2.2 Definition of a Foreign Entity
ASC 830-10 — Glossary
Foreign Entity
An operation (for example, subsidiary, division, branch, joint venture, and so forth) whose financial statements are both:
- Prepared in a currency other than the reporting currency of the reporting entity
- Combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity.
The first step in the functional-currency approach is to determine which foreign entities make up the reporting entity. To be considered a foreign entity, an operation (or set of operations) should have its own financial statements or be able to produce such statements. Accordingly, a foreign entity most likely would have a management team that uses dedicated resources to run the entity’s operations. The concept of “distinct and separable operations” is important to making this determination.
From a practical standpoint, a reporting entity may begin the determination of
its distinct and separable operations by identifying each legal entity in its
organizational structure. Next, the reporting entity must determine whether any of
those legal entities have two or more distinct and separable operations (e.g.,
divisions, branches, product lines). If a legal entity has more than one distinct
and separable operation, a reporting entity would consider each operation a separate
entity when applying the guidance in ASC 830. Otherwise, the legal entity itself
would generally be considered the entity subject to ASC 830. Judgment must be used
in the determination of whether a single legal entity has more than one separate and
distinct operation, and the reporting entity must thoroughly understand how and
where the legal entity conducts business.
Connecting the Dots
The term “foreign entity,” as used in ASC 830, refers to an entity that prepares
its financial statements in a currency other than the reporting currency but
does not refer to the entity’s geographical location. Therefore, an entity
that is domiciled in the United States would meet the definition of a
foreign entity under ASC 830 if it was consolidated by a reporting entity
that has a reporting currency other than USD. Similarly, an entity that is
domiciled in a foreign country would not meet the definition of a foreign
entity under ASC 830 if it was consolidated by a reporting entity that has
the same reporting currency as the entity. Therefore, the reporting entity
must determine the functional currency of each distinct and separable
operation (i.e., entity) within the consolidated group, regardless of where
that operation is geographically located. The identification of foreign
entities is important, since ASC 830 requires that the financial statements
of each foreign entity be translated into the reporting currency, as
discussed in Section
1.3.
2.2.1 Identifying Distinct and Separable Operations
ASC 830-10
45-5 An entity might have more than one distinct and separable operation, such as a division or branch, in which case each operation may be considered a separate entity. If those operations are conducted in different economic environments, they might have different functional currencies.
55-6 In some instances, a foreign entity might have more than one distinct and separable operation. For example, a foreign entity might have one operation that sells parent-entity-produced products and another operation that manufactures and sells foreign-entity-produced products. If they are conducted in different economic environments, those two operations might have different functional currencies. Similarly, a single subsidiary of a financial institution might have relatively self-contained and integrated operations in each of several different countries. In those circumstances, each operation may be considered to be an entity as that term is used in this Subtopic, and, based on the facts and circumstances, each operation might have a different functional currency.
ASC 830-10-45-5 presents the notion of a “distinct and separable operation” but
offers no definition of or qualifying criteria related to such an operation.
Further, a distinct and separable operation may or may not meet the definition
of a business in ASC 805-10. Thus, management will need to use judgment and
consider all facts and circumstances in determining which operations are
distinct and separable. However, the following factors, while not exhaustive,
may indicate that an operation is distinct and separable for purposes of the
functional-currency analysis:
-
The operation has specifically identifiable assets and liabilities (i.e., not shared or commingled with other operations’ assets and liabilities).
-
The operation can be managed separately and apart from other operations of the reporting entity.
-
Accounting records for the operation could be produced.
As noted previously, distinct and separable operations may be identified at a lower level than the legal entity itself. For instance, divisions or branches of the same legal entity (e.g., a subsidiary) may operate in different economic environments, in which case each may be considered a distinct and separable operation.
Example 2-1
Distinct and
Separable Operations
Company B, a holding company headquartered in the United
States, has a USD functional currency and conducts its
confectionery and coffee operations (the “confectionery
division” and “coffee division,” respectively) through a
Swiss subsidiary (SwissCo).
The confectionary division’s production and distribution
facilities, as well as its workforce, are located in
Switzerland, and substantially all of its revenues and
expenses are denominated and paid in Swiss francs (CHF).
The coffee division’s production and distribution
facilities, as well as its workforce, are located in
Italy, and substantially all of its revenues and
expenses are denominated and paid in euros (EUR). The
two divisions maintain separate accounting records and
prepare stand-alone financial information that
management uses to assess performance.
Although the divisions are part of the same legal entity,
ASC 830 permits B to identify distinct and separable
operations below the legal-entity level (e.g., at the
division level). The divisions operate in separate
economic environments and conduct business in their
local currencies. Therefore, B may conclude that the
confectionery division and coffee division are distinct
and separable operations (i.e., distinct foreign
entities) when identifying SwissCo’s functional
currencies.
Under ASC 830, a reporting entity is not required to separate the accounting records of its operations if doing so is impracticable. Further, just because certain operations may be separable in some way (e.g., the operations have their own set of accounting records), the operations are not necessarily distinct and separable.
Reporting entities should carefully consider all facts and circumstances, as well as the factors discussed in Section 2.3, when determining whether an operation is distinct and separable. The following are some factors (not all-inclusive) indicating that operations may not be distinct and separable, even if separate accounting records are maintained:
- A legal entity’s foreign division is solely responsible for manufacturing certain product lines for its parent.
- A holding company is essentially an extension of its parent or affiliate (see Section 2.3.1 for additional considerations related to shell and holding companies).
- A subsidiary or division functions only as a foreign sales office for its parent.
- Individual retail stores are managed centrally.
- A foreign subsidiary or division operates only as the treasury or internal administrative function for its parent.
Example 2-2
Operations That Are Not Distinct and Separable
The overall conclusion from Example
2-1 would be different if Bank IDB
engaged in (1) foreign-currency-hedge strategies, (2)
other means of converting a particular foreign currency
into the parent’s functional currency, or (3) activities
to convert a pool’s currency into the currency of
another country, such as USD or JPY. In such cases, the
operations of the pools would not be considered separate
and distinct operations because of the high degree of
intra-entity transactions, which effectively would make
each pool an extension of IDB. Therefore, the
determination of the functional currency would be
evaluated for IDB as a whole, including the operations
of the individual pools.