD from a U.S. bank, and AA
guarantees repayment of the loan. Company AA could have
provided an intra-entity loan to BB but decided not to
do so for tax reasons. For tax reasons, BB, rather than
AA, makes the interest payments. Subsidiary BB is not
expected to repay the loan in the foreseeable
future.
At its May 1982 meeting, the FASB 52 Implementation Group
concluded that a parent company’s guarantee of a subsidiary’s
foreign-currency-denominated debt does not meet the definition of a long-term
investment. Therefore, in the example above, the Mexican subsidiary must
recognize the transaction gains or losses in earnings for the USD-denominated
debt.
6.4.4.1 Settling Foreign-Currency-Denominated Debt and Making a Long-Term Investment
In a manner consistent with the transactions described
above, settlements of third-party debt through an intra-entity borrowing
also should be accounted for as separate transactions as they occur.
Therefore, any foreign currency adjustment associated with settlement of the
debt should be recorded as a transaction gain or loss in the period in which
the exchange rate changes, regardless of the nature of the intra-entity
borrowing. However, if the intra-entity foreign currency transaction is
determined to be of a long-term investment nature for which settlement is
not planned or anticipated in the foreseeable future, future foreign
currency adjustments associated with such an intra-entity loan may be
accounted for as a translation adjustment in accordance with ASC
830-20-35-3(b).
Example 6-7
Parent’s Settlement of Foreign Subsidiary’s Debt
Through Intra-Entity Borrowing
Company M is a subsidiary of Company
K. Company M’s functional currency is MXN, and K’s
functional currency is the USD. Company M has
third-party USD-denominated debt on its books for
which it must recognize transaction gains and losses
for the changes in the USD-to-MXN exchange rate.
Company K agrees to repay M’s
foreign-currency-denominated (i.e., USD-denominated)
debt, and M will record an intercompany
MXN-denominated payable to K.
In these circumstances, it would not
be appropriate for M to record the foreign currency
adjustment associated with settlement of the
USD-denominated debt as a translation adjustment
instead of as a foreign currency transaction gain or
loss. Rather, the intercompany borrowing and
settlement of third-party debt should be accounted
for separately. Therefore, any foreign currency
adjustment associated with settlement of the
USD-denominated debt should be recorded as a
transaction gain or loss in the period in which the
exchange rate changes. However, if K and M enter
into an intercompany foreign currency transaction
that is of a long-term investment nature for which
settlement is not planned or anticipated in the
foreseeable future, future foreign currency
adjustments associated with such an intercompany
loan may be accounted for as a translation
adjustment under ASC 830-20-35-3(b).
6.4.5 Settlements or Reductions of a Long-Term Advance
In certain circumstances, an entity may conclude that an
intra-entity balance (or part of an intra-entity balance) that was previously
(and appropriately) determined to be long-term in nature no longer qualifies as
such.3 In such cases, the entity should, going forward, report transaction gains
and losses in earnings; the exchange rate gains and losses previously reported
in CTA should not be reversed or otherwise adjusted until “sale or upon complete
or substantially complete liquidation of [the] investment in a foreign entity”
in accordance with ASC 830-30-40-1. See Section 5.4 for additional discussion of
the conditions for release of the gains and losses in CTA.
If only a portion of long-term advances is settled or reduced
and the remaining intercompany advances continue to qualify as a long-term
investment, the entity would continue to recognize in its CTA the exchange rate
gains or losses arising from the portion of the advances that is still
considered long-term. Example
5-20 demonstrates the appropriate accounting treatment in these
circumstances.
The forgiveness of an intra-entity balance is consistent with
the assertion that the amount was not intended to be settled. In such
circumstances, exchange rate gains and losses up through the date on which the
loan is legally forgiven or extinguished should continue to be recorded in CTA.
Once forgiven, the balance of the loan should be reclassified as a capital
contribution and no further exchange rate gains or losses should be
recognized.
Footnotes
1
An intra-entity transaction may qualify for the ASC 830-20-35-3(b) exception when a repayment is made, as long as the repayment was not planned or anticipated. The minutes of the December 1981 FASB 52 Implementation Group
meeting state, in part, “If a transaction is settled for
which settlement was not planned or anticipated, the amount
included in the special component of equity (applicable to
the period for which settlement was not planned or
anticipated) probably should remain there.”
2
On October 13, 2016, the U.S. Treasury and the
IRS released final and temporary regulations under Section 385
of the Internal Revenue Code that (1) “establish threshold
documentation requirements that must be satisfied in order for
certain related-party interests in a corporation to be treated
as indebtedness for [U.S.] federal income tax purposes” and (2)
“treat as stock certain related-party interests that otherwise
would be treated as indebtedness for [U.S.] federal income tax
purposes.” The regulations contain requirements related to
documenting certain related-party debt instruments as a
prerequisite to treating such instruments as debt. The rules
generally require written documentation of the following four
indebtedness factors: (1) the issuer’s unconditional obligation
to pay a certain sum; (2) the holder’s rights as a creditor; (3)
the issuer’s ability to repay the obligation; and (4) the
issuer’s and holder’s actions demonstrating a debtor-creditor
relationship, such as payments of interest or principal and
actions taken on default. For more information on the
regulations, see Deloitte’s October 14, 2016, United States Tax Alert.
3
For example, the United Kingdom’s decision to exit the
European Union (known as “Brexit”) may result in entities reassessing
their previously appropriate conclusions that certain intercompany
balances with entities within the United Kingdom or the European Union
are long-term in nature.
6.5 Intra-Entity Dividends
When a foreign subsidiary declares a dividend to its parent company and there is
a significant time lag between the record date and the payment date, the parent
would recognize transaction gains or losses related to the dividend receivable in
earnings as it would for other transaction gains or losses related to
foreign-currency-denominated assets or liabilities.4 If the U.S. parent’s functional currency is the USD, a receivable denominated
in a currency other than the dollar is a foreign currency transaction.
Similarly, a foreign subsidiary’s declaration of a dividend, which is not paid on the date of declaration, results in a payable. If the payable is not denominated in the subsidiary’s functional currency, the subsidiary is at risk for fluctuations in the foreign currency exchange rate between the declaration date and the date the exchange rate is fixed for the purpose of paying the dividend.
See Section 4.6.2 for additional guidance on the foreign exchange effects of declared dividends that are denominated in a foreign currency.
Footnotes
4
The FASB 52 Implementation Group addressed this issue in
December 1981.