5.2 Translation Process
ASC 830-30 defines foreign currency translation as the “process of
expressing in the reporting currency of the reporting entity those amounts that are
denominated or measured in a different currency.” The translation guidance outlined
in this chapter applies to an entity’s functional-currency-based results.
Example 5-1
Translating Financial Statements
Company B, a Polish company that has
identified the local currency (PLN) as its functional
currency, is a subsidiary of Parent Co, a U.S. parent that
uses the USD for reporting purposes. Company B has debt on
its books that is denominated in USD and EUR.
Before translating its financial statements,
B is first required to recognize transaction gains or losses
related to its foreign-currency-denominated debt. To do so,
B measures (1) the USD-denominated debt by using the
exchange rates existing as of the balance sheet date for the
PLN and the USD and (2) the EUR-denominated debt by using
the exchange rates existing as of the balance sheet date for
the PLN and the EUR. The offset to each of these entries is
recorded in earnings as a transaction gain or loss.
Next, Parent Co translates the
functional-currency (local-currency) financial statements of
B into USD. As discussed in Section 5.2.1, the
current exchange rate as of the balance sheet date is used
to translate assets and liabilities while an appropriate
rate (e.g., weighted-average exchange rate for the period)
is used to translate revenues, expenses, and other income
statement items. The translation adjustments are recorded as
a CTA, a separate component of OCI.
While not specifically addressed in ASC 810 or ASC 830, multitiered
organizations typically apply the translation process in the same sequence as the
consolidation process (on a step-by-step basis).
Example 5-2
Multilevel Consolidation
A U.S. parent wholly owns a second-tier
German subsidiary, which in turn wholly owns a third-tier
British subsidiary. The German subsidiary and British
subsidiary are separate foreign entities under ASC 830. The
local currency is the functional currency for all entities,
and the reporting currency of the consolidated entity is the
USD.
When preparing the financial statements for
the consolidation of the subsidiaries with the U.S. parent,
the entities would do the following:
-
The German subsidiary would translate the British subsidiary’s GBP-denominated financial statements (i.e., the functional-currency financial statements) into EUR-denominated financial statements. The GBP-to-EUR translation adjustment would be recorded in the CTA of the German subsidiary’s financial statements.
-
The U.S. parent would then translate the EUR-denominated, consolidated financial statements of the German subsidiary into USD. The EUR-to-USD translation adjustment would be recorded in the CTA of the U.S. parent’s financial statements.
5.2.1 Effecting a Translation
When applying the guidance in ASC 830-30 to translate functional
currency statements into a single reporting currency, an entity needs to
identify the appropriate exchange rate to use for this purpose.
In addition to applying the appropriate exchange rates, when
translating foreign currency statements of foreign entities that are
consolidated, combined, or accounted for under the equity method, an entity may
need to consider whether it needs to make additional adjustments to the
translated balances for items such as intra-entity eliminations as well as
goodwill and purchase price adjustments (i.e., basis differences), as discussed
below. Timing differences between the investee’s reporting periods and those of
the reporting entity (i.e., reporting time lags) should also be taken into
account in the determination of the exchange rate to be applied for translation,
as discussed in Section
3.3.1.
The following diagram illustrates the key factors an entity
should consider when translating foreign currency statements:
5.2.1.1 Exchange Rate
ASC 830-30
45-3 All elements of
financial statements shall be translated by using a
current exchange rate as follows:
- For assets and liabilities, the exchange rate at the balance sheet date shall be used.
- For revenues, expenses, gains, and losses, the exchange rate at the dates on which those elements are recognized shall be used.
This guidance also
applies to accounting allocations (for example,
depreciation, cost of sales, and amortization of
deferred revenues and expenses) and requires
translation at the current exchange rates applicable
to the dates those allocations are included in
revenues and expenses (that is, not the rates on the
dates the related items originated).
Under ASC 830-30, all financial statement elements must be
translated by using a current exchange rate, which ASC 830-30-45-4 defines
as “the rate as of the end of the period covered by the financial statements
or as of the dates of recognition in those statements in the case of
revenues, expenses, gains, and losses.” As noted in Section 3.2.1, for
practicality reasons, ASC 830 permits the use of weighted-average exchange
rates or other methods that provide a reasonable approximation of the rates
in effect on the date of recognition.
The following is a summary of the exchange rates used in the
translation process, as outlined in Section
3.2.1:
Further, as outlined in Section 3.2.1, while ASC 830 does not
provide specific guidance on which rate should be used to translate a
foreign entity’s equity accounts, it would be appropriate to translate
equity accounts at historical rates, except changes to retained earnings for
current-period net income.
5.2.1.1.1 Translation of Balances Reclassified From AOCI
The accounting literature is not explicit on the
exchange rate that applies to the translation of amounts reclassified
from accumulated other comprehensive income (AOCI) to earnings.
Accordingly, questions have been raised regarding whether the
translation of such balances should be based on (1) the historical
exchange rate or (2) the current average exchange rate. The following
graphic summarizes the difference between the two approaches:
For pension and other postretirement-related balances
originally recognized in OCI and reclassified from AOCI to net periodic
benefit cost in subsequent periods, both of these approaches are
considered acceptable in practice. The selection of either approach
would be viewed as an accounting policy election.
Under the historical exchange rate approach, AOCI is
viewed as akin to retained earnings. Accordingly, since amounts
accumulated in retained earnings are not translated at a current rate
under ASC 830 (i.e., retained earnings do not fluctuate as a result of
subsequent changes in exchange rates), the amounts reclassified from
AOCI to net periodic benefit cost should not be retranslated. Similarly,
since the amounts in AOCI have been previously recognized in
comprehensive income,1 the reclassification from AOCI to earnings should not be viewed as
a new recognition event from a translation perspective. Therefore, the
amounts initially recognized in OCI and translated at the rate in effect
at that time would reflect the balance subject to reclassification from
AOCI to net periodic benefit cost.
Under the current average exchange rate approach, the
reclassification of amounts in AOCI is viewed as akin to newly
recognized earnings. Accordingly, the rate in effect at the time of
reclassification, which will often be an average rate for the period as
the pension and other postretirement amounts are released over time,
would be used to determine the amount that is reclassified from AOCI to
net periodic benefit cost. This treatment would be consistent with the
ASC 830 approach for the initial recognition of income statement
items.
While the historical exchange rate approach may be viewed as the more supportable of the two approaches, the current average exchange rate approach is considered acceptable in practice as an alternative for pension and other postretirement-related balances. Initially, the objective of permitting the use of the current average exchange rate approach for applicable pension and other postretirement amounts was to allow for consistency with the approach used before the adoption of FASB Statement 158 (codified in ASC 715), since the
amendments were not intended to change the measurement of the applicable
pension and other postretirement balances.2 Before FASB Statement 158, unrecognized prior service
costs/credits, net gains or losses, and translation obligations/assets
remained off-balance-sheet and were translated at the average exchange
rates for the period when these amounts were recognized in net periodic
benefit cost.
For other balances deferred in AOCI (e.g., AFS
investments, amounts related to certain hedging instruments), ASC 830
similarly does not address the exchange rate applicable to translation
of amounts reclassified from AOCI to earnings. In such cases, while it
may be more supportable under ASC 830 to use the historical exchange
rate approach than it is to use the current average exchange rate
approach, an entity may elect either approach as an accounting
policy.
5.2.1.2 Intra-Entity Transactions
ASC 830-30
45-10 The elimination of
intra-entity profits that are attributable to sales
or other transfers between entities that are
consolidated, combined, or accounted for by the
equity method in the reporting entity’s financial
statements shall be based on the exchange rates at
the dates of the sales or transfers. The use of
reasonable approximations or averages is
permitted.
In a manner consistent with the accounting for
consolidations, combinations, and the equity method of accounting,
intra-entity profits are generally eliminated. For transactions that are
eliminated, ASC 830-30-45-10 prescribes the use of the sale or transfer date
exchange rate, or approximation thereof, which is consistent with the
exchange rate applicable to income statement items (as discussed in
Section
5.2.1.1). This requirement results in the application of an
exchange rate to items subject to elimination that is consistent with the
rate applicable to items that are not eliminated.
However, intra-entity foreign-currency-denominated
transactions may not be eliminated in all cases, as discussed in Chapter 6.
Accordingly, such transactions would result in earnings volatility, in the
absence of qualifying as a long-term investment, since the transaction would
be remeasured to the functional currency through earnings while the
translation to the reporting currency would be deferred through OCI.
Example 5-3
Exchange Gain or Loss Related to Intra-Entity
Loan
A U.S. parent, Company X, has a
wholly owned subsidiary, Company Y, in the United
Kingdom. Company X’s functional currency is the USD,
and Y’s is the GBP. Company X has provided a loan in
USD to Y. The loan is not considered part of X’s net
investment in Y.
No transaction gain or loss is
recorded in the separate financial statements of the
U.S. parent because the loan receivable is
denominated in X’s functional currency. In the
subsidiary’s separate financial statements, the loan
payable is a monetary item and the transaction gain
or loss related to remeasurement in Y’s functional
currency of the GBP is recognized in earnings in
accordance with ASC 830-20.
Upon consolidation, although the
intra-entity loan is eliminated from the statement
of financial position, the related transaction gain
or loss recognized in Y’s separate financial
statements for the USD loan payable survives the
consolidation process; thus, the gain or loss is
also recognized in consolidated earnings.
Further, in certain situations, the use of differing
translation rates may result in residual intra-entity receivables and
payables, as discussed in Section 6.2.1.
5.2.1.3 Goodwill and Purchase Price Adjustments
ASC 830-30
45-11 After a business
combination, the amount assigned at the acquisition
date to the assets acquired and the liabilities
assumed (including goodwill or the gain recognized
for a bargain purchase in accordance with Subtopic
805-30) shall be translated in conformity with the
requirements of this Subtopic.
ASC 830-30-45-3 and ASC 830-30-45-11 require that an entity
translate all elements of its financial statements, including goodwill and
other basis differences. Therefore, in the determination of the currency
translation adjustment in the acquirer’s consolidated financial statements,
the individual assets (including goodwill) of an acquired foreign entity
whose functional currency differs from its parent’s reporting currency must
be translated on the basis of the amounts recognized by the acquirer under
ASC 805-10, ASC 805-20, and ASC 805-30, even if that foreign entity elects
not to apply pushdown accounting in its separate financial statements.
An entity can either record the amounts in the foreign
entity’s books (i.e., actual pushdown accounting) or maintain the records
necessary to adjust the consolidated amounts to what they would have been
had the amounts been recorded in the foreign entity’s books and records
(i.e., notional pushdown accounting).
Example 5-4
Foreign Currency Translation for an Acquired
Foreign Entity
Company A acquires Company B in a
business combination. Company B is in a foreign
jurisdiction, and B’s functional currency, the USD,
differs from A’s reporting currency, the EUR. Assume
that the carrying value of all of B’s assets and
liabilities equals their fair values except for an
intangible asset that was unrecognized in B’s books
but will be recognized in A’s consolidated financial
statements at its fair value of €1,000. Company A
also recognizes goodwill of €150 from the
acquisition of B in its consolidated financial
statements. Company A has determined that B is a
foreign entity. Company B has elected not to apply
pushdown accounting in its separate financial
statements. Therefore, B’s assets are recognized at
A’s consolidated level by using A’s basis in the
assets, even though A’s basis was not pushed down to
B’s separate financial statements.
As of the acquisition date, the
intangible asset of €1,000 was the equivalent of
$1,200 and the goodwill of €150 was the equivalent
of $180 in B’s functional currency (exchange rate of
$1.20 to €1). Although B did not elect pushdown
accounting, when A translates B’s assets and
liabilities from B’s functional currency to A’s
reporting currency, A will translate B’s assets and
liabilities into A’s reporting currency by using A’s
basis in B’s assets and liabilities (i.e.,
stepped-up values) rather than the carrying values
of B’s assets and liabilities in B’s separate
financial statements. At the end of the reporting
period, the carrying values of the intangible asset
and goodwill in B’s functional currency are $1,080
($1,200 less amortization of $120) and $180 and the
exchange rate is $1.25 to €1. Therefore, in its
consolidated financial statements, A recognizes B’s
intangible asset of €864 ($1,080 ÷ 1.25) and
goodwill of €144 ($180 ÷ 1.25). Because B did not
elect pushdown accounting, separate accounting
records will need to be maintained to adjust A’s
consolidated amounts to what they would have been
had the amounts been recorded in B’s separate
financial statements (i.e., notional pushdown
accounting).
The preceding is a simplified example in which a single
foreign entity is acquired. In a multinational acquisition that includes
multiple foreign and domestic entities, the application of ASC 830 may be
complex depending on whether the acquirer needs to determine the amount of
goodwill for each foreign and domestic entity acquired. An entity may need
to use judgment in making such determinations.
In the measurement of a goodwill impairment charge,
a reporting unit’s carrying amount should only include the currently
translated assets and liabilities and would not contain any allocated CTA
from an entity’s AOCI. However, some or all of the CTA should be included in
the carrying amount of an investment in a foreign entity when that
investment is tested for impairment if the entity has committed to a plan to
dispose of that investment (see further discussion in Section 5.5.1). Investment impairment
testing differs from goodwill impairment testing; therefore, the CTA
generally would not meet the criteria for inclusion in a reporting unit in
accordance with ASC 350-20-35-39.
5.2.2 Equity Method Investments
ASC
830-10
15-5 The functional currency
approach applies equally to translation of financial
statements of foreign investees whether accounted for by
the equity method or consolidated. Therefore, the
foreign currency statements and the foreign currency
transactions of an investee that are accounted for by
the equity method shall be translated in conformity with
the requirements of this Topic in applying the equity
method.
In a manner consistent with ASC 830-10-15-5 above, ASC 323
requires that an investee’s income accounted for under the equity method be
determined as if the investee were a consolidated subsidiary. Accordingly, after
the adjustments to the foreign investee’s financial results, as outlined in ASC
323-10-35-5, the reporting entity should recognize and adjust its equity
investment carrying amount for its share of the foreign investee’s translated
net income and OCI (including its share of the CTA). The recognition date
exchange rates, as discussed in Section 5.2.1, would be used to translate
an investor’s share of the net income of a foreign currency equity method
investee into the investor’s reporting currency (or a weighted-average exchange
rate if appropriate). The historical rate would be applied to the existing
investment balances.
Example 5-5
Translation of an Equity Method Investment
On January 1, 20X1, Company A, a U.S.
entity whose functional currency is USD, acquires a 40
percent equity interest in Company B for €4 million.
Company B is located in Germany, and its functional
currency is the EUR.
Assume the following facts:
-
Company A accounts for its investment in B as an equity method investment.
-
Company A has determined that B is a foreign entity.
-
Company B is in its first year of operations and generated net income of €1 million during 20X1.
-
Company A did not recognize goodwill or other purchase price adjustments in relation to B, since B is a newly formed entity and the fair value of B was equal to the carrying amount at the time of acquisition by A.
-
The following exchange rates were in effect during the period:
-
Spot rate on January 1, 20X1: €1 = $1.1.
-
Spot rate on December 31, 20X1: €1 = $1.3.
-
Weighted-average exchange rate during 20X1: €1 = $1.25.
-
-
Company B’s statement of financial position on December 31, 20X1, denominated in euros and translated to U.S. dollars, is shown below.
Company A would record the following
journal entries during 20X1, all denominated in USD:
The preceding is a simplified example illustrating an equity
method investment in a newly formed, single foreign entity. If, at the time of
acquisition, A had recognized goodwill or other fair value adjustments, such
basis differences would be viewed as denominated in the foreign entity’s (B’s)
functional currency. Thus, such amounts would be subject to translation and
would affect the equity method investment balance the investor recognizes for
the foreign entity.
In applying the equity method, an investor may have to perform a
purchase price allocation when the purchase price for its share of the
investee’s net assets differs from the carrying amount in the investee’s
separate financial statements. If the investee’s functional currency differs
from that of the investor, this process could be complex, especially when there
may be multiple assets and liabilities for which there is a basis difference
between the carrying amount and the fair value of the asset or liability as of
the investment’s acquisition date. In such situations, one approach that an
investor uses in practice is to recast the investee‘s books to reflect the
investor‘s basis in the assets based on its purchase price, provided that the
investee is 100 percent owned. The example below illustrates this scenario.
Example 5-6
Translation of an Equity Method Investment With a
Different Basis
Assume the following:
- Investor C, which is based in the United States, invests $495 million to have a 25 percent interest in Investee D, an entity that operates a commercial real estate asset in Ireland, at the beginning of 20X1.
- Investor C’s functional and reporting currency is the USD.
- Investee D’s functional currency is the EUR.
- Investee D’s net book value as of the investment date is €1,500 million, and its only asset is a shopping mall; D has no liabilities.
- The shopping mall has no salvage value and a remaining depreciable life of 20 years.
- Investee D’s net income from the shopping mall’s operations at the end of 20X1 is €40 million, which includes €75 million of the depreciation expense related to the shopping mall.
- The exchange rate on the date C made the investment is $1.1 = €1.
- The end-of-year exchange rate for 20X1 is $1.2 = €1.
- The weighted-average exchange rate for 20X1 is $1.15 = €1.
Investor C has a €75 million ($82.5
million) basis difference as of the acquisition date,
which consists of the difference between C’s cost of
acquisition ($495 million ÷ 1.1 EUR to USD = €450
million) and C’s share of D’s net book value (€1,500
million × 25% = €375 million). As discussed in Section
5.2.1.3, the basis difference would be
viewed as denominated in the foreign investee’s (D’s)
functional currency. Thus, such amounts would be subject
to translation and would affect the equity method
investment balance the investor recognizes for the
foreign entity.
Investor C has determined that the basis
difference is attributable to the depreciable asset (the
shopping mall) and that, accordingly, the basis
difference should be depreciated over its remaining
useful life (20 years).
To recast D’s financial statements, C
first computes D’s overall net book value as of the date
of the investment on the basis of the cost paid by C.
That amount is €1,800 million, computed as the €450
million investment multiplied by 4. (For tracking
purposes and ignoring any control premium, if a 25
percent investment is worth €450 million, a 100 percent
investment is worth four times that amount.) Investor C
would then allocate the €1,800 million to D’s assets and
liabilities in a manner consistent with a business
combination. In this example, D’s only asset is the
shopping mall. Depreciation on the €1,800 million
shopping mall is computed as €90 million per year
(€1,800 million divided by 20 years; zero salvage
value). That is, if C owned 100 percent of D, the
“deemed depreciation expense” would be €15 million
higher than what the investee would present in its
separate financial statements.
The following table depicts the
translation of D’s financial information from EUR to
USD:
When an investor tracks the investment
in an equity method by using the total recast investee
values, in determining the amounts that would need to be
recognized in its financial statements, the investor has
to adjust the balances by its share of the investee’s net assets to properly
reflect the carrying amount.
Investor C can compute its share of D’s
net income from operations by using the weighted-average
exchange rate for the period as follows:
Similarly, in determining the amount of
the change in CTA for the period that is related to its
equity method investment, C will recognize its share of
the recast CTA as follows:
Investor C can compute the ending
carrying amount of its equity method investment by
translating its share (25
percent) of the recast net book value at the end-of-year
exchange rate as follows:
The following table shows the financial
statement impact (in millions) of the adjustments
described above on C’s financial statements:
Footnotes
1
The glossary in ASC 220-10 indicates that the
term “comprehensive income” encompasses all components of net
income as well as all components of OCI and that OCI refers to
“revenues, expenses, gains, and losses that [under GAAP] are
included in comprehensive income but excluded from net
income.”
2
Upon adopting FASB Statement 158 (codified in
ASC 715), companies and their subsidiaries (domestic and
foreign) were required to recognize the funded status of their
defined benefit plans. Accordingly, previously unrecognized
amounts (including gains or losses, prior service costs or
credits, and transition assets or obligations) were recorded,
net of tax, as a component of AOCI. However, FASB Statement
158’s recognition provisions did not change how net periodic
benefit cost is measured or recognized in an entity’s financial
statements.
After adoption of FASB Statement 158, ASC
715-30-35 and ASC 715-60-35 required that prior service costs or
credits, and gains or losses, respectively, that arise during
the period, and that are not immediately recognized as a
component of net periodic benefit cost, be recognized as a
component of OCI. Such amounts will ultimately be reclassified
to net periodic benefit cost in subsequent periods. Accordingly,
upon consolidation, parent companies with foreign subsidiaries
that sponsor defined benefit plans will need to consider the
impact of ASC 830 on the amounts recorded in, and reclassified
from, AOCI.