Intercompany balances denominated in a currency other than the functional currency of the parties to the transaction create foreign currency gains and losses that survive consolidation, even though the intercompany balances do not. For example, a reporting entity that enters into a loan with one of its foreign entities denominated in something other than its functional currency must measure the loan in its functional currency, which will create foreign currency transaction gains and losses that are recorded in the reporting entity’s consolidated income statement. These foreign currency transaction gains and losses are not eliminated in consolidation, even though the intercompany loan eliminates. Even when an intercompany balance is denominated in the reporting entity’s reporting currency, translating the foreign entity’s financial statements into the reporting currency does not reverse the foreign currency transaction gains and losses. Instead, translating the foreign entity’s financial statements into the reporting currency generates an equivalent gain or loss within the cumulative translation adjustment (CTA) account, a component of other comprehensive income. Example FX 7-1 illustrates the application of this guidance.

EXAMPLE FX 7-1
Effect of a foreign currency intercompany loan on the consolidated financial statements

USA Corp is a US registrant that uses the US dollar (USD) as its reporting currency.

Mexico SA is a wholly-owned subsidiary of USA Corp located in Tijuana, Mexico. It is a distinct and separable operation of USA Corp and has a functional currency of the Mexican peso (MXN); therefore, it meets the definition of a foreign entity of USA Corp.

On January 15, 20X1, USA Corp loans USD 50,000 to Mexico SA. The loan is payable in one year and USA Corp management believes that Mexico SA will repay the loan when due.

The relevant exchange rates are shown in the following table.

How should USA Corp account for the intercompany loan in its consolidated financial statements for the quarter ended March 31, 20X1?

Because the loan is denominated in a currency other than Mexico SA’s functional currency, Mexico SA must first measure and record the loan in its functional currency, MXN, using the exchange rate on the date the loan is funded.

USD 50,000 × (10/ 1) = MXN 500,000

The loan is denominated in USA Corp’s functional currency; therefore, the loan and the payment of cash is recorded for USD 50,000.

The USD loan is a monetary liability for Mexico SA. To prepare its March 31, 20X1 financial statements, Mexico SA has to first measure the foreign currency loan using the exchange rate on that date.

USD 50,000 × (13/ 1) = MXN 650,000

Mexico SA would record an entry to recognize the difference in exchange rates between March 31, 20X1 and the date the receivable was recognized. The offsetting entry is recorded in the income statement as a foreign currency transaction loss.

USA Corp translates the financial statements of Mexico SA before including them in its consolidated financial statements. The following table shows the effect of the USD denominated loan on USA Corp’s consolidated USD financial statements for the period ended March 31, 20X1.

The CTA balance results from USA Corp’s exposure to MXN and represents the impact of the change in foreign currency (between January 15 and March 31, 20X1) on the beginning balance plus the impact of the difference between the average exchange rate for the period and the exchange rate at March 31, on the transaction loss. It is calculated as follows:

[(MXN 500,000/10) – (MXN 500,000/13)] + [(MXN 150,000/11) – (MXN 150,000/13]

See FX 7.5 for information on the accounting for long-term intercompany loans and advances.