Intercompany inventory sales often result in an intercompany profit for the seller. The purchase price recorded by the buyer in its standalone financial statements has two components: a “true” cost component and an intercompany profit component. ASC 830 provides guidance on determining the exchange rate to use to eliminate intercompany profits.
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.
Changes in exchange rates subsequent to the transaction date should not impact the amount of intercompany profit to be eliminated. This requires a reporting entity to maintain intercompany inventory records. The cost component of the purchase price paid by the buyer should be translated using the exchange rate at the end of the reporting period.
Example FX 7-2 illustrates the application of this guidance.
EXAMPLE FX 7-2 Elimination of intercompany profits from a foreign currency inventory sale
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.
The relevant exchange rates are shown in the following table.
January 15, 20X1
USD 1 = MXN 10
March 31, 20X1
USD 1 = MXN 13
On January 15, 20X1, USA Corp sells inventory to Mexico SA for USD 10,000. USA Corp’s cost basis in the inventory is USD 6,000, resulting in intercompany profit of USD 4,000.
Mexico SA has not sold the inventory as of March 31, 20X1.
How should USA Corp account for the inventory sale in its consolidated financial statements for the quarter ended March 31, 20X1?
Mexico SA – 1/15/X1
Mexico SA should record the inventory purchase in its functional currency, MXN, using the exchange rate on the date the sale occurred.
USA Corp – 1/15/X1
USA Corp records the inventory sale in its functional currency, USD.
Dr. Cost of sales
USA Corp – 3/31/X1
USA Corp will translate the financial statements of Mexico SA before including them in its consolidated financial statements. Given that intercompany profit needs to be eliminated in consolidation, USA Corp must split Mexico SA’s inventory balance into its cost component and intercompany profit component. The original balances for each of these components in Mexico SA’s books and records are determined by considering USA Corp’s inventory cost and profit related to the inventory, measured in MXN using the exchange rate on the date of the inventory sale. Until Mexico SA sells the inventory to a third party, the exchange rate used to translate the intercompany profit component will remain at the exchange rate on the date that Mexico SA received the inventory from USA Corp. The exchange rate used to translate the cost component on Mexico SA’s inventory will be the current exchange rate.
USA Corp’s consolidated inventory balance is equal to cost component of the inventory Mexico Corp purchased from USA Corp translated at the exchange rate at the end of the reporting period.
MXN 60,000 × (1/13) = USD 4,615
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.
(MXN 60,000/10) – (MXN 60,000/13) = USD 1,385
The table below shows the effect of the USD inventory sale on USA Corp’s consolidated USD financial statements for the period ended March 31, 20X1.
Mexico SA balance
USA Corp balance
USA Corp consolidated balance
Cost of sales
See FX 5 for information on translating the financial statements of a foreign entity.
(1) As the entire Mexico SA inventory balance (MXN 100,000) was translated at USD 1 =MXN 13, in consolidation the intercompany profit portion (MXN 40,000) must be reversed in order to avoid generating CTA on this amount.
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