7.3 Accounting Effects When an Economy Becomes Highly Inflationary
If the cumulative inflation calculation demonstrates that the economy has become highly inflationary, the entity should commence the requisite accounting on the first day of the next reporting period. In such scenarios, entities should consider whether disclosures are warranted in the reporting period before commencing highly inflationary accounting, as discussed further in Section 9.2.3.
Example 7-2
Designation as Highly Inflationary
Company X is a calendar-year-end entity that has quarterly
reporting requirements. In the first quarter, X determines that its local
economy (whose currency is X’s functional currency) has become highly
inflationary on the basis of the inflationary data from the past 36 months.
Company X therefore should begin applying the accounting for highly inflationary
economies as of the beginning of the second quarter, or April 1. For
first-quarter reporting purposes, X should continue to use the local currency as
its functional currency but should disclose the adoption of highly inflationary
accounting commencing in the next quarter.
As noted above, an entity with interim reporting requirements should not wait until the end of its fiscal year to record the effects of this designation. An entity that does not have interim reporting requirements should perform the cumulative-rate calculation as of its fiscal year-end and apply the effects of becoming highly inflationary to its financial statements at the beginning of the following year.
|
Local Currency to the Reporting Currency as a Result of
Economy Being Highly Inflationary
| |||
|---|---|---|---|
Nonmonetary Assets and Liabilities | Monetary Assets and Liabilities | Equity Balances | Effect on Currency Translation Adjustment |
Translated balances at the end of the prior period become the new accounting basis | Translated balances at the end of the prior period become the new accounting basis | Remeasure by using historical exchange rates | No effect |
As summarized in the table above, when an economy is considered highly inflationary, an entity must remeasure its financial records in its parent’s reporting currency as of the first day of the next reporting period. The accounting treatment is the same as that described in Section 2.4.2 for changes from the local currency to the reporting currency related to a significant change in facts and circumstances.
In subsequent periods, if the underlying transactions of the entity
continue to be denominated in the currency of the highly inflationary economy, an entity
would recognize foreign currency exchange gains and losses in the income statement in
connection with the remeasurement of local-currency-denominated monetary balances.
Performance of such remeasurement is a result of the required change in functional currency
that, in prior periods, would have been recognized as part of the translation adjustment in
OCI when the local currency was the functional currency. Similarly, for monetary balances
denominated in the new functional currency, the entity would no longer recognize
remeasurement gains or losses in the income statement. Therefore, foreign currency gains and
losses recognized in the income statement may materially differ from those recognized in
prior periods.
Example 7-3
Effects of a Change in Functional Currency to the Reporting Currency
Company A, a public business entity, is a calendar-year-end
entity that has operations in Country B such that B’s local currency is A’s
functional currency. The functional currency of A’s parent, which is also the
reporting currency of the consolidated entity, is USD. During the first quarter
of 20X1, B’s economy is determined to be highly inflationary. In accordance with
the guidance on highly inflationary economies in ASC 830, A reports its
first-quarter results by using the local currency as its functional currency and
translates its results into its parent’s reporting currency (i.e., USD) for
consolidation purposes. As of April 1, 20X1, the translated balances (i.e., the
balances stated in the reporting currency) as of March 31, 20X1, become the new
accounting bases for all monetary and nonmonetary assets and liabilities.
Company A’s equity accounts should be remeasured at the historical rates.
Further, the CTA is not adjusted as a result of this change. Going forward, A
will use the historical exchange rate on March 31, 20X1, when remeasuring A’s
nonmonetary assets and liabilities.
Because a change in functional currency due to an economy’s designation as highly inflationary results from changes in economic factors (i.e., inflation), such a change is not considered a change in accounting policy and therefore should not be accounted for as a change in accounting principle in accordance with ASC 250. Therefore, previously issued financial statements should not be restated. An entity’s management should, however, consider whether the change will have a material impact on future operations and, if so, disclose the change in the notes to its financial statements.
When an entity operates in a multitiered organization, the entity generally should use the reporting currency of its most immediate parent and not that of the ultimate parent, provided that the entity’s immediate parent does not operate in a highly inflationary economy. (However, this topic is not addressed in ASC 830.)
Connecting the Dots
If an entity believes that its facts and circumstances are such that it should use the reporting currency of an entity other than its immediate parent when becoming highly inflationary, the entity is encouraged to consult with its accounting advisers.
Example 7-4
Identification of an Entity’s
Parent
Company E is a third-tier entity within Company A’s
multitiered international organization. Company A is headquartered in the United
States, and its reporting currency is the USD; however, A globally has
subsidiaries with multiple functional currencies. Company E has operations in
Venezuela and is a direct subsidiary of Company B, which has operations in
Mexico and a functional currency of MXN. Company A has determined that E’s
functional currency is the BsF.2 At period-end, E’s financial statements are consolidated into B’s
financial statements (i.e., translated into MXN), before being translated into
A’s ultimate reporting currency (the USD).
As of December 31, 20X1, Venezuela’s economy is determined to
be highly inflationary. As of January 1, 20X2, therefore, E’s financial
statements should be remeasured into MXN (i.e., B’s functional currency), which
will become its new functional currency. This is the case even though the USD is
the ultimate reporting currency of the consolidated entity.
7.3.1 Effects of Remeasuring Financial Statements
When an entity must remeasure its financial statements because an economy
becomes highly inflationary, the entity must consider several implications in conjunction
with the remeasurement. For example, an entity generally will continue to maintain its
books and records in the local currency. In these cases, remeasurement in the “new”
functional currency (i.e., the reporting currency of its immediate parent) is required in
each reporting period. Monetary assets and liabilities should be remeasured by using
current rates. However, nonmonetary assets and liabilities (including related income
statement items such as depreciation), should be remeasured by using the exchange rate
that was in effect on the date on which the entity began implementing the accounting
related to highly inflationary economies. In addition, transaction gains and losses
recognized in the local currency will need to be adjusted upon remeasurement if they are
related to monetary items denominated in currencies other than the local currency.
See Chapter 4 for an example illustrating the application of these remeasurement requirements in situations in which the foreign currency is not the functional currency.
7.3.1.1 Income Taxes
ASC 830-10
45-16 When the functional
currency is the reporting currency, paragraph
740-10-25-3(f) prohibits recognition of deferred
tax benefits that result from indexing for tax
purposes assets and liabilities that are
remeasured into the reporting currency using
historical exchange rates. Thus, deferred tax
benefits attributable to any such indexing that
occurs after the change in functional currency to
the reporting currency shall be recognized when
realized on the tax return and not before.
Deferred tax benefits that were recognized for
indexing before the change in functional currency
to the reporting currency are eliminated when the
related indexed amounts shall be realized as
deductions for tax purposes.
For more information about tax-related considerations related to foreign
currency accounting, see Chapter
8 of this Roadmap and Chapter 9 of
Deloitte’s Roadmap Income
Taxes.
7.3.1.2 Monetary Assets and Liabilities Denominated in Multiple Currencies
Another implication that entities should consider is the effect of a change in functional currency on monetary assets and liabilities that are denominated in multiple currencies.
Example 7-5
Effects of Multiple Currencies on
Monetary Items
If Company E from Example 7-4 has trade payables that are
denominated in MXN, it would not need to remeasure those payables; rather,
their actual value in MXN should become their accounting basis when E’s
functional currency changes to the MXN because Venezuela becomes highly
inflationary.
If E has trade payables dominated in CAD, those payables
would be translated directly from CAD to MXN (i.e., there would be no
remeasurement in the BsF before consolidation into the Mexican parent).
7.3.1.3 Considerations Related to Classified Balance Sheets
Entities with classified balance sheets should consider whether classifying certain foreign-currency-denominated monetary assets as current is still appropriate in light of the present economic environment. For example, an entity’s classification of assets as current may be inappropriate when such assets will be used to pay USD-denominated liabilities or dividends (rather than foreign-currency-denominated liabilities) and the entity encounters difficulties in converting such assets into USD. Such a determination will depend on an entity’s facts and circumstances and its ability to obtain necessary approvals to convert such balances at an appropriate exchange rate in the volume it needs to operate over the course of one year or its operating cycle, if longer.
7.3.2 Deconsolidation Considerations
ASC 810-10
15-10 A reporting entity shall apply
consolidation guidance for entities that are not in the scope of the Variable
Interest Entities Subsections (see the Variable Interest Entities Subsection
of this Section) as follows:
- All majority-owned subsidiaries — all entities in which
a parent has a controlling financial interest — shall be consolidated.
However, there are exceptions to this general rule.
-
A majority-owned subsidiary shall not be consolidated if control does not rest with the majority owner — for instance, if any of the following are present: . . .iii. The subsidiary operates under foreign exchange restrictions, controls, or other governmentally imposed uncertainties so severe that they cast significant doubt on the parent’s ability to control the subsidiary. . . .
-
ASC 830-20
30-2 . . . If the lack
of exchangeability is other than temporary, the propriety of consolidating,
combining, or accounting for the foreign operation by the equity method in the
financial statements of the reporting entity shall be carefully
considered.
In determining whether foreign exchange restrictions, controls, and other
governmentally imposed uncertainties are severe enough to result in a lack of control by a
parent entity, a reporting entity must exercise significant judgment and consider factors
including, but not limited to, the following:
-
Volume restrictions on currency exchange activity (either explicit or in-substance), in conjunction with uncertainties about the reporting entity’s or subsidiary’s ability to obtain approval for foreign currency exchange through the established exchange mechanisms.
-
The ability, currently and historically, to access available legal currency exchange mechanisms in volumes desired or needed by the reporting entity or subsidiary.
-
Recent economic developments and trends in the foreign jurisdiction that might affect expectations about the future direction of restrictions on currency exchanges.
-
The extent and severity of restrictions imposed by the government on a subsidiary’s operations and whether those restrictions demonstrate the reporting entity’s inability to control its subsidiary’s operations. The reporting entity must use considerable judgment in making this determination since many governments, including the U.S. federal government, require companies to adhere to a framework of laws and regulations that govern operational matters. Examples of government intervention might include restrictions on (1) labor force reductions, (2) decisions about product mix or pricing, and (3) sourcing of raw materials or other inputs into the production process.
The mere fact that currency exchangeability is lacking does not in and of itself
create a presumption that a reporting entity should not consolidate its foreign
subsidiary, nor does the ability to exchange some volume of currency create such a
presumption. In addition, in situations in which government control exists, the reporting
entity should consider such control in its VIE assessment when evaluating whether the
reporting entity has power. The existence of the above factors represents negative
evidence in the determination of whether consolidation is appropriate on the basis of the
reporting entity’s specific facts and circumstances. At the 2015 AICPA Conference on
Current SEC and PCAOB Developments, an SEC staff member, Professional Accounting Fellow
Chris Semesky, stated the following:
In the past year, OCA has observed registrant disclosures indicating
a loss of control of subsidiaries domiciled in Venezuela. Disclosures indicate that
these conclusions have been premised on judgments about lack of exchangeability being
other than temporary and, also in some instances, the severity of government imposed
controls. The application of U.S. GAAP in this area requires reasonable judgment to
determine when foreign exchange restrictions or government imposed controls or
uncertainties are so severe that a majority owner no longer controls a subsidiary. In
the same way, a restoration of exchangeability or loosening of government imposed
controls may result in the restoration of control and consolidation. In other words, I
would expect consistency in a particular registrant’s judgments around whether it has
lost control or regained control of a subsidiary. In addition, I would expect
registrants in these situations to have internal controls over financial reporting
that include continuous reassessment of foreign exchange restrictions and the severity
of government imposed controls.
Further, to the extent a majority owner concludes that it no longer
has a controlling financial interest in a subsidiary as a result of foreign exchange
restrictions and/or government imposed controls, careful consideration should be given
to whether that subsidiary would be considered a variable interest entity upon
deconsolidation because power may no longer reside with the equity-at-risk holders. As
a result, registrants should not only think about clear and appropriate disclosure of
the judgments around, and the financial reporting impact of, deconsolidation but also
of the ongoing disclosures for variable interest entities that are not
consolidated.
If a reporting entity ultimately concludes that nonconsolidation of a foreign subsidiary is appropriate, the reporting entity must determine the appropriate date for any deconsolidation, including the appropriate currency exchange rate to use for remeasuring its deconsolidated investment and any other outstanding monetary balances that are no longer eliminated in consolidation (if they are not considered fully impaired). Furthermore, a reporting entity should clearly disclose the basis for its consolidation/nonconsolidation conclusion about an investment in a foreign subsidiary for which there is negative evidence regarding whether it controls the foreign subsidiary. A reporting entity that continues to consolidate may wish to consider disclosing its intention to continue monitoring developments, along with a description of the possible financial statement impact, if estimable, if deconsolidation were to occur. In addition, if a reporting entity concludes that nonconsolidation of a foreign subsidiary is appropriate, the reporting entity should continue to monitor developments in each reporting period to determine whether it has regained control and thus should reconsolidate the foreign subsidiary.
For more information about deconsolidation implications related to an economy’s
designation as highly inflationary, see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial
Interest.
Footnotes
2
This currency is no longer used in Venezuela.