Chapter 7 — Highly Inflationary Economies
Chapter 7 — Highly Inflationary Economies
7.1 Overview
ASC 830 states that one of its objectives is for a reporting entity to “provide information that is generally compatible with the expected economic effects of a rate change on [the entity’s] cash flows and equity.” In providing such information, the entity needs to use a stable measuring unit (i.e., a stable currency).
In economies with significant inflation, the local currency may eventually be deemed instable. Although any degree of inflation may affect the usefulness of an entity’s financial statements, the higher the inflation rate, the less relevant historical costs become (i.e., historical values diminish over time and become smaller than similar costs incurred in a highly inflationary environment). Therefore, ASC 830 requires that entities operating in environments deemed to be highly inflationary remeasure their financial statements in the reporting currency.
This chapter discusses how to determine when highly inflationary conditions exist and the related accounting for a change in functional currency when an economy has been designated as highly inflationary.
7.2 Determining a Highly Inflationary Economy
ASC 830-10
45-11 The financial statements
of a foreign entity in a highly inflationary economy shall
be remeasured as if the functional currency were the
reporting currency. Accordingly, the financial statements of
those entities shall be remeasured into the reporting
currency according to the requirements of paragraph
830-10-45-17. For the purposes of this requirement, a highly
inflationary economy is one that has cumulative inflation of
approximately 100 percent or more over a 3-year period.
In determining whether it operates in a highly inflationary economy (i.e., one for which cumulative inflation is approximately 100 percent or higher over a three-year period), an entity may need to use judgment in addition to performing the cumulative inflation calculation. For example, when an economy’s cumulative inflation is approaching 100 percent, an entity must consider factors such as any relevant trends associated with the economy’s inflation rates. The Basis for Conclusions of FASB Statement 52 (codified in ASC 830) indicated that, in some cases, “the trend of inflation might be as important as the absolute rate” calculated in accordance with ASC 830-10.
However, this analysis is only necessary if an entity uses the highly inflationary economy’s currency as its functional currency. If another foreign currency is the functional currency, the entity is not considered to be operating in the local economy and therefore should only monitor the highly inflationary status of the economy related to its functional currency.
Example 7-1
Functional Currency Is Not the Local Currency of a Highly Inflationary
Economy
Company A is the subsidiary of a U.S.-based entity that is
physically located in Country V. Upon its acquisition by the U.S.-based entity
several years ago, A’s management determined its functional currency to be the
USD, and no significant changes in facts and circumstances have caused that
determination to change.
In the current year, V’s economy has been determined to be
highly inflationary. Because A does not use V’s local currency as its functional
currency, V’s designation as highly inflationary does not affect A’s accounting
records.
7.2.1 Calculating the Cumulative Inflation
ASC 830-10
45-12 The determination of a highly inflationary economy must begin by calculating the cumulative inflation rate for the three years that precede the beginning of the reporting period, including interim reporting periods. If that calculation results in a cumulative inflation rate in excess of 100 percent, the economy shall be considered highly inflationary in all instances. However, if that calculation results in the cumulative rate being less than 100 percent, historical inflation rate trends (increasing or decreasing) and other pertinent economic factors should be considered to determine whether such information suggests that classification of the economy as highly inflationary is appropriate. Projections cannot be used to overcome the presumption that an economy is highly inflationary if the 3-year cumulative rate exceeds 100 percent.
45-13 The definition of a highly inflationary economy is necessarily an arbitrary decision. In some instances, the trend of inflation might be as important as the absolute rate. The definition of a highly inflationary economy shall be applied with judgment.
45-14 Example 3 (see
paragraph 830-10-55-23) illustrates the application of
this guidance.
Example 3: Determination of a Highly Inflationary Economy
55-23 The following Cases
illustrate the application of paragraph 830-10-45-12:
-
The cumulative 3-year inflation rate exceeds 100 percent (Case A).
-
The cumulative 3-year inflation rate drops below 100 percent but no evidence suggests that drop is other than temporary (Case B).
-
The cumulative 3-year inflation rate drops below 100 percent after having spiked above 100 percent (Case C).
Case A: Cumulative 3-Year Inflation Rate Exceeds 100 Percent
55-24 Country A’s economy at the beginning of 19X9 continues to be classified as highly inflationary because the cumulative 3-year rate is in excess of 100 percent (see the following table). The recent trend of declining inflation rates should not be extrapolated to project future rates to overcome the classification that results from the calculation.
Case B: Cumulative 3-Year Inflation Rate Drops Below 100 Percent
55-25 Country B’s economy at the beginning of 19X9 should continue to be classified as highly inflationary even though the cumulative 3-year rate is less than 100 percent (see the following table) because there is no evidence to suggest that the drop below the 100 percent cumulative rate is other than temporary and the annual rate of inflation during the preceding 8 years has been high.
Case C: Cumulative 3-Year Inflation Rate Drops Below 100 Percent After Spike
55-26 Country C’s economy at the beginning of 19X9 should no longer be classified as highly inflationary because the cumulative 3-year rate is less than 100 percent (see the following table) and the historical inflation rates suggest that the prior classification resulted from an isolated spike in the annual inflation rate.
Although an entity may need to use some judgment in determining whether an
economy is highly inflationary, it should begin the determination by calculating the
cumulative inflation rate. As clarified in ASC 830-10-45-12, if the calculation (as
described below) “results in a cumulative inflation rate in excess of 100 percent, the
economy shall be considered highly inflationary in all instances”
(emphasis added). Further, ASC 830-10-45-12 states — and the examples in ASC 830-10-55-24
through 55-26 illustrate — that projections of future inflation rates “cannot be used to
overcome the presumption that an economy is highly inflationary if the 3-year cumulative
rate exceeds 100 percent.”
An entity should perform this assessment in each reporting period for the
three-year period ending as of the beginning of its current reporting period (including
interim periods). For example, calendar-year-end entities with interim reporting
requirements should calculate a cumulative inflation rate at the end of each quarter on
the basis of the inflationary information for the past 36 months.
Once the three-year period has been identified, an entity should determine the
appropriate inflation rate or index to use for the cumulative-rate calculation. Although
ASC 830 does not specify which rates or indices should be used, general indices or rates,
such as those historically reported by the IMF or the Economist Intelligence Unit, are the
most common ones employed. The rates or indices used for the analysis should generally be
comprehensive (e.g., the comparable rate of the U.S. Consumer Price Index reported to the
IMF by foreign governments) rather than industry- or entity-specific. For detailed
instructions on obtaining inflationary information from the IMF’s Web site, see Section 7.2.2.
After identifying an appropriate rate or index, an entity must calculate the cumulative inflation rate for the most recent three-year period. ASC 830 does not specify whether period-end rates or average rates for the period should be used in the calculation of the cumulative inflation rate. In practice, entities may exercise judgment in selecting which method to use in calculating a cumulative rate as long as the method is applied consistently. Regardless of the method used, the FASB 52 Implementation Group concluded at
its January 1982 meeting that the cumulative three-year inflation index should be
calculated on a compounded basis (an annual rate of approximately 26 percent, when
compounded, will result in a cumulative inflation rate of 100 percent).
The cases in ASC 830-10-55-24 through 55-26 illustrate how to calculate
cumulative inflation on a compounded basis. For example, the table below, adapted from
Case A in ASC 830-10-55-24, shows the annual rate and cumulative three-year rate for the
first three years.
In this scenario, an entity would perform the
following steps in calculating the cumulative inflation rate on a compound basis:
In some cases, an annual index, rather than a specific inflation rate, is available. In such circumstances, an entity must perform the additional step of calculating the annual inflation rate for each year in the three-year period. The calculation of the cumulative inflation rate in such cases is illustrated in the table below.
Calculation of Cumulative
Three-Year Rate by Using an Index
As noted in ASC 830-10-45-12, when the cumulative inflation rate is greater than
100 percent, the economy should be considered highly inflationary “in all instances.” When
the cumulative rate is less than 100 percent, an entity must use judgment and carefully
consider additional factors (e.g., trends). For example, when an economy’s cumulative
three-year rate has increased each year and is approaching 100 percent, an entity should
analyze whether this rate is expected to reach 100 percent in the near future. Similarly,
as illustrated in the example in ASC 830-10-55-25, an entity would not automatically cease
being considered highly inflationary simply because the cumulative inflation rate falls
below 100 percent; rather, the entity should consider whether the decrease is
temporary.
7.2.2 Role of the IPTF
Previously, the IPTF had discussed inflation in certain countries at its
semiannual joint meeting with the SEC staff. As reported in the November 21, 2017, joint
meeting highlights, the IPTF
concluded that ”it will no longer include [the inflation data] as a component of the
semi-annual meeting with SEC staff, but rather it will generate a separate document to
summarize the inflation data collected by the members of the IPTF.” The IPTF further
indicated that the “document will not be reviewed by the SEC staff, however, the SEC staff
has indicated that they are available for consultation should an entity wish to seek
preclearance on its conclusions in this area.”
The IPTF developed a framework for compiling and presenting inflation data to
help entities monitor inflation statistics in certain countries whose economies may be
highly inflationary. Entities should consider the recent activities of the IPTF when
determining whether an economy is highly inflationary. However, entities should not solely
rely on the IPTF’s framework. Rather, they should consider developing their own framework
to monitor countries whose economies may be highly inflationary, particularly if they have
operations in multiple countries. In addition, although information presented by the IPTF
may be helpful to making this determination, management should have appropriate controls
in place to independently monitor current reported inflation data as well as to consider
other economic indicators.
The IPTF semiannually issues a discussion document on monitoring inflation in
certain countries. The most recent one, which was released on November 18, 2024, states, in
part:
The Task Force compiled cumulative inflation data by country (for
those countries for which the International Monetary Fund [IMF] publishes data), and
then categorized the countries based on their cumulative inflation rates and the
implementation guidance in ASC 830. . . . In addition, the Task Force identified
countries where projected cumulative inflation rates would have been categorized into
categories considering the guidance in ASC 830 and in circumstances where there was
not consistent reliable data. The categories are . . . as follows:
1a. Countries with three-year cumulative inflation rates exceeding 100% (ASC
830, Case A) . . .
1b. Countries with projected three-year cumulative inflation rates greater than
100% in the current year . . .
2. Countries with three-year cumulative inflation rates exceeding 100% in
recent years, but with three-year cumulative inflation rates between 70% and 100%
in the last calendar year (ASC 830, Case B) . . .
3. Countries with recent three-year cumulative inflation rates exceeding 100%
after a spike in inflation in a discrete period (ASC 830, Case C) . . .
4. Countries with three-year cumulative inflation rates between 70% and 100% in
the current year, or with a significant (25% or more) increase in inflation during
the last calendar year, or a significant increase in projected inflation in the
current year, or with projected three-year cumulative inflation rates greater than
100% in the next year . . .
As the IPTF notes, ASC 830 provides examples illustrating several of the scenarios listed above. Specifically:
- Case A in ASC 830-10-55-24 provides an example in which the three-year cumulative rate exceeds 100 percent and in which a company must therefore classify the economy as highly inflationary.
- Case B in ASC 830-10-55-25 provides an example in which a country’s economy continues to be classified as highly inflationary even though the three-year cumulative rate is below 100 percent. The reason for this classification is that there is a lack of evidence suggesting that the drop below 100 percent is other than temporary and annual inflation has been consistently high.
- Case C in ASC 830-10-55-26 provides an example in which a country’s economy no longer exceeds 100 percent for the cumulative three-year rate and the classification as highly inflationary resulted from an isolated spike in annual inflation. ASC 830-10-55-26 indicates that this country’s economy should no longer be classified as highly inflationary.
The report includes countries that qualify for each of the categories listed in
the discussion document. An example of a single country’s data, obtained from Category 1a,
has been provided below. There may be additional countries that should be monitored that
are not included in the IPTF report because the sources used to compile the IPTF list do
not include inflation data for all countries or current inflation data.
As previously mentioned, although ASC 830 does not specify which rates or
indices should be used, those reported by the IMF are some of the most common
ones employed. In addition, we encourage entities not to rely solely on reports
such as those mentioned above to determine whether a country is highly
inflationary, particularly those entities with operations in multiple
countries.
Connecting the Dots
Inflation data is available on the IMF’s Web site. To access the data, an entity would perform the following steps:
- On the home page, click the “Data” tab.
- Select “World Economic Outlook [WEO] Databases” from the drop-down menu.
- Select the appropriate database, depending on the period for which an index or rate is needed.
- Select “By Countries (country-level data).”
- Select either the applicable country group and specific countries of interest or “All countries,” then click “Continue.”
- Under the “Monetary” header, select “Inflation, end of period consumer prices,” then click “Continue.”1
- Select a date range (e.g., 2014–2019) and click “Prepare Report.”
The IMF WEO report estimates inflation in instances in which actual inflation
data have not been obtained and describes the assumptions and methods used to
develop those estimates. The WEO report is generally released semiannually, and
the IMF data have limitations (e.g., the use of projected inflation data and
inconsistent dates through which actual data are included in the table may not
include certain indices). Nevertheless, the calculated three-year cumulative
inflation rates in the report are useful for determining which countries must be
further analyzed.
The IMF’s Web site indicates that historical information may be updated in the future as more information becomes available. Further, the information may differ from that reported by the respective countries’ central banks or governments (e.g., because a country has not reported inflation data to the IMF in a timely fashion). Accordingly, entities using the IMF data should consider whether they need to supplement such data with other pertinent information.
If an entity determines that such additional information is necessary, management may need to consider the applicable country’s central bank or government Web site to obtain annual or month-end inflationary information. When the presentation of such information differs from that used by the IMF to report the inflation data, the data may need to be converted because of differences in presentation (e.g., certain countries have recently reset their base index to 100).
Although the IMF rates are some of the most commonly used rates, an entity’s
management may consider other sources of information. In fact, while the IPTF uses the IMF
data to present inflationary data in its meeting minutes, the IPTF acknowledges that the
Task Force does “not [perform] procedures to identify any potential differences” between
the data used by the Task Force and “the inflation data reported by the respective
countries’ central banks or governments.” The IPTF therefore suggests that the “summarized
IMF information [be] supplemented, to the extent considered necessary, with other
pertinent information that may be available.” Regardless of the data used, however,
management must consider both the source and reliability of the information.
Connecting the Dots
Management is responsible for monitoring inflation and determining that an
economy is highly inflationary. The IPTF discussion document states, “Registrants are
responsible for monitoring inflation in countries in which they have operations.” To
the extent that management’s conclusion regarding an economy’s highly inflationary
status is inconsistent with inflation data provided by the IPTF, consultation with
accounting advisers is strongly encouraged.
Footnotes
1
Note that both the index and the
percentage change may not be available and that the
report may have different information.
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.
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
3
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.