2.4 Change in Functional Currency
ASC 830-10
Changes in the Functional Currency
45-7 Once the functional currency for a foreign entity is determined, that determination shall be used consistently unless significant changes in economic facts and circumstances indicate clearly that the functional currency has changed. Previously issued financial statements shall not be restated for any change in the functional currency.
45-8 See paragraph 250-10-45-1 for guidance on adoption
or modification of an accounting principle necessitated by transactions or
events that are clearly different in substance from those previously occurring.
Paragraphs 830-10-45-15 through 45-16 discuss changes related to highly
inflationary economies.
Functional Currency Changes From Reporting Currency to Foreign Currency
45-9 If the functional currency changes from the reporting currency to a foreign currency, the adjustment attributable to current-rate translation of nonmonetary assets as of the date of the change shall be reported in other comprehensive income.
Functional Currency Changes From Foreign Currency to Reporting Currency
45-10 If the functional currency changes from a foreign currency to the reporting currency, translation adjustments for prior periods shall not be removed from equity and the translated amounts for nonmonetary assets at the end of the prior period become the accounting basis for those assets in the period of the change and subsequent periods. This guidance shall be used also to account for a change in functional currency from the foreign currency to the reporting currency when an economy becomes highly inflationary.
ASC 830-10-45-7 indicates that there must be “significant changes in economic
facts and circumstances” to justify a change in functional currency. Except when an economy
is identified as highly inflationary (see Chapter 7), ASC 830 does not define or provide examples related to what
constitutes a significant change in facts and circumstances. An entity must therefore use
judgment in determining whether significant changes in facts and circumstances have
occurred. However, such changes are expected to be rare.
Changes in the functional currency may result from one-time transactions,
such as a merger or acquisition, or from a longer-term shift in an entity’s operations.
Regardless of the reason, it is important that management carefully consider whether such an
event is significant enough to warrant a change in the functional currency. Because ASC 830
does not provide guidance on how to determine whether a change is “significant,” preparers
may find it helpful to compare the indicators before and after the change in making the
determination. Entities are encouraged to consult with their accounting advisers in such
situations.
Example 2-8
Significant Changes in Facts and Circumstances That Justify a Change in
Functional Currency
Company H, located in Ireland, is a wholly owned subsidiary of
Company K, whose functional currency is USD. Company H has identified the EUR as
its functional currency because, among other indicators, its sales and
purchases, as well as its labor costs, have primarily been denominated in this
currency. During the fourth quarter, H’s operations begin to change. The sales
composition of H changes because it loses some sizable contracts and gains some
significant new contracts. Company K begins using H’s manufacturing facility to
complete its sales orders. Because more than 80 percent of H’s sales will come
from K’s operations, H will no longer need to generate its own sales; therefore,
H terminates its sales force. Company K builds a new facility to produce the
materials needed in its manufacturing processes. As of the end of the fiscal
year, H begins receiving all materials from K instead of from outside vendors.
On the basis of the changes in its business, H expects cash inflows and
outflows, except for wages, to be primarily denominated in USD.
These circumstances collectively justify a change in H’s
functional currency from EUR to USD. For example, the denomination of revenues
has changed from primarily EUR to USD. This change does not appear to be
temporary since H has terminated its sales force. In addition, the denomination
of cash outflows for materials also has changed to USD. Because K has built a
new facility to make these materials, this change does not appear to be
temporary either. Further, the philosophy behind H’s operations has changed: in
K’s overall operating strategy, H has changed from a self-supporting,
stand-alone operating company to a manufacturing facility of K.
Example 2-9
Impact of Significant Borrowings on Determination of Functional
Currency
Company O’s functional currency is USD, and O uses the equity
method to account for its 43 percent investment in Company M, a Mexican company
whose functional currency is the MXN. During the current year, M enters into a
$200 million third-party borrowing denominated in USD. Most of M’s operations,
labor costs, and purchases are denominated in MXN.
Despite the significant borrowing denominated in USD, it is
not appropriate for M to change its functional currency from MXN to USD. Because
most of M’s operations, sales, purchases, and labor cost are denominated in MXN,
M should continue using the MXN as its functional currency. Although a large
third-party financing in O’s functional currency may constitute some evidence of
a change in the functional currency from MXN to USD, there is insufficient
evidence of such a change in this example.
Example 2-10
Effects of an Acquisition on Functional Currency
Company W is a manufacturing entity whose primary operations
(e.g., headquarters, manufacturing operations, majority of sales contracts) are
located in the United States and whose functional currency is USD. Company W is
acquired by Company L, a similar manufacturing entity that is based in
Luxembourg and whose functional currency is the EUR, as part of L’s efforts to
expand into the North American market. Company L plans to cease manufacturing
operations in the United States, since it has adequate capacity within its
existing facilities in Europe, and to manage W’s operations from its European
headquarters in Luxembourg. These changes result in the conversion of W into a
foreign sales office for L. Therefore, W’s functional currency changes to the
EUR when it is acquired by L.
If significant changes had not been made to W’s operations
after the acquisition, W’s functional currency most likely would have remained
the USD.
SEC Considerations
The SEC’s Frequently Requested Accounting and Financial Reporting Interpretations and Guidance, released by the Division of Corporation Finance (the “Division”), provides an additional example in which a change in functional currency may be appropriate. This guidance states that “[r]egistrants with foreign operations in economies that have recently experienced economic turmoil should evaluate whether significant changes in economic facts and circumstances have occurred that warrant reconsideration of their functional currencies.” The Division warns, however, that it may be difficult to conclude that “currency exchange rate fluctuations alone would cause a self-contained foreign operation to become an extension of the parent company.” Regardless of the underlying reason for the change in functional currency, the Division suggests that, although ASC 830 does not require them to do so, “[r]egistrants should consider the need to disclose the nature and timing of the change, the actual and reasonably likely effects of the change, and economic facts and circumstances that led management to conclude that the change was appropriate. The effects of those underlying economic facts and circumstances on the registrant’s business should also be discussed in MD&A.”
2.4.1 Determining When to Change the Functional Currency
In accordance with ASC 830-10-45-7, a change in functional currency should be
reported as of the date on which it is determined that “significant changes in economic
facts and circumstances” have occurred. Although such a change could occur on any date
during the year, it is acceptable to use a date at the beginning of the most recent
reporting/accounting period.
2.4.2 Accounting for a Change in the Functional Currency
ASC 250-10-45-1 states that the “[a]doption or modification of an accounting
principle necessitated by transactions or events that are clearly different in substance
from those previously occurring” is not considered a change in accounting principle.
Because a change in functional currency is necessitated by a significant change in facts
and circumstances that are “clearly different in substance from those previously
occurring,” such a change does not meet the definition of a change in accounting principle
and therefore should not be accounted for as such (i.e., previously issued financial
statements should not be restated).
The accounting effects of a change in functional currency depend on (1) the type
of change being made (e.g., foreign currency [likely the local currency] to reporting
currency or reporting currency to foreign currency) and (2) the nature of the assets or
liabilities being restated (i.e., monetary or nonmonetary). The following table summarizes
the consolidated accounting treatment of a change in functional currency as of the first
day of a reporting period and assumes that the foreign entity is a direct subsidiary of
the parent:
Effect of Changes in Functional Currency on the Consolidated
Financial Statements
|
Type of Change
|
Nonmonetary Assets and Liabilities
|
Monetary Assets and Liabilities
|
Effect on CTA
|
|---|---|---|---|
|
Reporting currency to foreign currency1
|
Translate at the rate in effect on the date of change.
Causes a difference between historical carrying value (based
on rate at time of asset or liability’s inception) and new carrying value
(based on current rate).
|
Translate at the rate in effect on the date of change.
Causes no difference between historical carrying value and
new carrying value.
|
Difference between historical basis of nonmonetary assets
and liabilities and new basis is recorded in CTA.
|
|
Foreign currency to reporting currency
|
Translated balances at the end of the prior period become
the new accounting basis.
|
Translated balances at the end of the prior period become
the new accounting basis.
|
No effect.
|
|
Foreign currency to other foreign currency
|
Remeasure into the new functional currency at the rate in
effect on the date of the asset or liability’s inception.
Then translate into reporting currency based on current
exchange rate.
|
Remeasure into the new functional currency at the rate in
effect on the date of change.
Then translate into reporting currency based on current
exchange rate.
|
Difference between historical basis of nonmonetary assets
and liabilities and new basis is recorded in CTA.
|
In all scenarios, the rate on the date of change becomes the historical rate at which nonmonetary assets and liabilities are translated in subsequent years. Previously recorded CTA balances are not reversed.
For additional information on accounting for monetary and nonmonetary assets and liabilities, see Chapter 4.
Example 2-11
Accounting for a Change in Functional Currency
The table below represents the accounting records of Company
X, a foreign entity whose parent company’s reporting currency is USD. As a
result of a significant change in facts and circumstances, X’s functional
currency has changed from USD (its reporting currency) to EUR (its local
currency). The change occurs on January 1, 20X5. This example assumes the
following:
-
All nonmonetary assets and liabilities arise on the same date, January 1, 20X0, when the EUR-to-USD exchange rate is 1 to 2. Assume that no depreciation is taken on the PP&E.
-
Company X maintains its books and records in EUR, its local currency.
-
The EUR-to-USD exchange rate on the date of the change in functional currency is 1 to 1.5.
-
The reporting currency of the consolidated entity is USD.
Connecting the Dots
Considerations When Functional Currency Changes
A change in functional currency can have a number of effects on an entity, a few examples of which are depicted above. An entity should carefully consider the impact of the change in functional currency on all account balances. For example, the lower-of-cost-or-market analysis required by ASC 330-10 would have to be performed in the new functional currency. In addition, an entity should revisit its various investing and hedging positions to determine whether changes in methods or strategies are warranted.
Footnotes
1
This guidance does not apply to situations in which an
entity is changing its functional currency from the reporting currency to
a foreign currency (likely the local currency) because an economy ceases
to be highly inflationary. See Chapter 7 for guidance on such
situations and Example
7-6 for an illustration of the differences.