Foreign Currency

Dear Sir,

Under CBE Specimen Q3b ii

The question mentions that On 1 Sep 2016, Jacinta Co sold inventories costing $1.35 million to a wholly-owned overseas subsidiary for $2 million. There is no right of return.

The subsidiary has the euro as its functional currency. The exchange rate on the date of the sale from Jacinta Co to the overseas subsidiary was $1 = €1.25. At 31 December 20×6, the subsidiary still holds the goods in inventories and the exchange rate is $1 = €1.30. There is no intercompany debt outstanding at the year-end.

How the sale of inventories would be accounted for in the individual financial statements of the overseas subsidiary at 1 September 20X6.

Here is the answer
The subsidiary has recorded the cost of the inventories at €2·5 million ($2m x 1·25). At 1 September 20X6, the cost of the inventories includes the original cost to Jacinta Co of €1,687,500 ($1·35m x 1·25) plus the intragroup profit of €812,500 ($650,000 x 1·25) charged by Jacinta Co.

Why should the subsidiary record the cost of the inventories including the original cost to Jacinta Co of €1,687,500 ($1·35m x 1·25) plus the intragroup profit of €812,500 ($650,000 x 1·25) charged by Jacinta Co? shouldn’t the subsidiary just record DR €2,500,000 in inventories and CR €2,500,000 in cash will do?