5.6 Foreign Currency in a Debt Host
5.6.1 Background
This section discusses the analysis of whether a feature whose value changes on
the basis of changes in one or more foreign currency exchange rates should be
separated from a debt host contract and accounted for as a derivative. For
example, some debt instruments contain an option to convert principal, interest
payments, or both at a fixed foreign currency exchange rate. Further, the terms
of some debt instruments (e.g., dual currency bonds) have principal and interest
payments denominated in different currencies.
This section does not apply to a feature that does not present
an exposure to the risk of changes in the exchange rate of foreign currency that
is different from the currency in which the debt is denominated, such as certain
currency conversion convenience clauses (see Section
5.6.6). Further, it does not apply to debt merely by virtue of
its denomination in a currency that is different from the debtor’s functional
currency unless the debt contains one or more features that are denominated in a
currency that is different from that in which the debt was denominated (e.g., a
foreign currency option).
5.6.2 Bifurcation Analysis
The table below presents an overview of the bifurcation analysis of a foreign
currency feature embedded in a debt host contract. Further, an entity should always
consider the terms and conditions of a specific feature in light of all the relevant
accounting guidance before reaching a conclusion.
|
Bifurcation Condition
|
Condition Met?
|
Analysis
|
|---|---|---|
|
Not clearly and closely related (see Section
4.3.2)
|
Yes
|
A feature that presents an exposure to changes in the
exchange rate of foreign currency that is different from the
debt’s currency of denomination is not clearly and closely
related to a debt host.
|
|
Hybrid instrument not measured at fair value through earnings
on a recurring basis (see Section
4.3.3)
|
It depends
|
From the issuer’s perspective, debt is not measured at fair
value on a recurring basis unless the issuer elects the fair
value option in ASC 815-15 or ASC 825-10. The fair value
option cannot be elected for debt that contains a separately
recognized equity component at inception.
From the holder’s perspective, if a loan or debt security is
remeasured at fair value, with changes in fair value
recorded in earnings, any derivative embedded in the
interest would not need to be accounted for separately since
the accounting for the interest would already be the same as
that of a freestanding derivative.
|
|
Meets the definition of a derivative (see Section
4.3.4)
|
Yes
|
A feature that presents an exposure to changes in a foreign
currency exchange rate meets the definition of a
derivative.
|
|
Meets a scope exception (see Chapter 2 and Section
4.3.5)
|
It depends
|
The entity should evaluate whether the foreign currency
feature is exempt from derivative accounting under ASC
815-15-15-5.
|
As shown in the table above, an entity’s determination of whether a foreign currency
feature must be bifurcated from a debt host contract and accounted for as derivative
tends to focus on whether the feature meets a scope exception related to derivative
accounting unless the entity is remeasuring the hybrid instrument at fair value on a
recurring basis through earnings. Typically, such features meet the definition of a
derivative and are not clearly and closely related to a debt host (see the next
section).
5.6.3 Clearly-and-Closely-Related Analysis
A feature that presents an exposure to changes in the exchange rate
of foreign currency that is different from the debt’s currency of denomination is
not clearly and closely related to a debt host. As noted in ASC 815-15-55-212, for
example, a “foreign currency option is not clearly and closely related to issuing a
loan.” However, this guidance does not apply to a feature that does not present an
exposure to the risk of changes in the exchange rate of foreign currency that is
different from the currency in which the debt is denominated (see Section 5.6.6).
5.6.4 Derivative Analysis
The table below presents an analysis of whether a foreign currency feature embedded
in a debt host contract meets the definition of a derivative. Note, however, that an
entity should always consider the terms and conditions of a specific feature in
light of the applicable accounting guidance before reaching a conclusion.
|
Characteristics of a Derivative
|
Characteristic Present?
|
Analysis
|
|---|---|---|
|
Underlying and notional amount or payment provision (see
Section 1.4.1)
|
Yes
|
An embedded feature that presents an exposure to changes in a
foreign currency exchange rate that is based on a currency
that is different from the debt’s currency of denomination
has both an underlying (the foreign currency rate) and a
notional amount (e.g., the debt’s outstanding amount).
|
|
Initial net investment (see Section
1.4.2)
|
Yes
|
The initial net investment in a feature that presents an
exposure to changes in a foreign currency exchange rate that
is based on a currency that is different from the debt’s
currency of denomination is its fair value (i.e., the amount
that would need to be paid to acquire the feature on a
stand-alone basis without the host contract). This feature
has an initial net investment that is smaller than would be
required for a direct investment that has the same exposure
to changes in foreign currency exchange rates.
|
|
Net settlement (see Section 1.4.3)
|
Yes
|
A foreign currency feature meets the net settlement condition
because it is net cash settled.
|
As shown in the table above, a foreign currency feature embedded in a debt host
contract meets the definition of a derivative. Therefore, the analysis of whether
such a feature must be bifurcated as a derivative tends to focus on whether the
feature is exempt from the scope of derivative accounting unless the entity is
remeasuring the hybrid instrument at fair value on a recurring basis through
earnings.
5.6.5 Exception for Certain Foreign Currency Features
As noted in Section 4.3.5.2, under ASC 815-15-15-5, a
financial instrument with payments that are denominated in a foreign currency is
deemed not to contain an embedded foreign currency derivative if the amounts
that are denominated in the foreign currency must be remeasured at spot rates
under ASC 830-20. The exemption in ASC 815-15-15-5 does not apply to a foreign
currency feature that is not required to be remeasured under ASC 830-20 for
changes in spot foreign currency exchange rates.
5.6.6 Convenience Clauses That Do Not Present a Foreign Currency Exposure
Sometimes, debt contracts contain a convenience clause that permits or requires
principal or interest payments or both to be made in a currency that is different
from that in which the debt is denominated. The amount of the payment is determined
by applying the current spot foreign currency exchange rate at the time of payment
to the amount owed in the debt’s currency of denomination. For example, the terms of
a debt instrument denominated in USD might specify that payments may be made in one
or more currencies at the current spot exchange rate at the time of payment. Such a
clause does not represent a foreign currency feature that should be evaluated for
bifurcation since its monetary value does not vary on the basis of a foreign
currency exchange rate.