Chapter 7 — Highly Inflationary Economies

7.4 Accounting Effects When an Economy Ceases to Be Highly Inflationary

ASC 830-10

Functional Currency Changes From Reporting Currency to Foreign Currency Because Foreign Economy Is No Longer Highly Inflationary

45-15 If an entity’s subsidiary’s functional currency changes from the reporting currency to the local currency because the economy ceases to be considered highly inflationary, the entity shall restate the functional currency accounting bases of nonmonetary assets and liabilities at the date of change as follows:

The reporting currency amounts at the date of change shall be translated into the local currency at current exchange rates.
The translated amounts shall become the new functional currency accounting basis for the nonmonetary assets and liabilities.

Example 1 (see paragraph 830-10-55-12) illustrates the application of this guidance.

Example 1: Functional Currency Changes From Reporting Currency to Foreign Currency Because Foreign Economy Is No Longer Highly Inflationary

55-12 This Example illustrates the application of paragraph 830-10-45-15.

55-13 A foreign subsidiary of a U.S. entity operating in a highly inflationary economy purchased equipment with a 10-year useful life for 100,000 local currency (LC) on January 1, 19X1. The exchange rate on the purchase date was LC 10 to USD 1, so the U.S. dollar equivalent cost was USD 10,000. On December 31, 19X5, the equipment has a net book value on the subsidiary’s local books of LC 50,000 (original cost of LC 100,000 less accumulated depreciation of LC 50,000) and the current exchange rate is LC 75 to the U.S. dollar. In the U.S. parent’s financial statements, annual depreciation expense of USD 1,000 has been reported for each of the past 5 years, and at December 31, 19X5, the equipment is reported at USD 5,000 (foreign currency basis measured at the historical exchange rate).

55-14 As of the beginning of 19X6, the economy of the subsidiary ceases to be considered highly inflationary. Under paragraph 830-10-45-15, a new functional currency accounting basis for the equipment would be established as of January 1, 19X6, by translating the reporting currency amount of USD 5,000 into the functional currency at the current exchange rate of LC 75 to the U.S. dollar. The new functional currency accounting basis at the date of change would be LC 375,000. For U.S. reporting purposes, pursuant to this Subtopic, the new functional currency accounting basis and related depreciation would subsequently be translated into U.S. dollars at current and average exchange rates, respectively.

When an economy ceases to be designated as highly inflationary, an entity should discontinue using its parent’s reporting currency as its functional currency, provided that the entity’s facts and circumstances (as described in Chapter 2) have not changed in such a way that its functional currency should now be the same as the reporting currency used for highly inflationary accounting (e.g., analysis of the economic indicators described in ASC 830-10 results in the determination that the entity’s functional currency should be that of its parent regardless of the inflationary status of its local economy). When the economy ceases to be highly inflationary,3 the nonmonetary assets and liabilities are converted at the exchange rate in effect on the date of change. (This treatment is different from that for changes in the functional currency that are not inflation-related.)

The table below summarizes the effects of the change in these specific circumstances.

Reporting Currency to Local Currency as a Result of Economy Ceasing to Be Highly Inflationary
Nonmonetary Assets and Liabilities	Monetary Assets and Liabilities	Equity Balances	Effect on Currency Translation Adjustment
Remeasure by using exchange rate as of the date of change. Remeasured balance becomes the new basis. Subsequent translations to reporting currency (e.g., at future period-ends) are performed by using current exchange rates, with effects of exchange rate fluctuations recorded as a currency translation adjustment.	Remeasure by using exchange rate as of the date of change.	Remeasure by using historical exchange rates.	No adjustment.

As when an entity changes its functional currency because an economy becomes highly inflationary, when an entity changes its functional currency because an economy is no longer highly inflationary, the change is not considered a change in accounting principle in accordance with ASC 250. Therefore, in such circumstances, 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.

Example 7-6

Accounting for a Change in Functional Currency When an Economy No Longer Is Highly Inflationary

This example addresses the accounting records of Company X, a foreign entity operating in a highly inflationary economy whose parent company’s reporting currency is the USD. Because X’s local economy is deemed highly inflationary, it has been using the USD as its functional currency for a number of years. During the fourth quarter of 20X5, X’s local economy ceased being considered highly inflationary; therefore, X’s functional currency has changed from the USD (its reporting currency) back to its local currency (LC). The change was accounted for on January 1, 20X6. Assume the following:

Company X purchased all of its PP&E for 100,000 LC on December 31, 20X0, when the LC-to-USD exchange rate was 5:1. The PP&E has a 10-year life, and depreciation is calculated on a straight-line basis.
Company X’s local economy became highly inflationary in the fourth quarter of 20X2; therefore, X changed its functional currency to the USD on January 1, 20X3, when the LC-to-USD exchange rate was 15:1.
The LC-to-USD exchange rate on the date on which the local economy ceased being highly inflationary (i.e., January 1, 20X6) was 10:1.

If it is assumed that the PP&E was purchased for 100,000 LC on December 31, 20X0, when the LC-to-USD exchange rate was 5:1, and that its useful life is 10 years (depreciation is calculated on a straight-line basis), the nonmonetary asset basis would have been 50,000 LC on January 1, 20X6, if the functional currency never changed to USD. However, as shown above, there is a 16,670 decrease in the LC basis because the functional currency changed as a result of the economy’s ceasing to be highly inflationary. While ASC 830 does not provide guidance on how to recognize this adjustment in the local books, an acceptable approach is to recognize the adjustment to opening retained earnings on the date of the change in functional currency.

Alternative Fact Pattern

Assume the same facts as above except that Company X is changing its functional currency from the USD (its reporting currency) to its local currency (LC) because of a significant change in economic facts and circumstances rather than because its local economy ceases to be highly inflationary. As explained in Chapter 2, when such a change is made, the reporting-currency accounting basis for nonmonetary assets and liabilities, such as the PP&E in this example, is adjusted for the difference between the exchange rates when the asset or liability arose and those when the entity’s functional currency changes. The change was accounted for in January 20X6. Assume the following:

Company X purchased all of its PP&E for 100,000 LC on December 31, 20X0, when the LC-to-USD exchange rate was 5:1. The PP&E has a 10-year life, and depreciation is calculated on a straight-line basis.
The LC-to-USD exchange rate on the date on which the change in functional currency was accounted for was 10:1.

In this case, the local-currency basis of the nonmonetary asset does not change as a result of the change in functional currency. (This scenario is different from that above, in which the LC basis is adjusted because of the change associated with the economy’s ceasing to be highly inflationary.) Rather, the USD-denominated bases (i.e., the reporting-currency accounting bases) change, resulting in a decrease of $5,000 in the amount of PP&E. As explained in Chapter 2, this decrease, which is due to the difference between the carrying value of the PP&E in the reporting currency (i.e., USD) at the historical exchange rate and that at the current exchange rate, is recorded as a currency translation adjustment.

An entity should also be aware of several implications related to an economy’s ceasing to be highly inflationary. One of the most significant effects is that on deferred taxes, as discussed in Chapter 8 of this Roadmap and Chapter 9 of Deloitte’s Roadmap Income Taxes.

As explained in Chapter 2, a change in functional currency may have a number of other effects on an entity, a few examples of which are depicted in Section 2.4.2. An entity should carefully consider the impact of the change in functional currency on all of its account balances. For example, the lower-of-cost-or-market analysis required by ASC 330-10 would have to be performed in the new functional currency. In addition, an entity should revisit its various investing and hedging positions to determine whether changes in methods or strategies are warranted. Changes in functional currency may also affect the local subledgers the entity maintains in its local currency (such as the adjustment to retained earnings described above).

Further, for consolidated entities that determined deconsolidation was necessary for a subsidiary in a highly inflationary economy, such conclusions should be revisited.

Footnotes

When an entity changes its functional currency from the reporting currency to a foreign currency for reasons other than an economy’s ceasing to be highly inflationary, nonmonetary assets and liabilities are converted in a manner that results in a difference between the historical reporting-currency basis and the new reporting-currency basis. As a result, the account balances would be reflected in the reporting currency as if the new functional currency had always been the functional currency; these differences would be recorded in a CTA. See Chapter 2 for additional details.

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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.