Although intercompany transactions generally do not affect consolidated earnings, ASC 815
permits hedge accounting of intercompany receivables and payables denominated in a foreign currency because they create transaction gains and losses that are recognized in consolidated earnings. ASC 815
also permits hedges of forecasted intercompany foreign currency transactions. The impact of intercompany hedge accounting is not eliminated in consolidation.
Foreign currency transactions under ASC 830
result in transaction gains and losses that are recorded in earnings to reflect current exchange rates. A reporting entity may designate intercompany balances or the forecasted cash flows as the hedged item in foreign currency fair value or cash flow hedges, respectively, so long as the criteria in ASC 815
are fulfilled. Forecasted intercompany transactions (e.g., forecasted foreign currency-denominated sales to a foreign subsidiary) are also eligible for hedge accounting under ASC 815
As with other highly effective foreign currency cash flow hedging relationships, when the hedged item is an intercompany foreign currency-denominated asset or liability, ASC 815
requires the following accounting at each reporting period:
- The hedged item is measured based on the current spot rate, as required by ASC 830, and the resulting transaction gain or loss is recorded in earnings
- The hedging instrument is measured at fair value and the entire gain or loss is initially recorded in OCI
- An amount equal to the transaction gain or loss on the hedged item is transferred from OCI to earnings to offset the transaction gain or loss recorded in earnings
Example 14 in ASC 815-30-55
-86 through ASC 815-30-55
-90 addresses when the amounts in accumulated other comprehensive income related to intercompany transactions should be reclassified in earnings. It concludes that for consolidated statements, the amounts in OCI should be reclassified as earnings when the sale to an unrelated third party occurs; consolidated earnings are not affected until that time. For a hedge of the foreign currency cash flows of an intercompany purchase of inventory, the amounts accumulated in other comprehensive income would be released and included in cost of sales only when the related inventory is sold to third parties.
Question DH 8-14 and Question DH 8-15 discusses whether an intercompany hedging relationship would qualify for hedge accounting in the separate, standalone financial statements of a subsidiary and the consolidated statements of the parent.
Question DH 8-14
USA Corp has a subsidiary, Deutsche AG, which is a euro-functional currency entity. Deutsche AG enters into a firm commitment with a third party, which results in cash inflows of British pound sterling. Deutsche AG also has an intercompany note payable to USA Corp denominated in British pound sterling. Deutsche AG designates the British pound sterling intercompany note payable as a fair value hedge of its firm commitment.
Would the hedging relationship qualify for hedge accounting in the separate, standalone financial statements of Deutsche AG?
Yes. A nonderivative financial instrument that may give rise to a foreign currency transaction gain or loss can be designated as the hedging instrument in a fair value hedge of an unrecognized firm commitment attributable to foreign currency exchange rates. Additionally, intercompany transactions are considered external third-party transactions for the purposes of applying hedge accounting in the subsidiary’s separate, standalone financial statements because those transactions are with a party external to the reporting entity in those standalone financial statements.
Question DH 8-15
USA Corp has a subsidiary, Deutsche AG, which is a euro-functional currency entity. Deutsche AG enters into a firm commitment with a third party, which results in cash inflows of British pound sterling. Deutsche AG also has an intercompany note payable to USA Corp, denominated in British pound sterling. Deutsche AG designates the British pound sterling intercompany note payable as a fair value hedge of its firm commitment.
Would the hedging relationship qualify for hedge accounting in the consolidated financial statements of USA Corp?
No. In consolidation, the foreign currency risk has not been hedged, since the foreign currency risk relating to the transaction (i.e., the firm commitment denominated in British pound sterling) still remains within the consolidated group. Thus, hedge accounting would not be appropriate in the consolidated financial statements of USA Corp.
However, as discussed in ASC 815-20-25-60
and ASC 815-20-55
-167 through ASC 815-20-55
-170, the hedging relationship may qualify for hedge accounting in the consolidated financial statements if USA Corp enters into a third-party British pound sterling loan that offsets the foreign exchange exposure of the intercompany loan.