Chapter 4 — Foreign Currency Transactions
Chapter 4 — Foreign Currency Transactions
4.1 Overview
ASC 830-20 addresses the accounting for foreign currency transactions, which the ASC master glossary defines as transactions “whose terms are denominated in a currency other than the entity’s functional currency.” However, the guidance in ASC 830-20 is limited to the measurement and presentation of foreign currency transactions. Therefore, it does not provide guidance on when an entity should recognize a foreign currency transaction in its financial statements. Entities should apply other relevant accounting guidance to determine when a foreign currency transaction should be recognized.
Broadly speaking, there are two types of foreign currency transactions: (1) those that result in the receipt or payment of foreign currency cash only on the date on which the transaction is recognized (e.g., purchasing or selling inventory by using foreign currency cash) and (2) those that will result in the receipt or payment of foreign currency cash on a future date (e.g., purchasing or selling inventory on account). For the first type of foreign currency transaction, the only relevant accounting issue is how to initially measure the recognized asset, liability, or income statement account in an entity’s financial statements. However, for the second type of foreign currency transaction, an additional issue arises with respect to the subsequent measurement of the recognized asset or liability in the financial statements.
The remainder of this chapter focuses on the initial and subsequent accounting for foreign currency transactions.
4.2 Initial Measurement of Foreign Currency Transactions
ASC 830-20
25-1 At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be recorded in the functional currency of the recording entity.
30-1 At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be measured initially in the functional currency of the recording entity by use of the exchange rate in effect at that date.
Under ASC 830-20-25-1 and ASC 830-20-30-1, all foreign currency transactions
must be measured in the recording entity’s functional currency. This is accomplished
by using the exchange rate in effect on the date on which the transaction is
recognized. However, as discussed in Chapter 3, an entity may, out of convenience,
determine that an appropriate weighted-average exchange rate may be used for
measuring income statement accounts. The example below illustrates the initial
measurement of a foreign currency transaction.
Example 4-1
Initial Measurement of a Foreign Currency
Transaction
On September 15, 20X6, Retailer, a U.S.
entity whose functional currency is the USD, purchases
inventory from Supplier, a Japanese entity whose functional
currency is the JPY (¥). The amount that Retailer owes
Supplier for the inventory is ¥1,300. Assume that the
exchange rate in effect on September 15, 20X6, is $1 =
¥6.50.
This transaction represents a foreign
currency transaction for Retailer since its functional
currency is the USD and the transaction price is denominated
in a different currency (JPY). In accordance with ASC
830-20, Retailer must record the transaction in its
functional currency (USD). To determine the amount to record
in USD, Retailer divides the transaction price (¥1,300) by
the exchange rate that was in effect when the transaction
was recognized ($1 = ¥6.50). Therefore, Retailer would
record the following journal entry in its financial
statements on September 15, 20X6:
From Supplier’s perspective, this
transaction does not represent a foreign currency
transaction since it is denominated in its functional
currency (JPY). Therefore, Supplier recognizes the
transaction in its financial statements at the stated
transaction price (¥1,300).
4.3 Subsequent Measurement of Foreign Currency Transactions
ASC
830-20
35-1 A
change in exchange rates between the functional currency and
the currency in which a transaction is denominated increases
or decreases the expected amount of functional currency cash
flows upon settlement of the transaction. That increase or
decrease in expected functional currency cash flows is a
foreign currency transaction gain or loss that generally
shall be included in determining net income for the period
in which the exchange rate changes.
35-2 At each balance sheet
date, recorded balances that are denominated in a currency
other than the functional currency of the recording entity
shall be adjusted to reflect the current exchange rate. At a
subsequent balance sheet date, the current rate is that rate
at which the related receivable or payable could be settled
at that date. Paragraphs 830-20-30-2 through 30-3 provide
more information about exchange rates.
ASC 830-20-35-2 specifies that if a recorded balance is denominated
in a foreign currency, it must be remeasured in each period into the functional
currency by using the current exchange rate. (See Chapter 3 for a discussion of current exchange
rates.) ASC 830-20-35-1 further clarifies that the changes in those recorded
balances, which result from fluctuations in the current exchange rate, are generally
recorded in earnings. The overall objective of this remeasurement process is
explained in ASC 830-10-45-17:
If an entity’s books of record are not maintained in its
functional currency, remeasurement into the functional currency is required.
That remeasurement is required before translation into the reporting
currency. If a foreign entity’s functional currency is the reporting
currency, remeasurement into the reporting currency obviates translation.
The remeasurement of and subsequent accounting for transactions denominated
in a currency other than the functional currency shall be in accordance with
the requirements of Subtopic 830-20. The remeasurement
process is intended to produce the same result as if the entity’s books
of record had been maintained in the functional currency. To accomplish
that result, it is necessary to use historical exchange rates between
the functional currency and another currency in the remeasurement
process for certain accounts (the current rate will be used for all
others), and this guidance identifies those accounts. To accomplish that
result, it is also necessary to recognize currently in income all
exchange gains and losses from remeasurement of monetary assets and
liabilities that are not denominated in the functional currency (for
example, assets and liabilities that are not denominated in dollars if
the dollar is the functional currency). [Emphasis added]
ASC 830-10-45-17 states that to comply with the requirements in ASC
830-20 regarding the subsequent accounting for foreign currency transactions, an
entity must use historical exchange rates to remeasure some accounts and current
exchange rates to remeasure others. This guidance further suggests that “monetary”
assets and liabilities would be subject to remeasurement at current exchange rates.
In addition, ASC 830-10-45-18 identifies certain “nonmonetary” accounts that must be
remeasured by using historical exchange rates. Therefore, the subsequent measurement
of a foreign currency transaction depends on whether it results in the recognition
of monetary or nonmonetary assets and liabilities, as illustrated below.
Therefore, properly identifying an account as either monetary or
nonmonetary is critical to correctly applying the subsequent-measurement guidance in
ASC 830-20. The next section explains how to distinguish between the two.
4.3.1 Distinguishing Monetary Assets and Liabilities From Nonmonetary Assets and Liabilities
While the guidance in ASC 830-10-45-17 and 45-18 suggests that
the subsequent-measurement requirements for monetary assets and liabilities (at
current exchange rates) differ from those for nonmonetary assets and liabilities
(at historical exchange rates), it does not actually define either of those
terms. Therefore, it is important for entities to consider the guidance in ASC
830-20-35-2 when distinguishing between the two. This paragraph states that
recorded balances that are denominated in a foreign currency must be remeasured
at current exchange rates (i.e., those accounts would be considered monetary
assets and liabilities). The implementation guidance in ASC 830-10-55-1 and 55-2
clarifies the meaning of a recorded balance that is “denominated in a foreign
currency.”
ASC
830-10
55-1 To measure in foreign
currency is to quantify an attribute of an item in a
unit of currency other than the reporting currency.
Assets and liabilities are denominated in a foreign
currency if their amounts are fixed in terms of that
foreign currency regardless of exchange rate changes. An
asset or liability may be both measured and denominated
in one currency, or it may be measured in one currency
and denominated in another.
55-2 For example, two foreign
branches of a U.S. entity, one Swiss and one German,
purchase identical assets on credit from a Swiss vendor
at identical prices stated in Swiss francs. The German
branch measures the cost (an attribute) of that asset in
euros. Although the corresponding liability is also
measured in euros, it remains denominated in Swiss
francs since the liability must be settled in a
specified number of Swiss francs. The Swiss branch
measures the asset and liability in Swiss francs. Its
liability is both measured and denominated in Swiss
francs. Although assets and liabilities can be measured
in various currencies, rights to receive or obligations
to pay fixed amounts of a currency are, by definition,
denominated in that currency.
As noted above, a recorded balance is denominated in a foreign
currency (and is therefore subject to remeasurement at current exchange rates)
if its amount is “fixed in terms of that foreign currency regardless of exchange
rate changes.” Further, “rights to receive or obligations to pay fixed amounts
of a currency are, by definition, denominated in that currency.” Accordingly,
this implementation guidance suggests that an account would be remeasured at
current exchange rates (and therefore would be a monetary asset or liability) if
it represents a right to receive or an obligation to pay a fixed amount of a
foreign currency regardless of exchange rate changes. All other accounts thus
would be considered nonmonetary and would be remeasured at historical exchange
rates.
In addition, while ASC 830 does not explicitly define the terms
“monetary assets and liabilities” or “nonmonetary assets and liabilities,” other
Codification topics do, notably ASC 255 (on changing prices) and ASC 845 (on
nonmonetary exchanges). While neither of these standards amended or interpreted
the guidance in ASC 830, entities may find it useful to consider the below
definitions.
ASC
255-10 — Glossary
Monetary Assets
Money or a claim to receive a sum of
money the amount of which is fixed or determinable
without reference to future prices of specific goods or
services.
Monetary
Liability
An obligation to pay a sum of money the
amount of which is fixed or determinable without
reference to future prices of specific goods and
services.
ASC 845-10 — Glossary
Monetary Assets and
Liabilities
Monetary assets and liabilities are
assets and liabilities whose amounts are fixed in terms
of units of currency by contract or otherwise. Examples
are cash, short- or long-term accounts and notes
receivable in cash, and short- or long-term accounts and
notes payable in cash.
Nonmonetary Assets
and Liabilities
Nonmonetary assets and liabilities are
assets and liabilities other than monetary ones.
Examples are inventories; investments in common stocks;
property, plant, and equipment; and liabilities for rent
collected in advance.
The tables below summarize common monetary and nonmonetary
balance sheet accounts. Some of the intricate accounts are discussed in more
detail in Sections 4.4 through 4.20.
1
See Section 4.19 for
additional information.
2
See Section 4.20 for
additional information.
3
The term “contract liabilities,” as used here,
is intended to be consistent with the definition in ASC
606-10.
4
See Section 4.6.1 for further
discussion of instruments that must be subsequently remeasured
under ASC 480-10-S99.
Sections
4.3.2 and 4.3.3 discuss how to subsequently measure foreign currency
transactions that result in the recognition of monetary assets and liabilities
and those that result in the recognition of nonmonetary assets and liabilities,
respectively.
4.3.2 Monetary Assets and Liabilities
When a foreign currency transaction results in the recognition
of a monetary asset or liability, that asset or liability is subsequently
remeasured from the foreign currency to the functional currency as of each
reporting date by using the current exchange rate. Therefore, the carrying value
of a monetary asset or liability will change on each reporting date (until the
asset or liability is settled) as a result of changes to the exchange rate
between the foreign currency and the functional currency. Generally, these
changes in the carrying value of monetary assets and liabilities are recognized
in earnings as transaction gains or losses. However, there are certain
exceptions to recognizing such transaction gains and losses in earnings, as
discussed in further detail in Section 9.2.
Connecting the Dots
Transaction gains or losses are generally recorded in
earnings because the change in the exchange rate directly affects the
amount of functional currency that an entity will either receive or pay
when the transaction is settled. That is, changes in exchange rates have
direct effects on an entity’s future cash flows.
The example below illustrates the subsequent measurement of a
foreign currency transaction that results in the recognition of a monetary
liability.
Example 4-2
Subsequent Measurement of a Monetary Liability
This example represents a continuation
of Example 4-1. Assume the following
additional facts:
-
The terms of the transaction specify that Retailer must pay for the inventory in 60 days (on November 14, 20X6).
-
Retailer is a calendar-year public company that files quarterly financial statements.
-
The exchange rates in effect on Retailer’s quarterly reporting date and at the time the transaction is settled, respectively, are as follows:
-
September 30, 20X6: $1 = ¥6.25.
-
November 14, 20X6: $1 = ¥6.75.
-
The original transaction between
Retailer and Supplier resulted in Retailer’s recognition
of an accounts payable balance, which is a monetary
liability. Therefore, Retailer must remeasure that
account as of each reporting date by using the exchange
rate in effect on that date. Accordingly, on September
30, 20X6, Retailer remeasures its accounts payable
balance by dividing the transaction price of ¥1,300 by
the exchange rate in effect on that date ($1 = ¥6.25)
and determines it to be $208. To adjust the carrying
value of the accounts payable balance, Retailer would
record the following journal entry in its financial
statements on September 30, 20X6:
Because the JPY has strengthened against
the USD since the time the transaction was executed,
Retailer now needs more USD (its functional currency) to
pay for the inventory. Retailer therefore records a
foreign currency transaction loss in earnings to reflect
the additional amount of functional currency needed to
settle its liability.
On November 14, 20X6, Retailer settles
the transaction by paying Supplier ¥1,300. To record the
settlement in its financial statements, Retailer must
first remeasure its accounts payable by using the
exchange rate in effect on the settlement date.
Accordingly, Retailer remeasures its accounts payable
balance by dividing the transaction price of ¥1,300 by
the exchange rate in effect on that date ($1 = ¥6.75)
and determines it to be $193 (rounded). To adjust the
carrying value of the accounts payable balance and
settle the accounts payable balance, Retailer would
record the following journal entries in its financial
statements on November 14, 20X6:
From September 30, 20X6, through the
settlement date, the JPY has weakened against the USD.
Therefore, Retailer now needs fewer USD to settle its
obligation than it did on September 30, 20X6, because of
the change in the exchange rate. The remeasurement
therefore results in the recognition of a transaction
gain.
4.3.3 Nonmonetary Accounts
When a foreign currency transaction results in the recognition
of a nonmonetary asset or liability, that asset or liability is subsequently
remeasured by using the historical exchange rate. By using the historical
exchange rate, an entity will achieve the same results as it would if it had
originally acquired the asset or incurred the liability in its functional
currency, which is consistent with the remeasurement objective of ASC
830-10-45-17. Therefore, the carrying value of nonmonetary assets and
liabilities will not change as a result of changes in exchange rates between the
foreign currency and the functional currency. As a result, transaction gains or
losses are not recognized for nonmonetary assets and liabilities.
Note that the foreign currency transaction illustrated in
Examples 4-1
and 4-2 resulted in
the recognition of both a nonmonetary asset (inventory) and a monetary liability
(accounts payable). However, unlike the subsequent accounting for accounts
payable in Example 4-2, the inventory
would continue to be remeasured as of each reporting date at the historical
exchange rate. Therefore, Retailer would continue to measure the inventory at
$200 in its financial statements until it is sold or otherwise disposed of
(i.e., changes in the exchange rate would not affect the carrying value of the
inventory).
Connecting the Dots
While ASC 830 requires that nonmonetary assets and
liabilities be subsequently remeasured at historical exchange rates,
other authoritative literature may require that those assets and
liabilities be subsequently remeasured at current exchange rates. For
example, foreign-currency-denominated investments in AFS debt securities
and equity securities are identified by ASC 830 as nonmonetary assets
and therefore would need to be remeasured by using historical exchange
rates. However, ASC 320 and ASC 321 (as discussed further in Section 4.4.1)
require that AFS debt securities and equity securities be subsequently
remeasured at fair value, a component of which is related to foreign
currency exchange rates.
Other authoritative literature takes precedence over ASC
830 in such cases and that the asset or liability should be subsequently
remeasured in accordance with such literature. Therefore, if a
foreign-currency-denominated asset or liability is deemed nonmonetary,
an entity should further consider whether other authoritative literature
requires that the asset or liability be subsequently measured at current
exchange rates, given that such literature requires ongoing
remeasurement at fair value. Changes in the carrying value of the asset
or liability that are related to changes in exchange rates would not
necessarily be reported as transaction gains and losses under ASC 830
but should be presented in accordance with the requirements of those
other standards.
4.3.4 Remeasurement of Books and Records Maintained in a Foreign Currency
ASC
830-20
25-2 Paragraphs 830-10-55-3
through 55-7 provide guidance on the determination of a
reporting entity’s functional currency. Paragraph
830-10-45-17 states that if an entity’s books of record
are not maintained in its functional currency,
remeasurement into the functional currency is required
before translation into the reporting currency. That
paragraph provides further guidance on remeasurement of
books and records.
ASC 830-20-25-2 states that if an entity maintains its books and
records in a currency other than its functional currency, “remeasurement into
the functional currency is required before translation into the reporting
currency.” Such situations occur most commonly when an entity maintains its
books and records in the local currency but, because it operates in a highly
inflationary economy, uses the reporting currency of its immediate parent as its
functional currency. (See Chapter 7 for further discussion of highly inflationary
economies.) However, this requirement applies to all situations in which an
entity maintains its books and records in a currency that differs from its
functional currency.
In such situations, nonmonetary assets and liabilities must be
remeasured at historical exchange rates (i.e., the exchange rates in effect when
the assets or liabilities were initially recognized) while monetary assets and
liabilities must be remeasured at current exchange rates. Accordingly,
remeasurement of monetary assets and liabilities from the foreign currency into
the functional currency will result in the recognition of transaction gains or
losses in earnings. The objective of such remeasurement is to produce the same
results as those that would be produced if the entity had maintained its books
and records in the functional currency; this objective is consistent with the
overall remeasurement principle in ASC 830-10-45-17.
4.4 Investments in Debt and Equity Securities
In accordance with ASC 320-10, investments in debt securities can be classified
as trading, AFS, or HTM. Such classification dictates the foreign currency
accounting for these investments. Under ASC 321, equity securities are measured at
either (1) fair value, with changes in fair value recognized in earnings, or (2)
cost minus impairment, if any, plus or minus changes resulting from observable price
changes in orderly transactions for the identical or similar investment of the same
issuer (see ASC 321-10-35-2). The measurement approach applied will affect the
foreign currency accounting for these investments.
4.4.1 Investments in Debt Securities
ASC 320-10
35-1 Investments in debt securities shall be measured subsequently as follows:
- Trading securities. Investments in debt securities that are classified as trading shall be measured subsequently at fair value in the statement of financial position. Unrealized holding gains and losses for trading securities shall be included in earnings.
- Available-for-sale securities. Investments in debt securities that are classified as available for sale shall be measured subsequently at fair value in the statement of financial position. Unrealized holding gains and losses for available-for-sale securities (including those classified as current assets) shall be excluded from earnings and reported in other comprehensive income until realized except as indicated in the following sentence. All or a portion of the unrealized holding gain and loss of an available-for-sale security that is designated as being hedged in a fair value hedge shall be recognized in earnings during the period of the hedge, pursuant to paragraphs 815-25-35-1 and 815-25-35-4. . . .
Investments in debt securities that are classified as either trading or AFS under ASC 320-10 are nonmonetary assets and therefore are not subject to remeasurement at current exchange rates under ASC 830. However, ASC 320-10-35-1 requires that trading and AFS securities be subsequently remeasured at fair value.
If a trading or AFS security is denominated in a foreign currency, changes in the exchange rate between the foreign currency and an entity’s functional currency will affect the security’s fair value. Therefore, under ASC 320-10, the trading or AFS security must be remeasured from the foreign currency to the functional currency as of each reporting date by using the current exchange rate to determine the fair value of the security.
ASC 320 further requires that all changes in the fair value of a trading security be recognized in earnings. Conversely, all changes in the fair value of an AFS security must be recognized in OCI.
Connecting the Dots
It would not be appropriate for an entity to bifurcate the change in the fair value of a trading or AFS security related strictly to the change in exchange rates and classify that portion as a transaction gain or loss in the income statement. Rather, the entire change in the security’s fair value (including the portion related to a change in the exchange rates) would be classified in accordance with ASC 320-10.
4.4.1.1 Investments in HTM Debt Securities
ASC 320-10
35-1 Investments in debt
securities shall be measured subsequently as
follows: . . .
c. Held-to-maturity securities. Investments
in debt securities classified as held to maturity
shall be measured subsequently at amortized cost
in the statement of financial position. A
transaction gain or loss on a held-to-maturity
foreign-currency-denominated debt security shall
be accounted for pursuant to Subtopic
830-20.
Unlike trading and AFS securities, investments in debt
securities that are classified as HTM under ASC 320-10 are monetary assets
and therefore will give rise to transaction gains or losses under ASC
830-20. HTM debt securities are monetary assets because the amount that the
entity will receive upon settlement is fixed and determinable. Further,
unlike trading and AFS securities, HTM debt securities must be carried at
amortized cost, not fair value.
Accordingly, HTM debt securities that are denominated in a
foreign currency must be remeasured as of each reporting date by using the
current exchange rate. Any changes in the carrying value of the security
that are attributable to changes in exchange rates should be reported as a
transaction gain or loss in earnings. The following table summarizes the
exchange rates that should be used to remeasure the accounts that may be
associated with an investment in an HTM debt security:
Account Description
|
Exchange Rate
|
---|---|
Investment in HTM security
|
Current spot rate
|
Accrued interest
|
Current spot rate
|
Interest income
|
Weighted-average rate
|
Amortization of premium or
discount
|
Weighted-average rate
|
Connecting the Dots
Loan receivables that are classified as held for
investment (HFI) are measured at amortized cost. Therefore, the
guidance and examples that apply to HTM debt securities would also
apply to foreign-currency-denominated HFI loan receivables carried
at amortized cost.5 This guidance is illustrated in the examples below.
Example 4-3
Foreign-Currency-Denominated HTM Security
Purchased at Par
On January 1, 20X6, Investor
Co, a U.S. registrant whose functional currency is
the USD, purchases a 10-year bond bearing 6
percent annual interest with a par value of
1,000,000 EUR. The purchase price of the bond is
equal to its par value (i.e., no premium or
discount is associated with the bond).
Assume that Investor Co
classifies its investment in the bond as an HTM
security under ASC 320-10 and that the following
exchange rates are in effect during 20X6:
To record its initial
investment in the bond in its functional currency,
Investor Co records the following journal entry on
January 1, 20X6 [€1,000,000 × (€1:$1.2)]:
The table below summarizes the
various amounts that would be recorded in Investor
Co’s financial statements on December 31,
20X6.
The foreign currency
transaction gain calculated above consists of two
components: (1) remeasurement of the investment in
the bond ($300,000) and (2) remeasurement of
accrued interest receivable ($12,000). Since the
investment in the bond is a monetary asset, it
must be remeasured by using the current spot rate
in effect as of December 31, 20X6. This process
results in a transaction gain of $300,000
[€1,000,000 × (1.5 – 1.2)]. Further, because the
accrued interest receivable represents a monetary
asset, it must also be remeasured at the spot
rate. However, since the accrued interest
receivable was recorded throughout the year at the
weighted-average exchange rate (as the interest
income was recognized), the transaction gain of
$12,000 is calculated as the difference between
the spot rate on December 31, 20X6, and the
weighted-average exchange rate during 20X6
[€60,000 × (1.5 – 1.3)].
Example 4-4
Foreign-Currency-Denominated HTM Security
Purchased at a Discount
Assume the same facts as in
Example 4-3, except that Investor Co
only pays €900,000 to purchase the bond (i.e., the
bond is issued at a discount).
The table below reflects a
simplified bond amortization schedule for
20X6.
To record its initial
investment in the bond in its functional currency,
Investor Co records the following journal entry on
January 1, 20X6 [€900,000 × (€1:$1.2)]:
4.4.1.2 Impairment of Debt Securities
ASU
2016-13 adds to U.S. GAAP an impairment model (known as
the current expected credit loss [CECL] model) that is based on expected
losses rather than incurred losses. Under the new guidance, an entity
recognizes as an allowance its estimate of expected credit losses. The CECL
model is codified in ASC 326-20.
The CECL model applies to instruments held at amortized cost
(including HTM securities) but does not apply to AFS securities, which have
a separate impairment model (see ASC 326-30). Therefore, an entity will have
to use different credit loss models if its investment portfolio contains
both HTM and AFS securities. For foreign-currency-denominated AFS debt
securities, if a credit loss exists but the entity does not intend or would
not be required to sell the security before recovery of its amortized cost
basis, in accordance with ASC 320-10-35-36, the change in fair value would
be recognized (1) in earnings to the extent that the change is related to
expected credit losses and (2) in OCI to the extent that it is related to
changes in exchange rates and other factors.
ASU 2016-13 became effective for public business entities
that meet the definition of an SEC filer (excluding smaller reporting
companies) for annual periods beginning after December 15, 2019, including
interim periods therein. For all other entities, the ASU became effective
for annual periods beginning after December 15, 2022.
4.4.1.2.1 HTM Debt Securities
ASC 326-20
15-2 The guidance in this
Subtopic applies to the following items:
a. Financial assets measured at amortized
cost basis, including the following: . . .
2. Held-to-maturity debt
securities
30-1 The
allowance for credit losses is a valuation account
that is deducted from, or added to, the amortized
cost basis of the financial asset(s) to present
the net amount expected to be collected on the
financial asset. Expected recoveries of amounts
previously written off and expected to be written
off shall be included in the valuation account and
shall not exceed the aggregate of amounts
previously written off and expected to be written
off by an entity. At the reporting date, an entity
shall record an allowance for credit losses on
financial assets within the scope of this
Subtopic. An entity shall report in net income (as
a credit loss expense) the amount necessary to
adjust the allowance for credit losses for
management’s current estimate of expected credit
losses on financial asset(s).
HTM debt securities are within the scope of CECL. An
entity will recognize expected credit losses upon initial recognition of
an HTM debt security without regard to the security’s fair value. The
entity will continually update the underlying cash flows expected to be
collected in the currency of the HTM debt securities (i.e., the contract
currency) at the end of the financial reporting period when measuring
its expected credit losses, irrespective of the HTM debt security’s fair
value, and would record any expected credit loss as an allowance (or
contra asset) at the end of that reporting period. For more information
on how to account for the measurement of expected credit losses on HTM
securities, see Deloitte’s Roadmap Current Expected Credit
Losses.
Foreign-currency-denominated HTM debt securities are
monetary assets; therefore, the amortized cost of such securities would
be remeasured from the foreign currency to the entity’s functional
currency by using current exchange rates. In a manner consistent with
the treatment of the associated HTM debt security, any
foreign-currency-denominated allowance for estimated expected credit
losses would be treated as a monetary contra asset and would be
remeasured by using current exchange rates.
4.4.1.2.2 AFS Debt Securities
The CECL model in ASC 326-20 does not apply to AFS debt
securities. Rather, entities are required to recognize an allowance for
credit losses on AFS debt securities that are impaired as a result of
credit concerns in accordance with ASC 326-30. Such allowances for
credit losses can be reversed in subsequent financial reporting periods
if there is an improvement in the credit quality of an AFS debt
security. The flowchart below illustrates how an entity identifies and
assesses impairment on AFS debt securities denominated in a foreign
currency.
ASC 326-30
35-1 An investment is
impaired if the fair value of the investment is
less than its amortized cost basis.
35-6 In assessing whether a
credit loss exists, an entity shall compare the
present value of cash flows expected to be
collected from the security with the amortized
cost basis of the security. If the present value
of cash flows expected to be collected is less
than the amortized cost basis of the security, a
credit loss exists and an allowance for credit
losses shall be recorded for the credit loss,
limited by the amount that the fair value is less
than amortized cost basis. Credit losses on an
impaired security shall continue to be measured
using the present value of expected future cash
flows.
35-10 If an entity intends to
sell the debt security (that is, it has decided to
sell the security), or more likely than not will
be required to sell the security before recovery
of its amortized cost basis, any allowance for
credit losses shall be written off and the
amortized cost basis shall be written down to the
debt security’s fair value at the reporting date
with any incremental impairment reported in
earnings. If an entity does not intend to sell the
debt security, the entity shall consider available
evidence to assess whether it more likely than not
will be required to sell the security before the
recovery of its amortized cost basis (for example,
whether its cash or working capital requirements
or contractual or regulatory obligations indicate
that the security will be required to be sold
before the forecasted recovery occurs). In
assessing whether the entity more likely than not
will be required to sell the security before
recovery of its amortized cost basis, the entity
shall consider the factors in paragraphs
326-30-55-1 through 55-2.
ASC 320-10
35-36 The change in the fair
value of foreign-currency-denominated
available-for-sale debt securities, excluding the
amount recorded in the allowance for credit
losses, shall be reported in other comprehensive
income. See Subtopic 326-30 for measuring credit
losses on available-for-sale debt securities. In
accordance with the guidance in Subtopic 326-30,
an entity shall report credit losses on
available-for-sale debt securities in the
statement of financial performance as credit loss
expense.
When determining whether an impairment exists on an AFS
debt security that is denominated in a foreign currency, an entity
compares the security’s fair value (measured in the entity’s functional
currency at the current exchange rate) with its amortized cost basis
(measured at the historical exchange rate). If the fair value of the
security is below its amortized cost, the security is impaired. If the
impairment is due solely to a credit loss, an allowance for credit
losses must be recognized for the credit loss but is not to exceed the
amount by which the fair value of the security is less than its
amortized cost basis. If, however, (1) an entity intends to sell the
impaired security or (2) it is more likely than not that it will be
required to sell the impaired security before recovery of its amortized
cost basis, any allowance for credit losses must be written off and the
amortized cost basis must be written down to the security’s fair value,
with any incremental impairment recorded in earnings.
ASC 320-10-35-36 states, in part, that “[t]he change in
the fair value of foreign-currency-denominated available-for-sale debt
securities, excluding the amount recorded in the allowance for credit
losses, shall be reported in other comprehensive income.” As a result,
if the entity does not intend to sell the security or it is not more
likely than not that it will be required to sell the security before
recovery of its amortized cost basis, the entity would recognize in OCI
the change in the security’s fair value related to the changes in
foreign exchange rates.
Connecting the Dots
Stakeholders have questioned when unrealized
losses related to changes in foreign exchange rates on an AFS
debt security should be recognized in earnings and whether the
new guidance in ASC 326-30 will delay loss recognition.
Consequently, at the TRG’s November 2018 meeting, the FASB staff
confirmed that unrealized losses related to foreign exchange
rates should be reported in OCI and recognized in earnings “(a)
at the maturity of the security, (b) upon the sale of the
security, (c) when an entity intends to sell, or (d) when an
entity is more likely than not required to sell the security
before recovery of its amortized cost basis.” In addition, the
staff said that the concern that the amendments made by ASU
2016-13 (the guidance in ASC 326-30) will result in delayed loss
recognition “is beyond the scope of the Credit Losses TRG
because the topic relates to reporting changes in fair value
related to foreign exchange rates.”
There is diversity in how an entity may
translate its credit loss expense to reflect changes in the spot
rate. For example, an entity may translate its credit loss
expense at the end of the reporting period by using the spot
rate that existed when the asset was acquired or the spot rate
that exists at the end of the current reporting period. Either
approach is acceptable provided that it is applied consistently.
Note that this guidance does not apply to HTM securities. Any
impairment loss on HTM securities (i.e., monetary assets) is
translated by using the spot rate that exists at the end of the
current reporting period.
Example 7-4 in Deloitte’s Roadmap Current Expected Credit
Losses illustrates the accounting for an
impairment of a foreign-currency-denominated AFS debt security.
4.4.2 Investments in Equity Securities
ASC 321 requires that all equity securities be measured at fair value through
net income (FVTNI). However, for certain investments in equity securities
without a readily determinable fair value that do not qualify for the net asset
value practical expedient in ASC 820-10-35-59, an entity is permitted to elect a
practicability measurement exception7 to fair value measurement under which the investment is measured at cost,
less impairment, plus or minus observable price changes (in orderly
transactions) for an identical or similar investment of the same issuer.
For an equity security that is subsequently measured at fair value, all changes
in the fair value of the security, including those related to changes in
exchange rates, will be reported in net income. Period-end spot rates must be
used in such fair value measurements. For foreign-currency-denominated equity
securities accounted for by using the measurement exception, the historical
exchange rate as of the acquisition date is used to remeasure the security and
is updated only on the date a remeasurement adjustment is made as a result of an
impairment or an observable price change (see ASC 830-10-45-18).
4.4.2.1 Impairment of Equity Securities
Entities that elect the measurement alternative for equity securities will need
to assess the equity investment for impairment. As of each reporting period,
an entity must qualitatively consider whether the investment is impaired on
the basis of certain indicators. If it determines that the equity security
is impaired on the basis of the qualitative assessment, the entity must
recognize an impairment loss equal to the amount by which the security’s
carrying amount exceeds its fair value.
For equity securities whose fair value is determined in a foreign currency, the
fair value would be determined in the entity’s functional currency at the
current exchange rate (i.e., at the spot rate on the date of the
impairment). Further, the entire difference between the fair value of an
equity security and its carrying value would be recorded in earnings as an
impairment loss. Therefore, as shown in the example below, the portion of
the impairment loss attributable to changes in the exchange rate would not
be recorded separately as a foreign currency transaction loss under ASC 830.
Example 4-5
Impairment of a Foreign-Currency-Denominated
Equity Security
Investor Co, a U.S. entity whose
functional currency is the USD, purchases 750,000
shares of Lumber Co, a Canadian private entity, on
November 22, 20X6, for 1,000,000 CAD. Investor Co is
a public entity with a calendar year-end. Assume the
following facts:
-
Investor Co classifies its investment in the shares in Lumber Co as an FVTNI security under ASC 321-10.
-
The fair value of Investor Co’s investment in the shares of Lumber Co and the exchange rates in effect at the time of purchase and at year-end are as follows:
Further, assume that Investor Co has
elected the measurement alternative under ASC 321
and determined that the $210,000 impairment loss
should be recorded through the following journal
entry:
Although part of the impairment is
due to the devaluation of the CAD against the USD,
the portion of the impairment loss attributable to
changes in the exchange rate would not be recorded
separately as a foreign currency transaction
loss.
Footnotes
5
Loan receivables that are classified as held for sale (HFS)
are measured at the lower of amortized cost or fair value.
Both the amortized cost basis and the fair value of
foreign-currency-denominated loan receivables classified as
HFS would be affected by changes in exchange rates.
7
The measurement exception is not available to (1)
reporting entities that are investment companies, (2) broker-dealers in
securities, or (3) postretirement benefit plans.
4.5 Debt
Foreign-currency-denominated debt is a monetary liability and therefore should
be remeasured, as of each reporting date, in the functional currency at the current
exchange rate. Any change in the functional-currency-denominated value of the debt
caused by changes in exchange rates should be recognized as a transaction gain or
loss. However, if an entity has elected, in accordance with the fair value option,
to subsequently measure a liability at fair value, with changes reported in
earnings, the change in fair value that results from exchange rate changes will
represent a portion of the overall change in fair value and will not be reported
separately as a transaction gain or loss. ASC 825-10-45-5 requires an entity to
separately present, within OCI, the portion of the total change in the fair value of
a liability attributable to a change in the instrument-specific credit risk. ASC
830-20-35-7A addresses how to calculate the amount of the change in fair value that
is related to instrument-specific credit risk and indicates that an entity should
first measure this amount in the currency of denomination and then remeasure that
amount into the functional currency by using period-end spot rates.
4.5.1 Debt Issuance Costs
Under U.S. GAAP, entities are required to present debt issuance costs (other
than costs related to line-of-credit or
revolving-debt arrangements) on the balance sheet
as a direct deduction from the related debt
liability rather than as a deferred charge. Debt
issuance costs should be treated as a monetary
liability; therefore, the remeasurement of the
carrying amount of the debt liability in the
entity’s functional currency should reflect any
deduction related to debt issuance costs. In other
words, monetary liabilities (including the
carrying amount of a monetary debt liability that
has been adjusted for debt issuance costs) are
remeasured in the entity’s functional currency by
using current exchange rates.
4.6 Equity Transactions
As discussed in Section 4.3, equity-classified securities are nonmonetary accounts that must be measured at historical exchange rates (i.e., the rates that were in effect when the securities were issued).
ASC 480 provides guidance on determining whether a financial instrument with both debt- and equity-like characteristics must be classified as a liability (or, in certain circumstances, as an asset). ASC 480 applies to freestanding financial instruments only and therefore does not apply to embedded features in a hybrid instrument, such as a put option embedded in a preferred share. However, just because an entity concludes that it is not required to classify an instrument as a liability under ASC 480 does not mean that the instrument is automatically classified as equity. Rather, an entity must perform further analysis under other Codification subtopics (e.g., ASC 815-40, ASC 505) to determine whether the instrument should be classified as a liability or as equity.
4.6.1 Distinguishing Liabilities From Equity
Under ASC 480, certain financial instruments that embody an obligation of the
issuer should be accounted for as liabilities even if their legal form is that
of equity. ASC 480 requires that the following three classes of financial
instruments be accounted for as liabilities (or, in some circumstances, as
assets):
-
Mandatorily redeemable financial instruments — The issuer of a financial instrument that is in the form of a share must classify the share as a liability if it embodies an unconditional obligation requiring the issuer to redeem the share by transferring assets, unless redemption would occur only upon the liquidation or termination of the reporting entity (e.g., mandatorily redeemable shares and mandatorily redeemable NCIs that do not contain any substantive conversion features). This guidance does not, however, apply to certain mandatorily redeemable financial instruments issued by nonpublic entities that are not SEC registrants (see ASC 480-10-15-7A).
-
Obligations to repurchase the issuer’s equity shares by transferring assets — A financial instrument other than an equity share is classified as a liability if it both (1) embodies an obligation to repurchase the issuer’s equity shares (or is indexed to such an obligation) and (2) requires (or may require) the issuer to settle the obligation by transferring assets (e.g., physically settled or net-cash-settled forward purchase contracts or written put options on the entity’s own equity shares).
-
Certain obligations to issue a variable number of shares — A financial instrument that embodies an unconditional obligation or a financial instrument other than an outstanding share that embodies a conditional obligation that the issuer must or may settle by issuing a variable number of its equity shares is classified as a liability if the obligation’s monetary value is based solely or predominantly on one of the following: (1) a fixed monetary amount, (2) variations on something other than the fair value of the issuer’s equity shares, or (3) variations inversely related to changes in the fair value of the entity’s equity shares (e.g., share-settled debt and net-share-settled forward purchase contracts or written put options on the entity’s own equity shares). See ASC 480-10-25-14 for more information.
In addition, ASC 480-10-S99 contains SEC staff guidance on how to account for and present redeemable equity instruments (including classification within equity) that are not classified as liabilities under ASC 480-10-25 in an entity’s financial statements. As summarized in the table below, the foreign currency effects of financial instruments with characteristics of both debt and equity depend on whether those instruments are classified as liabilities, temporary equity, or permanent equity under ASC 480.
Classification | Foreign Currency Effects |
---|---|
Liability | The instrument represents a monetary liability and therefore should be
remeasured, as of each reporting date, in the functional
currency at the current exchange rate. Any change in the
functional-currency-denominated value of the debt caused
by changes in exchange rates should be recognized as a
transaction gain or loss unless the liability is
subsequently measured at fair value, with changes in
fair value recognized in earnings. In those situations,
the entire change in fair value (including the exchange
rate change component) would be recognized in the same
line item. |
Temporary equity | Like other equity instruments, instruments classified in temporary equity on the
balance sheet are considered nonmonetary accounts under
ASC 830. Changes in exchange rates therefore will not
result in transaction gains or losses under ASC 830.
However, to the extent that the instrument must be
subsequently remeasured under ASC 480-10-S99-3A, the
measurement of the instrument’s redemption value must
incorporate the effect of exchange rates. That is, the
effect of exchange rates would be recorded through
retained earnings (or, in the absence of retained
earnings, APIC) and included as an adjustment to net
income available to common shareholders in the
calculation of earnings per share in accordance with ASC
480-10-S99-3A. Further, although ASC 480-10-S99-3A does
not address foreign currency, consideration of the
effects of changes in exchange rates when the “floor” is
applied would be most consistent with the intention of
the concept in that guidance. |
Permanent equity | The instrument represents a nonmonetary account that must be measured at the historical exchange rate. Changes in exchange rates therefore will not result in transaction gains or losses. |
For further discussion of the application of ASC 480-10-S99-3A,
see Chapter 9 of
Deloitte’s Roadmap Distinguishing Liabilities From Equity.
4.6.2 Dividends
The declaration of a cash dividend, if the dividend is not paid on the
declaration date, results in the recognition of a monetary liability (i.e., a dividend payable). If the dividend is payable in a currency other than the entity’s functional currency, it must be remeasured, as of each reporting date, in the functional currency at the current exchange rate. Any change in the functional-currency-denominated value of the dividend payable caused by changes in exchange rates is recognized as a transaction gain or loss. The FASB 52
Implementation Group addressed this issue in December 1981 when it decided that
“the transaction adjustment on a dividend payable or receivable account should
be charged or credited to income.” This accounting is required regardless of
whether the dividend is payable to the entity’s parent or other third-party
shareholders.
Example 4-6
Foreign-Currency-Denominated Dividend
Company A, whose functional currency is
the ZAR, declares a $60 million dividend to its equity
shareholders on November 12, 20X6. The spot exchange
rate on the declaration date is $1 = ZAR 10. Assume the
following additional facts:
-
The dividend will be paid in ZAR at the spot rate in effect on December 27, 20X6.
-
The closing spot exchange rate on December 27, 20X6, is $1 = ZAR 12.
-
The dividend of ZAR 720 million ($60 million × 12) is paid on January 14, 20X7.
Because the payable is denominated in a
foreign currency (USD), A is at risk for fluctuations in
the foreign currency exchange rate between the
declaration date and December 27, the date on which the
exchange rate is fixed so that the dividend can be paid.
Therefore, A should record a transaction loss related to
the liability for the devaluation of the ZAR to the USD
for the period from November 12 through December 27.
Since the dividend will be paid in ZAR (i.e., A’s
functional currency), foreign exchange risk is no longer
associated with this payable after December 27.
4.7 Refundable Deposits and Advances
Refundable deposits and advances (both amounts received from customers and
amounts paid to suppliers) are monetary liabilities and assets. Therefore, if the
amounts are refundable in a foreign currency, the recognized asset or liability must
be remeasured in the functional currency on each reporting date at the current
exchange rate.
ASC 606 does not directly
address whether a refund liability should be
considered a monetary liability. However, the
determination of whether a refund liability is a
contract liability would affect whether the refund
liability would be considered a monetary or
nonmonetary liability. Regarding this
determination, paragraph BC37 of ASU
2016-20 states that “[a]n entity
should determine whether a refund liability should
be characterized as a contract liability on the
basis of the specific facts and circumstances of
the arrangement.”
4.8 Contract Assets and Contract Liabilities
ASC 606 requires the recognition of a (1) contract asset if an entity transfers goods or services to a customer before the customer pays consideration or before payment is due or (2) contract liability if an entity receives consideration (or had an unconditional right to consideration) before it transfers goods or services to the customer. This requirement is similar to the requirement under the legacy guidance in ASC 605-35 related to the recognition of costs in excess of billings or billings in excess of costs.
Like billings in excess of costs, contract liabilities8 are nonmonetary liabilities because they require an entity to perform a
service in the future. Contract assets are monetary assets for the same reason that
costs in excess of billings are monetary assets under legacy guidance. That is,
contract assets will ultimately be settled for an amount of cash to be received from
the customer.
A separate issue arises if a single contract with a customer contains a performance obligation that is in a contract asset position and another performance obligation that is in a contract liability position. ASC 606 requires an entity to present contract assets and contract liabilities on a net basis in the balance sheet. Therefore, questions have arisen about whether the guidance in ASC 830 should be applied to the gross contract asset and liability balances separately or only to the net contract asset or liability for a single contract.
The guidance in ASC 830 should generally be applied on a gross basis. Therefore,
if a single contract contains both a contract asset and a contract liability, an
entity would remeasure the gross contract asset as of each reporting date at the
current exchange rate. An entity would not remeasure the gross contract liability
since it represents a nonmonetary liability. The requirement to present contract
assets and liabilities on a net basis does not affect the recognition and
measurement of the asset and liability (i.e., the requirement strictly applies to
presentation matters); therefore, the “unit of account” is the gross asset and
liability. Entities are encouraged to consult with their accounting advisers if they
are considering applying the guidance in ASC 830 to the net contract asset/liability
for a single contract.
Footnotes
8
ASU 2016-20 clarifies that contract liabilities under ASC
606 are different from refund liabilities. Unlike contract liabilities,
refund liabilities are monetary liabilities and therefore must be remeasured
by using current exchange rates.
4.9 Inventories
ASC 830-10
55-8 The guidance on the subsequent measurement of inventory in Subtopic 330-10 requires special
application when the books of record are not kept in the functional currency. Inventories carried at cost in
the books of record in another currency should be first remeasured to cost in the functional currency using
historical exchange rates. Then, historical cost in the functional currency should be evaluated for impairment
under the subsequent measurement guidance using the functional currency. Application of the subsequent
measurement guidance in functional currency may require a write-down in the functional currency statements
even though no write-down has been made in the books of record maintained in another currency. Likewise, a
write-down in the books of record may need to be reversed if the application of the subsequent measurement
guidance in the functional currency does not require a write-down. If inventory has been written down in the
functional currency statements, that functional currency amount shall continue to be the carrying amount in
the functional currency financial statements until the inventory is sold or a further write-down is necessary.
An asset other than inventory may sometimes be written down from historical cost. Although different
measurement guidance may be used to determine that write-down, the approach described in this paragraph
might be appropriate. That is, a write-down may be required in the functional currency statements even though
not required in the books of record, and a write-down in the books of record may need to be reversed before
remeasurement to prevent the remeasured amount from exceeding functional currency historical cost.
ASC 830-10-45-18 states that inventory carried at cost is a nonmonetary asset.
Therefore, when an entity maintains its books and records in a foreign currency,
inventory must be remeasured in the functional currency at the historical exchange
rate (i.e., the rate that was in effect when the inventory was purchased). ASC
830-10-55-8 further requires that an entity apply the subsequent-measurement
guidance in ASC 330 to its functional currency.
Therefore, in certain instances, an entity may determine that it is required to
write down its inventory in its functional currency even though it is not required
to do so in the foreign currency. This situation typically arises when an entity
sells inventory in a foreign currency and the foreign currency has weakened against
the functional currency since the time the inventory was acquired. The example below
illustrates this concept.
Example 4-7
Subsequent Measurement When Books and Records Are
Maintained in a Foreign Currency
Parent Co, a U.S. registrant whose
functional and reporting currency is the USD, has a
subsidiary, Sub Co, that operates in Mexico. Assume that Sub
Co is a distinct and separable operation and that its
functional currency is the reporting currency (USD). Sub Co
maintains its books and records in MXN, the local
currency.
Assume that the following facts exist on
December 31, 20X6:
-
Sub Co uses the FIFO method for determining inventory cost.
-
Sub Co’s inventory balance is $50,000, which is equal to the local currency amount of MXN 500,000 translated at the historical exchange rate of MXN 1 = $0.10.
-
Sub Co determines that the net realizable value (NRV) of the inventory on December 31, 20X6, under ASC 330-10-35 is $30,000, computed on the basis of the 600,000 MXN and an exchange rate of 1 MXN = $0.05.
As a result, Sub Co recognizes a
subsequent-measurement adjustment of $20,000 on December 31,
20X6. The inventory will be carried in Sub Co’s financial
statements at $30,000 until it is disposed of or
subsequently written down as a result of a further decline
in its market value.
In this example, Sub Co is required to
recognize a subsequent-measurement adjustment in its
functional currency even though no write-down in the local
currency would have been required. That is, the NRV of the
inventory in the local currency is MXN 600,000, which is
greater than its carrying value of MXN 500,000. A
subsequent-measurement adjustment is required because of the
devaluation of the MXN against the USD since the inventory
was acquired.
4.10 Property, Plant, and Equipment
ASC 830-10-45-18 states that PP&E are
nonmonetary assets. Therefore, when an entity maintains its books and records in a
foreign currency, PP&E must be remeasured in the functional currency at the
historical exchange rate (i.e., the rate that was in effect when the PP&E was
purchased). Further, upon a triggering event, entities must perform a two-step test
under ASC 360-10 to determine whether PP&E is impaired:
-
Step 1 — Compare the carrying amount of the PP&E with the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group).
-
Step 2 — If the carrying value of the PP&E exceeds the undiscounted cash flows determined in step 1, compare the carrying value of the PP&E with its fair value. If the carrying value exceeds the fair value, an impairment loss is recognized for the difference.
As with the accounting for inventory discussed in Section 4.9, an entity must test PP&E for
impairment in its functional currency. Therefore, when an entity maintains its books
and records in a foreign currency, a devaluation of the foreign currency against the
functional currency could cause an entity to fail step 1 of the impairment test.
This is because PP&E constitute nonmonetary assets that must be remeasured at
the historical exchange rate, while the undiscounted cash flows are measured at the
exchange rate that is in effect when the impairment test is performed. As with
inventory, an impairment of PP&E in the functional currency may result even
though the entity is not required to report an impairment in the books and records
maintained in the foreign currency. The example below illustrates this concept.
Example 4-8
PP&E Impairment Test When Books and Records Are
Maintained in a Foreign Currency
Parent Co, a U.S. registrant whose
functional and reporting currency is the USD, has a
subsidiary, Sub Co, that operates in Mexico. Sub Co is a
distinct and separable operation whose functional currency
is the reporting currency (USD). Sub Co maintains its books
and records in MXN, the local currency.
Assume that Sub Co purchased a piece of
equipment for MXN 250,000 in 20X6, when the exchange rate
was MXN 1 = $0.10, and that the equipment is a single asset
group under ASC 360-10. In 20X9, because of a significant
decline in the operations of Sub Co, the equipment is tested
for impairment under ASC 360-10.
Assume that the following facts exist on
December 31, 20X9:
-
The carrying value of the equipment is $17,500 (MXN 175,000 measured at the historical exchange rate).
-
The sum of undiscounted cash flows expected to result from the use and eventual disposition of the equipment is MXN 200,000.
-
The exchange rate is MXN 1 = $0.05.
-
The fair value of the equipment is $5,000.
Sub Co determines that the carrying value of
the equipment ($17,500) exceeds the sum of the undiscounted
cash flows ($10,000) on a functional currency basis.
Therefore, Sub Co recognizes an impairment loss of $12,500
on December 31, 20X9 ($5,000 fair value less $17,500
carrying value).
As in Example 4-7, Sub Co
must recognize an impairment loss in its functional currency
even though no impairment would have been recognized if the
local currency were the functional currency. That is, the
sum of the undiscounted cash flows in the local currency is
MXN 200,000, which is greater than the equipment’s carrying
value of MXN 175,000.
4.11 Leases
With limited exceptions, ASC 842 requires lessees to recognize an
ROU asset and a lease liability as of the lease commencement date, regardless of
lease classification. The implementation guidance in ASC 842-20-55-10 clarifies that
an ROU asset is a nonmonetary asset and a lease liability is a monetary liability.
Therefore, when a lease is denominated in a foreign currency, the ROU asset must be
remeasured in the functional currency by using the historical exchange rate (in a
manner consistent with the remeasurement of PP&E purchased in a foreign
currency, which is discussed in Section 4.10) and the lease liability must be remeasured by using
the current exchange rate (in a manner consistent with the remeasurement of
foreign-currency-denominated debt, which is discussed in Section 4.5).
Connecting the Dots
Questions have arisen regarding what rate should be used —
and how it should be used — to remeasure the ROU asset after a lease has
been modified and the modification was not accounted for as a separate
contract, specifically whether (1) the ROU asset, in its entirety, should be
remeasured by using the exchange rate as of the “new” lease commencement
date (i.e., the date of the lease modification) or (2) the historical
exchange rate as of the original lease commencement date should be applied
to the ROU asset established before the modification and the exchange rate
as of the date of the lease modification should be applied to any increase
in the ROU asset resulting from the modification (i.e., a bifurcated
approach to foreign currency remeasurement). (See Deloitte’s Roadmap
Leases for additional discussion.)
4.12 Share-Based Payments
Under ASC 718, share-based payment awards are classified as either liabilities or equity. As summarized in the table below, the foreign currency effects of share-based payment awards that are denominated in a foreign currency depend on the classification of the award.
Classification Under ASC 718 | Measurement Under ASC 718 | Foreign Currency Effects |
---|---|---|
Liability | Generally, remeasured as of each reporting date at fair value until the award is settled. | The fair value of the award should be determined in the functional currency by using the current exchange rate. Fluctuations in the fair-value-based measure of the liability award are recorded as increases or decreases in compensation cost, either immediately or over the remaining service period, depending on the vested status of the award. Compensation cost is recorded in the functional currency by using the weighted-average exchange rate for the reporting period. Upon exercise, proceeds are measured at the spot rate in effect at that time, with any difference recorded in equity. |
Equity | Generally, measured on the grant date; not subsequently remeasured. | Compensation cost is recorded in the functional currency by using the weighted-average exchange rate for the reporting period. Upon exercise, proceeds are measured at the spot rate in effect at that time, with any difference recorded in equity. |
4.13 Deferred Taxes
As shown in the table in Section
4.3.1, DTAs and DTLs are classified as
monetary accounts. Typically, an entity files its
income tax return in the local currency of the
jurisdiction in which it operates. Further, an
entity’s tax basis in assets and liabilities is
generally determined in the local currency;
accordingly, deferred taxes are typically measured
in the local currency. Therefore, if an entity’s
functional currency is different from the currency
in which the entity has to pay taxes, deferred
taxes must be remeasured in each reporting period
at the current exchange rate. See Chapter
8 for further considerations related to
accounting for income taxes.
4.14 Warranty Obligations
When an entity sells a product to its customer, it may also provide the customer with a warranty on that product. The warranty might be described as a manufacturer’s warranty, a standard warranty, or an extended warranty. Some warranties protect the customer from defects that exist when the product is sold, while others protect the customer from faults that arise after the product has been received. In substance, an entity’s warranty obligation represents a promise to stand ready to replace or repair the product in accordance with the terms and conditions of the warranty.
ASC 460-10-25-5 states that warranty obligations incurred in connection with the
sale of goods or services represent contingent
liabilities and that an entity should therefore
accrue losses from warranty obligations when the
criteria in ASC 450-20-25-2 are met. The liability
recognized for an entity’s warranty obligation
represents a nonmonetary liability under ASC 830
(since it will not be settled in cash) and
therefore would not be subject to remeasurement in
each period.
4.15 Sales With a Right of Return
In some contracts, an entity sells a good to a customer and grants the customer the right to return
the good for a refund (e.g., if the customer is dissatisfied with the product). Under ASC 606-10-55-25, “[f]or any amounts received
(or receivable) for which an entity does not expect to be entitled, the entity should not recognize
revenue when it transfers products to customers but should recognize those amounts received (or
receivable) as a refund liability.” This liability represents a refundable
deposit received from the customer and therefore is a monetary liability under ASC 830. Therefore, if
the sales price of the good is denominated in a foreign currency, the entity should remeasure the liability
in its functional currency as of each reporting date, with changes recognized in earnings as transaction
gains or losses (in a manner consistent with the remeasurement of refundable advance payments
denominated in a foreign currency, which is discussed in Section 4.7).
4.16 Sales of Future Revenues
ASC 470-10
Sales of Future Revenues or Various Other Measures of Income
25-1 An entity receives cash from an investor and agrees to pay to the investor for a defined period a specified percentage or amount of the revenue or of a measure of income (for example, gross margin, operating income, or pretax income) of a particular product line, business segment, trademark, patent, or contractual right. It is assumed that immediate income recognition is not appropriate due to the facts and circumstances. The payment to the investor and the future revenue or income on which the payment is based may be denominated in a foreign currency.
ASC 470-10 requires that the proceeds received from an investor be classified as
either deferred income or debt depending on the facts and circumstances.
Specifically, ASC 470-10-25-2 states that there is a rebuttable presumption that the
proceeds should be classified as debt if any of the following factors are
present:
If an entity concludes that proceeds received from the sale of future revenues should be classified as debt, it should account for the foreign currency effects in the same manner as that described in Section 4.5. If an entity concludes that proceeds received from the sale of future revenues should be classified as deferred income, it should account for the foreign currency effects in the same manner as contract liabilities, which are discussed in Section 4.8.
4.17 Debt-for-Equity Swap
The implementation guidance in ASC 830-20-55-1 through 55-3 describes a
transaction in which a U.S. entity purchases dollar-denominated debt due from a
foreign government, or an entity that operates in that foreign country, for less
than its face value. The U.S. entity then exchanges that debt with the foreign
country’s government in a transaction denominated in the foreign currency and is
required to invest that money in its subsidiary operating in that foreign country.
The foreign government’s intent in this transaction is generally to induce the U.S.
entity to invest in long-lived assets in the foreign country (through its subsidiary
in that country). The graphic below illustrates this transaction.
Debt-for-equity swap programs may be in place in financially troubled countries, since the intent of the above transaction is to induce the U.S. entity to invest in the foreign country (by purchasing long-lived assets through its foreign subsidiary). In practice, debt-for-equity swaps are complicated transactions that can involve several brokers and are subject to both domestic and international currency regulations.
In general, the U.S. entity will receive more proceeds from the foreign
government than it paid to acquire the debt. Under
ASC 830-20-55-2, the cost basis of any long-lived
assets acquired or constructed should be reduced
by the amount by which the foreign currency
proceeds (received from the government) translated
at the official exchange rate exceed the purchase
cost of the debt. The example below illustrates
this concept.
Example 4-9
Debt-for-Equity Swap
Parent Co, a U.S. registrant
whose functional and reporting currency is the
USD, has a subsidiary, Sub Co, that operates in
Brazil. Parent Co purchases USD-denominated debt
with a principal amount of $5 million from a
Brazilian bank for $2 million (the debt’s price in
the secondary market). Immediately after acquiring
the debt, Parent Co sells the debt to the
Brazilian government for 15 million BRL, the local
currency. The official exchange rate in effect on
the date Parent Co sold the debt to Brazil was BRL
1 = $0.3. Therefore, the USD value of the proceeds
received from the Brazilian government is $4.5
million ($15 million × 0.3).
In this example, the excess of
the amount received from the Brazilian government
over the amount paid to acquire the debt is $2.5
million ($4.5 million proceeds – $2 million
purchase price). Assume that in accordance with
the terms of the sale to the government, Parent Co
is required to contribute the proceeds to Sub Co
and that Sub Co must use the proceeds to acquire
long-lived assets in Brazil. Under ASC
830-20-55-2, the carrying value of the long-lived
assets acquired must be reduced by the $2.5
million of excess proceeds received from the
Brazilian government.
4.18 Capitalized Interest
ASC 835-20 — Glossary
Interest Cost
Interest cost includes interest recognized on obligations having explicit
interest rates, interest imputed on certain types
of payables in accordance with Subtopic 835-30,
and interest related to a finance lease determined
in accordance with Topic 842. With respect to
obligations having explicit interest rates,
interest cost includes amounts resulting from
periodic amortization of discount or premium and
issue costs on debt.
Interest costs are the only costs that are eligible for capitalization under ASC
835-20. Further, AICPA Technical Q&As Section 2210.27 states that if a
foreign-currency-denominated loan is obtained to construct a building, “the
transaction gains and losses are not part of the cost of the building, but are a
result of the change in the exchange rate and are included in income each period in
which the exchange rate fluctuates.” That is, transaction gains or losses are
precluded from capitalization under ASC 835-20.
SEC Considerations
The SEC staff presented its views on this issue in a March 20, 1995, letter to the Accounting Principles Commission of the Mexican Institute of Public Accountants. The staff stated, in part:
The staff believes that the amount subject to capitalization on USD borrowings should be the stated rate on such borrowings. Therefore, both the foreign exchange loss and the monetary gain are excluded from the amount subject to capitalization. Under this policy, the amount subject to capitalization on USD borrowings would be the same if the Mexican entity were a reporting company or a subsidiary of a U.S. company.
4.19 Defined Benefit Pension Plans
In some cases, the benefits payable to plan participants under defined benefit pension or other postretirement plans may be denominated in a currency other than an entity’s functional currency. For example, a foreign entity whose functional currency is the reporting currency of its parent may sponsor a defined benefit plan with benefit payments payable in the local currency. In these instances, it is also common for the plan assets to be denominated in the foreign currency.
Under ASC 715-30, a reporting entity must remeasure the funded status of its defined benefit plans annually or upon the occurrence of certain significant events (e.g., a plan amendment or curtailment). ASC 715-30 requires that the plan assets be remeasured at fair value and that the benefit obligation be remeasured at its actuarial present value. Further, ASC 715-30 requires that all changes in the funded status of a plan that occur as a result of this remeasurement process be recognized in OCI. However, ASC 715-30 does not explicitly address how an entity should consider the effects of exchange rate changes in remeasuring the funded status of a plan that is denominated in a foreign currency.
Under ASC 830, an entity that maintains its books and records in a currency
other than the functional currency must remeasure
those books and records in its functional
currency.
The funded status of a defined benefit plan
that is denominated in a foreign currency should
be remeasured in the functional currency by using
the current exchange rate. As stated above, the
plan assets must be remeasured at fair value under
ASC 715-30. In such circumstances, an entity is
required to use current exchange rates to measure
the fair value of foreign-currency-denominated
plan assets in functional-currency units. In
addition, while the benefit obligation is not
measured at fair value, it is remeasured at the
amount for which the obligation could currently be
settled. Therefore, a current exchange rate must
be used to remeasure the benefit obligation so
that the amount for which it could currently be
settled is properly reflected in an entity’s
functional currency.
However, because neither ASC 715-30 nor ASC 830 explicitly addresses how to
account for the effects of exchange rate changes
related to defined benefit plans (i.e., whether
the change should be recorded as a component of
OCI or in earnings), there are two acceptable
views on presenting the change in the funded
status of a defined benefit plan due to exchange
rate fluctuations.
View A — Recognize Currency Adjustments in OCI
Under View A, the funded status of a defined benefit plan would be considered a
nonmonetary asset or liability under ASC 830. This view is based on an analogy
to the implementation guidance in ASC 255. Specifically, the table in ASC
255-10-55-1 states that the specific assets in “[p]ension, sinking, and other
funds under an entity’s control . . . should be classified as monetary or
nonmonetary” and that, for “[a]ccrued pension obligations,” the “[f]ixed amounts
payable to a fund are monetary” and “all other amounts are nonmonetary.”
Therefore, because the funded status of a plan does not represent a “fixed
amount payable to a fund,” it should be considered a nonmonetary asset or
liability under ASC 255. However, as discussed in Section 4.3.2, other authoritative
literature (in this case, ASC 715-30) may require that a nonmonetary asset or
liability be subsequently remeasured at current exchange rates. Therefore, under
View A, because ASC 715-30 requires that the funded status of a pension plan be
remeasured at current exchange rates, changes in the carrying value should also
be presented in accordance with ASC 715-30. Under ASC 715-30-25-4, all changes
resulting from the remeasurement of the funded status of a plan are reported in
OCI (provided that the entity’s accounting policy is to amortize the resulting
gains and losses into net income over future accounting periods and not to
immediately recognize those gains and losses in net income).
View B — Recognize Currency Adjustments in Income
Under View B, the funded status of a defined benefit plan would be considered a monetary asset or liability under ASC 830 for the following reasons:
- The account will ultimately be settled in cash, through either recovery of the net pension asset or settlement of the net pension liability.
- While not authoritative for entities reporting under U.S. GAAP, paragraph 16 of IAS 21 explicitly states that “pensions and other employee benefits to be paid in cash” are monetary items. Proponents of View B believe that IAS 21 and U.S. GAAP do not substantively differ regarding how an entity determines monetary and nonmonetary accounts when applying the guidance on accounting for the effects of exchange rate changes.
In accordance with ASC 830-10-45-17, all transaction gains and losses related to remeasurement of monetary assets and liabilities that are not denominated in the functional currency must be recognized currently in earnings.
The accounting for currency adjustments related to remeasuring a foreign-currency-denominated defined benefit plan in either OCI or earnings is an accounting policy election that should be applied consistently.
4.20 AROs and Environmental Remediation Liabilities
There is diversity in practice in the determination of whether an ARO or an
environmental remediation liability is a monetary liability, a nonmonetary
liability, or outside the scope of ASC 830 altogether. There is a presumption that
such liabilities are denominated in an entity’s functional currency, unless the
entity has entered into a binding agreement denominated in a foreign currency to
settle the obligation or has a legal obligation to settle the obligation in a
foreign currency. Therefore, such obligations would be outside the scope of ASC 830.
Various views on whether an ARO is a monetary or nonmonetary liability were
discussed in the May 4, 2005, EITF Agenda Committee Report. Although the EITF Agenda
Committee ultimately decided not to add this issue to the EITF’s agenda, the above
view is consistent with View C from the report, which states, in part:
In the absence of a binding agreement or legal requirement to
settle the obligation in a specific foreign currency, the entity should assume
that the liability is denominated in its own functional currency and,
accordingly, the liability is not within the scope of Statement 52.
Although the discussion in the report was limited to AROs, the above guidance
would apply equally to environmental remediation liabilities and other contingent
liabilities when a legal requirement to settle in a specific currency is not
provided.