Chapter 5 — Foreign Currency Translations

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 currency translation adjustment, 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 currency translation adjustment). 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 currency translation adjustment for the period that is related to its equity method investment, C will recognize its share of the currency translation adjustment 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

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.”

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.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.