Deloitte’s Roadmap: Foreign Currency Matters
Preface
Preface
We are pleased to present the 2024 edition of
Foreign Currency Matters. This Roadmap provides Deloitte’s insights into
and interpretations of the accounting guidance under ASC 830.1 While the guidance in ASC 830 has not changed significantly over the years,
the application of the existing framework has continued to evolve as a result of the
increasing interdependence and complexity of international economies and companies’
legal structures.
Each chapter of this publication typically
starts with a brief introduction and includes excerpts from ASC 830, Deloitte’s
interpretations of those excerpts, and examples to illustrate the relevant guidance.
This publication also addresses relevant SEC considerations and highlights from the
meetings of the AICPA SEC Regulations Committee’s International Practices Task Force
(highlighted by “SEC Considerations” icons). No significant changes have been made
to this publication since the release of the 2023 edition.
Be sure to check out On the
Radar (also available as a stand-alone publication),
which briefly summarizes emerging issues and trends related
to the accounting and financial reporting topics addressed
in the Roadmap.
Note that this Roadmap is not a substitute for the exercise of professional judgment, which is often essential to applying the requirements of ASC 830. It is also not a substitute for consulting with Deloitte professionals on complex accounting questions and transactions.
We hope that you find this publication a
valuable resource when considering the accounting guidance on foreign currency
matters.
Footnotes
1
For a list of abbreviations
used in this publication, see Appendix C. For the full titles of
standards, topics, and regulations used in this publication, see Appendix B.
On the Radar
On the Radar
Many entities operate in multiple countries. When an entity’s financial statements
include foreign operations, the entity must consolidate those foreign entities and
present them as though they were the financial statements of a single reporting
entity. This process of translating the accounts of foreign entities is addressed in
ASC 830, which has existed for decades without recent substantial changes, and is
known as the “functional-currency approach.”
Under the functional-currency
approach, a reporting entity must perform four steps:
The Functional-Currency Approach
The functional-currency approach comprises the following four steps:
-
Step 1: Identify each distinct and separable operation within the consolidated group — The first step in the functional-currency approach is to determine which foreign entities make up the reporting entity. To be considered a foreign entity, an operation (or set of operations) should have its own financial statements or be able to produce such statements. Accordingly, a foreign entity most likely would have a management team that uses dedicated resources to run the entity’s operations. The concept of “distinct and separable operations” is important to making this determination. While a legal entity may represent a distinct and separable operation, a legal entity could consist of multiple distinct and separable operations (i.e., multiple foreign entities for financial reporting purposes).
-
Step 2: Determine the functional currency for each distinct and separable operation — Once the distinct and separable operations (i.e., foreign entities) have been identified, the next step is to determine the “currency of the primary economic environment in which each [foreign] entity operates.” An entity may be required to use significant judgment in making this determination. Special consideration is required for entities that operate in highly inflationary economies (see further discussion below).
-
Step 3: Measure in the functional currency the assets, liabilities, and operations of each distinct and separable operation — Foreign currency transactions must be remeasured into an entity’s functional currency before those amounts are translated into the parent’s reporting currency. Accordingly, an entity must distinguish between monetary and nonmonetary items. Monetary items are remeasured into an entity’s functional currency by using a current exchange rate, which generally results in the recognition of gains or losses in earnings. On the other hand, nonmonetary items are remeasured at historical exchange rates; therefore, gains and losses would not be recognized in earnings for such items. An entity may need to use judgment in determining the exchange rate to use for such remeasurements (see further discussion below).
-
Step 4: Translate those amounts into the reporting currency — The last step is to translate the amounts of foreign entities into the reporting currency, which is generally the functional currency of the entity’s parent. This process is performed on a step-by-step basis (i.e., the amounts of third-tier foreign entities are translated into the reporting currency of their immediate parent before the intermediate parent’s amounts are translated into the ultimate parent’s reporting currency). As is the case with remeasurement, an entity may need to use judgment in determining the exchange rate to use for such translations (see further discussion below).
Common Misconception
It is important to understand the
difference between remeasurement and translation under
ASC 830, since the applicability of the two concepts
differs as does the treatment of the resulting gains and
losses. Remeasurement of financial results into the
functional currency of a foreign entity involves the
presentation of transactions denominated in a currency
that differs from the entity’s functional currency, and
this process generally affects the income statement.
Translation simply refers to the process of converting
the financial statements from the functional currency
into the parent’s reporting currency. The effects of
translation are reported in equity. For example, an
EUR-denominated subsidiary of a U.S. parent would
remeasure a JPY-denominated receivable into euros before
translating its financial statements into U.S. dollars.
Special Considerations
Exchange Rates
In remeasuring foreign-currency-denominated transactions into the entity’s
functional currency and translating financial statements into the parent’s
reporting currency, an entity must identify the appropriate exchange rate.
While ASC 830 provides some guidance on which exchange rates should be used,
it may not always be clear that a particular exchange rate is appropriate.
Significant judgment may be required when multiple legal exchange rates
coexist (e.g., when an official exchange rate and an unofficial exchange
rate exist).
Intra-Entity Transactions
Intra-entity foreign currency transactions can have unique effects on an
entity’s financial statements, including the (1) creation and transfer of
foreign currency risk from one entity in a consolidated group to another,
(2) creation of transaction gains and losses that “survive” consolidation,
and (3) application of exceptions to the general rules outlined in ASC 830.
In some situations, the remeasurement of loans between entities within a
consolidated group creates transaction gains or losses that are recognized
in earnings. In other situations, the remeasurement is recognized within
equity.
Highly Inflationary Economies
In economies with significant inflation, the local currency may be deemed
unstable. Therefore, ASC 830 requires that entities operating in
environments deemed to be highly inflationary remeasure their financial
statements into the reporting currency. That is, the reporting currency of
the entity’s immediate parent is used as the functional currency of the
foreign entity. An entity may need to use significant judgment in
determining whether a foreign entity has a highly inflationary economy. If
such an economy is determined to be highly inflationary, the guidance in ASC
830 on applying the functional-currency approach must be applied. The
application of such guidance can be time-consuming and complex.
This Roadmap comprehensively
discusses the scope, measurement, and disclosure
guidance in ASC 830.
Contacts
Contacts
|
Ashley Carpenter
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 203 761 3197
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|
Dennis Howell
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 203 761 3478
|
|
Ignacio Perez
Audit & Assurance
Managing Director
Deloitte & Touche
LLP
+1 203 761 3379
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For information about Deloitte’s service offerings related to foreign currency
matters, please contact:
|
Michael Lund
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 312 486 1942
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Chapter 1 — Introduction
Chapter 1 — Introduction
1.1 Overview
Since the issuance of FASB Statement 52 (codified in ASC 830) in
1981, domestic and international economies have become more interdependent. In
addition, the structures of many multinational corporations have become more
intricate. For example, many corporations are organized as a series of holding
companies that have no significant operations and only hold investments in other
entities within the group. Furthermore, certain significant global functions (e.g.,
treasury) that transact in many different currencies are performed entirely outside
the United States.
Despite such changes in the ways companies are organized and operated, the guidance
codified in ASC 830 has not changed significantly over the years. Under ASC 830, it
is assumed that the reporting entity uses the USD as its reporting currency and that
its foreign operations are either (1) self-contained and integrated into a
particular country or economic environment or (2) extensions of the reporting
entity. As a result, companies may encounter challenges in applying such guidance to
their operating structures because their foreign operations may not fit cleanly into
either of the two types contemplated in ASC 830. For example, the treasury function
mentioned above may transact in virtually every currency and operate independently
from the reporting entity. That is, it is neither (1) contained in a particular
economic environment nor (2) an extension of the reporting entity.
1.2 Scope
Although not defined in the ASC master glossary, the term “currency” commonly refers to a generally accepted form of money, including coins and paper notes, issued by a sovereign government and circulated within an economy. Currency is a medium of exchange for goods and services and is the basis for trade.
Cryptocurrencies are not cash and therefore would not be considered
a foreign currency within the scope of ASC 830. While cryptocurrencies may be used
as a medium of exchange, they are not backed by a sovereign government and do not
represent legal tender that must be accepted as a form of payment.
ASC 830-10 — Glossary
Foreign Currency
A currency other than the functional currency of the entity being referred to (for example, the dollar could be a
foreign currency for a foreign entity). Composites of currencies, such as the Special Drawing Rights, used to set
prices or denominate amounts of loans, and so forth, have the characteristics of foreign currency.
Foreign Currency Transactions
Transactions whose terms are denominated in a currency other than the entity’s functional currency. Foreign
currency transactions arise when a reporting entity does any of the following:
- Buys or sells on credit goods or services whose prices are denominated in foreign currency
- Borrows or lends funds and the amounts payable or receivable are denominated in foreign currency
- Is a party to an unperformed forward exchange contract
- For other reasons, acquires or disposes of assets, or incurs or settles liabilities denominated in foreign currency.
Special Drawing Rights on the International Monetary Fund are international reserve assets whose value is
based on a basket of key international currencies.
As indicated in ASC 830-10-15, all entities and all foreign currency
transactions are within the scope of ASC 830 regardless of which currency is
selected as the reporting currency. Reporting entities that engage in foreign
currency transactions should be aware that certain entities, generally multilateral
development banks (e.g., International Bank for Reconstruction and Development, Bank
for International Settlements), engage in foreign currency transactions denominated
in special drawing rights (SDRs).
If a reporting entity uses its local currency as the reporting currency and prepares
its financial statements in accordance with U.S. GAAP, it must apply ASC 830.
However, in these instances, ASC 830 would not apply for purposes “other than
consolidation, combination, or the equity method” (i.e., convenience
translations).
SEC Regulation S-X, Rule 3-20(b), provides guidance on presenting convenience
translations for foreign private issuers and states, in part, “[i]f the reporting
currency is not the U.S. dollar, dollar-equivalent financial statements or
convenience translations shall not be presented, except a translation may be
presented of the most recent fiscal year and any subsequent interim period presented
using the exchange rate as of the most recent balance sheet included in the filing,
except that a rate as of the most recent practicable date shall be used if
materially different.” In addition, SEC rules require foreign private issuers to
disclose prominently, on the face of the financial statements, the currency in which
amounts in the financial statements are stated. Further, if dividends on publicly
held equity securities are declared in a currency other than the reporting currency,
a note to the financial statements should identify that currency.
Footnotes
1
On its Web site, the
International Monetary Fund (IMF) describes SDRs as follows:
The SDR is an international reserve asset,
created by the IMF in 1969 to supplement its
member countries’ official reserves. So far SDR
660.7 billion (equivalent to about US$935.7
billion) has been allocated to members, including
SDR 182.7 billion allocated in 2009 in the wake of
the global financial crisis. The value of the SDR
is based on a basket of five currencies — the U.S.
dollar, the euro, the Chinese renminbi, the
Japanese yen, and the British pound
sterling.
1.3 Objective of ASC 830
The primary objective of ASC 830 is for reporting entities to present their consolidated financial statements as though they are the financial statements of a single entity. Therefore, if a reporting entity operates in more than one currency environment, it must translate the financial results of those operations into a single currency (referred to as the reporting currency). However, this process should not affect the financial results and relationships that were created in the economic environment of those operations.
In accordance with the primary objective of ASC 830, a reporting entity must use a “functional-currency approach” in which all transactions are first measured in the currency of the primary economic environment in which the reporting entity operates (i.e., the functional currency) and then translated into the reporting currency.
1.4 Functional-Currency Approach
Under the functional-currency approach, the reporting entity must perform four
steps:
Because the functional-currency approach requires an entity to measure the assets, liabilities, and operations in the functional currency, an entity that enters into transactions in currencies other than its functional currency must first remeasure those amounts in its functional currency before they are translated into the reporting currency.
Connecting the Dots
It is important to understand the difference between remeasurement and
translation under ASC 830. By remeasuring financial results in
the functional currency, an entity provides information about its future net
cash flows. That is, as exchange rates fluctuate, so too will the related
cash flows. For this reason, the effects of remeasurement are generally
reported in the income statement. Translation, on the other hand, simply
refers to the process of converting the financial statements from the
functional currency into a different currency. In other words, the
translation process has no impact on an entity’s future cash flows. For this
reason, the effects of translation are reported in equity.
To illustrate the application of the functional-currency approach under ASC 830,
this section is divided into the following two subsections:
-
“Decision Points” — This section discusses the two key decisions that management must make to apply the functional-currency approach: (1) identify the distinct and separable operations and (2) determine the functional currency of each. Management must use judgment in making each of these decisions before the reporting entity can apply the recognition and measurement guidance in ASC 830. As further discussed below, the terms “distinct and separable operation” and “foreign entity” are used interchangeably in this Roadmap.
-
“Mechanics of ASC 830” — This section summarizes the processes for remeasuring foreign currency transactions into the functional currency and translating foreign currency statements into the reporting currency. While some judgment may be required (e.g., selecting exchange rates, assessing intra-entity transactions that are of a long-term investment nature), the accounting for foreign currency transactions and financial statement translation is largely a mechanical exercise once the functional currency has been determined.
1.4.1 Decision Points
The first step in applying the functional-currency approach under ASC 830 is to identify each distinct and separable operation within the consolidated group. While ASC 830 does not explicitly define “distinct and separable operation,” ASC 830-10-45-5 states:
An entity might have more than one distinct and separable operation, such as a division or branch, in which case each operation may be considered a separate entity. If those operations are conducted in different economic environments, they might have different functional currencies.
ASC 830-10-45-5 highlights that the functional currency could be different for each distinct and separable operation, even if those operations are part of the same entity. Therefore, to correctly determine the functional currency under ASC 830, reporting entities must evaluate whether a single entity contains two or more distinct operations. See Chapter 2 for further guidance on determining distinct and separable operations.
After identifying the distinct and separable operations, the reporting entity
must determine the functional currency of each one. This step is critical to the
successful application of ASC 830 since the functional currency directly affects
the identification and measurement of foreign currency transactions and the
translation of the financial statements (discussed in Section 1.4.2).
ASC 830 defines functional currency as “the currency of the primary economic
environment in which the entity operates; normally, that is the currency of the
environment in which an entity primarily generates and expends cash.” ASC
830-10-45-6 further states that “the functional currency of an entity is, in
principle, a matter of fact.” That is, the functional currency of an entity is
not simply an election that the reporting entity makes but a determination that
is made on the basis of facts.
It can be challenging to determine an entity’s functional currency, depending on the nature of the entity’s operations. Therefore, to help reporting entities determine the functional currency of their entities, ASC 830 provides the following indicators, which must be assessed both individually and collectively:
Once an entity has determined the functional currency on the basis of evaluating
the indicators above, it is generally rare that this currency would change in
the future. ASC 830-10-45-7 indicates that there must be “significant changes in
economic facts and circumstances” to justify changing an entity’s functional
currency. However, ASC 830 also requires an entity to change its functional
currency to the reporting currency of its immediate parent if the economy in
which the entity operates becomes highly inflationary.
Connecting the Dots
ASC 830-10-45-5 clarifies that each distinct and separable operation of
the reporting entity is considered a separate “entity” when the
requirements of ASC 830 are applied. Furthermore, ASC 830-10-20 defines
a “foreign entity” and “reporting entity” as follows:
Foreign Entity
An operation (for example, subsidiary, division, branch, joint
venture, and so forth) whose financial statements are both:
- Prepared in a currency other than the reporting currency of the reporting entity
- Combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity.
Reporting Entity
An entity or group whose financial statements are being referred
to. Those financial statements reflect any of the following:
- The financial statements of one or more foreign operations by combination, consolidation, or equity accounting
- Foreign currency transactions.
Accordingly, each “distinct and separable operation” whose
financial statements are prepared in a currency other than the
reporting currency of the reporting entity (i.e., the direct
parent entity) would be considered a “foreign entity.”
Therefore, throughout this Roadmap, the terms “distinct and
separable operation” and “foreign entity” are used
interchangeably.
A distinct and separable operation whose financial statements are
prepared in the same currency as the reporting currency of the
reporting entity (e.g., a USD-denominated subsidiary of a
USD-denominated parent entity) may be referred to as a “domestic
entity.” While the guidance on foreign currency translation does
not apply in such circumstances, it may still be necessary to
identify such distinct and separable operations because doing so
could affect the determination of the distinct and separable
operations that constitute a foreign entity.2
For the remainder of this Roadmap, an “entity” refers to a
distinct and separable operation, which would constitute either
a foreign entity or a domestic entity.
1.4.2 Mechanics of ASC 830
The mechanics of ASC 830 include the processes for remeasuring foreign currency
transactions into the functional currency and translating foreign currency
financial statements into the reporting currency.
1.4.2.1 Measuring Foreign Currency Transactions
Under the functional-currency approach in ASC 830, the financial information of each distinct and separable operation of the reporting entity must be measured in its respective functional currency. Therefore, if an entity enters into a transaction that is denominated in a currency other than its functional currency (i.e., a foreign currency transaction), it must initially measure that transaction in its functional currency by using the exchange rate in effect when the transaction was recognized in its financial statements.
While all foreign currency transactions are initially measured in the functional currency at the then-current exchange rate, the subsequent measurement (i.e., remeasurement) of a foreign currency transaction for monetary assets and liabilities is different from that for nonmonetary assets and liabilities, as illustrated below.
- Monetary assets and liabilities — The exchange rate in effect on the reporting date must be used to remeasure monetary assets and liabilities (e.g., receivables or payables in a foreign currency) as of each reporting date in the functional currency. Therefore, fluctuations in the exchange rate between the date the foreign currency transaction was recognized and the date on which it is settled will cause the carrying amount of the monetary asset or liability to increase or decrease. That increase or decrease in the carrying amount of the asset or liability will result in a foreign currency transaction gain or loss (“transaction gain or loss”) in the period in which the exchange rate changes. With certain exceptions, transaction gains and losses should be presented in earnings in the period in which they arise.
- Nonmonetary assets and liabilities — The exchange rate that was in effect when the transaction was recognized (i.e., the historical exchange rate) must be used to remeasure, in the functional currency, nonmonetary assets and liabilities that are denominated in a foreign currency. Therefore, unlike the carrying amount of monetary assets and liabilities, the carrying amount of nonmonetary assets and liabilities will not increase or decrease as a result of fluctuations in exchange rates (and therefore no transaction gains and losses will arise). By using the historical exchange rate to remeasure nonmonetary assets and liabilities, an entity effectively achieves the same results it would have achieved if it had entered into the related transaction in its functional currency.
See Chapter 4 for more information about foreign currency transactions.
1.4.2.2 Translating Financial Statements
After all foreign currency transactions have been measured in the functional
currency, the reporting entity must translate the financial statements of
each foreign entity into the reporting currency. The purpose of the
translation process is to state all amounts that are denominated or measured
in a different currency in a single reporting currency (in a manner
consistent with the primary objective of ASC 830 — see Section 1.3).
Connecting the Dots
While the requirements in ASC 830 related to determining the functional currency
and measuring all transactions in this currency apply to all
distinct and separable operations within the reporting entity, the
translation process is only relevant to foreign entities. This is
because the financial statements of distinct and separable
operations that are not foreign entities (i.e., domestic entities)
are already measured in the reporting currency.
The graphic below summarizes which exchange rates are used to translate each account type.
Connecting the Dots
Equity accounts are not remeasured in the functional currency each
reporting period; rather, equity accounts (excluding changes in
retained earnings due to current-year net income) are
translated by using the historical exchange rate on the
date of recognition. (See Section 3.2.1 for additional
discussion of translation exchange rates.) Although nonmonetary
assets and liabilities are not remeasured in the functional
currency each reporting period, they must still be translated
into the reporting currency by using the current exchange rate. (See
Section
1.4 for an explanation of the difference between
remeasurement and translation.) The table below summarizes the
exchange rates that are used in the remeasurement and translation
processes for monetary and nonmonetary assets and liabilities.
Account Type
|
Exchange Rate for
Remeasurement
|
Exchange Rate for
Translation
|
---|---|---|
Monetary assets and
liabilities
|
Current exchange rate
|
Current exchange rate
|
Nonmonetary assets and
liabilities
|
Historical exchange rate
|
Current exchange rate
|
Translation gains or losses, which result from the process of translating a foreign entity’s financial statements into the reporting currency, are recorded in a cumulative translation adjustment (CTA), a separate component of other comprehensive income (OCI). See Chapter 5 for more information about the translation process.
Footnotes
2
The guidance on foreign currency transactions applies to
all entities.
Chapter 2 — Determining the Functional Currency
Chapter 2 — Determining the Functional Currency
2.1 Overview
ASC 830-10
45-2 The assets, liabilities, and operations of a foreign entity shall be measured using the functional currency of that entity. An entity’s functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment in which an entity primarily generates and expends cash.
To comply with the measurement and translation requirements in ASC 830, a reporting entity must identify the appropriate functional currency to use in measuring the financial position and operations of each of its foreign entities. A reporting entity may need to use significant judgment both in identifying foreign entities and in determining the “currency of the primary economic environment,” or functional currency, for each of these entities.
2.2 Definition of a Foreign Entity
ASC 830-10 — Glossary
Foreign Entity
An operation (for example, subsidiary, division, branch, joint venture, and so forth) whose financial statements are both:
- Prepared in a currency other than the reporting currency of the reporting entity
- Combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity.
The first step in the functional-currency approach is to determine which foreign entities make up the reporting entity. To be considered a foreign entity, an operation (or set of operations) should have its own financial statements or be able to produce such statements. Accordingly, a foreign entity most likely would have a management team that uses dedicated resources to run the entity’s operations. The concept of “distinct and separable operations” is important to making this determination.
From a practical standpoint, a reporting entity may begin the determination of
its distinct and separable operations by identifying each legal entity in its
organizational structure. Next, the reporting entity must determine whether any of
those legal entities have two or more distinct and separable operations (e.g.,
divisions, branches, product lines). If a legal entity has more than one distinct
and separable operation, a reporting entity would consider each operation a separate
entity when applying the guidance in ASC 830. Otherwise, the legal entity itself
would generally be considered the entity subject to ASC 830. Judgment must be used
in the determination of whether a single legal entity has more than one separate and
distinct operation, and the reporting entity must thoroughly understand how and
where the legal entity conducts business.
Connecting the Dots
The term “foreign entity,” as used in ASC 830, refers to an entity that prepares
its financial statements in a currency other than the reporting currency but
does not refer to the entity’s geographical location. Therefore, an entity
that is domiciled in the United States would meet the definition of a
foreign entity under ASC 830 if it was consolidated by a reporting entity
that has a reporting currency other than USD. Similarly, an entity that is
domiciled in a foreign country would not meet the definition of a foreign
entity under ASC 830 if it was consolidated by a reporting entity that has
the same reporting currency as the entity. Therefore, the reporting entity
must determine the functional currency of each distinct and separable
operation (i.e., entity) within the consolidated group, regardless of where
that operation is geographically located. The identification of foreign
entities is important, since ASC 830 requires that the financial statements
of each foreign entity be translated into the reporting currency, as
discussed in Section
1.3.
2.2.1 Identifying Distinct and Separable Operations
ASC 830-10
45-5 An entity might have more than one distinct and separable operation, such as a division or branch, in which case each operation may be considered a separate entity. If those operations are conducted in different economic environments, they might have different functional currencies.
55-6 In some instances, a foreign entity might have more than one distinct and separable operation. For example, a foreign entity might have one operation that sells parent-entity-produced products and another operation that manufactures and sells foreign-entity-produced products. If they are conducted in different economic environments, those two operations might have different functional currencies. Similarly, a single subsidiary of a financial institution might have relatively self-contained and integrated operations in each of several different countries. In those circumstances, each operation may be considered to be an entity as that term is used in this Subtopic, and, based on the facts and circumstances, each operation might have a different functional currency.
ASC 830-10-45-5 presents the notion of a “distinct and separable operation” but
offers no definition of or qualifying criteria related to such an operation.
Further, a distinct and separable operation may or may not meet the definition
of a business in ASC 805-10. Thus, management will need to use judgment and
consider all facts and circumstances in determining which operations are
distinct and separable. However, the following factors, while not exhaustive,
may indicate that an operation is distinct and separable for purposes of the
functional-currency analysis:
-
The operation has specifically identifiable assets and liabilities (i.e., not shared or commingled with other operations’ assets and liabilities).
-
The operation can be managed separately and apart from other operations of the reporting entity.
-
Accounting records for the operation could be produced.
As noted previously, distinct and separable operations may be identified at a lower level than the legal entity itself. For instance, divisions or branches of the same legal entity (e.g., a subsidiary) may operate in different economic environments, in which case each may be considered a distinct and separable operation.
Example 2-1
Distinct and Separable Operations
Bank IDB is an international development
bank that conducts its operations through various
currency pools. Each pool is self-contained and
integrated within a particular currency. The activities
of each pool are separable, distinct, and conducted in
the economic environment of the foreign country. Within
each pool, funds are raised in a single currency from
borrowings, loan participations, capital, and
accumulated earnings. These funds are for the most part
held, invested, or loaned, and IDB may not convert a
pool’s currency (e.g., the JPY pool may not convert JPY
into USD, GBP, etc.). Loans are denominated in the
currency of the pool. Generally, pools do not convert
currencies or engage in hedging currencies. For example,
a loan denominated in JPY would be funded by JPY
resources from the JPY pool. The loan and interest
thereon would be repaid in JPY as well.
Under ASC 830, each pool may be viewed
as a separate and distinct operation that should have
its own functional currency. The pools described above
operate in separate economic environments, and each has
its own currency in which substantially all of its
activities are executed. The pools do not hedge the
local currency against the parent’s functional currency.
This is an important factor because it demonstrates that
the pool operates in the local currency and does not peg
its operations, or results thereof, to another currency
by using derivatives. If one of the pools were to
liquidate its investments in the cash or loans, IDB
would be required to reclassify into income the amounts
it has recognized in its CTA related to those liquidated
amounts, since the only holdings of the pools are
financial instruments (i.e., financial assets and
financial liabilities instead of operations).
Under ASC 830, a reporting entity is not required to separate the accounting records of its operations if doing so is impracticable. Further, just because certain operations may be separable in some way (e.g., the operations have their own set of accounting records), the operations are not necessarily distinct and separable.
Reporting entities should carefully consider all facts and circumstances, as well as the factors discussed in Section 2.3, when determining whether an operation is distinct and separable. The following are some factors (not all-inclusive) indicating that operations may not be distinct and separable, even if separate accounting records are maintained:
- A legal entity’s foreign division is solely responsible for manufacturing certain product lines for its parent.
- A holding company is essentially an extension of its parent or affiliate (see Section 2.3.1 for additional considerations related to shell and holding companies).
- A subsidiary or division functions only as a foreign sales office for its parent.
- Individual retail stores are managed centrally.
- A foreign subsidiary or division operates only as the treasury or internal administrative function for its parent.
Example 2-2
Operations That Are Not Distinct and Separable
The overall conclusion from Example
2-1 would be different if Bank IDB
engaged in (1) foreign-currency-hedge strategies, (2)
other means of converting a particular foreign currency
into the parent’s functional currency, or (3) activities
to convert a pool’s currency into the currency of
another country, such as USD or JPY. In such cases, the
operations of the pools would not be considered separate
and distinct operations because of the high degree of
intra-entity transactions, which effectively would make
each pool an extension of IDB. Therefore, the
determination of the functional currency would be
evaluated for IDB as a whole, including the operations
of the individual pools.
2.3 Definition of Functional Currency and Indicators
ASC
830-10
45-3 It is
neither possible nor desirable to provide unequivocal
criteria to identify the functional currency of foreign
entities under all possible facts and circumstances and
still fulfill the objectives of foreign currency
translation. Arbitrary rules that might dictate the
identification of the functional currency in each case would
accomplish a degree of superficial uniformity but, in the
process, might diminish the relevance and reliability of the
resulting information.
45-4 Multinational reporting
entities may consist of entities operating in a number of
economic environments and dealing in a number of foreign
currencies. All foreign operations are not alike. To fulfill
the objectives in paragraph 830-10-10-2, it is necessary to
recognize at least two broad classes of foreign
operations:
-
In the first class are foreign operations that are relatively self-contained and integrated within a particular country or economic environment. The day-to-day operations are not dependent on the economic environment of the parent’s functional currency; the foreign operation primarily generates and expends foreign currency. The foreign currency net cash flows that it generates may be reinvested or converted and distributed to the parent. For this class, the foreign currency is the functional currency.
-
In the second class are foreign operations that are primarily a direct and integral component or extension of the parent entity’s operations. Significant assets may be acquired from the parent entity or otherwise by expending dollars and, similarly, the sale of assets may generate dollars that are available to the parent. Financing is primarily by the parent or otherwise from dollar sources. In other words, the day-to-day operations are dependent on the economic environment of the parent’s currency, and the changes in the foreign entity’s individual assets and liabilities impact directly on the cash flows of the parent entity in the parent’s currency. For this class, the dollar is the functional currency.
45-5 An
entity might have more than one distinct and separable
operation, such as a division or branch, in which case each
operation may be considered a separate entity. If those
operations are conducted in different economic environments,
they might have different functional currencies.
45-6 The functional currency of
an entity is, in principle, a matter of fact. In some cases,
the facts will clearly identify the functional currency; in
other cases they will not. For example, if a foreign entity
conducts significant amounts of business in two or more
currencies, the functional currency might not be clearly
identifiable. In those instances, the economic facts and
circumstances pertaining to a particular foreign operation
shall be assessed in relation to the stated objectives for
foreign currency translation (see paragraphs 830-10-10-1
through 10-2). Management’s judgment will be required to
determine the functional currency in which financial results
and relationships are measured with the greatest degree of
relevance and reliability.
Once the distinct and separable operations have been identified, the
next step is to determine the “currency of the primary economic environment in which
the [distinct and separable operation] operates.” An entity may be required to use
significant judgment in making this determination, depending on the nature of the
operation being evaluated. The following are two scenarios illustrating the
determination of the functional currency:
- Entity A, a subsidiary of a U.S. parent, is an operating company located in France that is relatively autonomous. Entity A conducts all of its operations in France, and all of its transactions are denominated in EUR.
- Entity B, a subsidiary of a U.S. parent, is a holding company located in Germany and obtains a loan denominated in USD from its U.S. parent. In addition, B borrows additional funds denominated in EUR from an unrelated third party and invests the entire amount, denominated in EUR, in Entity C, an operating company also located in Germany. Entity B intends to use dividends received from its investment in C to remit dividends to the parent in USD.
In the first scenario, the determination of the functional currency
is relatively straightforward: A’s functional currency is the EUR. However, in the
second scenario, it is not clear whether B’s functional currency is USD or the EUR.
Management would need to use judgment in determining B’s functional currency in the
second scenario.
Further, it should not be assumed that the functional currency is
either that of the parent or that of the jurisdiction in which the distinct and
separable operation operates (i.e., the local currency). Management may also
conclude, on the basis of the facts and circumstances, that the functional currency
is that of another jurisdiction (although such a conclusion is not as common).
In determining the appropriate functional currency, management
should consider each of the economic factors in ASC 830-10-55 and thoroughly
document the conclusions reached.
ASC
830-10
55-3 The
following provides guidance for determination of the
functional currency. The economic factors cited here, and
possibly others, should be considered both individually and
collectively when determining the functional
currency.
55-4 This general guidance
presents indicators of facts to be considered in identifying
the functional currency. In those instances in which the
indicators are mixed and the functional currency is not
obvious, management’s judgment will be required to determine
the functional currency that most faithfully portrays the
economic results of the entity’s operations and thereby best
achieves the objectives of foreign currency translation set
forth in paragraph 830-10-10-2. Management is in the best
position to obtain the pertinent facts and weigh their
relative importance in determining the functional currency
for each operation. It is important to recognize that
management’s judgment is essential and paramount in this
determination, provided only that it is not contradicted by
the facts.
55-5 The
following salient economic factors, and possibly others,
should be considered both individually and collectively when
determining the functional currency:
- Cash flow indicators, for example:
- Foreign currency. Cash flows related to the foreign entity’s individual assets and liabilities are primarily in the foreign currency and do not directly affect the parent entity’s cash flows.
- Parent’s currency. Cash flows related to the foreign entity’s individual assets and liabilities directly affect the parent’s cash flows currently and are readily available for remittance to the parent entity.
- Sales price indicators, for example:
- Foreign currency. Sales prices for the foreign entity’s products are not primarily responsive on a short-term basis to changes in exchange rates but are determined more by local competition or local government regulation.
- Parent’s currency. Sales prices for the foreign entity’s products are primarily responsive on a short-term basis to changes in exchange rates; for example, sales prices are determined more by worldwide competition or by international prices.
- Sales market indicators, for example:
- Foreign currency. There is an active local sales market for the foreign entity’s products, although there also might be significant amounts of exports.
- Parent’s currency. The sales market is mostly in the parent’s country or sales contracts are denominated in the parent’s currency.
- Expense indicators, for example:
- Foreign currency. Labor, materials, and other costs for the foreign entity’s products or services are primarily local costs, even though there also might be imports from other countries.
- Parent’s currency. Labor, materials, and other costs for the foreign entity’s products or services continually are primarily costs for components obtained from the country in which the parent entity is located.
- Financing indicators, for example:
- Foreign currency. Financing is primarily denominated in foreign currency, and funds generated by the foreign entity’s operations are sufficient to service existing and normally expected debt obligations.
- Parent’s Currency — Financing is primarily from the parent or other dollar-denominated obligations, or funds generated by the foreign entity’s operations are not sufficient to service existing and normally expected debt obligations without the infusion of additional funds from the parent entity. Infusion of additional funds from the parent entity for expansion is not a factor, provided funds generated by the foreign entity’s expanded operations are expected to be sufficient to service that additional financing.
- Intra-entity transactions and arrangements indicators, for example:
- Foreign currency. There is a low volume of intra-entity transactions and there is not an extensive interrelationship between the operations of the foreign entity and the parent entity. However, the foreign entity’s operations may rely on the parent’s or affiliates’ competitive advantages, such as patents and trademarks.
- Parent’s currency. There is a high volume of intra-entity transactions and there is an extensive interrelationship between the operations of the foreign entity and the parent entity. Additionally, the parent’s currency generally would be the functional currency if the foreign entity is a device or shell corporation for holding investments, obligations, intangible assets, and so forth, that could readily be carried on the parent’s or an affiliate’s books.
55-6 In
some instances, a foreign entity might have more than one
distinct and separable operation. For example, a foreign
entity might have one operation that sells
parent-entity-produced products and another operation that
manufactures and sells foreign-entity-produced products. If
they are conducted in different economic environments, those
two operations might have different functional currencies.
Similarly, a single subsidiary of a financial institution
might have relatively self-contained and integrated
operations in each of several different countries. In those
circumstances, each operation may be considered to be an
entity as that term is used in this Subtopic, and, based on
the facts and circumstances, each operation might have a
different functional currency.
55-7
Foreign investments that are consolidated or accounted for
by the equity method are controlled by or subject to
significant influence by the parent entity. Likewise, the
parent’s currency is often used for measurements,
assessments, evaluations, projections, and so forth,
pertaining to foreign investments as part of the management
decision-making process. Such management control, decisions,
and resultant actions may reflect, indicate, or create
economic facts and circumstances. However, the exercise of
significant management control and the use of the parent’s
currency for decision-making purposes do not determine, per
se, that the parent’s currency is the functional currency
for foreign operations.
ASC 830 does not address how the above economic factors should be
applied (e.g., weightings or hierarchy may differ for certain factors) but states
that these “factors, and possibly others, should be considered both individually and
collectively when determining the functional currency.”
However, because changes in functional currency are expected to be
infrequent (see Section
2.4), management should place greater emphasis on long-term
considerations related to each factor than it does on short-term considerations. For
example, start-up operations may receive significant financing from the parent in
the parent’s functional currency but ultimately plan to operate primarily in a
foreign economic environment. In such cases, the facts and circumstances may
indicate that, while the start-up operation’s financing was in the currency of its
parent in the short term, the start-up operation may eventually operate primarily in
the foreign economic environment. Therefore, consideration of the factors above
would most likely lead to a conclusion that the start-up operation’s functional
currency is, in fact, different from the parent’s.
Connecting the Dots
An unconsolidated joint venture or an equity method
investment in which a reporting entity invests is subject to the same
functional currency assessment that the reporting entity is required to
perform for an entity it consolidates (i.e., because the functional currency
of such unconsolidated entities may also differ from that of the reporting
entity). However, because such entities are not consolidated, the reporting
entity may not have access to certain information that it would otherwise
have for a consolidated entity. Accordingly, a reporting entity would most
likely need to exercise greater judgment when determining the functional
currency for an unconsolidated joint venture or equity method
investment.
Example 2-3
Functional Currency Is the Same as the Parent’s
Company X, which is incorporated in the
United States, is a subsidiary of a U.S.-based parent whose
reporting currency is USD. Company X maintains branches,
including marketing and manufacturing, in several countries.
Belgium is the predominant manufacturing location, and
Canada is the predominant research and development location.
In addition, X has operations in two other countries.
Management has determined that none of X’s foreign branches
are distinct and separable. Therefore, the functional
currency has been determined for X as a whole.
Management of X uses USD when preparing its
company-wide budget and internal reports. Salaries and other
general expenses are paid in the local currencies of the
countries in which X operates. Sales are invoiced in USD,
but local customers frequently pay in the local currency at
the current exchange rate. All intercompany sales are
denominated and paid in USD. About 80 percent of X’s
borrowings are denominated in USD.
Company X
Several of the indicators in ASC 830-10-55-5
demonstrate that X’s functional currency is USD. Because X
transacts business in several countries, one local currency
is not considered more dominant than another. Sales
invoicing, financing, and intercompany transactions are
predominantly in USD, and this currency is dominant in
management’s budgeting and pricing process. While selling
and general expenses are paid in other currencies, doing so
is a function of X’s business transactions in those
countries. For example, a worker in the Belgian
manufacturing plant would expect his or her salary to be
paid in the local currency (i.e., EUR), not in USD. Further,
net cash flows appear to be in USD.
Example 2-4
Subsidiaries With Different Functional Currencies
Company
Z, a U.K.-based entity whose functional currency is the GBP,
has two operating subsidiaries, Company A and Company B,
which are distinct and separable operations under ASC 830.
Both A and B obtain financing from Z, which is denominated
in GBP (i.e., neither subsidiary maintains third-party
debt). See Example 2-5 for discussion related to
B.
Company A is located in Spain,
where most of its products are manufactured and sold. Sales
prices charged by A are denominated in EUR and determined on
the basis of local conditions (i.e., market competition or
government regulations in Spain). Similarly, selling and
administrative expenses are paid in EUR. Any excess cash
flows are retained by A and reinvested in the Spain-based
operations. Company A does not have intercompany
transactions other than payments made to the parent entity
in GBP in connection with its outstanding intercompany debt,
which is not material to A’s balance sheet.
Company A
Company A’s functional currency is the EUR. Although financing is entirely in
GBP, the majority of the remaining economic indicators are
in EUR. Sales are invoiced, selling and general expenses are
paid in EUR, and excess cash flows are retained by A and
reinvested in the Spanish operations.
Example 2-5
Subsidiaries With Different Functional Currencies
Company B
is located in Mexico, but its products are manufactured
primarily in the United Kingdom and purchased from Z at a
transfer price set to cover both production costs and
research and development; these intercompany sales are
invoiced in GBP. Sales prices charged by B are denominated
in MXN and determined on the basis of local conditions
(i.e., market competition or government regulations in
Mexico). Similarly, selling and administrative expenses are
paid in local currency. Any excess cash flows generated by B
are distributed to and invested by Z in the United
Kingdom.
Company B
Company B’s functional currency is GBP. Financing is entirely in GBP, and
intra-entity transactions, which include significant
inventory transfers, are predominantly in GBP. Further,
excess cash flows are repatriated to the United Kingdom,
where they are invested by the parent entity. Although sales
are invoiced and selling and general expenses are paid in
MXN, doing so is a function of conducting business in
Mexico, and it appears that these are the only cash flows
not denominated in GBP. In this case, group management most
likely views B as a local sales branch integral to the
parent.
Example 2-6
Functional Currency of a Start-Up Operation
Newco is
a U.K.-based, newly formed, wholly owned subsidiary of
Company A, a U.S.-based entity whose functional currency is
USD. Because of a series of legal transactions associated
with the creation of Newco, cash received from A as part of
initial equity financing and a note due from another
subsidiary of A (the “note”) are Newco’s only assets, both
of which are denominated in USD; it has no significant
liabilities. Newco does not currently have any operational
activities or any employees of its own since A’s employees
currently manage and operate the entity. In considering
Newco’s functional currency, A’s management focuses on
longer-term considerations rather than shorter-term
considerations, including intentions for Newco to (1)
establish local manufacturing operations, (2) recruit and
hire locally based management and a general workforce, and
(3) create a sales force to develop a local customer base.
In addition, management’s intention is for Newco to retain
the initial cash financing and retain and accumulate the
repaid principal and interest earned on the note (all
denominated in USD). The accumulated USD-denominated funds
will be used to fund the start-up operations and consummate
potential future acquisitions of U.K.-based entities.
Management has no intention to repatriate any funds held by
Newco to A.
Newco
On the basis of Newco’s current structure
and operations, it seems to have the same functional
currency as its parent (i.e., USD). However, management’s
long-term intention is for Newco to act as a distinct and
separate entity within the United Kingdom. Newco, therefore,
will have the characteristics of an entity that is
integrated into a particular economic environment (i.e., the
United Kingdom) and that has a currency different from the
one that currently represents most of Newco’s operations.
Although intra-entity transactions are denominated in USD,
they are limited to payments received in connection with the
note. Upon formation, therefore, Newco’s functional currency
is GBP rather than USD.
2.3.1 Considerations for Shell and Holding Companies
2.3.1.1 Subsidiaries Formed as Shell or Holding Companies
Although ASC 830 does not assign weight to or provide a
specific hierarchy for the indicators discussed above, it stipulates that if
a shell or holding company was formed primarily to hold assets or
liabilities (e.g., investments, debt, intangible assets) that could “readily
be carried on the parent’s or an affiliate’s books,” the functional currency
for that shell or holding company would generally be that of its immediate
parent. This could be the case, for example, when a holding company is
established to conduct a narrow transaction or set of transactions (e.g.,
borrowing) that could have easily been performed by the parent. In listing
factors that may indicate that the parent’s currency should be the entity’s
functional currency, ASC 830-10-55-5(f)(2) states:
There is a high volume of intra-entity transactions
and there is an extensive interrelationship between the operations
of the foreign entity and the parent entity. Additionally, the
parent’s currency generally would be the functional currency if the
foreign entity is a device or shell corporation for holding
investments, obligations, intangible assets, and so forth, that
could readily be carried on the parent’s or an affiliate’s
books.
Example 2-7
Functional Currency for Holding
Companies
Company A, which has identified the USD as its
functional currency, establishes two wholly owned
subsidiary holding companies, Company B and Company
C. Company B is incorporated in the United States,
and C is incorporated in the United Kingdom. Company
A loans 5 million GBP (£) to each company; B and C
both record the transaction as an intercompany
payable. Company B has no other assets, liabilities,
or operations besides the cash received and the
corresponding intercompany payable. In addition, C
borrows an additional £2 million from an unrelated
third party; A guarantees this loan. Company C
invests the entire £7 million in Company D, an
operating company in the United Kingdom, and intends
to use dividends received from its investment in D
to repay the loan to the third party.
The functional currency of B should
be USD, the same functional currency as that of its
parent company. Although B’s loan transaction
results in a payable denominated in a foreign
currency, it is a shell company. It has no
substantive operations of its own and is not
conducting any operations that the parent could not
otherwise conduct itself. Therefore, its functional
currency should be USD.
Company C also appears to be a shell company.
However, C must consider additional indicators in
determining its functional currency; these
indicators demonstrate that C is “integrated within
a particular country or economic environment.”
Specifically, C is incorporated in the United
Kingdom and has an investment in a substantive
operating company that is also incorporated in the
United Kingdom; has borrowed money from a third
party that is denominated in GBP instead of USD; and
intends to repay its third-party loan by using
dividends from its investment in D. Thus, C’s
functional currency appears to be GBP.
2.3.1.2 Parent Formed as a Shell or Holding Company
There may be cases in which the parent entity itself is a
holding company (e.g., when a company is trying to access a particular
market, such as the U.S. market, a holding company may be established to
facilitate market access). There is no explicit guidance on how to determine
the functional currency of such entities. In such circumstances, entities
are encouraged to consult with their accounting advisers.
Connecting the Dots
To facilitate their access to the U.S. or other
global capital markets, Chinese operating companies commonly
establish holding companies in a foreign territory or country (e.g.,
the Cayman Islands) that serve as the ultimate parent of the
consolidated group. In such cases, questions have arisen regarding
what the functional currency of the ultimate parent holding company
should be.
ASC 830 does not directly address the determination
of the functional currency of the ultimate parent holding company.
However, in practice, entities have used one of the two approaches
discussed below to determine the ultimate parent holding company’s
functional currency in such situations.
Approach 1 (“Top-Down”
Approach)
Under the top-down approach, the functional currency
is assessed on the basis of the ultimate parent holding company’s
activities. In this context, the ultimate parent holding company
generally does not carry out any substantive business operations;
rather, its main purpose is to hold the investments in Chinese
operating entities and earn a return through dividends to be
received from those entities. Further, the ultimate parent holding
company, in addition to serving as a listing vehicle, is generally
responsible for financing and raising capital in USD, as well as
paying dividends to its own investors in USD. These activities may
be considered relevant to assessing economic factors in the
determination of the functional currency. That is, “the financing
indicator” in ASC 830-10-55-5(e) may be considered the most relevant
indicator and may lead management to conclude that USD would be the
appropriate functional currency of the ultimate parent holding
company.
Approach 2 (“Bottom-Up”
Approach)
Under the bottom-up approach, the ultimate parent
holding company is deemed to be an extension of the operating
subsidiaries in China. The ultimate parent holding company does not
have substantive business operations, and its principal purpose is
to raise capital to fund the Chinese operating entities. Therefore,
it would be acceptable to look through the legal form and consider
the ultimate parent to be an “extension” of the Chinese operating
subsidiaries rather than as a self-sustained parent entity with
substantive operations. ASC 830-10-55-5(f)(2) indicates that in the
determination of the functional currency, “the parent’s currency
generally would be the functional currency if the foreign entity is
a device or shell corporation for holding investments, obligations,
intangible assets, and so forth that could readily be carried on the
parent’s or an affiliate’s books.” However, because the ultimate
parent in this scenario does not have substantive operations, the
ultimate parent holding company under this approach could be viewed
as nonsubstantive and as a device or shell corporation for holding
investments, obligations, etc., that could readily be carried on the
Chinese operating company’s books. Accordingly, in such
circumstances, the functional currency of the ultimate parent
holding company could be considered the same as that of its Chinese
operating entities.
The bottom-up approach provides for a reasonable
framework when substantially all of the company’s operations are
concentrated within a specific foreign jurisdiction and the
functional currency is the same for all those subsidiaries.
Additional consideration would be required when subsidiaries’
operations span multiple foreign jurisdictions (i.e., multiple
operating subsidiaries with different functional currencies). In
these instances, it may prove challenging to conclude that the
ultimate parent holding company is an extension of subsidiaries in a
single jurisdiction when no individual operations are significantly
larger than others.
2.4 Change in Functional Currency
ASC 830-10
Changes in the Functional Currency
45-7 Once the functional currency for a foreign entity is determined, that determination shall be used consistently unless significant changes in economic facts and circumstances indicate clearly that the functional currency has changed. Previously issued financial statements shall not be restated for any change in the functional currency.
45-8 See paragraph 250-10-45-1 for guidance on adoption
or modification of an accounting principle necessitated by transactions or
events that are clearly different in substance from those previously occurring.
Paragraphs 830-10-45-15 through 45-16 discuss changes related to highly
inflationary economies.
Functional Currency Changes From Reporting Currency to Foreign Currency
45-9 If the functional currency changes from the reporting currency to a foreign currency, the adjustment attributable to current-rate translation of nonmonetary assets as of the date of the change shall be reported in other comprehensive income.
Functional Currency Changes From Foreign Currency to Reporting Currency
45-10 If the functional currency changes from a foreign currency to the reporting currency, translation adjustments for prior periods shall not be removed from equity and the translated amounts for nonmonetary assets at the end of the prior period become the accounting basis for those assets in the period of the change and subsequent periods. This guidance shall be used also to account for a change in functional currency from the foreign currency to the reporting currency when an economy becomes highly inflationary.
ASC 830-10-45-7 indicates that there must be “significant changes in economic
facts and circumstances” to justify a change in functional currency. Except when an economy
is identified as highly inflationary (see Chapter 7), ASC 830 does not define or provide examples related to what
constitutes a significant change in facts and circumstances. An entity must therefore use
judgment in determining whether significant changes in facts and circumstances have
occurred. However, such changes are expected to be rare.
Changes in the functional currency may result from one-time transactions,
such as a merger or acquisition, or from a longer-term shift in an entity’s operations.
Regardless of the reason, it is important that management carefully consider whether such an
event is significant enough to warrant a change in the functional currency. Because ASC 830
does not provide guidance on how to determine whether a change is “significant,” preparers
may find it helpful to compare the indicators before and after the change in making the
determination. Entities are encouraged to consult with their accounting advisers in such
situations.
Example 2-8
Significant Changes in Facts and Circumstances That Justify a Change in
Functional Currency
Company H, located in Ireland, is a wholly owned subsidiary of
Company K, whose functional currency is USD. Company H has identified the EUR as
its functional currency because, among other indicators, its sales and
purchases, as well as its labor costs, have primarily been denominated in this
currency. During the fourth quarter, H’s operations begin to change. The sales
composition of H changes because it loses some sizable contracts and gains some
significant new contracts. Company K begins using H’s manufacturing facility to
complete its sales orders. Because more than 80 percent of H’s sales will come
from K’s operations, H will no longer need to generate its own sales; therefore,
H terminates its sales force. Company K builds a new facility to produce the
materials needed in its manufacturing processes. As of the end of the fiscal
year, H begins receiving all materials from K instead of from outside vendors.
On the basis of the changes in its business, H expects cash inflows and
outflows, except for wages, to be primarily denominated in USD.
These circumstances collectively justify a change in H’s
functional currency from EUR to USD. For example, the denomination of revenues
has changed from primarily EUR to USD. This change does not appear to be
temporary since H has terminated its sales force. In addition, the denomination
of cash outflows for materials also has changed to USD. Because K has built a
new facility to make these materials, this change does not appear to be
temporary either. Further, the philosophy behind H’s operations has changed: in
K’s overall operating strategy, H has changed from a self-supporting,
stand-alone operating company to a manufacturing facility of K.
Example 2-9
Impact of Significant Borrowings on Determination of Functional
Currency
Company O’s functional currency is USD, and O uses the equity
method to account for its 43 percent investment in Company M, a Mexican company
whose functional currency is the MXN. During the current year, M enters into a
$200 million third-party borrowing denominated in USD. Most of M’s operations,
labor costs, and purchases are denominated in MXN.
Despite the significant borrowing denominated in USD, it is
not appropriate for M to change its functional currency from MXN to USD. Because
most of M’s operations, sales, purchases, and labor cost are denominated in MXN,
M should continue using the MXN as its functional currency. Although a large
third-party financing in O’s functional currency may constitute some evidence of
a change in the functional currency from MXN to USD, there is insufficient
evidence of such a change in this example.
Example 2-10
Effects of an Acquisition on Functional Currency
Company W is a manufacturing entity whose primary operations
(e.g., headquarters, manufacturing operations, majority of sales contracts) are
located in the United States and whose functional currency is USD. Company W is
acquired by Company L, a similar manufacturing entity that is based in
Luxembourg and whose functional currency is the EUR, as part of L’s efforts to
expand into the North American market. Company L plans to cease manufacturing
operations in the United States, since it has adequate capacity within its
existing facilities in Europe, and to manage W’s operations from its European
headquarters in Luxembourg. These changes result in the conversion of W into a
foreign sales office for L. Therefore, W’s functional currency changes to the
EUR when it is acquired by L.
If significant changes had not been made to W’s operations
after the acquisition, W’s functional currency most likely would have remained
the USD.
SEC Considerations
The SEC’s Frequently Requested Accounting and Financial Reporting Interpretations and Guidance, released by the Division of Corporation Finance (the “Division”), provides an additional example in which a change in functional currency may be appropriate. This guidance states that “[r]egistrants with foreign operations in economies that have recently experienced economic turmoil should evaluate whether significant changes in economic facts and circumstances have occurred that warrant reconsideration of their functional currencies.” The Division warns, however, that it may be difficult to conclude that “currency exchange rate fluctuations alone would cause a self-contained foreign operation to become an extension of the parent company.” Regardless of the underlying reason for the change in functional currency, the Division suggests that, although ASC 830 does not require them to do so, “[r]egistrants should consider the need to disclose the nature and timing of the change, the actual and reasonably likely effects of the change, and economic facts and circumstances that led management to conclude that the change was appropriate. The effects of those underlying economic facts and circumstances on the registrant’s business should also be discussed in MD&A.”
2.4.1 Determining When to Change the Functional Currency
In accordance with ASC 830-10-45-7, a change in functional currency should be
reported as of the date on which it is determined that “significant changes in economic
facts and circumstances” have occurred. Although such a change could occur on any date
during the year, it is acceptable to use a date at the beginning of the most recent
reporting/accounting period.
2.4.2 Accounting for a Change in the Functional Currency
ASC 250-10-45-1 states that the “[a]doption or modification of an accounting
principle necessitated by transactions or events that are clearly different in substance
from those previously occurring” is not considered a change in accounting principle.
Because a change in functional currency is necessitated by a significant change in facts
and circumstances that are “clearly different in substance from those previously
occurring,” such a change does not meet the definition of a change in accounting principle
and therefore should not be accounted for as such (i.e., previously issued financial
statements should not be restated).
The accounting effects of a change in functional currency depend on (1) the type
of change being made (e.g., foreign currency [likely the local currency] to reporting
currency or reporting currency to foreign currency) and (2) the nature of the assets or
liabilities being restated (i.e., monetary or nonmonetary). The following table summarizes
the consolidated accounting treatment of a change in functional currency as of the first
day of a reporting period and assumes that the foreign entity is a direct subsidiary of
the parent:
Effect of Changes in Functional Currency on the Consolidated
Financial Statements
Type of Change
|
Nonmonetary Assets and Liabilities
|
Monetary Assets and Liabilities
|
Effect on CTA
|
---|---|---|---|
Reporting currency to foreign currency1
|
Translate at the rate in effect on the date of change.
Causes a difference between historical carrying value (based
on rate at time of asset or liability’s inception) and new carrying value
(based on current rate).
|
Translate at the rate in effect on the date of change.
Causes no difference between historical carrying value and
new carrying value.
|
Difference between historical basis of nonmonetary assets
and liabilities and new basis is recorded in CTA.
|
Foreign currency to reporting currency
|
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.
|
No effect.
|
Foreign currency to other foreign currency
|
Remeasure into the new functional currency at the rate in
effect on the date of the asset or liability’s inception.
Then translate into reporting currency based on current
exchange rate.
|
Remeasure into the new functional currency at the rate in
effect on the date of change.
Then translate into reporting currency based on current
exchange rate.
|
Difference between historical basis of nonmonetary assets
and liabilities and new basis is recorded in CTA.
|
In all scenarios, the rate on the date of change becomes the historical rate at which nonmonetary assets and liabilities are translated in subsequent years. Previously recorded CTA balances are not reversed.
For additional information on accounting for monetary and nonmonetary assets and liabilities, see Chapter 4.
Example 2-11
Accounting for a Change in Functional Currency
The table below represents the accounting records of Company
X, a foreign entity whose parent company’s reporting currency is USD. As a
result of a significant change in facts and circumstances, X’s functional
currency has changed from USD (its reporting currency) to EUR (its local
currency). The change occurs on January 1, 20X5. This example assumes the
following:
-
All nonmonetary assets and liabilities arise on the same date, January 1, 20X0, when the EUR-to-USD exchange rate is 1 to 2. Assume that no depreciation is taken on the PP&E.
-
Company X maintains its books and records in EUR, its local currency.
-
The EUR-to-USD exchange rate on the date of the change in functional currency is 1 to 1.5.
-
The reporting currency of the consolidated entity is USD.
Connecting the Dots
Considerations When Functional Currency Changes
A change in functional currency can have a number of effects on an entity, a few examples of which are depicted above. An entity should carefully consider the impact of the change in functional currency on all 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.
Footnotes
1
This guidance does not apply to situations in which an
entity is changing its functional currency from the reporting currency to
a foreign currency (likely the local currency) because an economy ceases
to be highly inflationary. See Chapter 7 for guidance on such
situations and Example
7-6 for an illustration of the differences.
2.5 Change in Reporting Currency
ASC 830 does not specifically address a change in reporting currency (i.e., the currency in which the financial statements are presented). The FASB staff has said that it would permit some sort of “convenience translation” (i.e., the translation of an entity’s financial statements from its reporting currency into another currency for the convenience of readers) if the change in reporting currency was necessitated by a change in the parent’s functional currency. However, the FASB staff prefers a restatement of the prior periods as though the information originally had been presented in the new reporting currency.
SEC Considerations
In accordance with SEC Regulation S-X, Rule 3-20(e), if an SEC registrant changes its reporting currency, it is required to “recast its financial statements as if the newly adopted currency had been used since at least the earliest period presented in the filing.” In addition, the registrant should disclose the “decision to change and the reason for the change in the reporting currency” in the period in which the change occurs.
Chapter 3 — Exchange Rates
Chapter 3 — Exchange Rates
3.1 Overview
Foreign currency transactions must be remeasured into an entity’s
functional currency in accordance with ASC 830-20 on accounting for foreign currency
transactions, as described in Chapter 4.
After the remeasurement process, an entity must use the current-rate
method to translate its financial statements into its parent’s reporting currency.
See Chapter 5 for
further discussion related to the translation of foreign entity financial
statements.
While ASC 830 provides some guidance on which exchange rates are to
be used, it may not always be clear that a particular exchange rate is appropriate
and an entity may need to use judgment in making this determination. For example, an
entity may often consider economic, market, and political circumstances. This
chapter discusses the selection and use of appropriate exchange rates, both as
discussed in ASC 830 and in various other situations.
3.2 Selecting Exchange Rates
ASC 830 defines an exchange rate as the “ratio between a unit of one
currency and the amount of another currency for which that unit can be exchanged at
a particular time.”
3.2.1 Current Rate Versus Average Rate
Foreign entities are required to use the current exchange
rate1 to translate their financial statements into the reporting currency of the
reporting entity. ASC 830-30-45-3 describes such translation as follows:
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).
The following table summarizes the translation exchange rates to
use for various types of accounts:
Type
of Account | Exchange Rate for Translation |
---|---|
Assets and liabilities | Current exchange rate in effect on the
balance sheet date |
Equity (excluding change in retained
earnings due to current-year net income) | Historical exchange rates |
Dividends | Current rate at dividend declaration |
Capital-contribution equity
transactions | Current rate as of the transaction date |
Change in retained earnings —
current-year net income | Weighted-average exchange rate for the
period |
Income statement accounts | Weighted-average exchange rate for the
period |
As indicated above, assets and liabilities should be translated
at the exchange rate on the balance sheet date. However, although ASC 830 states
that revenues, expenses, gains, losses, and accounting allocations (e.g.,
depreciation, cost of sales, and amortization of deferred revenues and expenses)
should be translated by using the exchange rate on each date of recognition in
earnings during the period, a weighted-average rate generally may be
appropriate, as discussed further below. Moreover, although ASC 830 does not
provide 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 (as indicated in the table above), except changes to retained
earnings for current-period net income, which would be translated at the
weighted-average rate (discussed further below). When historical exchange rates
are used, capital transactions, such as contributions, investments, and
dividends, would be translated at the rate on the date of recognition.
Because of the recognition requirements for certain types of
income statement items, translation at the exchange rate on each date of
recognition may prove difficult or burdensome. ASC 830 therefore provides an
expedient under which an entity uses an appropriate rate that is expected to
yield a result similar to that achieved by using the exchange rate on each date
of recognition.
ASC
830-10
55-10 Literal application of
the standards in this Subtopic might require a degree of
detail in record keeping and computations that could be
burdensome as well as unnecessary to produce reasonable
approximations of the results. Accordingly, it is
acceptable to use averages or other methods of
approximation. For example, because translation at the
exchange rates at the dates the numerous revenues,
expenses, gains, and losses are recognized is generally
impractical, an appropriately weighted average exchange
rate for the period may be used to translate those
elements. Likewise, the use of other time- and
effort-saving methods to approximate the results of
detailed calculations is permitted.
55-11 Average rates used shall
be appropriately weighted by the volume of functional
currency transactions occurring during the accounting
period. For example, to translate revenue and expense
accounts for an annual period, individual revenue and
expense accounts for each quarter or month may be
translated at that quarter’s or that month’s average
rate. The translated amounts for each quarter or month
should then be combined for the annual
totals.
Period-appropriate, weighted-average exchange rates are most
commonly used for income statement items that have recognition patterns
throughout the period. A monthly, quarterly, or annual rate should be determined
and used to translate monthly, quarterly, or annual income statements,
respectively. Monthly or quarterly income statements translated at the relevant
averaged rates would then be added together, as appropriate, to arrive at the
year-end statement. An entity should carefully determine when it is appropriate
to use averaging to translate income statement items. For example, a
weighted-average rate may not be appropriate for items that are tied to discrete
events, such as certain impairments or write-offs. In that case, the exchange
rate from that specific date would be required.
Connecting the Dots
When applying weighted-average exchange rates to income
statement items, an entity should calculate the “weighting”
appropriately by considering the pattern of recognition. Developing an
appropriate weighted-average exchange rate may include consideration of
complexities that are specific to the foreign entity’s operations,
including seasonality, multiple product lines with various recognition
patterns, and uneven expense recognition. An entity should also consider
volatility in foreign currency exchange rates. Further, an entity has
flexibility to determine the appropriate rate given that “other
[appropriate] methods of approximation” may also be used for translating
income statement items. For these reasons, consultation with accounting
advisers is encouraged if an entity needs to use significant judgment in
calculating a weighted-average exchange rate or applying another method
of approximation.
3.2.2 Multiple Exchange Rates
When multiple legal exchange rates coexist, such as an official
exchange rate and an unofficial exchange rate, a parallel or dual exchange-rate
situation exists. In such circumstances, if it can be reasonably demonstrated
that transactions have been or could have been legally settled at the unofficial
rate (including currency exchanges for dividend or profit repatriations), it may
be appropriate to use the unofficial rate for translation or remeasurement.
ASC
830-30
45-6 In the absence of unusual
circumstances, the exchange rate applicable to
conversion of a currency for purposes of dividend
remittances shall be used to translate foreign currency
statements.
Although not codified, paragraph 138 of the Basis for Conclusions of FASB Statement 52 (codified in ASC 830) is helpful for
understanding this concept. The FASB concluded that in the absence of unusual
circumstances, an entity should use the dividend remittance rate to translate
foreign financial statements if multiple exchange rates exist. This rate was
considered more meaningful because cash flows to the reporting entity can only
occur at this rate and realization of the net investment depends on the cash
flows from that foreign entity.
Unusual circumstances in which an entity may be permitted to use
an alternative legal exchange rate in translating the financial statements of a
foreign subsidiary could include (1) a history of obtaining the alternative
exchange rate for remittances of earnings or dividends distributed outside the
foreign country and (2) the ability to source funds at the alternative exchange
rate if there is no question of asset impairment.
Example 3-1
Multiple Exchange Rates
Company A, a U.S. company whose fiscal
year ended on June 30, 20X1, has a foreign subsidiary,
Company B. On June 30, 20X1, an official exchange rate
existed for conversion of the foreign currency to USD.
Because of foreign currency restrictions, however, few
exchanges were made at that rate. About 80 percent of
B’s earnings for the year ended June 30, 20X1, were
converted to USD (and remitted to A) at a rate
substantially lower than the official rate (the
unofficial rate). The unofficial exchange rate was
determined by the local broker making the conversion and
by an informal foreign exchange market that existed in
the foreign country. Although exchange restrictions
existed, B’s remittance transactions at the unofficial
rate were not illegal transactions. In this example, the
unofficial rate should be used for translation or
remeasurement.
Furthermore, the rate used must be a legal rate (see Section 3.2.4).
3.2.2.1 Determining the Appropriate Exchange Rate for Remeasurement When Multiple Rates Exist
Under ASC 830, all entities must remeasure all
foreign-currency-denominated transactions into their functional currency for
each reporting period, with changes in foreign currency rates recognized in
earnings. ASC 830-20-30-3 indicates that to perform such remeasurement, an
entity should use the applicable rate(s) at which a transaction could be
settled as of the transaction date to translate and record the transaction.
If multiple exchange mechanisms and published exchange rates exist that are
considered to be legal (official and unofficial), such rates could
potentially be available for remeasurement. Accordingly, the entity will be
required to reevaluate the exchange rate previously used for remeasurement.
While the ultimate selection of an exchange rate (or multiple rates) should
be based on the entity’s specific facts and circumstances, relevant factors
for consideration include (but may not be limited to) the following:
-
Whether the entity can legally use a specified rate (or multiple rates) to convert currency or settle transactions.
-
Whether the exchange rates are published.
-
The probability of accessing and obtaining USD by using a particular rate or exchange mechanism.
-
The entity’s intent and ability to use a particular exchange mechanism.
Management will need to exercise significant judgment when
considering the above factors. Accordingly, an entity should clearly
document the facts and circumstances that it considered in its analysis of
what exchange rate(s) to use for remeasurement. Because of the potential for
frequent changes in exchange rate mechanisms, an entity may not have
experience with settling transactions at certain exchange rates given the
limited period in which these exchange rates have been available.
Notwithstanding a lack of history at transacting at a particular exchange
rate, an entity should be able to support (1) how the rate or rates used for
remeasurement are most representative of the entity’s economic circumstances
and (2) its intent to use the rate(s) or exchange mechanism(s) specified. An
entity may also need to assess whether it should obtain a legal
interpretation to sustain its assertion that it can access certain exchange
rates and mechanisms.
The SEC considerations below are based on informal
discussions with the SEC staff regarding Venezuelan highly inflationary
foreign operations. However, entities can apply these observations in
determining the most appropriate exchange rate to use when multiple exchange
mechanisms and published exchange rates exist.
SEC Considerations
The SEC staff has observed that as a result of
changes in the currency rate environment, an entity may, in certain
circumstances, be able to support using a rate other than the
official rate for remeasurement.
When determining the most appropriate exchange rate(s) for
remeasurement of an entity’s foreign-currency-denominated monetary balances
when multiple exchange rates exist, an entity may find the following process
helpful:
-
Identify transactions for which the entity’s government has granted approval to obtain another currency at certain rates (including foreign-currency-denominated monetary assets that will be required before approved foreign-currency-denominated liabilities can be settled) and remeasure by using the preapproved exchange rate(s).
-
For any remaining foreign-currency-denominated liabilities (i.e., those for which the entity’s government has not yet granted approval to settle by using the foreign currency obtained at certain rates), determine which mechanisms the entity can legally access to obtain the foreign currency and remeasure the volume of foreign-currency-denominated monetary assets needed to obtain that foreign currency at the exchange rates that the entity expects to use when it settles the payables.
-
Remeasure any remaining net foreign-currency-denominated monetary items by using the rates that are most representative of the entity’s economics and are most likely to be available to settle the transactions.
SEC Considerations
The SEC staff identified factors that registrants
should consider in selecting the exchange rate(s) to use for
remeasurement. The staff reiterated that:
- A registrant must exercise judgment when determining the exchange rate(s) that should be used to remeasure its foreign-currency-denominated balances. That judgment should be based on the registrant’s specific facts and circumstances.
- In U.S. GAAP, there is no support for use of a rebuttable presumption under which registrants should remeasure foreign currency monetary assets/liabilities by using the least favorable legal exchange rate when multiple legal exchange rates exist.
- A registrant that previously used a different rate to remeasure its foreign-currency-denominated monetary assets/liabilities in prior periods should (1) consider all of the recent changes in the entity’s foreign exchange mechanisms and (2) consistently apply its rate selection approach.
- Depending on facts and circumstances, it may be appropriate for a registrant to use multiple exchange rates for remeasurement.
- Registrants with material foreign operations affected by multiple exchange rates should continue to provide transparent disclosures regarding the items described above.
Regardless of the rate selected, registrants should maintain
documentation of their rate selection analysis as well as the relevant facts
and circumstances they considered in using their judgment to select an
appropriate exchange rate or rates.
3.2.2.2 Assets and Liabilities Subject to Multiple Exchange Rates
ASC 830-30 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Foreign Currency Issues:
Multiple Foreign Currency Exchange Rates
S99-1 This SEC staff
announcement provides the SEC staff’s views on
Foreign Currency Issues.
The SEC staff has received a number of inquiries regarding
certain foreign currency issues related to
investments in Venezuela. This announcement is in
response to those inquiries that have been received
by the SEC staff on the issues described below.
Amongst other requirements, current restrictions of foreign
currency exchange in Venezuela provide that entities
use the official rate of exchange (official rate) to
exchange funds. The official rate is set by the
Venezuelan government and in order to use the
official rate to exchange currency, entities seek
the ability to utilize the official rate from
Venezuela’s Commission for Administration of Foreign
Currencies (CADIVI).
As an alternative to the use of the official rate it may
also be legal to utilize the parallel rate. It is
possible that the parallel rate provides entities
with a more liquid exchange and entities can access
the parallel rate using a series of transactions via
a broker. The parallel rate has recently been
significantly different from the official rate.
Reported Balances in an Entity’s Financial Statements
That Differ From Their Underlying U.S. Dollar
Denominated Values
With respect to accounting for a subsidiary in Venezuela in
cases where the parent’s reporting currency is the
U.S. dollar and the Venezuelan subsidiary’s
functional currency is the Venezuelan Bolivar
(“Bolivar” or “BsF”), the staff has recently become
aware of the following fact pattern: In years prior
to 2010, certain entities may have used the parallel
rate to remeasure certain U.S. dollar denominated
balances that the Venezuelan subsidiary held and
then subsequently translated the Venezuelan
subsidiary’s assets, liabilities, and operations
using the official rate. The effect of this
accounting treatment resulted in reported balances
in an entity’s financial statements that differed
from their underlying U.S. dollar denominated
values. (The staff notes that these differences
arise when different rates are used for
remeasurement and translation.) In order to
illustrate the impact that these differences may
have on different accounts within the financial
statements, two illustrations are provided
below.
First, assume that at a period end prior to January 1, 2010
(for a calendar year entity), a U.S. entity’s
Venezuelan subsidiary held $10 million of cash
denominated in U.S. dollars. Further assume that at
the period end, the parallel rate was 5 Bolivars to
every 1 U.S. dollar and the official rate was 2
Bolivars to every 1 U.S. dollar. Upon the
remeasurement of the U.S. denominated cash to
Bolivars and the subsequent translation of the
Venezuelan subsidiary’s financial statements, an
entity would have reported cash of $25 million for
financial reporting purposes. (The $25 million is
calculated as follows: First, the $10 million of
cash is remeasured using the parallel rate to 50
million BsF; subsequently, the 50 million BsF is
translated back to U.S. dollars using the official
rate of 2 Bolivars to 1 U.S. dollars, resulting in a
translated reported balance of $25 million.)
Second, assume that at a period end prior to January 1,
2010 (for a calendar year entity), a U.S. entity’s
Venezuelan subsidiary held $15 million of accounts
payable denominated in U.S. dollars (also assume the
exchange rates are the same as in the example
above). Upon the remeasurement of the U.S.
denominated accounts payables to Bolivars and the
subsequent translation of the Venezuelan
subsidiary’s financial statements, an entity would
have reported accounts payable of $37.5 million for
financial reporting purposes. (The $37.5 million is
calculated as follows: First, the $15 million of
accounts payable is remeasured using the parallel
rate to 75 million BsF; subsequently, the 75 million
BsF is translated back to U.S. dollars using the
official rate of 2 Bolivars to 1 U.S. dollars,
resulting in a translated reported balance of $37.5
million.)
Finally, the staff has noted that Venezuela has met the
thresholds for being considered highly inflationary
and accordingly, calendar year entities that have
not previously accounted for their Venezuelan
investment as highly inflationary will begin
applying highly inflationary accounting beginning
January 1, 2010.
Disclosures
The staff believes that in cases where reported balances
for financial reporting purposes differ from the
actual U.S. dollar denominated balances (such as in
the illustrations above), a registrant should make
disclosures that inform users of the financial
statements as to the nature of these differences.
When material, the disclosures in both annual and
interim financial statements should, at a minimum,
consist of the following (The staff is aware that
certain registrants have already filed their 2009
Form 10-K’s and accordingly the staff would not
necessarily expect these specific disclosures to be
included in these registrant’s 2009 Form 10-K’s.):
-
Disclosure of the rates used for remeasurement and translation.
-
A description of why the actual U.S. dollar denominated balances differ from the amounts reported for financial reporting purposes, including the reasons for using two different rates with respect to remeasurement and translation.
-
Disclosure of the relevant line items (e.g. cash, accounts payable) on the financial statements for which the amounts reported for financial reporting purposes differ from the underlying U.S. dollar denominated values.
-
For each relevant line item, the difference between the amounts reported for financial reporting purposes versus the underlying U.S. dollar denominated values.
-
Disclosure of the amount that will be recognized through the income statement (as well as the impact on the other financial statements) as part of highly inflationary accounting beginning in 2010 (see below).
Impact of Highly Inflationary Accounting on Differences
Between Amounts Recorded for Financial Reporting
Purposes Versus the Underlying U.S. Dollar
Denominated Values
The staff notes that upon application of highly
inflationary accounting (January 1, 2010 for
calendar year registrants), registrants must follow
the accounting outlined in paragraph 830-10-45-11,
which states that “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, upon the application of highly inflationary
accounting requirements, a U.S. reporting currency
parent and subsidiary effectively utilize the same
currency (U.S. dollars) and accordingly there should
no longer be any differences between the amounts
reported for financial reporting purposes and the
amount of any underlying U.S. dollar denominated
values that are held by the subsidiary. Therefore,
the staff believes that any differences that may
have existed prior to applying highly inflationary
accounting requirements between the reported
balances for financial reporting and the U.S. dollar
denominated balances should be recognized in the
income statement, unless the registrant can document
that the difference was previously recognized as a
cumulative translation adjustment (in which case the
difference should be recognized as an adjustment to
the cumulative translation adjustment).
Furthermore, the staff believes that these differences
should be recognized at the time of adoption of
highly inflationary accounting.
Other
The SEC staff is aware that the EITF will be discussing
certain issues related to foreign currency,
including the accounting for multiple exchange rates
in Venezuela, and accordingly the guidance in this
staff announcement is intended to be interim
guidance pending the EITF completing its
deliberations.
When “differences that may have existed prior to applying
highly inflationary accounting requirements between the reported balances
for financial reporting and the U.S. dollar denominated balances” are to be
recognized in earnings, an entity should disclose the effects of the
adjustment on the financial statements in the period before the entity
reflects the accounting effects of the economy’s becoming highly
inflationary.
Connecting the Dots
Although the guidance above indicates that
recognition of the impact in CTA is a potential outcome when highly
inflationary accounting is initially adopted, such an outcome is
expected to be rare in practice. In cases in which an entity
believes that it can demonstrate that the difference was previously
recognized in CTA, consultation with accounting advisers is strongly
encouraged.
3.2.3 Preference or Penalty Rates
ASC
830-30
45-7 If unsettled intra-entity
transactions are subject to and translated using
preference or penalty rates, translation of foreign
currency statements at the rate applicable to dividend
remittances may cause a difference between intra-entity
receivables and payables. Until that difference is
eliminated by settlement of the intra-entity
transaction, the difference shall be treated as a
receivable or payable in the reporting entity’s
financial statements.
Regulation of foreign exchange markets by foreign governments
may dictate the exchange rates to be used to convert local currency into other
currencies. Those rates are set by the foreign governments, rather than the
market exchange rate, and may be either favorable (preferential rate) or
unfavorable (penalty rate) compared with the rate that applies to other
transactions. For example, a foreign government may establish a rate of LC5:$1
for certain goods it deems essential while the prevailing market rate may be
LC10:$1. As indicated in the example above provided by the SEC staff in a
speech, this situation has existed in Venezuela in recent years because its
government enacted regulations to protect the country’s level of currency
reserves as a result of the deterioration of the Venezuelan economy.
An entity should carefully consider whether the rate to be used
for remeasuring monetary items is the preference or penalty rate and should
appropriately support use of either rate for remeasuring monetary items to
demonstrate that conversion of the monetary items at that rate could have been
achieved. If use of a preference or penalty rate cannot be supported, the entity
should use the rate applicable to dividend remittances.
Connecting the Dots
In certain jurisdictions, governments enact exchange laws that impose
strict criminal and economic sanctions on exchanging local currency with
other foreign currency through methods that are not officially
designated or on obtaining foreign currency under false pretenses.
Because of the currency volume limitations imposed by
governments, entities may try to find other legal ways of exchanging
currency. One method that some entities use is the purchase of debt or
equity securities in the local market and the immediate sale of those
securities in the international market for a different currency,
generally U.S. dollars. These transactions result in an indirect rate —
sometimes called a “parallel,” “offshore,” or “blue chip” rate — through
which entities may obtain foreign currency “legally” without resorting
to or requesting currency directly from the government. The average rate
of exchange in these markets is variable and can fluctuate significantly
above the official rate. The U.S. security would be purchased and
subsequently sold outside the jurisdiction that imposes the currency
restrictions. Therefore, these market transactions may be used to settle
foreign currency obligations and to move currency in and out of those
jurisdictions.
When entities transact by swapping securities, foreign
currency is purchased through a series of transactions that involve a
broker. For example, an entity would purchase a bond in the local
jurisdiction by using local currency, swap it for a
U.S.-dollar-denominated security, sell the U.S. security on the
international securities market, and obtain U.S. dollars on the same
date. However, in certain jurisdictions, laws preclude an entity from
purchasing and selling securities on the same date in a different
jurisdiction. Such a situation is referred to as the minimum holding
period (e.g., three or five days). When a minimum holding period exists,
the purchase/sale of securities cannot be construed as representing an
exchange rate under ASC 830 but should be considered a purchase and
separate disposal of securities in which the gain or loss represents a
gain or loss on the disposal of securities. The determination of whether
a minimum holding period exists is a matter of legal interpretation;
accordingly, entities should consider obtaining legal advice when making
this determination.
3.2.4 Black Market Rates
In certain countries, illegal foreign currency exchange markets
may develop as a result of restrictive foreign exchange controls. Such markets
and resulting rates are referred to as “black market exchange rates” or “black
market rates” since they are not legally recognized. Accordingly, use of black
market rates is not appropriate for either remeasurement or translation purposes
under ASC 830.
This conclusion is consistent with discussion at the March 4,
2003, meeting of the AICPA SEC Regulations Committee’s International Practices
Task Force2 (IPTF or “the Task Force”) and was later reaffirmed in the highlights of the November 25, 2008, meeting concerning the
appropriate foreign exchange rates to be used for remeasurement and translation
purposes. The meeting highlights state, in part:
The Task Force believes that . . . US GAAP does not
permit the use of a black market exchange rate since such a rate is not
objective or determinable. Instead, individual transactions should be
translated at either the parallel rate, or the official exchange rate
based on the facts and circumstances, and if there are more than one
official exchange rate depending on the transaction (e.g., dividend
remittances), then the appropriate exchange rate should be used.
3.2.5 Lack of Exchangeability
ASC
830-20
30-2 If exchangeability between
two currencies is temporarily lacking at the transaction
date or balance sheet date, the first subsequent rate at
which exchanges could be made shall be used for purposes
of this Subtopic. 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.
This concept is illustrated in the following example from ASC
830-30-55-1:
Example 1: Exchange Rate When
Exchangeability Is Lacking Temporarily
This Example illustrates the appropriate exchange rate
to be used for translating financial statements when foreign exchange
trading is temporarily suspended at year-end. The following are facts
involving a reporting entity that had a significant subsidiary in
Israel:
-
On December 29, 1988, the currency market was open and foreign currencies were traded. The exchange rate was FC 1.68 = USD 1.00.
-
On December 30, 1988, Israeli banks were officially open but foreign exchange trading was suspended until January 2, 1989. A devaluation to occur on January 2, 1989, was announced. Most businesses were closed for the holidays.
-
On December 31, 1988, banks were closed.
-
On January 1, 1989, banks were closed.
-
On January 2, 1989, foreign exchange transactions were executed but left unsettled until the following day when a new rate was to be established.
-
On January 3, 1989, a new exchange rate of FC 1.81 = USD 1.00 was established and was effective for transactions left unsettled the previous day.
Thus, exchangeability was temporarily lacking and the
rate established as of January 3, 1989, the first subsequent rate, is
the appropriate rate to use for translating the December 31, 1988,
financial statements.
In a manner consistent with ASC 830-20-30-2 and the example
above, if there is a temporary lack of exchangeability between two currencies as
of the transaction or balance sheet date, an entity should use the first
subsequent rate at which exchanges could be made.
The IPTF discussed what was intended by the term “first
subsequent rate” at its January 14, 2001, meeting. The meeting highlights state:
The Task Force did not believe that this guidance should be read
literally as the “first” exchange transaction. Certain members of the
Task Force informally discussed this issue with the staff of the FASB,
who indicated their view that the guidance in FAS 52 was not intended to
be literally the “first” transaction.
Accordingly, an entity should use judgment in determining the
appropriate exchange rate to use. In making this determination, the entity
should consider all factors available, including the volume, size, and types of
transactions. Furthermore, the absence of observable large transactions would
not necessarily be indicative of a continued temporary lack of
exchangeability.
Footnotes
1
ASC 830-30-45-4 defines the current exchange rate 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.”
2
The IPTF is a committee of the Center for Audit Quality
that focuses on emerging international technical accounting and
reporting issues related to SEC rules and regulations. The IPTF meets
periodically with the SEC staff to discuss such issues.
3.3 Changes in Exchange Rates
ASC 830-30
45-16 A reporting entity’s financial statements shall not be adjusted for a rate change that occurs after the date of the reporting entity’s financial statements or after the date of the foreign currency statements of a foreign entity if they are consolidated, combined, or accounted for by the equity method in the financial statements of the reporting entity.
50-2 Disclosure of a rate change
that occurs after the date of the reporting entity’s
financial statements or after the date of the foreign
currency statements of a foreign entity if they are
consolidated, combined, or accounted for by the equity
method in the financial statements of the reporting entity
and its effects on unsettled balances pertaining to foreign
currency transactions, if significant, may be necessary.
ASC 830-20
50-2 Disclosure of a rate
change that occurs after the date of the reporting entity’s
financial statements and its effects on unsettled balances
pertaining to foreign currency transactions, if significant,
may be necessary. If disclosed, the disclosure shall include
consideration of changes in unsettled transactions from the
date of the financial statements to the date the rate
changed. In some cases it may not be practicable to
determine these changes; if so, that fact shall be
stated.
Under ASC 830-30-45-16, an entity should not adjust its financial statements to
reflect changes in exchange rates that occur after the balance sheet date of a
reporting entity or foreign entity included in the financial statements. Rather, in
accordance with ASC 830-20-50-2 and ASC 830-30-50-2, an entity must disclose
significant effects of changes in exchange rates related to unsettled foreign
currency transactions.
3.3.1 Foreign Entity Reported on a Lag — Impact of a Significant Devaluation
ASC 830-30
45-8 If a foreign entity whose balance sheet date differs from that of the reporting entity is consolidated or combined with or accounted for by the equity method in the financial statements of the reporting entity, the current rate is the rate in effect at the foreign entity’s balance sheet date for purposes of applying the requirements of this Subtopic to that foreign entity.
Despite the guidance in ASC 830-30-45-8 above, it may sometimes be appropriate
to translate the financial statements of a consolidated subsidiary by using an
exchange rate as of the parent’s balance sheet date.
ASC 810-10-45-12 states that “recognition should be given by disclosure or otherwise to the effect of intervening events that
materially affect the financial position or results of operations” (emphasis
added) that occur during the reporting time lag (i.e., the period between the
subsidiary’s year-end reporting date and the parent’s balance sheet date). We
believe that an entity may elect a policy of either disclosing, or disclosing and recognizing, all material intervening events,
including changes in exchange rates, provided that either policy is consistently
applied.
Example 3-2
Foreign Entity Reported on a Lag — Impact of a
Significant Devaluation
A parent company includes a foreign
subsidiary’s financial statements for the year ended
November 30, 20X1, in the parent company’s consolidated
financial statements for the year ended December 31,
20X1. Between November 30 and December 31, the
functional currency of the subsidiary devalues
significantly against the parent company’s reporting
currency.
Therefore, the parent company should
consider whether the devaluation of the foreign
subsidiary’s functional currency constitutes a material
intervening event. If the parent company concludes that
the devaluation is a material intervening event and has
an established accounting policy to disclose and
recognize material intervening events, it should use the
December 31, 20X1, exchange rate to translate the
subsidiary’s November 30, 20X1, financial statements. In
all circumstances, regardless of which policy is
elected, detailed disclosure should be provided in the
financial statements.
Chapter 4 — Foreign Currency Transactions
Chapter 4 — Foreign Currency Transactions
4.1 Overview
ASC 830-20 addresses the accounting for foreign currency transactions, which the ASC master glossary defines as transactions “whose terms are denominated in a currency other than the entity’s functional currency.” However, the guidance in ASC 830-20 is limited to the measurement and presentation of foreign currency transactions. Therefore, it does not provide guidance on when an entity should recognize a foreign currency transaction in its financial statements. Entities should apply other relevant accounting guidance to determine when a foreign currency transaction should be recognized.
Broadly speaking, there are two types of foreign currency transactions: (1) those that result in the receipt or payment of foreign currency cash only on the date on which the transaction is recognized (e.g., purchasing or selling inventory by using foreign currency cash) and (2) those that will result in the receipt or payment of foreign currency cash on a future date (e.g., purchasing or selling inventory on account). For the first type of foreign currency transaction, the only relevant accounting issue is how to initially measure the recognized asset, liability, or income statement account in an entity’s financial statements. However, for the second type of foreign currency transaction, an additional issue arises with respect to the subsequent measurement of the recognized asset or liability in the financial statements.
The remainder of this chapter focuses on the initial and subsequent accounting for foreign currency transactions.
4.2 Initial Measurement of Foreign Currency Transactions
ASC 830-20
25-1 At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be recorded in the functional currency of the recording entity.
30-1 At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be measured initially in the functional currency of the recording entity by use of the exchange rate in effect at that date.
Under ASC 830-20-25-1 and ASC 830-20-30-1, all foreign currency transactions
must be measured in the recording entity’s functional currency. This is accomplished
by using the exchange rate in effect on the date on which the transaction is
recognized. However, as discussed in Chapter 3, an entity may, out of convenience,
determine that an appropriate weighted-average exchange rate may be used for
measuring income statement accounts. The example below illustrates the initial
measurement of a foreign currency transaction.
Example 4-1
Initial Measurement of a Foreign Currency
Transaction
On September 15, 20X6, Retailer, a U.S.
entity whose functional currency is the USD, purchases
inventory from Supplier, a Japanese entity whose functional
currency is the JPY (¥). The amount that Retailer owes
Supplier for the inventory is ¥1,300. Assume that the
exchange rate in effect on September 15, 20X6, is $1 =
¥6.50.
This transaction represents a foreign
currency transaction for Retailer since its functional
currency is the USD and the transaction price is denominated
in a different currency (JPY). In accordance with ASC
830-20, Retailer must record the transaction in its
functional currency (USD). To determine the amount to record
in USD, Retailer divides the transaction price (¥1,300) by
the exchange rate that was in effect when the transaction
was recognized ($1 = ¥6.50). Therefore, Retailer would
record the following journal entry in its financial
statements on September 15, 20X6:
From Supplier’s perspective, this
transaction does not represent a foreign currency
transaction since it is denominated in its functional
currency (JPY). Therefore, Supplier recognizes the
transaction in its financial statements at the stated
transaction price (¥1,300).
4.3 Subsequent Measurement of Foreign Currency Transactions
ASC
830-20
35-1 A
change in exchange rates between the functional currency and
the currency in which a transaction is denominated increases
or decreases the expected amount of functional currency cash
flows upon settlement of the transaction. That increase or
decrease in expected functional currency cash flows is a
foreign currency transaction gain or loss that generally
shall be included in determining net income for the period
in which the exchange rate changes.
35-2 At each balance sheet
date, recorded balances that are denominated in a currency
other than the functional currency of the recording entity
shall be adjusted to reflect the current exchange rate. At a
subsequent balance sheet date, the current rate is that rate
at which the related receivable or payable could be settled
at that date. Paragraphs 830-20-30-2 through 30-3 provide
more information about exchange rates.
ASC 830-20-35-2 specifies that if a recorded balance is denominated
in a foreign currency, it must be remeasured in each period into the functional
currency by using the current exchange rate. (See Chapter 3 for a discussion of current exchange
rates.) ASC 830-20-35-1 further clarifies that the changes in those recorded
balances, which result from fluctuations in the current exchange rate, are generally
recorded in earnings. The overall objective of this remeasurement process is
explained in ASC 830-10-45-17:
If an entity’s books of record are not maintained in its
functional currency, remeasurement into the functional currency is required.
That remeasurement is required before translation into the reporting
currency. If a foreign entity’s functional currency is the reporting
currency, remeasurement into the reporting currency obviates translation.
The remeasurement of and subsequent accounting for transactions denominated
in a currency other than the functional currency shall be in accordance with
the requirements of Subtopic 830-20. The remeasurement
process is intended to produce the same result as if the entity’s books
of record had been maintained in the functional currency. To accomplish
that result, it is necessary to use historical exchange rates between
the functional currency and another currency in the remeasurement
process for certain accounts (the current rate will be used for all
others), and this guidance identifies those accounts. To accomplish that
result, it is also necessary to recognize currently in income all
exchange gains and losses from remeasurement of monetary assets and
liabilities that are not denominated in the functional currency (for
example, assets and liabilities that are not denominated in dollars if
the dollar is the functional currency). [Emphasis added]
ASC 830-10-45-17 states that to comply with the requirements in ASC
830-20 regarding the subsequent accounting for foreign currency transactions, an
entity must use historical exchange rates to remeasure some accounts and current
exchange rates to remeasure others. This guidance further suggests that “monetary”
assets and liabilities would be subject to remeasurement at current exchange rates.
In addition, ASC 830-10-45-18 identifies certain “nonmonetary” accounts that must be
remeasured by using historical exchange rates. Therefore, the subsequent measurement
of a foreign currency transaction depends on whether it results in the recognition
of monetary or nonmonetary assets and liabilities, as illustrated below.
Therefore, properly identifying an account as either monetary or
nonmonetary is critical to correctly applying the subsequent-measurement guidance in
ASC 830-20. The next section explains how to distinguish between the two.
4.3.1 Distinguishing Monetary Assets and Liabilities From Nonmonetary Assets and Liabilities
While the guidance in ASC 830-10-45-17 and 45-18 suggests that
the subsequent-measurement requirements for monetary assets and liabilities (at
current exchange rates) differ from those for nonmonetary assets and liabilities
(at historical exchange rates), it does not actually define either of those
terms. Therefore, it is important for entities to consider the guidance in ASC
830-20-35-2 when distinguishing between the two. This paragraph states that
recorded balances that are denominated in a foreign currency must be remeasured
at current exchange rates (i.e., those accounts would be considered monetary
assets and liabilities). The implementation guidance in ASC 830-10-55-1 and 55-2
clarifies the meaning of a recorded balance that is “denominated in a foreign
currency.”
ASC
830-10
55-1 To measure in foreign
currency is to quantify an attribute of an item in a
unit of currency other than the reporting currency.
Assets and liabilities are denominated in a foreign
currency if their amounts are fixed in terms of that
foreign currency regardless of exchange rate changes. An
asset or liability may be both measured and denominated
in one currency, or it may be measured in one currency
and denominated in another.
55-2 For example, two foreign
branches of a U.S. entity, one Swiss and one German,
purchase identical assets on credit from a Swiss vendor
at identical prices stated in Swiss francs. The German
branch measures the cost (an attribute) of that asset in
euros. Although the corresponding liability is also
measured in euros, it remains denominated in Swiss
francs since the liability must be settled in a
specified number of Swiss francs. The Swiss branch
measures the asset and liability in Swiss francs. Its
liability is both measured and denominated in Swiss
francs. Although assets and liabilities can be measured
in various currencies, rights to receive or obligations
to pay fixed amounts of a currency are, by definition,
denominated in that currency.
As noted above, a recorded balance is denominated in a foreign
currency (and is therefore subject to remeasurement at current exchange rates)
if its amount is “fixed in terms of that foreign currency regardless of exchange
rate changes.” Further, “rights to receive or obligations to pay fixed amounts
of a currency are, by definition, denominated in that currency.” Accordingly,
this implementation guidance suggests that an account would be remeasured at
current exchange rates (and therefore would be a monetary asset or liability) if
it represents a right to receive or an obligation to pay a fixed amount of a
foreign currency regardless of exchange rate changes. All other accounts thus
would be considered nonmonetary and would be remeasured at historical exchange
rates.
In addition, while ASC 830 does not explicitly define the terms
“monetary assets and liabilities” or “nonmonetary assets and liabilities,” other
Codification topics do, notably ASC 255 (on changing prices) and ASC 845 (on
nonmonetary exchanges). While neither of these standards amended or interpreted
the guidance in ASC 830, entities may find it useful to consider the below
definitions.
ASC
255-10 — Glossary
Monetary Assets
Money or a claim to receive a sum of
money the amount of which is fixed or determinable
without reference to future prices of specific goods or
services.
Monetary
Liability
An obligation to pay a sum of money the
amount of which is fixed or determinable without
reference to future prices of specific goods and
services.
ASC 845-10 — Glossary
Monetary Assets and
Liabilities
Monetary assets and liabilities are
assets and liabilities whose amounts are fixed in terms
of units of currency by contract or otherwise. Examples
are cash, short- or long-term accounts and notes
receivable in cash, and short- or long-term accounts and
notes payable in cash.
Nonmonetary Assets
and Liabilities
Nonmonetary assets and liabilities are
assets and liabilities other than monetary ones.
Examples are inventories; investments in common stocks;
property, plant, and equipment; and liabilities for rent
collected in advance.
The tables below summarize common monetary and nonmonetary
balance sheet accounts. Some of the intricate accounts are discussed in more
detail in Sections 4.4 through 4.20.
1
See Section 4.19 for
additional information.
2
See Section 4.20 for
additional information.
3
The term “contract liabilities,” as used here,
is intended to be consistent with the definition in ASC
606-10.
4
See Section 4.6.1 for further
discussion of instruments that must be subsequently remeasured
under ASC 480-10-S99.
Sections
4.3.2 and 4.3.3 discuss how to subsequently measure foreign currency
transactions that result in the recognition of monetary assets and liabilities
and those that result in the recognition of nonmonetary assets and liabilities,
respectively.
4.3.2 Monetary Assets and Liabilities
When a foreign currency transaction results in the recognition
of a monetary asset or liability, that asset or liability is subsequently
remeasured from the foreign currency to the functional currency as of each
reporting date by using the current exchange rate. Therefore, the carrying value
of a monetary asset or liability will change on each reporting date (until the
asset or liability is settled) as a result of changes to the exchange rate
between the foreign currency and the functional currency. Generally, these
changes in the carrying value of monetary assets and liabilities are recognized
in earnings as transaction gains or losses. However, there are certain
exceptions to recognizing such transaction gains and losses in earnings, as
discussed in further detail in Section 9.2.
Connecting the Dots
Transaction gains or losses are generally recorded in
earnings because the change in the exchange rate directly affects the
amount of functional currency that an entity will either receive or pay
when the transaction is settled. That is, changes in exchange rates have
direct effects on an entity’s future cash flows.
The example below illustrates the subsequent measurement of a
foreign currency transaction that results in the recognition of a monetary
liability.
Example 4-2
Subsequent Measurement of a Monetary Liability
This example represents a continuation
of Example 4-1. Assume the following
additional facts:
-
The terms of the transaction specify that Retailer must pay for the inventory in 60 days (on November 14, 20X6).
-
Retailer is a calendar-year public company that files quarterly financial statements.
-
The exchange rates in effect on Retailer’s quarterly reporting date and at the time the transaction is settled, respectively, are as follows:
-
September 30, 20X6: $1 = ¥6.25.
-
November 14, 20X6: $1 = ¥6.75.
-
The original transaction between
Retailer and Supplier resulted in Retailer’s recognition
of an accounts payable balance, which is a monetary
liability. Therefore, Retailer must remeasure that
account as of each reporting date by using the exchange
rate in effect on that date. Accordingly, on September
30, 20X6, Retailer remeasures its accounts payable
balance by dividing the transaction price of ¥1,300 by
the exchange rate in effect on that date ($1 = ¥6.25)
and determines it to be $208. To adjust the carrying
value of the accounts payable balance, Retailer would
record the following journal entry in its financial
statements on September 30, 20X6:
Because the JPY has strengthened against
the USD since the time the transaction was executed,
Retailer now needs more USD (its functional currency) to
pay for the inventory. Retailer therefore records a
foreign currency transaction loss in earnings to reflect
the additional amount of functional currency needed to
settle its liability.
On November 14, 20X6, Retailer settles
the transaction by paying Supplier ¥1,300. To record the
settlement in its financial statements, Retailer must
first remeasure its accounts payable by using the
exchange rate in effect on the settlement date.
Accordingly, Retailer remeasures its accounts payable
balance by dividing the transaction price of ¥1,300 by
the exchange rate in effect on that date ($1 = ¥6.75)
and determines it to be $193 (rounded). To adjust the
carrying value of the accounts payable balance and
settle the accounts payable balance, Retailer would
record the following journal entries in its financial
statements on November 14, 20X6:
From September 30, 20X6, through the
settlement date, the JPY has weakened against the USD.
Therefore, Retailer now needs fewer USD to settle its
obligation than it did on September 30, 20X6, because of
the change in the exchange rate. The remeasurement
therefore results in the recognition of a transaction
gain.
4.3.3 Nonmonetary Accounts
When a foreign currency transaction results in the recognition
of a nonmonetary asset or liability, that asset or liability is subsequently
remeasured by using the historical exchange rate. By using the historical
exchange rate, an entity will achieve the same results as it would if it had
originally acquired the asset or incurred the liability in its functional
currency, which is consistent with the remeasurement objective of ASC
830-10-45-17. Therefore, the carrying value of nonmonetary assets and
liabilities will not change as a result of changes in exchange rates between the
foreign currency and the functional currency. As a result, transaction gains or
losses are not recognized for nonmonetary assets and liabilities.
Note that the foreign currency transaction illustrated in
Examples 4-1
and 4-2 resulted in
the recognition of both a nonmonetary asset (inventory) and a monetary liability
(accounts payable). However, unlike the subsequent accounting for accounts
payable in Example 4-2, the inventory
would continue to be remeasured as of each reporting date at the historical
exchange rate. Therefore, Retailer would continue to measure the inventory at
$200 in its financial statements until it is sold or otherwise disposed of
(i.e., changes in the exchange rate would not affect the carrying value of the
inventory).
Connecting the Dots
While ASC 830 requires that nonmonetary assets and
liabilities be subsequently remeasured at historical exchange rates,
other authoritative literature may require that those assets and
liabilities be subsequently remeasured at current exchange rates. For
example, foreign-currency-denominated investments in AFS debt securities
and equity securities are identified by ASC 830 as nonmonetary assets
and therefore would need to be remeasured by using historical exchange
rates. However, ASC 320 and ASC 321 (as discussed further in Section 4.4.1)
require that AFS debt securities and equity securities be subsequently
remeasured at fair value, a component of which is related to foreign
currency exchange rates.
Other authoritative literature takes precedence over ASC
830 in such cases and that the asset or liability should be subsequently
remeasured in accordance with such literature. Therefore, if a
foreign-currency-denominated asset or liability is deemed nonmonetary,
an entity should further consider whether other authoritative literature
requires that the asset or liability be subsequently measured at current
exchange rates, given that such literature requires ongoing
remeasurement at fair value. Changes in the carrying value of the asset
or liability that are related to changes in exchange rates would not
necessarily be reported as transaction gains and losses under ASC 830
but should be presented in accordance with the requirements of those
other standards.
4.3.4 Remeasurement of Books and Records Maintained in a Foreign Currency
ASC
830-20
25-2 Paragraphs 830-10-55-3
through 55-7 provide guidance on the determination of a
reporting entity’s functional currency. Paragraph
830-10-45-17 states that if an entity’s books of record
are not maintained in its functional currency,
remeasurement into the functional currency is required
before translation into the reporting currency. That
paragraph provides further guidance on remeasurement of
books and records.
ASC 830-20-25-2 states that if an entity maintains its books and
records in a currency other than its functional currency, “remeasurement into
the functional currency is required before translation into the reporting
currency.” Such situations occur most commonly when an entity maintains its
books and records in the local currency but, because it operates in a highly
inflationary economy, uses the reporting currency of its immediate parent as its
functional currency. (See Chapter 7 for further discussion of highly inflationary
economies.) However, this requirement applies to all situations in which an
entity maintains its books and records in a currency that differs from its
functional currency.
In such situations, nonmonetary assets and liabilities must be
remeasured at historical exchange rates (i.e., the exchange rates in effect when
the assets or liabilities were initially recognized) while monetary assets and
liabilities must be remeasured at current exchange rates. Accordingly,
remeasurement of monetary assets and liabilities from the foreign currency into
the functional currency will result in the recognition of transaction gains or
losses in earnings. The objective of such remeasurement is to produce the same
results as those that would be produced if the entity had maintained its books
and records in the functional currency; this objective is consistent with the
overall remeasurement principle in ASC 830-10-45-17.
4.4 Investments in Debt and Equity Securities
In accordance with ASC 320-10, investments in debt securities can be classified
as trading, AFS, or HTM. Such classification dictates the foreign currency
accounting for these investments. Under ASC 321, equity securities are measured at
either (1) fair value, with changes in fair value recognized in earnings, or (2)
cost minus impairment, if any, plus or minus changes resulting from observable price
changes in orderly transactions for the identical or similar investment of the same
issuer (see ASC 321-10-35-2). The measurement approach applied will affect the
foreign currency accounting for these investments.
4.4.1 Investments in Debt Securities
ASC 320-10
35-1 Investments in debt securities shall be measured subsequently as follows:
- Trading securities. Investments in debt securities that are classified as trading shall be measured subsequently at fair value in the statement of financial position. Unrealized holding gains and losses for trading securities shall be included in earnings.
- Available-for-sale securities. Investments in debt securities that are classified as available for sale shall be measured subsequently at fair value in the statement of financial position. Unrealized holding gains and losses for available-for-sale securities (including those classified as current assets) shall be excluded from earnings and reported in other comprehensive income until realized except as indicated in the following sentence. All or a portion of the unrealized holding gain and loss of an available-for-sale security that is designated as being hedged in a fair value hedge shall be recognized in earnings during the period of the hedge, pursuant to paragraphs 815-25-35-1 and 815-25-35-4. . . .
Investments in debt securities that are classified as either trading or AFS under ASC 320-10 are nonmonetary assets and therefore are not subject to remeasurement at current exchange rates under ASC 830. However, ASC 320-10-35-1 requires that trading and AFS securities be subsequently remeasured at fair value.
If a trading or AFS security is denominated in a foreign currency, changes in the exchange rate between the foreign currency and an entity’s functional currency will affect the security’s fair value. Therefore, under ASC 320-10, the trading or AFS security must be remeasured from the foreign currency to the functional currency as of each reporting date by using the current exchange rate to determine the fair value of the security.
ASC 320 further requires that all changes in the fair value of a trading security be recognized in earnings. Conversely, all changes in the fair value of an AFS security must be recognized in OCI.
Connecting the Dots
It would not be appropriate for an entity to bifurcate the change in the fair value of a trading or AFS security related strictly to the change in exchange rates and classify that portion as a transaction gain or loss in the income statement. Rather, the entire change in the security’s fair value (including the portion related to a change in the exchange rates) would be classified in accordance with ASC 320-10.
4.4.1.1 Investments in HTM Debt Securities
ASC 320-10
35-1 Investments in debt
securities shall be measured subsequently as
follows: . . .
c. Held-to-maturity securities. Investments
in debt securities classified as held to maturity
shall be measured subsequently at amortized cost
in the statement of financial position. A
transaction gain or loss on a held-to-maturity
foreign-currency-denominated debt security shall
be accounted for pursuant to Subtopic
830-20.
Unlike trading and AFS securities, investments in debt
securities that are classified as HTM under ASC 320-10 are monetary assets
and therefore will give rise to transaction gains or losses under ASC
830-20. HTM debt securities are monetary assets because the amount that the
entity will receive upon settlement is fixed and determinable. Further,
unlike trading and AFS securities, HTM debt securities must be carried at
amortized cost, not fair value.
Accordingly, HTM debt securities that are denominated in a
foreign currency must be remeasured as of each reporting date by using the
current exchange rate. Any changes in the carrying value of the security
that are attributable to changes in exchange rates should be reported as a
transaction gain or loss in earnings. The following table summarizes the
exchange rates that should be used to remeasure the accounts that may be
associated with an investment in an HTM debt security:
Account Description
|
Exchange Rate
|
---|---|
Investment in HTM security
|
Current spot rate
|
Accrued interest
|
Current spot rate
|
Interest income
|
Weighted-average rate
|
Amortization of premium or
discount
|
Weighted-average rate
|
Connecting the Dots
Loan receivables that are classified as held for
investment (HFI) are measured at amortized cost. Therefore, the
guidance and examples that apply to HTM debt securities would also
apply to foreign-currency-denominated HFI loan receivables carried
at amortized cost.5 This guidance is illustrated in the examples below.
Example 4-3
Foreign-Currency-Denominated HTM Security
Purchased at Par
On January 1, 20X6, Investor
Co, a U.S. registrant whose functional currency is
the USD, purchases a 10-year bond bearing 6
percent annual interest with a par value of
1,000,000 EUR. The purchase price of the bond is
equal to its par value (i.e., no premium or
discount is associated with the bond).
Assume that Investor Co
classifies its investment in the bond as an HTM
security under ASC 320-10 and that the following
exchange rates are in effect during 20X6:
To record its initial
investment in the bond in its functional currency,
Investor Co records the following journal entry on
January 1, 20X6 [€1,000,000 × (€1:$1.2)]:
The table below summarizes the
various amounts that would be recorded in Investor
Co’s financial statements on December 31,
20X6.
The foreign currency
transaction gain calculated above consists of two
components: (1) remeasurement of the investment in
the bond ($300,000) and (2) remeasurement of
accrued interest receivable ($12,000). Since the
investment in the bond is a monetary asset, it
must be remeasured by using the current spot rate
in effect as of December 31, 20X6. This process
results in a transaction gain of $300,000
[€1,000,000 × (1.5 – 1.2)]. Further, because the
accrued interest receivable represents a monetary
asset, it must also be remeasured at the spot
rate. However, since the accrued interest
receivable was recorded throughout the year at the
weighted-average exchange rate (as the interest
income was recognized), the transaction gain of
$12,000 is calculated as the difference between
the spot rate on December 31, 20X6, and the
weighted-average exchange rate during 20X6
[€60,000 × (1.5 – 1.3)].
Example 4-4
Foreign-Currency-Denominated HTM Security
Purchased at a Discount
Assume the same facts as in
Example 4-3, except that Investor Co
only pays €900,000 to purchase the bond (i.e., the
bond is issued at a discount).
The table below reflects a
simplified bond amortization schedule for
20X6.
To record its initial
investment in the bond in its functional currency,
Investor Co records the following journal entry on
January 1, 20X6 [€900,000 × (€1:$1.2)]:
4.4.1.2 Impairment of Debt Securities
Entities use the current expected credit loss (CECL) model
in ASC 326-20 to recognize impairment of debt securities held at amortized
cost (i.e., HTM securities). Impairment of AFS debt securities is recognized
by using the credit loss model in ASC 326-30. Therefore, an entity will have
to use different credit loss models if its investment portfolio contains
both HTM and AFS securities. For foreign-currency-denominated AFS debt
securities, if a credit loss exists but the entity does not intend or would
not be required to sell the security before recovery of its amortized cost
basis, in accordance with ASC 320-10-35-36, the change in fair value would
be recognized (1) in earnings to the extent that the change is related to
credit losses and (2) in OCI to the extent that it is related to changes in
exchange rates and other factors.
4.4.1.2.1 HTM Debt Securities
ASC 326-20
15-2 The guidance in this
Subtopic applies to the following items:
a. Financial assets measured at amortized
cost basis, including the following: . . .
2. Held-to-maturity debt
securities
30-1 The
allowance for credit losses is a valuation account
that is deducted from, or added to, the amortized
cost basis of the financial asset(s) to present
the net amount expected to be collected on the
financial asset. Expected recoveries of amounts
previously written off and expected to be written
off shall be included in the valuation account and
shall not exceed the aggregate of amounts
previously written off and expected to be written
off by an entity. At the reporting date, an entity
shall record an allowance for credit losses on
financial assets within the scope of this
Subtopic. An entity shall report in net income (as
a credit loss expense) the amount necessary to
adjust the allowance for credit losses for
management’s current estimate of expected credit
losses on financial asset(s).
HTM debt securities are within the scope of CECL. An
entity will recognize expected credit losses upon initial recognition of
an HTM debt security without regard to the security’s fair value. The
entity will continually update the underlying cash flows expected to be
collected in the currency of the HTM debt securities (i.e., the contract
currency) at the end of the financial reporting period when measuring
its expected credit losses, irrespective of the HTM debt security’s fair
value, and would record any expected credit loss as an allowance (or
contra asset) at the end of that reporting period. For more information
on how to account for the measurement of expected credit losses on HTM
securities, see Deloitte’s Roadmap Current Expected Credit
Losses.
Foreign-currency-denominated HTM debt securities are
monetary assets; therefore, the amortized cost of such securities would
be remeasured from the foreign currency to the entity’s functional
currency by using current exchange rates. In a manner consistent with
the treatment of the associated HTM debt security, any
foreign-currency-denominated allowance for estimated expected credit
losses would be treated as a monetary contra asset and would be
remeasured by using current exchange rates.
4.4.1.2.2 AFS Debt Securities
Entities are required to recognize an allowance for
credit losses on AFS debt securities that are impaired as a result of
credit concerns in accordance with ASC 326-30. Such allowances for
credit losses can be reversed in subsequent financial reporting periods
if there is an improvement in the credit quality of an AFS debt
security. The flowchart below illustrates how an entity identifies and
assesses impairment on AFS debt securities denominated in a foreign
currency.
ASC 326-30
35-1 An investment is
impaired if the fair value of the investment is
less than its amortized cost basis.
35-6 In assessing whether a
credit loss exists, an entity shall compare the
present value of cash flows expected to be
collected from the security with the amortized
cost basis of the security. If the present value
of cash flows expected to be collected is less
than the amortized cost basis of the security, a
credit loss exists and an allowance for credit
losses shall be recorded for the credit loss,
limited by the amount that the fair value is less
than amortized cost basis. Credit losses on an
impaired security shall continue to be measured
using the present value of expected future cash
flows.
35-10 If an entity intends to
sell the debt security (that is, it has decided to
sell the security), or more likely than not will
be required to sell the security before recovery
of its amortized cost basis, any allowance for
credit losses shall be written off and the
amortized cost basis shall be written down to the
debt security’s fair value at the reporting date
with any incremental impairment reported in
earnings. If an entity does not intend to sell the
debt security, the entity shall consider available
evidence to assess whether it more likely than not
will be required to sell the security before the
recovery of its amortized cost basis (for example,
whether its cash or working capital requirements
or contractual or regulatory obligations indicate
that the security will be required to be sold
before the forecasted recovery occurs). In
assessing whether the entity more likely than not
will be required to sell the security before
recovery of its amortized cost basis, the entity
shall consider the factors in paragraphs
326-30-55-1 through 55-2.
ASC 320-10
35-36 The change in the fair
value of foreign-currency-denominated
available-for-sale debt securities, excluding the
amount recorded in the allowance for credit
losses, shall be reported in other comprehensive
income. See Subtopic 326-30 for measuring credit
losses on available-for-sale debt securities. In
accordance with the guidance in Subtopic 326-30,
an entity shall report credit losses on
available-for-sale debt securities in the
statement of financial performance as credit loss
expense.
When determining whether an impairment exists on an AFS
debt security that is denominated in a foreign currency, an entity
compares the security’s fair value (measured in the entity’s functional
currency at the current exchange rate) with its amortized cost basis
(measured at the historical exchange rate). If the fair value of the
security is below its amortized cost, the security is impaired. If the
impairment is due solely to a credit loss, an allowance for credit
losses must be recognized for the credit loss but is not to exceed the
amount by which the fair value of the security is less than its
amortized cost basis. If, however, (1) an entity intends to sell the
impaired security or (2) it is more likely than not that it will be
required to sell the impaired security before recovery of its amortized
cost basis, any allowance for credit losses must be written off and the
amortized cost basis must be written down to the security’s fair value,
with any incremental impairment recorded in earnings.
ASC 320-10-35-36 states, in part, that “[t]he change in
the fair value of foreign-currency-denominated available-for-sale debt
securities, excluding the amount recorded in the allowance for credit
losses, shall be reported in other comprehensive income.” As a result,
if the entity does not intend to sell the security or it is not more
likely than not that it will be required to sell the security before
recovery of its amortized cost basis, the entity would recognize in OCI
the change in the security’s fair value related to the changes in
foreign exchange rates.
Connecting the Dots
Stakeholders have questioned when unrealized
losses related to changes in foreign exchange rates on an AFS
debt security should be recognized in earnings and whether the
new guidance in ASC 326-30 will delay loss recognition.
Consequently, at the TRG’s November 2018 meeting, the FASB staff
confirmed that unrealized losses related to foreign exchange
rates should be reported in OCI and recognized in earnings “(a)
at the maturity of the security, (b) upon the sale of the
security, (c) when an entity intends to sell, or (d) when an
entity is more likely than not required to sell the security
before recovery of its amortized cost basis.” In addition, the
staff said that the concern that the amendments made by
ASU 2016-13
(the guidance in ASC 326-30) will result in delayed loss
recognition “is beyond the scope of the Credit Losses TRG
because the topic relates to reporting changes in fair value
related to foreign exchange rates.”
There is diversity in how an entity may
translate its credit loss expense to reflect changes in the spot
rate. For example, an entity may translate its credit loss
expense at the end of the reporting period by using the spot
rate that existed when the asset was acquired or the spot rate
that exists at the end of the current reporting period. Either
approach is acceptable provided that it is applied consistently.
Note that this guidance does not apply to HTM securities. Any
impairment loss on HTM securities (i.e., monetary assets) is
translated by using the spot rate that exists at the end of the
current reporting period.
Example 7-4 in Deloitte’s Roadmap Current Expected Credit
Losses illustrates the accounting for an
impairment of a foreign-currency-denominated AFS debt security.
4.4.2 Investments in Equity Securities
ASC 321 requires that all equity securities be measured at fair value through
net income (FVTNI). However, for certain investments in equity securities
without a readily determinable fair value that do not qualify for the net asset
value practical expedient in ASC 820-10-35-59, an entity is permitted to elect a
practicability measurement exception6 to fair value measurement under which the investment is measured at cost,
less impairment, plus or minus observable price changes (in orderly
transactions) for an identical or similar investment of the same issuer.
For an equity security that is subsequently measured at fair value, all changes
in the fair value of the security, including those related to changes in
exchange rates, will be reported in net income. Period-end spot rates must be
used in such fair value measurements. For foreign-currency-denominated equity
securities accounted for by using the measurement exception, the historical
exchange rate as of the acquisition date is used to remeasure the security and
is updated only on the date a remeasurement adjustment is made as a result of an
impairment or an observable price change (see ASC 830-10-45-18).
4.4.2.1 Impairment of Equity Securities
Entities that elect the measurement alternative for equity securities will need
to assess the equity investment for impairment. As of each reporting period,
an entity must qualitatively consider whether the investment is impaired on
the basis of certain indicators. If it determines that the equity security
is impaired on the basis of the qualitative assessment, the entity must
recognize an impairment loss equal to the amount by which the security’s
carrying amount exceeds its fair value.
For equity securities whose fair value is determined in a foreign currency, the
fair value would be determined in the entity’s functional currency at the
current exchange rate (i.e., at the spot rate on the date of the
impairment). Further, the entire difference between the fair value of an
equity security and its carrying value would be recorded in earnings as an
impairment loss. Therefore, as shown in the example below, the portion of
the impairment loss attributable to changes in the exchange rate would not
be recorded separately as a foreign currency transaction loss under ASC 830.
Example 4-5
Impairment of a Foreign-Currency-Denominated
Equity Security
Investor Co, a U.S. entity whose
functional currency is the USD, purchases 750,000
shares of Lumber Co, a Canadian private entity, on
November 22, 20X6, for 1,000,000 CAD. Investor Co is
a public entity with a calendar year-end. Assume the
following facts:
-
Investor Co classifies its investment in the shares in Lumber Co as an FVTNI security under ASC 321-10.
-
The fair value of Investor Co’s investment in the shares of Lumber Co and the exchange rates in effect at the time of purchase and at year-end are as follows:
Further, assume that Investor Co has
elected the measurement alternative under ASC 321
and determined that the $210,000 impairment loss
should be recorded through the following journal
entry:
Although part of the impairment is
due to the devaluation of the CAD against the USD,
the portion of the impairment loss attributable to
changes in the exchange rate would not be recorded
separately as a foreign currency transaction
loss.
Footnotes
5
Loan receivables that are classified as held for sale (HFS)
are measured at the lower of amortized cost or fair value.
Both the amortized cost basis and the fair value of
foreign-currency-denominated loan receivables classified as
HFS would be affected by changes in exchange rates.
6
The measurement exception is not available to (1)
reporting entities that are investment companies, (2) broker-dealers in
securities, or (3) postretirement benefit plans.
4.5 Debt
Foreign-currency-denominated debt is a monetary liability and therefore should
be remeasured, as of each reporting date, in the functional currency at the current
exchange rate. Any change in the functional-currency-denominated value of the debt
caused by changes in exchange rates should be recognized as a transaction gain or
loss. However, if an entity has elected, in accordance with the fair value option,
to subsequently measure a liability at fair value, with changes reported in
earnings, the change in fair value that results from exchange rate changes will
represent a portion of the overall change in fair value and will not be reported
separately as a transaction gain or loss. ASC 825-10-45-5 requires an entity to
separately present, within OCI, the portion of the total change in the fair value of
a liability attributable to a change in the instrument-specific credit risk. ASC
830-20-35-7A addresses how to calculate the amount of the change in fair value that
is related to instrument-specific credit risk and indicates that an entity should
first measure this amount in the currency of denomination and then remeasure that
amount into the functional currency by using period-end spot rates.
4.5.1 Debt Issuance Costs
Under U.S. GAAP, entities are required to present debt issuance costs (other
than costs related to line-of-credit or
revolving-debt arrangements) on the balance sheet
as a direct deduction from the related debt
liability rather than as a deferred charge. Debt
issuance costs should be treated as a monetary
liability; therefore, the remeasurement of the
carrying amount of the debt liability in the
entity’s functional currency should reflect any
deduction related to debt issuance costs. In other
words, monetary liabilities (including the
carrying amount of a monetary debt liability that
has been adjusted for debt issuance costs) are
remeasured in the entity’s functional currency by
using current exchange rates.
4.6 Equity Transactions
As discussed in Section 4.3, equity-classified securities are nonmonetary accounts that must be measured at historical exchange rates (i.e., the rates that were in effect when the securities were issued).
ASC 480 provides guidance on determining whether a financial instrument with both debt- and equity-like characteristics must be classified as a liability (or, in certain circumstances, as an asset). ASC 480 applies to freestanding financial instruments only and therefore does not apply to embedded features in a hybrid instrument, such as a put option embedded in a preferred share. However, just because an entity concludes that it is not required to classify an instrument as a liability under ASC 480 does not mean that the instrument is automatically classified as equity. Rather, an entity must perform further analysis under other Codification subtopics (e.g., ASC 815-40, ASC 505) to determine whether the instrument should be classified as a liability or as equity.
4.6.1 Distinguishing Liabilities From Equity
Under ASC 480, certain financial instruments that embody an obligation of the
issuer should be accounted for as liabilities even if their legal form is that
of equity. ASC 480 requires that the following three classes of financial
instruments be accounted for as liabilities (or, in some circumstances, as
assets):
-
Mandatorily redeemable financial instruments — The issuer of a financial instrument that is in the form of a share must classify the share as a liability if it embodies an unconditional obligation requiring the issuer to redeem the share by transferring assets, unless redemption would occur only upon the liquidation or termination of the reporting entity (e.g., mandatorily redeemable shares and mandatorily redeemable NCIs that do not contain any substantive conversion features). This guidance does not, however, apply to certain mandatorily redeemable financial instruments issued by nonpublic entities that are not SEC registrants (see ASC 480-10-15-7A).
-
Obligations to repurchase the issuer’s equity shares by transferring assets — A financial instrument other than an equity share is classified as a liability if it both (1) embodies an obligation to repurchase the issuer’s equity shares (or is indexed to such an obligation) and (2) requires (or may require) the issuer to settle the obligation by transferring assets (e.g., physically settled or net-cash-settled forward purchase contracts or written put options on the entity’s own equity shares).
-
Certain obligations to issue a variable number of shares — A financial instrument that embodies an unconditional obligation or a financial instrument other than an outstanding share that embodies a conditional obligation that the issuer must or may settle by issuing a variable number of its equity shares is classified as a liability if the obligation’s monetary value is based solely or predominantly on one of the following: (1) a fixed monetary amount, (2) variations on something other than the fair value of the issuer’s equity shares, or (3) variations inversely related to changes in the fair value of the entity’s equity shares (e.g., share-settled debt and net-share-settled forward purchase contracts or written put options on the entity’s own equity shares). See ASC 480-10-25-14 for more information.
In addition, ASC 480-10-S99 contains SEC staff guidance on how to account for and present redeemable equity instruments (including classification within equity) that are not classified as liabilities under ASC 480-10-25 in an entity’s financial statements. As summarized in the table below, the foreign currency effects of financial instruments with characteristics of both debt and equity depend on whether those instruments are classified as liabilities, temporary equity, or permanent equity under ASC 480.
Classification | Foreign Currency Effects |
---|---|
Liability | The instrument represents a monetary liability and therefore should be
remeasured, as of each reporting date, in the functional
currency at the current exchange rate. Any change in the
functional-currency-denominated value of the debt caused
by changes in exchange rates should be recognized as a
transaction gain or loss unless the liability is
subsequently measured at fair value, with changes in
fair value recognized in earnings. In those situations,
the entire change in fair value (including the exchange
rate change component) would be recognized in the same
line item. |
Temporary equity | Like other equity instruments, instruments classified in temporary equity on the
balance sheet are considered nonmonetary accounts under
ASC 830. Changes in exchange rates therefore will not
result in transaction gains or losses under ASC 830.
However, to the extent that the instrument must be
subsequently remeasured under ASC 480-10-S99-3A, the
measurement of the instrument’s redemption value must
incorporate the effect of exchange rates. That is, the
effect of exchange rates would be recorded through
retained earnings (or, in the absence of retained
earnings, APIC) and included as an adjustment to net
income available to common shareholders in the
calculation of earnings per share in accordance with ASC
480-10-S99-3A. Further, although ASC 480-10-S99-3A does
not address foreign currency, consideration of the
effects of changes in exchange rates when the “floor” is
applied would be most consistent with the intention of
the concept in that guidance. |
Permanent equity | The instrument represents a nonmonetary account that must be measured at the historical exchange rate. Changes in exchange rates therefore will not result in transaction gains or losses. |
For further discussion of the application of ASC 480-10-S99-3A,
see Chapter 9 of
Deloitte’s Roadmap Distinguishing Liabilities From Equity.
4.6.2 Dividends
The declaration of a cash dividend, if the dividend is not paid on the declaration date, results in the recognition of a monetary liability (i.e., a dividend payable). If the dividend is payable in a currency other than the entity’s functional currency, it must be remeasured, as of each reporting date, in the functional currency at the current exchange rate. Any change in the functional-currency-denominated value of the dividend payable caused by changes in exchange rates is recognized as a transaction gain or loss. The FASB 52
Implementation Group addressed this issue in December 1981 when it decided that
“the transaction adjustment on a dividend payable or receivable account should
be charged or credited to income.” This accounting is required regardless of
whether the dividend is payable to the entity’s parent or other third-party
shareholders.
Example 4-6
Foreign-Currency-Denominated Dividend
Company A, whose functional currency is
the ZAR, declares a $60 million dividend to its equity
shareholders on November 12, 20X6. The spot exchange
rate on the declaration date is $1 = ZAR 10. Assume the
following additional facts:
-
The dividend will be paid in ZAR at the spot rate in effect on December 27, 20X6.
-
The closing spot exchange rate on December 27, 20X6, is $1 = ZAR 12.
-
The dividend of ZAR 720 million ($60 million × 12) is paid on January 14, 20X7.
Because the payable is denominated in a
foreign currency (USD), A is at risk for fluctuations in
the foreign currency exchange rate between the
declaration date and December 27, the date on which the
exchange rate is fixed so that the dividend can be paid.
Therefore, A should record a transaction loss related to
the liability for the devaluation of the ZAR to the USD
for the period from November 12 through December 27.
Since the dividend will be paid in ZAR (i.e., A’s
functional currency), foreign exchange risk is no longer
associated with this payable after December 27.
4.7 Refundable Deposits and Advances
Refundable deposits and advances (both amounts received from customers and
amounts paid to suppliers) are monetary liabilities and assets. Therefore, if the
amounts are refundable in a foreign currency, the recognized asset or liability must
be remeasured in the functional currency on each reporting date at the current
exchange rate.
ASC 606 does not directly
address whether a refund liability should be considered a monetary liability. In determining
whether a refund liability is a contract liability, an entity will need to use judgment and
consider the specific facts and circumstances. This determination will affect whether the
refund liability would be considered a monetary or nonmonetary liability. Refund liabilities
that are not contract liabilities represent monetary liabilities that must be remeasured by
using current exchange rates.
4.8 Contract Assets and Contract Liabilities
ASC 606 requires the recognition of a (1) contract asset if an entity transfers goods or services to a customer before the customer pays consideration or before payment is due or (2) contract liability if an entity receives consideration (or had an unconditional right to consideration) before it transfers goods or services to the customer. This requirement is similar to the requirement under the legacy guidance in ASC 605-35 related to the recognition of costs in excess of billings or billings in excess of costs.
Like billings in excess of costs, contract liabilities are nonmonetary
liabilities because they require an entity to perform a service in the future.
Contract assets are monetary assets for the same reason that costs in excess of
billings are monetary assets under legacy guidance. That is, contract assets will
ultimately be settled for an amount of cash to be received from the customer.
A separate issue arises if a single contract with a customer contains a performance obligation that is in a contract asset position and another performance obligation that is in a contract liability position. ASC 606 requires an entity to present contract assets and contract liabilities on a net basis in the balance sheet. Therefore, questions have arisen about whether the guidance in ASC 830 should be applied to the gross contract asset and liability balances separately or only to the net contract asset or liability for a single contract.
The guidance in ASC 830 should generally be applied on a gross basis. Therefore,
if a single contract contains both a contract asset and a contract liability, an
entity would remeasure the gross contract asset as of each reporting date at the
current exchange rate. An entity would not remeasure the gross contract liability
since it represents a nonmonetary liability. The requirement to present contract
assets and liabilities on a net basis does not affect the recognition and
measurement of the asset and liability (i.e., the requirement strictly applies to
presentation matters); therefore, the “unit of account” is the gross asset and
liability. Entities are encouraged to consult with their accounting advisers if they
are considering applying the guidance in ASC 830 to the net contract asset/liability
for a single contract.
4.9 Inventories
ASC 830-10
55-8 The guidance on the subsequent measurement of inventory in Subtopic 330-10 requires special
application when the books of record are not kept in the functional currency. Inventories carried at cost in
the books of record in another currency should be first remeasured to cost in the functional currency using
historical exchange rates. Then, historical cost in the functional currency should be evaluated for impairment
under the subsequent measurement guidance using the functional currency. Application of the subsequent
measurement guidance in functional currency may require a write-down in the functional currency statements
even though no write-down has been made in the books of record maintained in another currency. Likewise, a
write-down in the books of record may need to be reversed if the application of the subsequent measurement
guidance in the functional currency does not require a write-down. If inventory has been written down in the
functional currency statements, that functional currency amount shall continue to be the carrying amount in
the functional currency financial statements until the inventory is sold or a further write-down is necessary.
An asset other than inventory may sometimes be written down from historical cost. Although different
measurement guidance may be used to determine that write-down, the approach described in this paragraph
might be appropriate. That is, a write-down may be required in the functional currency statements even though
not required in the books of record, and a write-down in the books of record may need to be reversed before
remeasurement to prevent the remeasured amount from exceeding functional currency historical cost.
ASC 830-10-45-18 states that inventory carried at cost is a nonmonetary asset.
Therefore, when an entity maintains its books and records in a foreign currency,
inventory must be remeasured in the functional currency at the historical exchange
rate (i.e., the rate that was in effect when the inventory was purchased). ASC
830-10-55-8 further requires that an entity apply the subsequent-measurement
guidance in ASC 330 to its functional currency.
Therefore, in certain instances, an entity may determine that it is required to
write down its inventory in its functional currency even though it is not required
to do so in the foreign currency. This situation typically arises when an entity
sells inventory in a foreign currency and the foreign currency has weakened against
the functional currency since the time the inventory was acquired. The example below
illustrates this concept.
Example 4-7
Subsequent Measurement When Books and Records Are
Maintained in a Foreign Currency
Parent Co, a U.S. registrant whose
functional and reporting currency is the USD, has a
subsidiary, Sub Co, that operates in Mexico. Assume that Sub
Co is a distinct and separable operation and that its
functional currency is the reporting currency (USD). Sub Co
maintains its books and records in MXN, the local
currency.
Assume that the following facts exist on
December 31, 20X6:
-
Sub Co uses the FIFO method for determining inventory cost.
-
Sub Co’s inventory balance is $50,000, which is equal to the local currency amount of MXN 500,000 translated at the historical exchange rate of MXN 1 = $0.10.
-
Sub Co determines that the net realizable value (NRV) of the inventory on December 31, 20X6, under ASC 330-10-35 is $30,000, computed on the basis of the 600,000 MXN and an exchange rate of 1 MXN = $0.05.
As a result, Sub Co recognizes a
subsequent-measurement adjustment of $20,000 on December 31,
20X6. The inventory will be carried in Sub Co’s financial
statements at $30,000 until it is disposed of or
subsequently written down as a result of a further decline
in its market value.
In this example, Sub Co is required to
recognize a subsequent-measurement adjustment in its
functional currency even though no write-down in the local
currency would have been required. That is, the NRV of the
inventory in the local currency is MXN 600,000, which is
greater than its carrying value of MXN 500,000. A
subsequent-measurement adjustment is required because of the
devaluation of the MXN against the USD since the inventory
was acquired.
4.10 Property, Plant, and Equipment
ASC 830-10-45-18 states that PP&E are
nonmonetary assets. Therefore, when an entity maintains its books and records in a
foreign currency, PP&E must be remeasured in the functional currency at the
historical exchange rate (i.e., the rate that was in effect when the PP&E was
purchased). Further, upon a triggering event, entities must perform a two-step test
under ASC 360-10 to determine whether PP&E is impaired:
-
Step 1 — Compare the carrying amount of the PP&E with the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group).
-
Step 2 — If the carrying value of the PP&E exceeds the undiscounted cash flows determined in step 1, compare the carrying value of the PP&E with its fair value. If the carrying value exceeds the fair value, an impairment loss is recognized for the difference.
As with the accounting for inventory discussed in Section 4.9, an entity must test PP&E for
impairment in its functional currency. Therefore, when an entity maintains its books
and records in a foreign currency, a devaluation of the foreign currency against the
functional currency could cause an entity to fail step 1 of the impairment test.
This is because PP&E constitute nonmonetary assets that must be remeasured at
the historical exchange rate, while the undiscounted cash flows are measured at the
exchange rate that is in effect when the impairment test is performed. As with
inventory, an impairment of PP&E in the functional currency may result even
though the entity is not required to report an impairment in the books and records
maintained in the foreign currency. The example below illustrates this concept.
Example 4-8
PP&E Impairment Test When Books and Records Are
Maintained in a Foreign Currency
Parent Co, a U.S. registrant whose
functional and reporting currency is the USD, has a
subsidiary, Sub Co, that operates in Mexico. Sub Co is a
distinct and separable operation whose functional currency
is the reporting currency (USD). Sub Co maintains its books
and records in MXN, the local currency.
Assume that Sub Co purchased a piece of
equipment for MXN 250,000 in 20X6, when the exchange rate
was MXN 1 = $0.10, and that the equipment is a single asset
group under ASC 360-10. In 20X9, because of a significant
decline in the operations of Sub Co, the equipment is tested
for impairment under ASC 360-10.
Assume that the following facts exist on
December 31, 20X9:
-
The carrying value of the equipment is $17,500 (MXN 175,000 measured at the historical exchange rate).
-
The sum of undiscounted cash flows expected to result from the use and eventual disposition of the equipment is MXN 200,000.
-
The exchange rate is MXN 1 = $0.05.
-
The fair value of the equipment is $5,000.
Sub Co determines that the carrying value of
the equipment ($17,500) exceeds the sum of the undiscounted
cash flows ($10,000) on a functional currency basis.
Therefore, Sub Co recognizes an impairment loss of $12,500
on December 31, 20X9 ($5,000 fair value less $17,500
carrying value).
As in Example 4-7, Sub Co
must recognize an impairment loss in its functional currency
even though no impairment would have been recognized if the
local currency were the functional currency. That is, the
sum of the undiscounted cash flows in the local currency is
MXN 200,000, which is greater than the equipment’s carrying
value of MXN 175,000.
4.11 Leases
With limited exceptions, ASC 842 requires lessees to recognize an
ROU asset and a lease liability as of the lease commencement date, regardless of
lease classification. The implementation guidance in ASC 842-20-55-10 clarifies that
an ROU asset is a nonmonetary asset and a lease liability is a monetary liability.
Therefore, when a lease is denominated in a foreign currency, the ROU asset must be
remeasured in the functional currency by using the historical exchange rate (in a
manner consistent with the remeasurement of PP&E purchased in a foreign
currency, which is discussed in Section 4.10) and the lease liability must be remeasured by using
the current exchange rate (in a manner consistent with the remeasurement of
foreign-currency-denominated debt, which is discussed in Section 4.5).
Connecting the Dots
Questions have arisen regarding what rate should be used —
and how it should be used — to remeasure the ROU asset after a lease has
been modified and the modification was not accounted for as a separate
contract, specifically whether (1) the ROU asset, in its entirety, should be
remeasured by using the exchange rate as of the “new” lease commencement
date (i.e., the date of the lease modification) or (2) the historical
exchange rate as of the original lease commencement date should be applied
to the ROU asset established before the modification and the exchange rate
as of the date of the lease modification should be applied to any increase
in the ROU asset resulting from the modification (i.e., a bifurcated
approach to foreign currency remeasurement). (See Deloitte’s Roadmap
Leases for additional discussion.)
4.12 Share-Based Payments
Under ASC 718, share-based payment awards are classified as either liabilities or equity. As summarized in the table below, the foreign currency effects of share-based payment awards that are denominated in a foreign currency depend on the classification of the award.
Classification Under ASC 718 | Measurement Under ASC 718 | Foreign Currency Effects |
---|---|---|
Liability | Generally, remeasured as of each reporting date at fair value until the award is settled. | The fair value of the award should be determined in the functional currency by using the current exchange rate. Fluctuations in the fair-value-based measure of the liability award are recorded as increases or decreases in compensation cost, either immediately or over the remaining service period, depending on the vested status of the award. Compensation cost is recorded in the functional currency by using the weighted-average exchange rate for the reporting period. Upon exercise, proceeds are measured at the spot rate in effect at that time, with any difference recorded in equity. |
Equity | Generally, measured on the grant date; not subsequently remeasured. | Compensation cost is recorded in the functional currency by using the weighted-average exchange rate for the reporting period. Upon exercise, proceeds are measured at the spot rate in effect at that time, with any difference recorded in equity. |
4.13 Deferred Taxes
As shown in the table in Section
4.3.1, DTAs and DTLs are classified as
monetary accounts. Typically, an entity files its
income tax return in the local currency of the
jurisdiction in which it operates. Further, an
entity’s tax basis in assets and liabilities is
generally determined in the local currency;
accordingly, deferred taxes are typically measured
in the local currency. Therefore, if an entity’s
functional currency is different from the currency
in which the entity has to pay taxes, deferred
taxes must be remeasured in each reporting period
at the current exchange rate. See Chapter
8 for further considerations related to
accounting for income taxes.
4.14 Warranty Obligations
When an entity sells a product to its customer, it may also provide the customer with a warranty on that product. The warranty might be described as a manufacturer’s warranty, a standard warranty, or an extended warranty. Some warranties protect the customer from defects that exist when the product is sold, while others protect the customer from faults that arise after the product has been received. In substance, an entity’s warranty obligation represents a promise to stand ready to replace or repair the product in accordance with the terms and conditions of the warranty.
ASC 460-10-25-5 states that warranty obligations incurred in connection with the
sale of goods or services represent contingent
liabilities and that an entity should therefore
accrue losses from warranty obligations when the
criteria in ASC 450-20-25-2 are met. The liability
recognized for an entity’s warranty obligation
represents a nonmonetary liability under ASC 830
(since it will not be settled in cash) and
therefore would not be subject to remeasurement in
each period.
4.15 Sales With a Right of Return
In some contracts, an entity sells a good to a customer and grants the customer the right to return
the good for a refund (e.g., if the customer is dissatisfied with the product). Under ASC 606-10-55-25, “[f]or any amounts received
(or receivable) for which an entity does not expect to be entitled, the entity should not recognize
revenue when it transfers products to customers but should recognize those amounts received (or
receivable) as a refund liability.” This liability represents a refundable
deposit received from the customer and therefore is a monetary liability under ASC 830. Therefore, if
the sales price of the good is denominated in a foreign currency, the entity should remeasure the liability
in its functional currency as of each reporting date, with changes recognized in earnings as transaction
gains or losses (in a manner consistent with the remeasurement of refundable advance payments
denominated in a foreign currency, which is discussed in Section 4.7).
4.16 Sales of Future Revenues
ASC 470-10
Sales of Future Revenues or Various Other Measures of Income
25-1 An entity receives cash from an investor and agrees to pay to the investor for a defined period a specified percentage or amount of the revenue or of a measure of income (for example, gross margin, operating income, or pretax income) of a particular product line, business segment, trademark, patent, or contractual right. It is assumed that immediate income recognition is not appropriate due to the facts and circumstances. The payment to the investor and the future revenue or income on which the payment is based may be denominated in a foreign currency.
ASC 470-10 requires that the proceeds received from an investor be classified as
either deferred income or debt depending on the facts and circumstances.
Specifically, ASC 470-10-25-2 states that there is a rebuttable presumption that the
proceeds should be classified as debt if any of the following factors are
present:
If an entity concludes that proceeds received from the sale of future revenues should be classified as debt, it should account for the foreign currency effects in the same manner as that described in Section 4.5. If an entity concludes that proceeds received from the sale of future revenues should be classified as deferred income, it should account for the foreign currency effects in the same manner as contract liabilities, which are discussed in Section 4.8.
4.17 Debt-for-Equity Swap
The implementation guidance in ASC 830-20-55-1 through 55-3 describes a
transaction in which a U.S. entity purchases dollar-denominated debt due from a
foreign government, or an entity that operates in that foreign country, for less
than its face value. The U.S. entity then exchanges that debt with the foreign
country’s government in a transaction denominated in the foreign currency and is
required to invest that money in its subsidiary operating in that foreign country.
The foreign government’s intent in this transaction is generally to induce the U.S.
entity to invest in long-lived assets in the foreign country (through its subsidiary
in that country). The graphic below illustrates this transaction.
Debt-for-equity swap programs may be in place in financially troubled countries, since the intent of the above transaction is to induce the U.S. entity to invest in the foreign country (by purchasing long-lived assets through its foreign subsidiary). In practice, debt-for-equity swaps are complicated transactions that can involve several brokers and are subject to both domestic and international currency regulations.
In general, the U.S. entity will receive more proceeds from the foreign
government than it paid to acquire the debt. Under
ASC 830-20-55-2, the cost basis of any long-lived
assets acquired or constructed should be reduced
by the amount by which the foreign currency
proceeds (received from the government) translated
at the official exchange rate exceed the purchase
cost of the debt. The example below illustrates
this concept.
Example 4-9
Debt-for-Equity Swap
Parent Co, a U.S. registrant
whose functional and reporting currency is the
USD, has a subsidiary, Sub Co, that operates in
Brazil. Parent Co purchases USD-denominated debt
with a principal amount of $5 million from a
Brazilian bank for $2 million (the debt’s price in
the secondary market). Immediately after acquiring
the debt, Parent Co sells the debt to the
Brazilian government for 15 million BRL, the local
currency. The official exchange rate in effect on
the date Parent Co sold the debt to Brazil was BRL
1 = $0.3. Therefore, the USD value of the proceeds
received from the Brazilian government is $4.5
million ($15 million × 0.3).
In this example, the excess of
the amount received from the Brazilian government
over the amount paid to acquire the debt is $2.5
million ($4.5 million proceeds – $2 million
purchase price). Assume that in accordance with
the terms of the sale to the government, Parent Co
is required to contribute the proceeds to Sub Co
and that Sub Co must use the proceeds to acquire
long-lived assets in Brazil. Under ASC
830-20-55-2, the carrying value of the long-lived
assets acquired must be reduced by the $2.5
million of excess proceeds received from the
Brazilian government.
4.18 Capitalized Interest
ASC 835-20 — Glossary
Interest Cost
Interest cost includes interest recognized on obligations having explicit
interest rates, interest imputed on certain types
of payables in accordance with Subtopic 835-30,
and interest related to a finance lease determined
in accordance with Topic 842. With respect to
obligations having explicit interest rates,
interest cost includes amounts resulting from
periodic amortization of discount or premium and
issue costs on debt.
Interest costs are the only costs that are eligible for capitalization under ASC
835-20. Further, AICPA Technical Q&As Section 2210.27 states that if a
foreign-currency-denominated loan is obtained to construct a building, “the
transaction gains and losses are not part of the cost of the building, but are a
result of the change in the exchange rate and are included in income each period in
which the exchange rate fluctuates.” That is, transaction gains or losses are
precluded from capitalization under ASC 835-20.
SEC Considerations
The SEC staff presented its views on this issue in a March 20, 1995, letter to the Accounting Principles Commission of the Mexican Institute of Public Accountants. The staff stated, in part:
The staff believes that the amount subject to capitalization on USD borrowings should be the stated rate on such borrowings. Therefore, both the foreign exchange loss and the monetary gain are excluded from the amount subject to capitalization. Under this policy, the amount subject to capitalization on USD borrowings would be the same if the Mexican entity were a reporting company or a subsidiary of a U.S. company.
4.19 Defined Benefit Pension Plans
In some cases, the benefits payable to plan participants under defined benefit pension or other postretirement plans may be denominated in a currency other than an entity’s functional currency. For example, a foreign entity whose functional currency is the reporting currency of its parent may sponsor a defined benefit plan with benefit payments payable in the local currency. In these instances, it is also common for the plan assets to be denominated in the foreign currency.
Under ASC 715-30, a reporting entity must remeasure the funded status of its defined benefit plans annually or upon the occurrence of certain significant events (e.g., a plan amendment or curtailment). ASC 715-30 requires that the plan assets be remeasured at fair value and that the benefit obligation be remeasured at its actuarial present value. Further, ASC 715-30 requires that all changes in the funded status of a plan that occur as a result of this remeasurement process be recognized in OCI. However, ASC 715-30 does not explicitly address how an entity should consider the effects of exchange rate changes in remeasuring the funded status of a plan that is denominated in a foreign currency.
Under ASC 830, an entity that maintains its books and records in a currency
other than the functional currency must remeasure
those books and records in its functional
currency.
The funded status of a defined benefit plan
that is denominated in a foreign currency should
be remeasured in the functional currency by using
the current exchange rate. As stated above, the
plan assets must be remeasured at fair value under
ASC 715-30. In such circumstances, an entity is
required to use current exchange rates to measure
the fair value of foreign-currency-denominated
plan assets in functional-currency units. In
addition, while the benefit obligation is not
measured at fair value, it is remeasured at the
amount for which the obligation could currently be
settled. Therefore, a current exchange rate must
be used to remeasure the benefit obligation so
that the amount for which it could currently be
settled is properly reflected in an entity’s
functional currency.
However, because neither ASC 715-30 nor ASC 830 explicitly addresses how to
account for the effects of exchange rate changes
related to defined benefit plans (i.e., whether
the change should be recorded as a component of
OCI or in earnings), there are two acceptable
views on presenting the change in the funded
status of a defined benefit plan due to exchange
rate fluctuations.
View A — Recognize Currency Adjustments in OCI
Under View A, the funded status of a defined benefit plan would be considered a
nonmonetary asset or liability under ASC 830. This view is based on an analogy
to the implementation guidance in ASC 255. Specifically, the table in ASC
255-10-55-1 states that the specific assets in “[p]ension, sinking, and other
funds under an entity’s control . . . should be classified as monetary or
nonmonetary” and that, for “[a]ccrued pension obligations,” the “[f]ixed amounts
payable to a fund are monetary” and “all other amounts are nonmonetary.”
Therefore, because the funded status of a plan does not represent a “fixed
amount payable to a fund,” it should be considered a nonmonetary asset or
liability under ASC 255. However, as discussed in Section 4.3.2, other authoritative
literature (in this case, ASC 715-30) may require that a nonmonetary asset or
liability be subsequently remeasured at current exchange rates. Therefore, under
View A, because ASC 715-30 requires that the funded status of a pension plan be
remeasured at current exchange rates, changes in the carrying value should also
be presented in accordance with ASC 715-30. Under ASC 715-30-25-4, all changes
resulting from the remeasurement of the funded status of a plan are reported in
OCI (provided that the entity’s accounting policy is to amortize the resulting
gains and losses into net income over future accounting periods and not to
immediately recognize those gains and losses in net income).
View B — Recognize Currency Adjustments in Income
Under View B, the funded status of a defined benefit plan would be considered a monetary asset or liability under ASC 830 for the following reasons:
- The account will ultimately be settled in cash, through either recovery of the net pension asset or settlement of the net pension liability.
- While not authoritative for entities reporting under U.S. GAAP, paragraph 16 of IAS 21 explicitly states that “pensions and other employee benefits to be paid in cash” are monetary items. Proponents of View B believe that IAS 21 and U.S. GAAP do not substantively differ regarding how an entity determines monetary and nonmonetary accounts when applying the guidance on accounting for the effects of exchange rate changes.
In accordance with ASC 830-10-45-17, all transaction gains and losses related to remeasurement of monetary assets and liabilities that are not denominated in the functional currency must be recognized currently in earnings.
The accounting for currency adjustments related to remeasuring a foreign-currency-denominated defined benefit plan in either OCI or earnings is an accounting policy election that should be applied consistently.
4.20 AROs and Environmental Remediation Liabilities
There is diversity in practice in the determination of whether an ARO or an
environmental remediation liability is a monetary liability, a nonmonetary
liability, or outside the scope of ASC 830 altogether. There is a presumption that
such liabilities are denominated in an entity’s functional currency, unless the
entity has entered into a binding agreement denominated in a foreign currency to
settle the obligation or has a legal obligation to settle the obligation in a
foreign currency. Therefore, such obligations would be outside the scope of ASC 830.
Various views on whether an ARO is a monetary or nonmonetary liability were
discussed in the May 4, 2005, EITF Agenda Committee Report. Although the EITF Agenda
Committee ultimately decided not to add this issue to the EITF’s agenda, the above
view is consistent with View C from the report, which states, in part:
In the absence of a binding agreement or legal requirement to
settle the obligation in a specific foreign currency, the entity should assume
that the liability is denominated in its own functional currency and,
accordingly, the liability is not within the scope of Statement 52.
Although the discussion in the report was limited to AROs, the above guidance
would apply equally to environmental remediation liabilities and other contingent
liabilities when a legal requirement to settle in a specific currency is not
provided.
Chapter 5 — Foreign Currency Translations
Chapter 5 — Foreign Currency Translations
5.1 Overview
ASC 830-10
10-1 Financial statements are
intended to present information in financial terms about the
performance, financial position, and cash flows of a
reporting entity. For this purpose, the financial statements
of separate entities within a reporting entity, which may
exist and operate in different economic and currency
environments, are consolidated and presented as though they
were the financial statements of a single reporting entity.
Because it is not possible to combine, add, or subtract
measurements expressed in different currencies, it is
necessary to translate into a single reporting currency
those assets, liabilities, revenues, expenses, gains, and
losses that are measured or denominated in a foreign
currency. Paragraph 830-10-55-1 discusses the meaning of
measurement in a foreign currency.
This chapter focuses on ASC 830-30, which “provides guidance for translating foreign currency statements that are incorporated in the financial statements of a reporting entity by consolidation, combination, or the equity method of accounting.” An entity applies the translation guidance in ASC 830-30 to translate the functional-currency-denominated financial results of foreign entities into a common reporting currency when combining the results of domestic and foreign entities.
The concept of measuring foreign currency transactions under ASC 830-20 is distinct from the concept of translating financial statements under ASC 830-30. This distinction is important since the applicability of the two concepts differs, as does the treatment of the resulting gains and losses. The following diagram summarizes the difference between the two concepts:
5.2 Translation Process
ASC 830-30 defines foreign currency translation as the “process of
expressing in the reporting currency of the reporting entity those amounts that are
denominated or measured in a different currency.” The translation guidance outlined
in this chapter applies to an entity’s functional-currency-based results.
Example 5-1
Translating Financial Statements
Company B, a Polish company that has
identified the local currency (PLN) as its functional
currency, is a subsidiary of Parent Co, a U.S. parent that
uses the USD for reporting purposes. Company B has debt on
its books that is denominated in USD and EUR.
Before translating its financial statements,
B is first required to recognize transaction gains or losses
related to its foreign-currency-denominated debt. To do so,
B measures (1) the USD-denominated debt by using the
exchange rates existing as of the balance sheet date for the
PLN and the USD and (2) the EUR-denominated debt by using
the exchange rates existing as of the balance sheet date for
the PLN and the EUR. The offset to each of these entries is
recorded in earnings as a transaction gain or loss.
Next, Parent Co translates the
functional-currency (local-currency) financial statements of
B into USD. As discussed in Section 5.2.1, the
current exchange rate as of the balance sheet date is used
to translate assets and liabilities while an appropriate
rate (e.g., weighted-average exchange rate for the period)
is used to translate revenues, expenses, and other income
statement items. The translation adjustments are recorded as
a CTA, a separate component of OCI.
While not specifically addressed in ASC 810 or ASC 830, multitiered
organizations typically apply the translation process in the same sequence as the
consolidation process (on a step-by-step basis).
Example 5-2
Multilevel Consolidation
A U.S. parent wholly owns a second-tier
German subsidiary, which in turn wholly owns a third-tier
British subsidiary. The German subsidiary and British
subsidiary are separate foreign entities under ASC 830. The
local currency is the functional currency for all entities,
and the reporting currency of the consolidated entity is the
USD.
When preparing the financial statements for
the consolidation of the subsidiaries with the U.S. parent,
the entities would do the following:
-
The German subsidiary would translate the British subsidiary’s GBP-denominated financial statements (i.e., the functional-currency financial statements) into EUR-denominated financial statements. The GBP-to-EUR translation adjustment would be recorded in the CTA of the German subsidiary’s financial statements.
-
The U.S. parent would then translate the EUR-denominated, consolidated financial statements of the German subsidiary into USD. The EUR-to-USD translation adjustment would be recorded in the CTA of the U.S. parent’s financial statements.
5.2.1 Effecting a Translation
When applying the guidance in ASC 830-30 to translate functional
currency statements into a single reporting currency, an entity needs to
identify the appropriate exchange rate to use for this purpose.
In addition to applying the appropriate exchange rates, when
translating foreign currency statements of foreign entities that are
consolidated, combined, or accounted for under the equity method, an entity may
need to consider whether it needs to make additional adjustments to the
translated balances for items such as intra-entity eliminations as well as
goodwill and purchase price adjustments (i.e., basis differences), as discussed
below. Timing differences between the investee’s reporting periods and those of
the reporting entity (i.e., reporting time lags) should also be taken into
account in the determination of the exchange rate to be applied for translation,
as discussed in Section
3.3.1.
The following diagram illustrates the key factors an entity
should consider when translating foreign currency statements:
5.2.1.1 Exchange Rate
ASC 830-30
45-3 All elements of
financial statements shall be translated by using a
current exchange rate as follows:
- For assets and liabilities, the exchange rate at the balance sheet date shall be used.
- For revenues, expenses, gains, and losses, the exchange rate at the dates on which those elements are recognized shall be used.
This guidance also
applies to accounting allocations (for example,
depreciation, cost of sales, and amortization of
deferred revenues and expenses) and requires
translation at the current exchange rates applicable
to the dates those allocations are included in
revenues and expenses (that is, not the rates on the
dates the related items originated).
Under ASC 830-30, all financial statement elements must be
translated by using a current exchange rate, which ASC 830-30-45-4 defines
as “the rate as of the end of the period covered by the financial statements
or as of the dates of recognition in those statements in the case of
revenues, expenses, gains, and losses.” As noted in Section 3.2.1, for
practicality reasons, ASC 830 permits the use of weighted-average exchange
rates or other methods that provide a reasonable approximation of the rates
in effect on the date of recognition.
The following is a summary of the exchange rates used in the
translation process, as outlined in Section
3.2.1:
Further, as outlined in Section 3.2.1, while ASC 830 does not
provide specific guidance on which rate should be used to translate a
foreign entity’s equity accounts, it would be appropriate to translate
equity accounts at historical rates, except changes to retained earnings for
current-period net income.
5.2.1.1.1 Translation of Balances Reclassified From AOCI
The accounting literature is not explicit on the
exchange rate that applies to the translation of amounts reclassified
from accumulated other comprehensive income (AOCI) to earnings.
Accordingly, questions have been raised regarding whether the
translation of such balances should be based on (1) the historical
exchange rate or (2) the current average exchange rate. The following
graphic summarizes the difference between the two approaches:
For pension and other postretirement-related balances
originally recognized in OCI and reclassified from AOCI to net periodic
benefit cost in subsequent periods, both of these approaches are
considered acceptable in practice. The selection of either approach
would be viewed as an accounting policy election.
Under the historical exchange rate approach, AOCI is
viewed as akin to retained earnings. Accordingly, since amounts
accumulated in retained earnings are not translated at a current rate
under ASC 830 (i.e., retained earnings do not fluctuate as a result of
subsequent changes in exchange rates), the amounts reclassified from
AOCI to net periodic benefit cost should not be retranslated. Similarly,
since the amounts in AOCI have been previously recognized in
comprehensive income,1 the reclassification from AOCI to earnings should not be viewed as
a new recognition event from a translation perspective. Therefore, the
amounts initially recognized in OCI and translated at the rate in effect
at that time would reflect the balance subject to reclassification from
AOCI to net periodic benefit cost.
Under the current average exchange rate approach, the
reclassification of amounts in AOCI is viewed as akin to newly
recognized earnings. Accordingly, the rate in effect at the time of
reclassification, which will often be an average rate for the period as
the pension and other postretirement amounts are released over time,
would be used to determine the amount that is reclassified from AOCI to
net periodic benefit cost. This treatment would be consistent with the
ASC 830 approach for the initial recognition of income statement
items.
While the historical exchange rate approach may be viewed as the more supportable of the two approaches, the current average exchange rate approach is considered acceptable in practice as an alternative for pension and other postretirement-related balances. Initially, the objective of permitting the use of the current average exchange rate approach for applicable pension and other postretirement amounts was to allow for consistency with the approach used before the adoption of FASB Statement 158 (codified in ASC 715), since the
amendments were not intended to change the measurement of the applicable
pension and other postretirement balances.2 Before FASB Statement 158, unrecognized prior service
costs/credits, net gains or losses, and translation obligations/assets
remained off-balance-sheet and were translated at the average exchange
rates for the period when these amounts were recognized in net periodic
benefit cost.
For other balances deferred in AOCI (e.g., AFS
investments, amounts related to certain hedging instruments), ASC 830
similarly does not address the exchange rate applicable to translation
of amounts reclassified from AOCI to earnings. In such cases, while it
may be more supportable under ASC 830 to use the historical exchange
rate approach than it is to use the current average exchange rate
approach, an entity may elect either approach as an accounting
policy.
5.2.1.2 Intra-Entity Transactions
ASC 830-30
45-10 The elimination of
intra-entity profits that are attributable to sales
or other transfers between entities that are
consolidated, combined, or accounted for by the
equity method in the reporting entity’s financial
statements shall be based on the exchange rates at
the dates of the sales or transfers. The use of
reasonable approximations or averages is
permitted.
In a manner consistent with the accounting for
consolidations, combinations, and the equity method of accounting,
intra-entity profits are generally eliminated. For transactions that are
eliminated, ASC 830-30-45-10 prescribes the use of the sale or transfer date
exchange rate, or approximation thereof, which is consistent with the
exchange rate applicable to income statement items (as discussed in
Section
5.2.1.1). This requirement results in the application of an
exchange rate to items subject to elimination that is consistent with the
rate applicable to items that are not eliminated.
However, intra-entity foreign-currency-denominated
transactions may not be eliminated in all cases, as discussed in Chapter 6.
Accordingly, such transactions would result in earnings volatility, in the
absence of qualifying as a long-term investment, since the transaction would
be remeasured to the functional currency through earnings while the
translation to the reporting currency would be deferred through OCI.
Example 5-3
Exchange Gain or Loss Related to Intra-Entity
Loan
A U.S. parent, Company X, has a
wholly owned subsidiary, Company Y, in the United
Kingdom. Company X’s functional currency is the USD,
and Y’s is the GBP. Company X has provided a loan in
USD to Y. The loan is not considered part of X’s net
investment in Y.
No transaction gain or loss is
recorded in the separate financial statements of the
U.S. parent because the loan receivable is
denominated in X’s functional currency. In the
subsidiary’s separate financial statements, the loan
payable is a monetary item and the transaction gain
or loss related to remeasurement in Y’s functional
currency of the GBP is recognized in earnings in
accordance with ASC 830-20.
Upon consolidation, although the
intra-entity loan is eliminated from the statement
of financial position, the related transaction gain
or loss recognized in Y’s separate financial
statements for the USD loan payable survives the
consolidation process; thus, the gain or loss is
also recognized in consolidated earnings.
Further, in certain situations, the use of differing
translation rates may result in residual intra-entity receivables and
payables, as discussed in Section 6.2.1.
5.2.1.3 Goodwill and Purchase Price Adjustments
ASC 830-30
45-11 After a business
combination, the amount assigned at the acquisition
date to the assets acquired and the liabilities
assumed (including goodwill or the gain recognized
for a bargain purchase in accordance with Subtopic
805-30) shall be translated in conformity with the
requirements of this Subtopic.
ASC 830-30-45-3 and ASC 830-30-45-11 require that an entity
translate all elements of its financial statements, including goodwill and
other basis differences. Therefore, in the determination of the currency
translation adjustment in the acquirer’s consolidated financial statements,
the individual assets (including goodwill) of an acquired foreign entity
whose functional currency differs from its parent’s reporting currency must
be translated on the basis of the amounts recognized by the acquirer under
ASC 805-10, ASC 805-20, and ASC 805-30, even if that foreign entity elects
not to apply pushdown accounting in its separate financial statements.
An entity can either record the amounts in the foreign
entity’s books (i.e., actual pushdown accounting) or maintain the records
necessary to adjust the consolidated amounts to what they would have been
had the amounts been recorded in the foreign entity’s books and records
(i.e., notional pushdown accounting).
Example 5-4
Foreign Currency Translation for an Acquired
Foreign Entity
Company A acquires Company B in a
business combination. Company B is in a foreign
jurisdiction, and B’s functional currency, the USD,
differs from A’s reporting currency, the EUR. Assume
that the carrying value of all of B’s assets and
liabilities equals their fair values except for an
intangible asset that was unrecognized in B’s books
but will be recognized in A’s consolidated financial
statements at its fair value of €1,000. Company A
also recognizes goodwill of €150 from the
acquisition of B in its consolidated financial
statements. Company A has determined that B is a
foreign entity. Company B has elected not to apply
pushdown accounting in its separate financial
statements. Therefore, B’s assets are recognized at
A’s consolidated level by using A’s basis in the
assets, even though A’s basis was not pushed down to
B’s separate financial statements.
As of the acquisition date, the
intangible asset of €1,000 was the equivalent of
$1,200 and the goodwill of €150 was the equivalent
of $180 in B’s functional currency (exchange rate of
$1.20 to €1). Although B did not elect pushdown
accounting, when A translates B’s assets and
liabilities from B’s functional currency to A’s
reporting currency, A will translate B’s assets and
liabilities into A’s reporting currency by using A’s
basis in B’s assets and liabilities (i.e.,
stepped-up values) rather than the carrying values
of B’s assets and liabilities in B’s separate
financial statements. At the end of the reporting
period, the carrying values of the intangible asset
and goodwill in B’s functional currency are $1,080
($1,200 less amortization of $120) and $180 and the
exchange rate is $1.25 to €1. Therefore, in its
consolidated financial statements, A recognizes B’s
intangible asset of €864 ($1,080 ÷ 1.25) and
goodwill of €144 ($180 ÷ 1.25). Because B did not
elect pushdown accounting, separate accounting
records will need to be maintained to adjust A’s
consolidated amounts to what they would have been
had the amounts been recorded in B’s separate
financial statements (i.e., notional pushdown
accounting).
The preceding is a simplified example in which a single
foreign entity is acquired. In a multinational acquisition that includes
multiple foreign and domestic entities, the application of ASC 830 may be
complex depending on whether the acquirer needs to determine the amount of
goodwill for each foreign and domestic entity acquired. An entity may need
to use judgment in making such determinations.
In the measurement of a goodwill impairment charge,
a reporting unit’s carrying amount should only include the currently
translated assets and liabilities and would not contain any allocated CTA
from an entity’s AOCI. However, some or all of the CTA should be included in
the carrying amount of an investment in a foreign entity when that
investment is tested for impairment if the entity has committed to a plan to
dispose of that investment (see further discussion in Section 5.5.1). Investment impairment
testing differs from goodwill impairment testing; therefore, the CTA
generally would not meet the criteria for inclusion in a reporting unit in
accordance with ASC 350-20-35-39.
5.2.2 Equity Method Investments
ASC
830-10
15-5 The functional currency
approach applies equally to translation of financial
statements of foreign investees whether accounted for by
the equity method or consolidated. Therefore, the
foreign currency statements and the foreign currency
transactions of an investee that are accounted for by
the equity method shall be translated in conformity with
the requirements of this Topic in applying the equity
method.
In a manner consistent with ASC 830-10-15-5 above, ASC 323
requires that an investee’s income accounted for under the equity method be
determined as if the investee were a consolidated subsidiary. Accordingly, after
the adjustments to the foreign investee’s financial results, as outlined in ASC
323-10-35-5, the reporting entity should recognize and adjust its equity
investment carrying amount for its share of the foreign investee’s translated
net income and OCI (including its share of the CTA). The recognition date
exchange rates, as discussed in Section 5.2.1, would be used to translate
an investor’s share of the net income of a foreign currency equity method
investee into the investor’s reporting currency (or a weighted-average exchange
rate if appropriate). The historical rate would be applied to the existing
investment balances.
Example 5-5
Translation of an Equity Method Investment
On January 1, 20X1, Company A, a U.S.
entity whose functional currency is USD, acquires a 40
percent equity interest in Company B for €4 million.
Company B is located in Germany, and its functional
currency is the EUR.
Assume the following facts:
-
Company A accounts for its investment in B as an equity method investment.
-
Company A has determined that B is a foreign entity.
-
Company B is in its first year of operations and generated net income of €1 million during 20X1.
-
Company A did not recognize goodwill or other purchase price adjustments in relation to B, since B is a newly formed entity and the fair value of B was equal to the carrying amount at the time of acquisition by A.
-
The following exchange rates were in effect during the period:
-
Spot rate on January 1, 20X1: €1 = $1.1.
-
Spot rate on December 31, 20X1: €1 = $1.3.
-
Weighted-average exchange rate during 20X1: €1 = $1.25.
-
-
Company B’s statement of financial position on December 31, 20X1, denominated in euros and translated to U.S. dollars, is shown below.
Company A would record the following
journal entries during 20X1, all denominated in USD:
The preceding is a simplified example illustrating an equity
method investment in a newly formed, single foreign entity. If, at the time of
acquisition, A had recognized goodwill or other fair value adjustments, such
basis differences would be viewed as denominated in the foreign entity’s (B’s)
functional currency. Thus, such amounts would be subject to translation and
would affect the equity method investment balance the investor recognizes for
the foreign entity.
In applying the equity method, an investor may have to perform a
purchase price allocation when the purchase price for its share of the
investee’s net assets differs from the carrying amount in the investee’s
separate financial statements. If the investee’s functional currency differs
from that of the investor, this process could be complex, especially when there
may be multiple assets and liabilities for which there is a basis difference
between the carrying amount and the fair value of the asset or liability as of
the investment’s acquisition date. In such situations, one approach that an
investor uses in practice is to recast the investee‘s books to reflect the
investor‘s basis in the assets based on its purchase price, provided that the
investee is 100 percent owned. The example below illustrates this scenario.
Example 5-6
Translation of an Equity Method Investment With a
Different Basis
Assume the following:
- Investor C, which is based in the United States, invests $495 million to have a 25 percent interest in Investee D, an entity that operates a commercial real estate asset in Ireland, at the beginning of 20X1.
- Investor C’s functional and reporting currency is the USD.
- Investee D’s functional currency is the EUR.
- Investee D’s net book value as of the investment date is €1,500 million, and its only asset is a shopping mall; D has no liabilities.
- The shopping mall has no salvage value and a remaining depreciable life of 20 years.
- Investee D’s net income from the shopping mall’s operations at the end of 20X1 is €40 million, which includes €75 million of the depreciation expense related to the shopping mall.
- The exchange rate on the date C made the investment is $1.1 = €1.
- The end-of-year exchange rate for 20X1 is $1.2 = €1.
- The weighted-average exchange rate for 20X1 is $1.15 = €1.
Investor C has a €75 million ($82.5
million) basis difference as of the acquisition date,
which consists of the difference between C’s cost of
acquisition ($495 million ÷ 1.1 EUR to USD = €450
million) and C’s share of D’s net book value (€1,500
million × 25% = €375 million). As discussed in Section
5.2.1.3, the basis difference would be
viewed as denominated in the foreign investee’s (D’s)
functional currency. Thus, such amounts would be subject
to translation and would affect the equity method
investment balance the investor recognizes for the
foreign entity.
Investor C has determined that the basis
difference is attributable to the depreciable asset (the
shopping mall) and that, accordingly, the basis
difference should be depreciated over its remaining
useful life (20 years).
To recast D’s financial statements, C
first computes D’s overall net book value as of the date
of the investment on the basis of the cost paid by C.
That amount is €1,800 million, computed as the €450
million investment multiplied by 4. (For tracking
purposes and ignoring any control premium, if a 25
percent investment is worth €450 million, a 100 percent
investment is worth four times that amount.) Investor C
would then allocate the €1,800 million to D’s assets and
liabilities in a manner consistent with a business
combination. In this example, D’s only asset is the
shopping mall. Depreciation on the €1,800 million
shopping mall is computed as €90 million per year
(€1,800 million divided by 20 years; zero salvage
value). That is, if C owned 100 percent of D, the
“deemed depreciation expense” would be €15 million
higher than what the investee would present in its
separate financial statements.
The following table depicts the
translation of D’s financial information from EUR to
USD:
When an investor tracks the investment
in an equity method by using the total recast investee
values, in determining the amounts that would need to be
recognized in its financial statements, the investor has
to adjust the balances by its share of the investee’s net assets to properly
reflect the carrying amount.
Investor C can compute its share of D’s
net income from operations by using the weighted-average
exchange rate for the period as follows:
Similarly, in determining the amount of
the change in CTA for the period that is related to its
equity method investment, C will recognize its share of
the recast CTA as follows:
Investor C can compute the ending
carrying amount of its equity method investment by
translating its share (25
percent) of the recast net book value at the end-of-year
exchange rate as follows:
The following table shows the financial
statement impact (in millions) of the adjustments
described above on C’s financial statements:
Footnotes
1
The glossary in ASC 220-10 indicates that the
term “comprehensive income” encompasses all components of net
income as well as all components of OCI and that OCI refers to
“revenues, expenses, gains, and losses that [under GAAP] are
included in comprehensive income but excluded from net
income.”
2
Upon adopting FASB Statement 158 (codified in
ASC 715), companies and their subsidiaries (domestic and
foreign) were required to recognize the funded status of their
defined benefit plans. Accordingly, previously unrecognized
amounts (including gains or losses, prior service costs or
credits, and transition assets or obligations) were recorded,
net of tax, as a component of AOCI. However, FASB Statement
158’s recognition provisions did not change how net periodic
benefit cost is measured or recognized in an entity’s financial
statements.
After adoption of FASB Statement 158, ASC
715-30-35 and ASC 715-60-35 required that prior service costs or
credits, and gains or losses, respectively, that arise during
the period, and that are not immediately recognized as a
component of net periodic benefit cost, be recognized as a
component of OCI. Such amounts will ultimately be reclassified
to net periodic benefit cost in subsequent periods. Accordingly,
upon consolidation, parent companies with foreign subsidiaries
that sponsor defined benefit plans will need to consider the
impact of ASC 830 on the amounts recorded in, and reclassified
from, AOCI.
5.3 Accounting for Exchange Differences Arising Upon Translation
ASC 830-30
45-12 If an entity’s functional currency is a foreign currency, translation adjustments result from the process of translating that entity’s financial statements into the reporting currency. Translation adjustments shall not be included in determining net income but shall be reported in other comprehensive income.
After performing the translation process, an entity records the resulting translation adjustments within the CTA, a separate component of OCI. The translation adjustment is initially deferred through OCI, since it is akin to an unrealized gain or loss that would only be realized under certain circumstances, as discussed in Section 5.4.
If it is assumed that no equity transactions occurred during the year, the CTA would equal the sum of (1) beginning net assets multiplied by the difference between the end-of-year foreign currency exchange rate and the beginning-of-year foreign currency exchange rate and (2) net profit/loss for the year multiplied by the difference between the end-of-year foreign currency exchange rate and the average foreign currency exchange rate (used to translate the income statement).
The following is a simplified example illustrating a CTA. If, for example, there were dividends issued, a recognized impairment, or other one-time transactions, an entity would need to consider the impact of these transactions in calculating the rollforward of net assets for the period.
Example 5-7
Calculation of CTA
Assume the same balance sheet
as in Example 5-5.
Further assume the following facts for Company A:
-
Beginning net assets: €10,000.
-
20X1 net income: €1,000.
-
January 1, 20X1, rate: €1 = $1.10.
-
December 31, 20X1, rate: €1 = $1.30.
-
Weighted-average exchange rate during 20X1: €1 = $1.25.
As of December 31, 20X1, A
reports a CTA of $2,050 in AOCI. The CTA
calculation consists of two components: (1)
beginning net assets multiplied by the difference
between the end-of-year rate and the
beginning-of-year rate [€10,000 × (1.30 – 1.10)]
and (2) 20X1 net income multiplied by the
difference between the end-of-year rate and the
weighted-average exchange rate [€1,000 × (1.30 –
1.25)].
5.3.1 Allocation of CTA to Noncontrolling Interest
ASC 830-30
45-17 Accumulated translation adjustments attributable to noncontrolling interests shall be allocated to and reported as part of the noncontrolling interest in the consolidated reporting entity.
In determining whether a CTA can be attributed to NCI holders, the reporting entity should note that the CTA exists at the consolidated level as a result of differences between the subsidiary’s functional currency and the reporting currency. Accordingly, the CTA is directly related to the parent entity’s reporting currency and may not reflect the reporting currency of the NCI holders.
In light of these factors, in a manner consistent with the guidance in ASC
830-30-45-17 and the attribution guidance in ASC
810-10, a CTA should nonetheless be attributed to
the partially owned subsidiary’s NCI that gives
rise to the adjustment. That is, the objective of
NCI is to give investors of the consolidated
entity visibility into how their claim on the net
assets of a partially owned subsidiary changes
from period to period.
Accordingly, it would be misleading to allocate to the controlling interest 100
percent of a CTA associated with a foreign,
non-wholly-owned subsidiary that reflects the
impact of changing currency rates on the
subsidiary’s total net assets. Thus, it would be
appropriate to allocate a proportionate amount of
the CTA to NCI. For additional discussion, see
Deloitte’s Roadmap Noncontrolling
Interests.
Example 5-8
Allocation of CTA to NCI
Parent Co is a multinational
financial services company with global operations
whose functional currency is the USD. Parent Co
holds a controlling interest of 60 percent in
Company ABC. The remaining 40 percent is held by a
third party and represents an NCI.
Company ABC, which is located
and operates in Germany, uses the EUR as its
functional currency. Parent has determined that
ABC is a foreign entity. There are no agreements
in place that would govern allocations of ABC’s
income, loss, or OCI between Parent Co and the NCI
in a manner that differs from their proportionate
ownership interests.
At the end of 20X1, the
translation of ABC’s assets, liabilities, and
operations from the EUR to the USD results in a
CTA of $100 million. Of the $100 million, $40
million is allocated to the NCI in Parent Co’s
consolidated financial statements.
5.4 Release of CTA
ASC 830-30 includes guidance on the circumstances under which a CTA
may be released, such as scenarios involving (1) full and substantially complete
liquidations and (2) partial sales and liquidations. To apply the guidance in ASC
830-30, an entity needs to identify whether the sale or liquidation is related to an
investment in a foreign entity or an investment within a foreign
entity as well as whether the investment is consolidated or accounted for under the
equity method. An investment in a foreign entity is typically reflected via a
direct ownership interest in the foreign entity. By contrast, an investment
within a foreign entity reflects the net assets or ownership of the
foreign entity and is indirect.
Example 5-9
Distinguishing Between an Investment in and an Investment
Within a Foreign Entity
Company A owns 80 percent of the equity
interest in Company B, a foreign entity that owns various
real estate properties.
Company A has an 80 percent investment
in B, whose real estate properties represent an
investment within B. Upon a disposition of B’s real
estate properties, while there would be a change in the
investment within B from A’s perspective, the
investment in B (i.e., the 80 percent ownership
interest) would remain unchanged. Conversely, if A sold its
direct equity interest in B, there would be a change to the
investment in B.
The table below provides an overview of these distinctions and the
related impact on the treatment of a CTA. The transactions will be discussed further
below in the sections indicated in the table.
Transaction | Change | Treatment
of CTA | Section |
---|---|---|---|
When the foreign
entity is consolidated or combined: | |||
Sale of
an investment in a foreign
entity | Loss of
control. | CTA is
released. | |
Sale of
part of an investment in a foreign
entity | Ownership
is reduced but control is maintained. | CTA is
not released. Allocation of CTA to NCI may change and is accounted for in accordance with ASC
810-10-45-23 and 45-24. | |
Sale of
an investment within a foreign
entity | Reduction
of the foreign entity’s net assets. | CTA is
not released unless the sale results in a complete or
substantially complete liquidation. | |
When the foreign
entity is accounted for as an equity method
investment: | |||
Additional investment in a foreign entity, which
qualifies as a step acquisition (see ASC 805-10-25-9 and
25-10). | Control
is obtained. | CTA is
released. | |
Sale of
an equity method investment in a
foreign entity | Ownership
is reduced and significant influence is
maintained. | CTA is
released on a pro rata basis. | |
Sale of
an investment, or part of an investment, in a foreign entity | Ownership
is reduced and significant influence is lost. | For those equity instruments that must be measured at fair value, the release of
CTA would flow through earnings. | |
Sale of an investment within a foreign entity | Reduction
of the foreign entity’s net assets. | CTA is
not released unless the sale results in a complete or
substantially complete liquidation. |
5.4.1 Sales and Liquidations of Investments in a Foreign Entity
ASC
830-30
40-1 Upon sale or upon complete
or substantially complete liquidation of an investment
in a foreign entity, the amount attributable to that
entity and accumulated in the translation adjustment
component of equity shall be both:
- Removed from the separate component of equity
- Reported as part of the gain or loss on sale or liquidation of the investment for the period during which the sale or liquidation occurs.
40-1A A sale shall include:
- The loss of a controlling financial interest in an investment in a foreign entity resulting from circumstances contemplated by Subtopic 810-10 (see paragraph 810-10-55-4A for related implementation guidance)
- An acquirer obtaining control of an acquiree in which it held an equity interest, accounted for as an equity method investment that is a foreign entity, immediately before the acquisition date in a business combination achieved in stages (see paragraphs 805-10-25-9 through 25-10).
5.4.1.1 Loss of Control of an Investment in a Foreign Entity
A loss of control of an investment in a foreign entity would
trigger a deconsolidation in accordance with ASC 810-10. In a manner
consistent with ASC 830-30-40-1A, such a deconsolidation would be treated as
a sale of the investment in the foreign entity and a release of the CTA
would be required irrespective of whether an NCI is retained.
Example 5-10
Sale of a Wholly Owned Investment in a Foreign
Entity in Which the Parent Ceases to Have a
Controlling Financial Interest
Company Z, a parent company, has
held a 100 percent ownership interest in Company X
for a number of years. Company X is a foreign
entity, and a $4 million CTA related to X has been
recognized in OCI and accumulated.
On December 31, 20X1, Z sells a 60
percent ownership interest in X. As a result of the
sale, Z’s ownership interest is reduced to 40
percent and Z ceases to have a controlling financial
interest in X. Company Z accounts for its remaining
40 percent ownership interest in X under the equity
method, since it has retained significant influence
over X.
When an entity loses control of a
subsidiary that includes an investment in a foreign
entity, such a loss of control is accounted for as a
“sale” under ASC 830-30 irrespective of whether the
entity retains an interest in the former subsidiary.
Consequently, the CTA related to X, previously
recognized in OCI and accumulated in equity, is
fully reclassified from equity to gain or loss at
the time of deconsolidation.
Example 5-11
Sale of a Partially Owned Investment in a Foreign
Entity in Which the Parent Ceases to Have a
Controlling Financial Interest
Company Z, a parent company, has
held an 80 percent ownership interest in Company X
for a number of years. Company X is a foreign
entity, and a $4 million CTA related to X has been
recognized in OCI. Of this balance, $3.2 million was
attributed to the controlling interest and $0.8
million was attributed to the NCI holders.
On December 31, 20X1, Z sells a 40
percent ownership interest in X. As a result of the
sale, Z’s ownership interest is reduced to 40
percent and Z ceases to have a controlling financial
interest in X. Company Z accounts for its remaining
40 percent ownership interest in X under the equity
method, since it has retained significant influence
over X.
As illustrated in Example
5-10, regardless of Z’s continuing
influence over X, all of the CTA associated with X
must be released from AOCI. Therefore, in accordance
with ASC 830-30-40-1A, the CTA associated with Z’s
ownership of X ($3.2 million) is reclassified from
equity to gain or loss. The CTA attributable to the
NCI holders ($0.8 million) would already have been
reflected as part of the NCI in the consolidated
financial statements and would therefore be included
in the gain or loss calculation on disposal of X (in
accordance with ASC 810-10-40).
5.4.1.2 Gain of Control of an Investment in a Foreign Entity
Under ASC 830-30-40-1A(b), a CTA is released when an
acquirer obtains “control of an acquiree in which it held an equity
interest, accounted for as an equity method investment that is a foreign
entity, immediately before the acquisition date in a business combination
achieved in stages.” ASC 805-10-25-10 also discusses this concept, stating
in part:
If the business combination achieved in stages
relates to a previously held equity method investment that is a
foreign entity, the amount of accumulated other comprehensive income
that is reclassified and included in the calculation of gain or loss
shall include any foreign currency translation adjustment related to
that previously held investment. For guidance on derecognizing
foreign currency translation adjustments recorded in accumulated
other comprehensive income, see Section 830-30-40.
Therefore, a business combination achieved in stages is
viewed as the equivalent of a disposition of the equity method investment in
a foreign entity and the acquisition of a controlling financial interest in
a foreign entity. By contrast, a release of an existing CTA would not be
permitted for acquisitions that increase the ownership interest of (1) an
already consolidated foreign entity or (2) a foreign-entity equity method
investee in the absence of a change of control.
Example 5-12
Obtaining a Controlling Financial Interest in a
Foreign Entity Through a Step Acquisition
Company A, a U.S. company, holds a
45 percent ownership interest in B, a foreign
entity, which it accounts for under the equity
method. After its initial investment, A acquires an
additional 40 percent ownership interest — and
therefore obtains a controlling financial interest —
in B. As of the acquisition date, A’s CTA recorded
in AOCI for its investment in B is $100,000.
Upon obtaining a controlling
financial interest in B, A should release 100
percent of the CTA balance into earnings. The
accounting for obtaining the controlling interest is
based on a view that the transaction reflects two
separate and distinct events: (1) the disposition of
A’s equity method investment and (2) A’s acquisition
of a controlling financial interest. When a
reporting entity disposes of a foreign entity, it
must reclassify any related CTA in earnings, as
contemplated in ASC 830-30. In this example, A
“disposed of” its equity method investment in B; all
of the related CTA therefore would be released into
earnings.
5.4.1.3 Partial Sale of an Investment in a Foreign Entity
ASC 830-30
40-2 If a reporting entity
sells part of its ownership interest in an equity
method investment that is a foreign entity, a pro
rata portion of the accumulated translation
adjustment component of equity attributable to that
equity method investment shall be recognized in
measuring the gain or loss on the sale. If the sale
of part of an equity method investment that is a
foreign entity results in the loss of significant
influence, see paragraphs 323-10-35-37 through 35-39
for guidance on how to account for the pro rata
portion of the accumulated translation adjustment
component of equity attributable to the remaining
investment. For guidance if an entity sells a
noncontrolling interest in a consolidated foreign
entity, but still retains a controlling financial
interest in the foreign entity, see paragraph
810-10-45-23 through 45-24.
For the sale of an NCI in a foreign entity that is combined
or consolidated and for which the parent does not lose control as a result
of the partial sale, the change in ownership interest should be accounted
for in accordance with ASC 810-10-45-23 and 45-24. Accordingly, an
acquisition or sale of any NCI should be accounted for as an equity
transaction, with any difference in price paid, and the carrying amount of
the NCI reflected, directly in equity and not in net income as a gain or
loss. (For more information, see Deloitte’s Roadmap Noncontrolling
Interests.) Further, the CTA should be reallocated
between controlling interest and NCI to reflect the revised ownership
interest.
Example 5-13
Sale of an Equity Method Investment in a Foreign
Entity in Which Significant Influence Is
Retained
Company I has held a 40 percent
interest in an equity method investee, Company B,
for a number of years. Company B is a foreign
entity, and a $1 million CTA related to B has been
recognized in OCI.
Company I disposes of 25 percent of
its interest in B but retains significant influence
through its remaining holding. Under ASC
830-30-40-2, when an investor disposes of part of
its interest in an equity method investee that is a
foreign entity but retains significant influence
over that investee, the investor must reclassify to
earnings the pro rata share of the CTA deferred in
AOCI.
Consequently, in this example, 25
percent of the CTA (i.e., $250,000) must be
reclassified from CTA to earnings on the transaction
date.
Example 5-14
Partial Sale of an Investment in a Foreign Entity
in Which the Parent Retains a Controlling
Financial Interest
Company P, a parent company, has
held a 100 percent interest in a subsidiary, Company
S, for a number of years. Company S is a foreign
entity, and a $2.5 million CTA related to S has been
recognized in OCI. Company P sells 20 percent of its
ownership interest in S but retains control over S.
Under ASC 810-10-45-24, when a
parent disposes of part of its interest in a
subsidiary that is a foreign entity but retains
control of that subsidiary, “the carrying amount of
[the CTA must] be adjusted to reflect the change in
ownership interest . . . through a corresponding
charge or credit to equity attributable to the
parent”; in such cases, the CTA would not be
released into earnings.
Consequently, in this example, 20
percent of the CTA (i.e., $500,000) is transferred
within equity from CTA to the NCI on the transaction
date. No amounts are reclassified to earnings.
Example 5-15
Impact of a Change in Functional Currency on
Release of CTA
Parent Co is a U.S. entity that has
investments in various foreign entities. Each
foreign entity has determined that its local
currency is its appropriate functional currency,
while Parent Co’s functional currency is the USD.
If, during the year, the functional
currency of one of the foreign subsidiaries changes,
a release of the CTA into earnings would not be
triggered. A change in functional currency does not
trigger a release of the CTA into earnings
regardless of whether the change is to the reporting
currency or another foreign currency. As noted in
ASC 830-30-40-1, only the sale, or complete or
substantially complete liquidation, of a foreign
subsidiary would trigger a release of the portion of
the CTA attributable to that subsidiary into
earnings (as part of the gain or loss on sale or
liquidation of the investment in the subsidiary).
See Section 2.4 for
additional discussion of the accounting for a change
in functional currency.
5.4.1.3.1 Treatment of CTA Associated With Retained Interest When Significant Influence Is Lost
For partial sales of an investment in a foreign entity
that is accounted for as an equity method investment, when an investor
retains an interest in, but loses significant influence over, the
foreign entity, the CTA should be released on a pro rata basis into
earnings and the CTA remaining after this release should be recorded as
an adjustment to the carrying value of the remaining interest. If the
investor loses significant influence, the equity method investment will
generally be measured at cost and subsequently at fair value, with
changes in fair value recognized in net income. An exception to this
requirement is that ASC 321 permits entities to measure certain
qualifying equity securities without a readily determinable fair value
at cost minus impairment, adjusted for changes in qualifying observable
prices. Accordingly, upon a loss of significant influence, the impact on
net income for instruments that must be subsequently measured at fair
value would effectively be the same as it would be if the entire amount
of CTA was recognized through earnings.
Example 5-16
Sale of an Equity Method Investment in a
Foreign Entity (Loss of Significant
Influence)
Company K has held a 40 percent
interest in an equity method investee, Company A,
a foreign entity, for a number of years. On
September 15, 20X9, the equity method investment
in A has a book value of $1 million, and a
$100,000 CTA related to A has been recognized in
OCI.
On September 15, 20X9, K
disposes of 75 percent of its interest in A for
$900,000. Company K has determined that it no
longer has significant influence over A and will
account for it under ASC 321 as an equity
instrument measured at fair value.
On the date of the sale, $75,000
($100,000 × 75%) will be released through earnings
and the remaining CTA of $25,000 should be
recorded as an adjustment to the carrying value of
the remaining interest, resulting in a carrying
value of $275,000 [($1,000,000 × 25%) + $25,000].
The fair value of the retained
investment is $300,000; therefore, K would
subsequently recognize a $25,000 gain ($300,000 –
$275,000) in earnings in accordance with ASC 321.
5.4.2 Sales and Liquidations of Investments Within Foreign Entities
ASC
830-30
40-3 Although partial
liquidations by a parent of net assets held within a
foreign entity may be considered similar to a sale of
part of an ownership interest in the foreign entity if
the liquidation proceeds are distributed to the parent,
extending pro rata recognition (release of the
cumulative translation adjustment into net income) to
such partial liquidations would require that their
substance be distinguished from ordinary dividends. Such
a distinction is neither possible nor desirable. For
those partial liquidations, no cumulative translation
adjustment is released into net income until the
criteria in paragraph 830-30-40-1 are met.
When a parent liquidates net assets within a foreign entity, the
appropriate accounting depends on whether the derecognition results in a
complete or substantially complete liquidation of the foreign entity. To qualify
as a substantially complete liquidation, generally 90 percent or more of the net
assets of a foreign entity should be liquidated. Further, the term “liquidate”
implies that proceeds received have been transferred out of the liquidated
foreign entity. However, there may be instances in which the proceeds have not
been transferred out (e.g., they are legally retained by the subsidiary as cash
in the bank account of the liquidated subsidiary). In those circumstances, the
subsidiary could be deemed to become an extension of the parent and a
substantially complete liquidation may still occur. Furthermore, if an entity’s
sale of substantially all the net assets of one foreign entity is followed by a
reinvestment in the same type of business and in the same location, the
transaction would not qualify as a liquidation.
If the transaction results in a complete or substantially
complete liquidation of a foreign entity, 100 percent of the CTA should be
released into earnings even if certain assets are retained. If the transaction
does not result in a complete or substantially complete liquidation of a foreign
entity, no adjustments to the CTA should be recorded. The examples below
illustrate the application of this guidance.
Example 5-17
Sale of a Second-Tier Subsidiary
Company A, a U.S. entity, has a wholly
owned subsidiary, B, that is located in the United
Kingdom. In turn, B has a wholly owned subsidiary, C,
that is located in the same country. Subsidiaries B and
C are considered to be a single foreign entity in
accordance with ASC 830. On December 1, 20X1, C is sold
to Company D, an unrelated third party, and the proceeds
from the sale are remitted to A.
The CTA balance related to A’s
investment in C should not be released into earnings
unless the sale represents a substantially complete
liquidation of the foreign entity that C had previously
been part of. Therefore, if C represents 90 percent or
more of the total net assets of the entire foreign
entity, it would be appropriate to release the CTA
related to the foreign entity into earnings.
Example 5-18
Sale of an Asset Group Within a Foreign Entity
Company A has a wholly owned subsidiary,
B, that is located in the United Kingdom and is
considered a foreign entity under ASC 830. On December
1, 20X1, B sells an asset group that represents 95
percent of B’s total net assets. The proceeds received
from the sale of the asset group are retained and
reinvested in B.
In this scenario, although the asset
group disposed of constitutes over 90 percent of the net
assets of B, no CTA should be released into earnings
because the proceeds were reinvested in the foreign
entity. Therefore, B’s assets were merely
recharacterized as a result of the disposition and the
transaction would not be considered a substantially
complete liquidation. Further, while the asset group
sold by B may represent a business as defined in the
Codification, this is irrelevant (i.e., business versus
asset) to the determination of whether a CTA should be
released to earnings upon the sale. Rather, as noted
above, the determining factor is whether the transaction
results in a sale or a complete or substantially
complete liquidation of the foreign entity.
Example 5-19
Annual Dividends Equal to Foreign Subsidiary’s Net
Income
Company A has a wholly owned subsidiary,
B, that is a foreign entity under ASC 830. Company B
makes a dividend payment to A that is equal to B’s net
income on an annual basis.
The payment of an annual dividend that
is equal to the foreign subsidiary’s net income does not
qualify as a sale or a complete or substantially
complete liquidation of the foreign entity in accordance
with ASC 830-30-40-1. Therefore, the payment does not
trigger a release of the CTA to earnings.
Conversely, if B had paid a dividend
that resulted in its complete or substantially complete
liquidation, the reclassification of the CTA to earnings
would be appropriate.
Example 5-20
Determining Whether Reduction of a Long-Term Advance
Triggers Recognition of a CTA in Earnings
A U.S. company, A, has an investment in
a wholly owned U.K. subsidiary, B, to which it has made
certain intercompany advances. The intercompany advances
are denominated in GBP, the functional currency of B,
and are considered a long-term investment under ASC
830-20-35-3(b). Company A, therefore, has not recognized
transaction gains or losses related to the intercompany
advances for the differences in the exchange rate
between the USD and GBP; instead, A has recorded these
differences in the same manner as translation
adjustments (i.e., as a CTA).
For reasons that were previously not
planned or anticipated, B wishes to reduce the amount of
the long-term advances; however, A is not completely or
substantially liquidating its investment in B.
A reduction in the long-term advance
will not affect the CTA already recorded by A. The CTA
balance should not be released into earnings until A’s
investment in B is sold or substantially or completely
liquidated.
If the remaining advance continues to be
long-term (i.e., only the amount of the intercompany
advance has changed), A would continue to recognize
exchange rate gains or losses associated with that
investment in CTA for the portion of the advance that is
considered long-term. If, after modification, the
long-term advance no longer meets the requirements in
ASC 830-20-35-3(b) for a long-term investment, future
exchange rate gains or losses related to the advance
will be recognized in earnings along with any other
transaction gains or losses associated with any of A’s
foreign-currency-denominated receivables or
payables.
For additional information on qualifying
and accounting for a long-term investment, see Section
6.4.
Example 5-21
Changing the Form of a Long-Term Investment in a
Foreign Subsidiary
Company O, a U.S. company, has a
Canadian subsidiary to which it has made advances that
are denominated in CAD. Company O has previously
asserted that the advances are intended to be a
long-term investment; therefore, in accordance with ASC
830-20-35-3, exchange rate gains and losses related to
the advances have been recorded in the same manner as
translation adjustments. There have been no previous
repayments of the advances.
Because the value of the CAD has
decreased against the USD, the value of the advances has
also declined. To receive a tax deduction in the United
States for the decrease, the advances would need to be
repaid. Accordingly, O proposes to make a capital (cash)
contribution to its Canadian subsidiary that the
subsidiary can use to repay the advances.
In the proposed transaction, O would not
release the CTA that pertains to the advances into
earnings. In the proposed transaction, O essentially is
replacing one form of long-term investment with another
form of investment. In accordance with ASC 830-30-40-1, the translation adjustment attributable to the long-term intercompany advances should remain a component of CTA until the Canadian subsidiary is sold or is completely or substantially liquidated. The settlement of intercompany transactions for which settlement was previously not planned or anticipated was addressed by the FASB 52 Implementation Group at its December 21,
1981, meeting. The group stated:
If a transaction is settled for
which settlement was not planned or anticipated,
the amount included in the special component of
equity (applicable to the period for which
settlement was not planned or anticipated)
probably should remain there.
Further, the FASB staff has agreed with
the conclusion that the translation adjustment included
in equity should remain there until the foreign entity
is sold or is completely or substantially
liquidated.
For additional information on qualifying
and accounting for a long-term investment, see Section
6.4.
5.4.3 Common-Control Transactions
While neither ASC 805 nor ASC 830 specifically addresses how to
consider CTAs in the context of a common-control transaction, the release of
CTAs through earnings related to such a transaction would generally be
inconsistent with the principles of ASC 805-50-30-5.
The principles of ASC 805 imply that to release a CTA into
earnings on a consolidated basis, the requirements of ASC 830-30 need to be met
from the consolidated perspective of each reporting entity. Accordingly, the
common-control principles may have a greater effect on multinational
corporations that contain multiple reporting entities; in such cases, an entity
may be required to track CTAs by originating foreign entity.
Additional complexity may arise when a common-control
transaction, such as a restructuring or spin-off, results in a change in the
functional currency of the foreign entity. When the functional currency changes,
an entity would consider the guidance in ASC 830-10-45-10. In such cases, a
freeze of the CTA would be required and its release would not be triggered (see
Section 2.4.2
for additional discussion), potentially resulting in a scenario in which a
frozen CTA is recognized on a consolidated basis for a now domestic currency
entity. Accordingly, it is important to track the CTA and the foreign entity
that originated it.
Example 5-22
Effect of Restructuring on CTA
Parent Co conducts its European
operations through a U.S. legal entity. The European
operations are segregated as a separate division (the
“Division”) that is accounted for as a separate foreign
entity under ASC 830. Parent Co’s functional currency is
the USD, and the Division’s functional currency is the
EUR. Parent Co has recognized a CTA balance of $3
million related to the Division in its consolidated
financial statements as of December 31, 20X1.
Subsequently, Parent Co restructure its
operations. As a result, the Division’s operations will
be sold from the U.S. legal entity to a newly created
and wholly owned Swiss legal entity. This new Swiss
legal entity will continue the Division’s
operations.
In this example, since the new wholly
owned Swiss legal entity continues the same operations,
the reorganization is a change in legal organization but
not a change in the consolidated entity (i.e., the
entity is still owned and operated by Parent Co).
Therefore, the CTA balance associated with the Division
would not be released into earnings, since Parent Co has
neither sold nor completely or substantially liquidated
its investment in the Division.
5.4.4 Timing of Gain and Loss Recognition
ASC
830-30
40-4 Under Subtopic 220-20, a
gain or loss on disposal of part or all of a net
investment may be recognized in a period other than that
in which actual sale or liquidation occurs. Paragraph
830-30-40-1 does not alter the period in which a gain or
loss on sale or liquidation is recognized under existing
generally accepted accounting principles (GAAP).
An entity determines the timing of the CTA release in accordance
with the guidance in ASC 830-30. However, the timing for the CTA release does
not affect when gains or losses related to a sale or liquidation are recognized
in accordance with other GAAP, nor does it affect when impairment losses are
recognized, as discussed in Section 5.5.
Example 5-23
Discontinued Foreign Entities — Timing of Recognition
of Foreign Currency Translation Adjustments in Net
Income
Company A has plans to sell its foreign
subsidiary that represents a foreign entity. On December
31, 20X1, A’s investment in the foreign subsidiary is
appropriately classified as HFS and reported as a
discontinued operation in accordance with ASC 205-20.
The disposal of the foreign subsidiary is expected to
occur in 20X2. On December 31, 20X1, there is an
accumulated CTA balance of $1 million related to the
foreign subsidiary.
While the subsidiary is classified as
HFS and reported as a discontinued operation, since the
foreign subsidiary has neither been sold nor completely
or substantially liquidated as of December 31, 20X1, it
is not appropriate to reclassify any related CTA to
earnings until such a sale or liquidation occurs in
accordance with ASC 830-30-40-1.
However, A should consider the guidance
in ASC 830-30-45-13 through 45-15 when analyzing its
investment in the foreign subsidiary for potential
impairment. See Section 5.5 for
further discussion.
5.5 Impairment Considerations Related to CTA
5.5.1 Impairment and CTA
ASC 830-30
45-13 An entity that has committed to a plan that will cause the cumulative translation adjustment for an equity method investment or a consolidated investment in a foreign entity to be reclassified to earnings shall include the cumulative translation adjustment as part of the carrying amount of the investment when evaluating that investment for impairment. The scope of this guidance includes an investment in a foreign entity that is either consolidated by the reporting entity or accounted for by the reporting entity using the equity method. This guidance does not address either of the following:
- Whether the cumulative translation adjustment shall be included in the carrying amount of the investment when assessing impairment for an investment in a foreign entity when the reporting entity does not plan to dispose of the investment (that is, the investment or related consolidated assets are held for use)
- Planned transactions involving foreign investments that, when consummated, will not cause a reclassification of some amount of the cumulative translation adjustment.
45-14 In both cases,
paragraph 830-30-40-1 is clear that no basis exists to
include the cumulative translation adjustment in an
impairment assessment if that assessment does not
contemplate a planned sale or liquidation that will
cause reclassification of some amount of the cumulative
translation adjustment. (If the reclassification will be
a partial amount of the cumulative translation
adjustment, this guidance contemplates only the
cumulative translation adjustment amount subject to
reclassification pursuant to paragraphs 830-30-40-2
through 40-4.)
45-15 An entity shall include the portion of the cumulative translation adjustment that represents a gain or loss from an effective hedge of the net investment in a foreign operation as part of the carrying amount of the investment when evaluating that investment for impairment.
In accordance with the guidance above, a reporting entity would not consider a
CTA balance in an impairment assessment unless it has a clear plan to sell or
liquidate the investment in a manner that would trigger the CTA release into
earnings, as outlined in Section 5.4. In the absence of such a plan, the realization of
the CTA would not be expected and the entity would therefore have no basis for
including the CTA balance when assessing the impairment loss. Further, while the
above guidance may indicate that the CTA balance should be included in the
measurement of the impairment loss in certain situations, such amounts recorded
in CTA would not be released into earnings until the conditions noted in
Section 5.4 have been met.
Connecting the Dots
When the CTA associated with a foreign entity is included in the measurement of an impairment loss and is in a cumulative loss position (i.e., cumulative debit CTA), questions have arisen regarding whether the loss that is recognized on the impairment should be limited to the carrying amount of the investment (i.e., excluding amounts in AOCI) given that the CTA cannot be reclassified to earnings until the sale or substantial or complete liquidation of the foreign entity.
Two approaches have been accepted in practice by analogy to a speech by Adam Brown, a professional accounting
fellow, at the 2008 AICPA Conference on SEC and PCAOB Developments. By
analogy to Mr. Brown’s speech, the use of either of the following two
approaches may be considered in a scenario in which a loss in excess of
an asset’s carrying amount is expected: (1) recognize an impairment loss
in excess of the carrying value of the disposal group, thereby
establishing a valuation allowance until the CTA may be released into
earnings, or (2) limit the impairment loss to the carrying value of the
disposal group. The selected approach should be applied consistently as
an accounting policy election to all similar transactions.
Example 5-24
Treatment of OCI in Impairment Test for the Disposal
of a Foreign Entity
Company P, the parent company, has a
wholly owned subsidiary, Company S, that is a foreign
entity. Company P has unrealized CTA gains of
approximately $90 million that are reported in AOCI in
relation to S and carries its investment in S at $386
million.
Company P has initiated a plan to sell
its investment in S for $261 million. While the
transaction is expected to close in January 20X2, P has
determined that its investment in S meets all of the
criteria in ASC 360-10-45-9 through 45-11 for
classification as HFS and for the results of its
operations to be reported as a discontinued operation in
P’s consolidated financial statements as of December 31,
20X1.
In this example, P would include the
unrealized CTA gain in the carrying amount of its
investment in S when evaluating S for impairment in
accordance with ASC 360-10-35-38 through 35-49; however,
the balance recorded in CTA would not be released into
earnings until the sale occurs and the conditions under
ASC 830-30 are met. The following calculations
illustrate the impairment loss assessment and subsequent
accounting effects of this example in accordance with
ASC 830-30-45-13:
5.5.2 Abandonment and CTA
In the context of a plan to abandon a foreign entity, the principles of ASC 830-30 continue to apply to the determination of whether the criteria allowing for the inclusion of the CTA in the impairment assessment are met. Accordingly, it is necessary to consider what is being abandoned in the context of the foreign entity as well as what the abandonment would entail, which would further affect the timing of the CTA release, as noted in Section 5.4.
Example 5-25
Accounting for Currency Translation Adjustments in
Abandonment of an Investment in a Foreign
Entity
Company A has a wholly owned foreign
subsidiary that is a foreign entity, Company X. In
connection with its investment in X, A has unrealized
translation gains and losses within CTA in its
consolidated financial statements. In the fourth quarter
of 20X1, A states its intent to abandon its investment
in X as soon as practicable in 20X2 and has a plan in
place to have all of X’s facilities and offices closed
by March 1, 20X2. Concurrently with this decision, A
records an impairment loss for its investment in X in
accordance with ASC 360.
In this scenario, the CTA balance should
not be released from AOCI into earnings until X’s
facilities and offices have been closed (i.e., on March
1, 20X2) and, in essence, abandoned. ASC 360-10-35-47
states, in part, that a “long-lived asset to be
abandoned is disposed of when it ceases to be used.”
Before this time, it would not be appropriate to
recognize the release of CTA associated with the
abandoned investment, in accordance with ASC
830-30-40-1, which states that CTA is released into
earnings “[u]pon sale or upon complete or substantially
complete liquidation of an investment in a foreign
entity.” The abandonment of X is akin to a sale or
liquidation of X, since X would cease to exist as an
operating subsidiary of A and would no longer provide
future benefits to A after the abandonment.
The CTA should be included in the
carrying amount of A’s investment in the foreign
subsidiary in the evaluation of that investment for
impairment under ASC 830-30-45-13.
Chapter 6 — Intra-Entity Transactions
Chapter 6 — Intra-Entity Transactions
6.1 Overview
Intra-entity foreign currency transactions can have unique effects on an entity’s financial statements, including the (1) creation and transfer of foreign currency risk from one entity in a consolidated group to another, (2) creation of transaction gains and losses that “survive” consolidation, and (3) application of exceptions to the general rules outlined in ASC 830. This chapter discusses the accounting effects of intra-entity transactions.
6.2 Intra-Entity Transactions Arising in the Normal Course of Business
ASC 830-20
35-1 A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally shall be included in determining net income for the period in which the exchange rate changes.
35-2 At each balance sheet
date, recorded balances that are denominated in a
currency other than the functional currency of the
recording entity shall be adjusted to reflect the
current exchange rate. At a subsequent balance
sheet date, the current rate is that rate at which
the related receivable or payable could be settled
at that date. Paragraphs 830-20-30-2 through 30-3
provide more information about exchange rates.
Entities often regularly transact with other entities (e.g., the parent entity
or other subsidiaries) within their consolidated group (e.g.,
through the sale or purchase of inventory). When the entities that
are party to such transactions have different functional currencies,
transaction gains and losses may result, just as they do when
similar transactions are entered into with outside parties (see
Chapter
4). Under ASC 830-20-35-1 and 35-2, transaction
gains and losses associated with transactions that are denominated
in a currency other than the entity’s functional currency should be
included in earnings unless they meet any of the criteria in ASC
830-20-35-3, one of which is discussed in more detail in Section
6.4. Although the related intra-entity payable or
receivable will be eliminated upon consolidation, the transaction
gain or loss “survives” consolidation because it results in (or will
result in) actual changes to the entity’s cash flows.
For example, in the preparation of the foreign entity’s functional-currency financial results, intra-entity transactions between a parent entity and a foreign entity that are denominated in the parent’s functional currency are subject to the measurement guidance in ASC 830-20; as a result, a transaction gain or loss may be recognized in the foreign entity’s earnings. However, upon consolidation, the foreign entity’s financial results would be subject to ASC 830-30 and translated, with the resulting translation adjustment reflected in the consolidated entity’s CTA. In such situations, the transaction gain or loss recognized by the foreign entity would not be eliminated upon consolidation. This would also be the case when an intra-entity transaction is denominated in the foreign entity’s functional currency, resulting in the recognition by the parent (instead of the foreign entity investee) of a transaction gain or loss that would not be eliminated upon consolidation.
Example 6-1
Foreign-Currency-Denominated Intra-Entity
Payables Arising in the Normal Course of
Business
Company J, an entity whose
functional currency is the USD, has a wholly owned
Mexican subsidiary, M. Management of M previously
determined that the MXN is its functional
currency, primarily because M’s sales to third
parties, as well as its labor costs, are
denominated in this currency. Purchases of raw
materials from J are denominated in USD, and the
related intra-entity payables to J are therefore
denominated in USD as well.
In the absence of
contemporaneous evidence to the contrary, payables
arising through the ordinary course of business
are expected to be settled in the foreseeable
future. Therefore, such balances should be
accounted for in the same manner as similar
transactions with outside parties (as discussed in
Example 4-2).
Upon consolidation, the
intra-entity payable (on M’s books) and receivable
(on J’s books) would be eliminated. However, any
exchange rate fluctuations that result in
transaction gains and losses on M’s books in
connection with the USD-denominated payables would
not be eliminated but would “survive”
consolidation and be reflected in earnings.
However, if M negotiates a
long-term advance with its parent, J, for which
repayment is neither planned nor anticipated in
the foreseeable future, gains or losses resulting
from future foreign currency fluctuations may be
accounted for prospectively from the date of the
negotiated advance or note payable in a manner
similar to translation adjustments. See Section
6.4 for a discussion related to
intra-entity accounts that are long-term in
nature.
6.2.1 Unsettled Intra-Entity Transactions When Multiple Exchange Rates Exist
ASC 830-30
45-7 If unsettled intra-entity transactions are subject to and translated using preference or penalty rates, translation of foreign currency statements at the rate applicable to dividend remittances may cause a difference between intra-entity receivables and payables. Until that difference is eliminated by settlement of the intra-entity transaction, the difference shall be treated as a receivable or payable in the reporting entity’s financial statements.
Generally, a foreign entity’s financial statements should be translated by using the exchange rate that applies to dividend remittances (see Chapter 3). However, there may be different preference or penalty rates that apply to unsettled intercompany transactions. Differences between the dividend remittance rate and the preference or penalty rate could result in a receivable or payable (that survives consolidation) until the intra-entity balance is ultimately settled (and the differences are therefore eliminated).
6.3 Intra-Entity Profit
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.
As noted in the guidance above, intra-entity profits resulting from “sales or other transfers between entities that are consolidated, combined, or accounted for by the equity method” should be translated by using the exchange rate on the transaction date (or another appropriate alternative). For example, in the case of an intra-entity sale of inventory, any profit recognized by the selling entity would also be included in the inventory balance on the books of the purchasing entity and should be eliminated in consolidation until the inventory is sold to an outside party. Subsequent exchange rate fluctuations should not affect the intra-entity profit being eliminated.
Accordingly, an entity should track the portion of the inventory balance attributable to the intra-entity profit that originated on the transaction date and the portion attributable to the underlying cost of the inventory (i.e., the selling entity’s cost basis). As noted above, the portion attributable to the intra-entity profit should be translated at the historical rate in effect on the date of the intra-entity sale. The portion attributable to the underlying cost component should be translated at the current exchange rate.
Example 6-2
Intra-Entity Profit Elimination
Company B, a U.S. company, has a wholly
owned foreign subsidiary, W, which has identified the EUR as
its functional currency. On September 18, 20X1, B sells
inventory to W for $500,000 (the inventory costs $350,000).
As a result of the sale, B realizes intercompany profit of
$150,000 ($500,000 – $350,000). The exchange rate on the
date of the sale was $1 = €1.30. Subsidiary W records the
inventory at €650,000 ($500,000 × [€1.30 ÷ $1]). As of
September 30, 20X1, the inventory has not yet been sold and
the exchange rate is $1 = €1.40.
The €650,000 inventory balance recorded by W
as of September 30, 20X1, consists of the following:
-
Intra-entity profit: €195,000 ($150,000 × [€1.30 ÷ $1]).
-
Cost of the inventory: €455,000 ($350,000 × [€1.30 ÷ $1]).
The intra-entity profit of €195,000 is
translated at the historical rate in effect on September 18,
20X1, the date of the intra-entity sale (i.e., €1.30 ÷ $1).
As a result, the intra-entity profit would be $150,000,
which equals the intercompany profit amount recognized by B,
the U.S. parent. These two balances are then fully
eliminated in consolidation until the sale is realized
outside of the consolidated group.
The cost of the inventory, €455,000, is
translated at the current exchange rate as of September 30,
20X1. Accordingly, an inventory amount of $325,000 (€455,000
÷ [€1.40 ÷ $1]) is recognized on B’s consolidated balance
sheet.
Therefore, as of September 30, 20X1, B will
recognize a CTA loss of $25,000 ($350,000 – $325,000)
associated with the inventory on hand held by W.
Connecting the Dots
The application of the requirements from ASC 830 that are illustrated in the above example may be unduly burdensome for some entities. ASC 830 therefore provides an expedient under which an entity uses an appropriate rate that is expected to yield a result similar to that achieved by using the exchange rate on each date of recognition (see Section 3.2 for information about selecting exchange rates).
6.4 Long-Term Intra-Entity Transactions
ASC 830-20
35-3 Gains and losses on the
following foreign currency transactions shall not be
included in determining net income but shall be reported in
the same manner as translation adjustments: . . .
b. Intra-entity foreign currency transactions that
are of a long-term-investment nature (that is,
settlement is not planned or anticipated in the
foreseeable future), when the entities to the
transaction are consolidated, combined, or accounted
for by the equity method in the reporting entity’s
financial statements.
35-4 Intra-entity transactions and
balances for which settlement is not planned or anticipated
in the foreseeable future are considered to be part of the
net investment. This might include balances that take the
form of an advance or a demand note payable provided that
payment is not planned or anticipated in the foreseeable
future.
A consolidated entity should pay particular attention to long-term
intra-entity transactions, since the facts and circumstances associated with such
transactions may result in an accounting treatment for the consolidated entity that
is inconsistent with the general principles in ASC 830.
6.4.1 Meaning of “Foreseeable Future”
ASC 830-20-35-3(b) contains an exception that allows entities to
recognize exchange rate gains or losses as a CTA within OCI for intra-entity
transactions that are “of a long-term investment nature” (i.e., the settlement
of such transactions “is not planned or anticipated in the foreseeable future”).
Whether repayment is planned is a key factor in applying this exception.
The FASB 52 Implementation Group discussed this issue at its
December 1981 meeting, concluding that the term “foreseeable future” does not
imply a specific period but is an intent-based indicator. Specifically, the
group noted that an intra-entity transaction may qualify for the ASC
830-20-35-3(b) exception if:
-
There are no planned or anticipated repayments.1
-
Management, having the appropriate authority, represents that (1) it does not intend to require repayment of an intra-entity account and (2) the parent company’s management views the intra-entity account as part of its investment in the foreign subsidiary.
If the criteria for the exception are met, the exchange rate
gains and losses are recorded through the CTA as if they were part of the net
investment.
Example 6-3
Short-Term Intra-Entity Debt
Company C is a wholly owned U.S.
subsidiary (whose functional currency is the USD) of
Company D, a Swiss-based holding company. Company C has
notes due to D that are denominated in EUR. The notes
have stated maturities ranging from six months to one
year. Although the notes are short-term by contract, D
represents each year that it will not demand payment for
that year; historically, the notes have been renewed
each year.
In this case, the short-term notes would
not qualify for the exception in ASC 830-20-35-3(b).
Company D only represents that it will not require
payment in the current year on the rolled-over
short-term notes; it does not represent that it will not
demand payment on the notes in the foreseeable future
(i.e., the timing of the repayment appears uncertain).
In other words, because D (the parent)
cannot assert that repayment will not be required in the
anticipated or foreseeable future, it is inappropriate
for D to apply the exception in ASC 830-20-35-3(b). Further, the FASB 52 Implementation Group concluded that
rolling- or minimum-balance intra-entity accounts do not
qualify for this exception (see Example
6-5).
As demonstrated in the example above, uncertainty regarding the
timing of a repayment is not a criterion under which a transaction can be
considered long-term in nature. For an entity to apply the exception in ASC
830-20-35-3(b), there must not be a planned or anticipated repayment in the
foreseeable future. Conversely, an intra-entity loan or advance may have a
stated maturity or be due on demand, but if the lending entity does not intend
to demand repayment despite the maturity date (i.e., management has stated its
intentions to renew the loan or advance), it may be acceptable to apply the
exception. The appropriate accounting in such cases will depend on management’s
specific, stated intentions. In the example below, an intra-entity loan may seem
to be long-term in nature given management’s intentions but does not, in fact,
qualify for the exception.
Example 6-4
Determining Whether Linked Transactions Can Be
Accounted for as Long-Term in Nature
Company A, which uses its local currency
(EUR) as its functional currency, is a subsidiary of a
U.S. parent company, P. Bank B has loaned A $100 million
USD that is due in 20X4. Company A currently makes
interest-only payments. The debt with B is
collateralized in full with a letter of credit from P.
Company A will most likely not be able to make its
balloon payment (and possibly not its interest payments)
under the existing agreement and will not be able to
obtain alternative financing. Therefore, B is expected
to convert the letter of credit in full payment of the
debt as soon as A defaults. After default, P will have
the third-party B debt and a USD-denominated
intra-entity receivable from A. Company A will have a
USD-denominated intra-entity payable to P.
In accordance with ASC 830-20-35-3(b),
it is not acceptable for A to currently account for its
debt to B as an intra-entity foreign currency
transaction that is “of a long-term-investment nature”
even though there is a high probability of default and
conversion to an intra-entity payable is expected.
Company P’s settlement of A’s debt with
B is anticipated in the near future with the creation of
a new debt instrument also from P (its obligation under
the letter of credit), and A will have an intra-entity
payable to P. The settlement of A’s existing debt with
B, the borrowing under the letter of credit, and the
intra-entity transaction are not seen as one continuous
transaction under ASC 830. Therefore, A’s debt to B does
not currently meet the criteria to be reported in the
same manner as a translation adjustment.
Because A currently makes
USD-denominated interest payments to B, its functional
currency cash flows are affected by changes in the
foreign currency exchange rate. Changes in the foreign
currency exchange rate affect A’s actual and expected
functional currency cash flows. Therefore, the exchange
rate gains and losses on such borrowings should continue
to be accounted for as transaction gains and losses to
be included in the determination of net income.
Management should also consider factors other than its intent in
determining whether a transaction qualifies as long-term in nature. For
instance, management should consider its history with similar instruments for
which the intention was not to repay. If the entity, despite management’s
intention, has historically been unable to maintain the long-term nature of
similar instruments (e.g., repayments were necessary as a result of cash flow
constraints), the entity may conclude that the instrument does not meet the
“foreseeable future” criterion and that it cannot apply the exception. Other
factors for an entity to consider in determining whether it qualifies for the
exception are (1) its ability to control whether and, if so, when repayment will
occur (e.g., if repayment is contingent on the occurrence of a certain event or
transaction) and (2) whether there is a legitimate business purpose for not
settling the intra-entity account. Further, when applying this exception,
management should ensure that its intentions related to long-term intra-entity
accounts are consistent with assertions being made for other purposes (e.g.,
indefinite reinvestment assertions for income tax purposes).
Connecting the Dots
The amounts subject to these long-term intra-entity
transactions are often large enough that board approval is needed. An
entity should therefore ensure that management personnel with the
appropriate level of authority have approved the fact that the loans
will not be repaid in the foreseeable future.
In addition, management should look for contradictory
evidence regarding the assertion that the loans will not be repaid in
the foreseeable future. For example, often these loans are created to
generate an interest expense deduction in a high-tax-rate jurisdiction.
Many tax jurisdictions require that an entity repay the loan at some
point in time to receive the tax deduction.2 Accordingly, management will need to determine whether the
assertion made for tax purposes (i.e., the intention to receive the
deduction) contradicts the assertion made for financial reporting
purposes (i.e., the settlement of such a transaction “is not planned or
anticipated in the foreseeable future”). If the two assertions are
contradictory, management will need to evaluate whether the deferral of
foreign currency transaction gains and losses is appropriate or whether
an uncertain tax position should be established for the interest
deduction. See Deloitte’s Roadmap Income Taxes for additional
information on the tax accounting impacts of these types of
transactions.
The long-term-nature exception discussed above applies only to
the consolidated entity’s financial statements. If an individual entity in the
intra-entity transaction (e.g., a subsidiary) compiles stand-alone financial
statements, the general rules in ASC 830 would apply and the transaction gains
and losses associated with such accounts would be recorded in earnings.
Similarly, if an ultimate parent entity enters into an intra-entity advance or
loan with a third-tier subsidiary that is consolidated into an intermediary
subsidiary, the accounting for the transaction in the intermediary’s
stand-alone, consolidated financial statements would not qualify for the
exception because the transaction is between the intermediary’s subsidiary and
an entity outside its stand-alone, consolidated group (i.e., its ultimate
parent). The image below illustrates this concept.
Accounts that are not determined to be long-term in nature (and
are therefore subject to the same accounting treatment as similar accounts with
third parties) will expose the entity to foreign currency exchange rate
fluctuations since the effects of such fluctuations are reported in
earnings.
6.4.2 Intra-Entity Debt With Interest Payments
If an intra-entity debt instrument is determined to be long-term
in nature in accordance with the guidance discussed above, any related interest
receivable or payable would not qualify for the same exception as the debt
instrument itself when periodic interest payments are required. Rather, any
transaction gains or losses related to the interest receivable or payable would
be recorded in earnings (and would not be reclassified into a CTA upon
consolidation). Such gains and losses would survive consolidation in a manner
consistent with those that occur in the normal course of business (as discussed
in Section 6.2).
6.4.3 Rolling or Minimum Balances
Many parent entities will maintain a minimum balance when
managing intra-entity receivable or payable accounts. Management often views
this minimum balance as a component in its financing of the subsidiary; however,
rolling-balance and minimum-balance intra-entity accounts generally do not
qualify for the exception for long-term investments under ASC 830.
Example 6-5
Rolling or Minimum Balances Viewed as Long-Term
Investments
Company A, whose functional currency is
the USD, advances EUR to its foreign subsidiary, AB,
which has identified the EUR as its functional currency.
Subsidiary AB may repay some of the advances; generally,
however, they are replaced with new advances within a
short time frame (i.e., three to five days). In total,
AB has 50 million EUR advances outstanding at all
times.
The advances from A to AB do not qualify
as a long-term investment under ASC 830-20-35-3(b).
Company A should therefore recognize transaction gains
or losses related to such advances in earnings.
The FASB 52 Implementation Group addressed a similar question at
its December 1981 meeting, concluding that the “aggregate balance of trade
receivables or payables (each open invoice will be settled) cannot qualify as a
long-term investment.” The group further concluded that intra-entity
transactions must be evaluated individually, not on an aggregate or net basis
(i.e., even if all intra-entity balances are aggregated in one general ledger
account, an entity must consider the transactions individually to determine
which ones qualify as long-term in nature).
6.4.4 Parent’s Guarantee of a Foreign Subsidiary’s Debt
Like the linked transaction in Example 6-4, a parent company’s guarantee
of a subsidiary’s debt (either through contribution of equity or intra-entity
lending) does not qualify for the long-term investment exception in ASC
830-20-35-3(b). Consider the following example:
Example 6-6
Parent’s Guarantee of Foreign Subsidiary’s
Debt
Company AA, a U.S. company, has a
Mexican subsidiary, BB, whose functional currency is the
MXN. Subsidiary BB borrows USD from a U.S. bank, and AA
guarantees repayment of the loan. Company AA could have
provided an intra-entity loan to BB but decided not to
do so for tax reasons. For tax reasons, BB, rather than
AA, makes the interest payments. Subsidiary BB is not
expected to repay the loan in the foreseeable
future.
At its May 1982 meeting, the FASB 52 Implementation Group
concluded that a parent company’s guarantee of a subsidiary’s
foreign-currency-denominated debt does not meet the definition of a long-term
investment. Therefore, in the example above, the Mexican subsidiary must
recognize the transaction gains or losses in earnings for the USD-denominated
debt.
6.4.4.1 Settling Foreign-Currency-Denominated Debt and Making a Long-Term Investment
In a manner consistent with the transactions described
above, settlements of third-party debt through an intra-entity borrowing
also should be accounted for as separate transactions as they occur.
Therefore, any foreign currency adjustment associated with settlement of the
debt should be recorded as a transaction gain or loss in the period in which
the exchange rate changes, regardless of the nature of the intra-entity
borrowing. However, if the intra-entity foreign currency transaction is
determined to be of a long-term investment nature for which settlement is
not planned or anticipated in the foreseeable future, future foreign
currency adjustments associated with such an intra-entity loan may be
accounted for as a translation adjustment in accordance with ASC
830-20-35-3(b).
Example 6-7
Parent’s Settlement of Foreign Subsidiary’s Debt
Through Intra-Entity Borrowing
Company M is a subsidiary of Company
K. Company M’s functional currency is MXN, and K’s
functional currency is the USD. Company M has
third-party USD-denominated debt on its books for
which it must recognize transaction gains and losses
for the changes in the USD-to-MXN exchange rate.
Company K agrees to repay M’s
foreign-currency-denominated (i.e., USD-denominated)
debt, and M will record an intercompany
MXN-denominated payable to K.
In these circumstances, it would not
be appropriate for M to record the foreign currency
adjustment associated with settlement of the
USD-denominated debt as a translation adjustment
instead of as a foreign currency transaction gain or
loss. Rather, the intercompany borrowing and
settlement of third-party debt should be accounted
for separately. Therefore, any foreign currency
adjustment associated with settlement of the
USD-denominated debt should be recorded as a
transaction gain or loss in the period in which the
exchange rate changes. However, if K and M enter
into an intercompany foreign currency transaction
that is of a long-term investment nature for which
settlement is not planned or anticipated in the
foreseeable future, future foreign currency
adjustments associated with such an intercompany
loan may be accounted for as a translation
adjustment under ASC 830-20-35-3(b).
6.4.5 Settlements or Reductions of a Long-Term Advance
In certain circumstances, an entity may conclude that an
intra-entity balance (or part of an intra-entity balance) that was previously
(and appropriately) determined to be long-term in nature no longer qualifies as
such.3 In such cases, the entity should, going forward, report transaction gains
and losses in earnings; the exchange rate gains and losses previously reported
in CTA should not be reversed or otherwise adjusted until “sale or upon complete
or substantially complete liquidation of [the] investment in a foreign entity”
in accordance with ASC 830-30-40-1. See Section 5.4 for additional discussion of
the conditions for release of the gains and losses in CTA.
If only a portion of long-term advances is settled or reduced
and the remaining intercompany advances continue to qualify as a long-term
investment, the entity would continue to recognize in its CTA the exchange rate
gains or losses arising from the portion of the advances that is still
considered long-term. Example
5-20 demonstrates the appropriate accounting treatment in these
circumstances.
The forgiveness of an intra-entity balance is consistent with
the assertion that the amount was not intended to be settled. In such
circumstances, exchange rate gains and losses up through the date on which the
loan is legally forgiven or extinguished should continue to be recorded in CTA.
Once forgiven, the balance of the loan should be reclassified as a capital
contribution and no further exchange rate gains or losses should be
recognized.
Footnotes
1
An intra-entity transaction may qualify for the ASC 830-20-35-3(b) exception when a repayment is made, as long as the repayment was not planned or anticipated. The minutes of the December 1981 FASB 52 Implementation Group
meeting state, in part, “If a transaction is settled for
which settlement was not planned or anticipated, the amount
included in the special component of equity (applicable to
the period for which settlement was not planned or
anticipated) probably should remain there.”
2
On October 13, 2016, the U.S. Treasury and the
IRS released final and temporary regulations under Section 385
of the Internal Revenue Code that (1) “establish threshold
documentation requirements that must be satisfied in order for
certain related-party interests in a corporation to be treated
as indebtedness for [U.S.] federal income tax purposes” and (2)
“treat as stock certain related-party interests that otherwise
would be treated as indebtedness for [U.S.] federal income tax
purposes.” The regulations contain requirements related to
documenting certain related-party debt instruments as a
prerequisite to treating such instruments as debt. The rules
generally require written documentation of the following four
indebtedness factors: (1) the issuer’s unconditional obligation
to pay a certain sum; (2) the holder’s rights as a creditor; (3)
the issuer’s ability to repay the obligation; and (4) the
issuer’s and holder’s actions demonstrating a debtor-creditor
relationship, such as payments of interest or principal and
actions taken on default. For more information on the
regulations, see Deloitte’s October 14, 2016, United States Tax Alert.
3
For example, the United Kingdom’s decision to exit the
European Union (known as “Brexit”) may result in entities reassessing
their previously appropriate conclusions that certain intercompany
balances with entities within the United Kingdom or the European Union
are long-term in nature.
6.5 Intra-Entity Dividends
When a foreign subsidiary declares a dividend to its parent company and there is
a significant time lag between the record date and the payment date, the parent
would recognize transaction gains or losses related to the dividend receivable in
earnings as it would for other transaction gains or losses related to
foreign-currency-denominated assets or liabilities.4 If the U.S. parent’s functional currency is the USD, a receivable denominated
in a currency other than the dollar is a foreign currency transaction.
Similarly, a foreign subsidiary’s declaration of a dividend, which is not paid on the date of declaration, results in a payable. If the payable is not denominated in the subsidiary’s functional currency, the subsidiary is at risk for fluctuations in the foreign currency exchange rate between the declaration date and the date the exchange rate is fixed for the purpose of paying the dividend.
See Section 4.6.2 for additional guidance on the foreign exchange effects of declared dividends that are denominated in a foreign currency.
Footnotes
4
The FASB 52 Implementation Group addressed this issue in
December 1981.
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 should 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.
On May 21, 2019, the IPTF issued a discussion document, Monitoring Inflation in Certain Countries, which 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
Note that 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 CTA |
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,2 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 CTA |
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 in CTA. | 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 CTA.
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
2
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.
Chapter 8 — Income Taxes
Chapter 8 — Income Taxes
8.1 Overview
ASC 740 provides guidance on accounting for income taxes and applies to all entities (both domestic and foreign) within a reporting entity. The two primary objectives of ASC 740 are to (1) “recognize the amount of taxes payable or refundable for the current year” and (2) “recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.”
With respect to the second objective, a difference between the tax basis of an
asset or a liability and its reported amount in the statement of financial position
(i.e., its book basis), referred to as a temporary difference, will generally result
in the recognition of either a DTA or a DTL. DTAs are recorded for temporary
differences and carryforwards that will result in a decrease to taxes payable in
future years (sometimes referred to as tax benefits). DTLs, on the other hand, are
recorded for temporary differences that will result in an increase to taxes payable
in future years. There are income tax implications associated with foreign currency
transactions and the translation of foreign entities’ financial statements. For
additional guidance on these implications, see Chapter
9 of Deloitte’s Roadmap Income Taxes.
Chapter 9 — Presentation and Disclosure
Chapter 9 — Presentation and Disclosure
9.1 Overview
This chapter summarizes the foreign-currency-related presentation and disclosure requirements for reporting entities, including those in ASC 830 and those that affect SEC registrants.
9.2 Transaction Gains and Losses
ASC 830-20
Income Statement Presentation
Aggregate Transaction Gain or Loss
45-1 The aggregate
transaction gain or loss included in determining
net income for the period shall be presented in
the financial statements or disclosed in the notes
thereto (see paragraph 830-20-50-1).
45-2 Certain entities, primarily banks, are dealers in foreign exchange. Although certain gains or losses from dealer transactions may fit the definition of transaction gains or losses in this Subtopic, they may be disclosed as dealer gains or losses rather than as transaction gains or losses.
Aggregate Transaction Gain or Loss
50-1 If not presented in the
financial statements as discussed in paragraph
830-20-45-1, the aggregate transaction gain or
loss included in determining net income for the
period shall be disclosed in notes to financial
statements.
The disclosure required by ASC 830-20-45-1 should include amounts that (1) may
have been appropriately classified within other
line items (e.g., sales and cost of sales) and,
(2) in the case of highly inflationary economies,
result from remeasurement from the local currency
into the reporting currency (see Section
9.2.3 for further discussion of highly
inflationary economies).
Although ASC 830 is silent on the presentation of transaction gains and losses,
the following are two acceptable alternatives for
presenting such gains and losses in the income
statement:
-
Classify transaction gains and losses related to operational activities (e.g., receivables, payables) in income from operations as a separate line item, and classify transaction gains and losses related to debt in other income and expense.
-
Classify the aggregate transaction gain or loss as a separate line item in either income from operations or other income and expense.
The manner in which transaction gains and losses are presented should be disclosed and applied consistently to all periods presented. In providing such disclosures, an entity should consider its specific facts and circumstances as well as what types of information might be most useful to investors. Such information may include:
- The nature of the transactions that resulted in the gains and losses.
- The classification of the gains and losses by line item within the financial statements.
- Support for the classification chosen for the gains and losses.
- The amount of gains or losses included in each line item.
9.2.1 Transaction Gains and Losses Related to Deferred Taxes
ASC 830-20
Change in Deferred Foreign Tax Assets and Liabilities
45-3 When the reporting
currency (not the foreign currency) is the
functional currency, remeasurement of a reporting
entity’s deferred foreign tax liability or asset
after a change in the exchange rate will result in
a transaction gain or loss that is recognized
currently in determining net income. The preceding
paragraph [ASC 830-20-45-2] requires disclosure of
the aggregate transaction gain or loss included in
determining net income but does not specify how to
display that transaction gain or loss or its
components for financial reporting. See paragraph
830-740-45-1 for further guidance.
Income Tax Consequences of Rate Changes
45-5 Subtopic 740-10 requires income tax expense to be allocated among income from continuing operations, discontinued operations, adjustments of prior periods (or of the opening balance of retained earnings), and direct entries to other equity accounts. Some transaction gains and losses are reported in other comprehensive income. Any income taxes related to those transaction gains and losses shall be allocated to other comprehensive income.
ASC 830-740
45-1 As indicated in
paragraph 830-20-45-3, when the reporting currency
(not the foreign currency) is the functional
currency, remeasurement of an entity’s deferred
foreign tax liability or asset after a change in
the exchange rate will result in a transaction
gain or loss that is recognized currently in
determining net income. Paragraph 830-20-45-1
requires disclosure of the aggregate transaction
gain or loss included in determining net income
but does not specify how to display that
transaction gain or loss or its components for
financial reporting. Accordingly, a transaction
gain or loss that results from remeasuring a
deferred foreign tax liability or asset may be
included in the reported amount of deferred tax
benefit or expense if that presentation is
considered to be more useful. If reported in that
manner, that transaction gain or loss is still
included in the aggregate transaction gain or loss
for the period to be disclosed as required by that
paragraph.
ASC 830-740-45-1 indicates that transaction gains and losses related to
remeasuring deferred tax balances “may be included
in the reported amount of deferred tax benefit or
expense if that presentation is considered to be
more useful.” Entities that select this
presentation method must still include the
transaction gain or loss in “the aggregate
transaction gain or loss for the period to be
disclosed as required by [ASC 830-20-45-1].” See
Deloitte’s Roadmap Income
Taxes for additional guidance on
accounting for deferred taxes.
9.2.2 Gains and Losses Related to Long-Term Intra-Entity Transactions in Separate Financial Statements
The exception for long-term intra-entity transactions that is discussed in
Section 6.4 applies only to the
consolidated entity’s financial statements. A
foreign entity (e.g., a subsidiary) would apply
the general guidance in ASC 830 to its stand-alone
financial statements and would record the
foreign-currency-related gains and losses
associated with such transactions in earnings.
9.2.3 Highly Inflationary Economies
In addition to considering narrative disclosures describing the change to highly
inflationary accounting and the impact it may have
on the financial statements in general, an entity
should consider the impact of such a change on its
transaction gains and losses. Therefore, preparers
should keep in mind that the requirement in ASC
830-20-45-1 to disclose the aggregate transaction
gain or loss presented in the income statement,
including the gain or loss attributable to
remeasurement due to a highly inflationary
economy, still applies.
SEC Considerations
SEC registrants with material operations in a highly inflationary economy should disclose the economy’s status as highly inflationary in their financial statements, even though ASC 830 does not explicitly require such disclosures. Such disclosures should discuss the factors that the entity considered in determining that an economy is highly inflationary as well as the timing of this determination.
Section 6700 of the
SEC Financial Reporting Manual contains requirements for foreign issuers
operating in hyperinflationary environments and addresses the
price-level adjustments that entities need to make when they use a
hyperinflationary currency as their reporting currency.
Registrants should also explain the accounting impact of the designation as highly inflationary and the impact the resulting change in functional currency will have on the entity’s financial reporting.
ASC 830-740
45-2 The deferred taxes
associated with the temporary differences that
arise from a change in functional currency
discussed in paragraph 830-740-25-3 when an
economy ceases to be considered highly
inflationary shall be presented as an adjustment
to the cumulative translation adjustments
component of shareholders’ equity and therefore
shall be recognized in other comprehensive
income.
The above guidance notes that deferred taxes that arise because an economy ceases to be considered highly inflationary should be recognized in OCI.
For additional accounting and disclosure considerations related to highly inflationary economies, see Chapter 7.
9.3 Cumulative Translation Adjustment
ASC 830-30
45-12 If an entity’s functional currency is a foreign currency, translation adjustments result from the process of translating that entity’s financial statements into the reporting currency. Translation adjustments shall not be included in determining net income but shall be reported in other comprehensive income.
As explained in Chapter 5, adjustments that result from the translation of an entity’s financial statements from its functional currency to the reporting currency should be recorded in OCI (i.e., such adjustments do not affect net income).
9.3.1 Noncontrolling Interests and Equity Method Investments
ASC 830-30
45-17 Accumulated translation adjustments attributable to noncontrolling interests shall be allocated to and reported as part of the noncontrolling interest in the consolidated reporting entity.
For investees that are not wholly owned, the presentation of CTA will depend on whether the parent consolidates the foreign entity investee or accounts for it by using the equity method:
9.3.2 Changes in Cumulative Translation Adjustment
ASC 830-30
Analysis of Changes in Cumulative Translation Adjustment
45-18 An analysis of the changes during the period in the accumulated amount of translation adjustments reported in equity shall be provided in any of the following ways:
- In a separate financial statement
- In notes to financial statements
- As part of a statement of changes in equity.
45-19 This accumulated amount in equity might be titled Equity Adjustment from Foreign Currency Translation or given a similar title.
45-20 At a minimum, the
analysis shall disclose all of the following (see
paragraph 830-30-50-1):
-
Beginning and ending amount of cumulative translation adjustments
-
The aggregate adjustment for the period resulting from translation adjustments (see paragraph 830-30-45-12) and gains and losses from certain hedges and intra-entity balances (see paragraph 830-20-35-3).
-
The amount of income taxes for the period allocated to translation adjustments (see paragraph 830-30-45-21)
-
The amounts transferred from cumulative translation adjustments and included in determining net income for the period as a result of the sale or complete or substantially complete liquidation of an investment in a foreign entity (see paragraph 830-30-40-1).
Analysis of Changes in Cumulative Translation Adjustment
50-1 If not provided in a
separate financial statement or as part of a
statement of changes in equity, an analysis of the
changes during the period in the accumulated
amount of translation adjustments reported in
equity shall be provided in notes to financial
statements. At a minimum, the analysis shall
disclose the items enumerated in paragraph
830-30-45-20.
As noted in the guidance above, an entity must provide certain disclosures
analyzing the changes in the CTA. Such an analysis can be presented in (1) a
separate financial statement, (2) the notes to the financial statements, or (3)
a statement of changes in equity. Regardless of the format in which the analysis
is provided, it must contain the items listed in ASC 830-30-45-20.
9.3.3 Income Taxes Recorded in Cumulative Translation Adjustment
ASC 830-30
45-21 Subtopic 740-10 requires income tax expense to be allocated among income from continuing operations, discontinued operations, adjustments of prior periods (or of the opening balance of retained earnings), and direct entries to other equity accounts. All translation adjustments are reported in other comprehensive income. Any income taxes related to those translation adjustments shall be allocated to other comprehensive income. Translation adjustments are accounted for in the same way as temporary differences under the provisions of Subtopic 740-10. If under the requirements of Subtopic 740-30 deferred taxes are not provided for unremitted earnings of a subsidiary, in those instances, deferred taxes shall not be provided on translation adjustments.
Deferred taxes should “not be provided for [the] translation adjustments”
discussed in ASC 830-30-45-21. Specifically, ASC 740-30-25-17 explains that “no
income taxes shall be accrued by the parent entity . . . if sufficient evidence
shows that the subsidiary has invested or will invest the undistributed earnings
indefinitely or that the earnings will be remitted in a tax-free
liquidation.”
Example 9-1
Deferred Taxes Related to Translation
Adjustments
Company N is a domestic corporation with
a wholly owned subsidiary, S, operating in a foreign tax
jurisdiction. The functional currency of S is the local
currency and, historically, no earnings have been
repatriated to N because the parent company considers
its investment to be permanent.
In this case, deferred income tax assets
and liabilities should not be recognized for the
adjustment resulting from translation of S’s financial
statements into USD.
9.4 Exchange Rate Changes
ASC 830-20
Subsequent Rate Changes
50-2 Disclosure of a rate change that occurs after the date of the reporting entity’s financial statements and its effects on unsettled balances pertaining to foreign currency transactions, if significant, may be necessary. If disclosed, the disclosure shall include consideration of changes in unsettled transactions from the date of the financial statements to the date the rate changed. In some cases it may not be practicable to determine these changes; if so, that fact shall be stated.
Effects of Rate Changes on Results of Operations
50-3 Management is encouraged to supplement the disclosures required by this Subtopic with an analysis and discussion of the effects of rate changes on the reported results of operations. This type of disclosure might include the mathematical effects of translating revenue and expenses at rates that are different from those used in a preceding period as well as the economic effects of rate changes, such as the effects on selling prices, sales volume, and cost structures. The purpose is to assist financial report users in understanding the broader economic implications of rate changes and to compare recent results with those of prior periods.
ASC 830-30
Subsequent Change in Exchange Rate
45-16 A reporting entity’s financial statements shall not be adjusted for a rate change that occurs after the date of the reporting entity’s financial statements or after the date of the foreign currency statements of a foreign entity if they are consolidated, combined, or accounted for by the equity method in the financial statements of the reporting entity.
Subsequent Rate Changes
50-2 Disclosure of a rate change that occurs after the date of the reporting entity’s financial statements or after the date of the foreign currency statements of a foreign entity if they are consolidated, combined, or accounted for by the equity method in the financial statements of the reporting entity and its effects on unsettled balances pertaining to foreign currency transactions, if significant, may be necessary.
As indicated in the guidance above, an entity should not adjust its financial statements for a rate change that occurs after the date of its financial statements (except in situations in which there is significant devaluation for subsidiaries reporting on a lag, as discussed in Section 3.3.1). However, disclosures related to such a rate change may be warranted depending on the change’s significance as well as its impact on foreign currency transactions that remain unsettled as of the balance sheet date. Such disclosures may include discussion of the effects of changes in exchange rates on the following:
- Results of operations.
- Selling prices.
- Sales volume.
- Cost structures.
The purpose of such disclosures is to help financial statement users understand the overall effects of changes in exchange rates on an entity’s cash flows and net income. If there are no unsettled foreign currency transactions as of the balance sheet date, an entity is not required to provide such disclosures since any change in exchange rates would only affect subsequent translation adjustments, which do not affect net income or cash flows (i.e., translation adjustments are recorded in equity).
SEC Considerations
If the impact of a change in exchange rates is expected to significantly affect
an SEC registrant’s future cash flows, the
registrant should disclose this fact in its
MD&A.
As with disclosures about the effects of post-balance-sheet rate changes, ASC
830-20-50-3 notes that an entity is “encouraged to
supplement the [required] disclosures” with
additional analysis of the effects that changes in
exchange rates have had on the entity’s operations
within the current reporting period. Such an
analysis may include the effects of changes in
exchange rates on the items listed above along
with the effect of changes on items such as the
translation of revenue and expenses at rates
different from those used in prior periods.
ASC 830-20-50-3 further notes that such supplemental disclosures may “assist
financial report users in understanding the
broader economic implications of rate changes and
to compare recent results with those of prior
periods.”
SEC Considerations
If a foreign government officially changes a fixed exchange rate and this change
causes the local currency to decline with respect to other currencies, the
SEC is likely to expect registrants to include appropriate disclosures about
the event in MD&A. See Section 9.5
for information about disclosures that may be appropriate, depending on an
entity’s particular facts and circumstances.
9.5 Highly Inflationary Economies
The SEC staff continues to focus on accounting and disclosure considerations
related to the foreign currency exchange environment in countries whose economies
(1) are highly inflationary or (2) risk becoming highly inflationary. Registrants
with material operations in an economy at risk for being highly inflationary are
encouraged to closely monitor the economic environment within the country and to
ensure that appropriate processes are in place for identifying relevant inflation
data. Entities with material operations in economies at risk for being highly
inflationary are encouraged to carefully consider the requirements in ASC 275
related to disclosing risks and uncertainties resulting from certain concentrations,
including concentrations associated with foreign operations and therefore with
exposure to foreign exchange risk.
SEC Regulation S-K, Item 303, requires registrants to disclose in their MD&A any known trends, events,
or uncertainties that are reasonably likely to have a material effect on their liquidity, capital resources,
or results of operations. SEC Regulation S-K, Items 305 and 503(c), require registrants to disclose risks,
including risk factors and market risks. The SEC staff has emphasized that registrants should present
tailored risk factors in their filings and avoid using boilerplate language.
The SEC staff has also historically provided informal guidance for registrants with foreign operations that
may be subject to material risks and uncertainties, such as political risks, currency risks, and business
climate and taxation risks. The staff has reminded registrants that the effects on their consolidated
operations of an adverse event related to these risks may be disproportionate to the size of their foreign
operations. Therefore, the staff has historically encouraged registrants to discuss in their MD&A any
trends, risks, and uncertainties related to their operations in individual countries or geographic areas
and possibly to supplement such disclosures with disaggregated financial information about those
operations.
SEC Considerations
The SEC staff has indicated in informal discussions that a registrant should
consider providing additional disclosures, if material, about its operations
if these operations are considered highly inflationary and may have multiple
exchange rates. The following disclosures are consistent with those
recommended by the SEC staff:
-
The overall environment in the highly inflationary economy and its effect on the entity’s financial statements both historically and currently. This disclosure can include information about (1) price controls, inflation, and foreign currency exchange limitations or restrictions; (2) changes in the entity’s revenues and associated costs; and (3) any triggering events, impairment indicators, or impairments.
-
The extent of the entity’s exposure to the highly inflationary operations, including the nature of the entity’s activities in the highly inflationary economy (e.g., imports, manufacturing, and size of operations) and other meaningful financial information, such as disaggregated financial information about the highly inflationary operations (e.g., summarized balance sheets, income statements, and cash flow statements).
-
A description of the possible effects of the currency exchange limitations or government restrictions on the entity’s operations, including how such limitations or restrictions may affect the entity’s liquidity, cash flows, or debt covenants. An entity should also describe how the existence of such limitations or restrictions affects the application of the entity’s accounting policies.
-
The exchange rate(s) used for remeasurement and the basis for judgments applied in determining the rate(s), including:
-
If multiple exchange rates are used, how each rate was determined, what transactions each rate applies to, and the relative significance of the various exchange rates.
-
Any volume restrictions or limitations on a particular exchange rate.
-
Any assumptions used in the determination of the appropriate exchange rate.
-
Any risks or uncertainties related to the entity’s ability to settle at the exchange rate selected.
-
A description of the use of any exchange rates that differ from those used in prior reporting periods.
-
In addition to the above, an entity should consider the following
disclosures:
-
The impact of remeasurement on the financial statements, including (1) the amount of any foreign exchange gain or loss that arises from using the various rates for remeasurement and (2) the financial statement line item in which the gain or loss is recorded.
-
If applicable, ongoing disclosure of variable interests, if any, in foreign VIEs in accordance with the disclosure requirements of ASC 810.
For more information about the recent scrutiny related to highly inflationary economies, see Chapter 7.
9.6 Statement of Cash Flows
ASC
830-230
45-1 A statement of cash flows
of an entity with foreign currency transactions or foreign
operations shall report the reporting currency equivalent of
foreign currency cash flows using the exchange rates in
effect at the time of the cash flows. An appropriately
weighted average exchange rate for the period may be used
for translation if the result is substantially the same as
if the rates at the dates of the cash flows were used. (That
is, paragraph 830-30-45-3 applies to cash receipts and cash
payments.) The statement of cash flows shall report the
effect of exchange rate changes on cash, cash equivalents,
and amounts generally described as restricted cash or
restricted cash equivalents held in foreign currencies as a
separate part of the reconciliation of the change in the
total of cash, cash equivalents, and amounts generally
described as restricted cash or restricted cash equivalents
during the period. See Example 1 (paragraph 830-230-55-1)
for an illustration of this guidance.
Entities may have transactions that are denominated in a foreign
currency or businesses that operate in foreign currency environments. For
transactions denominated in a foreign currency, an entity should report the cash
flow effects on changes in cash, cash equivalents, and amounts generally described
as restricted cash or restricted cash equivalents by using the exchange rates in
effect on the date of such cash flows. As noted above, instead of using the actual
exchange rate on the date of a foreign currency transaction, an entity may use an
“appropriately weighted average exchange rate” for translation “if the result is
substantially the same as if the rates at the dates of the cash flows were
used.”
A consolidated entity with operations whose functional currencies
are foreign currencies may use the following approach when preparing its
consolidated statement of cash flows:
- Prepare a separate statement of cash flows for each foreign entity by using the operation’s functional currency.
- Translate the stand-alone cash flow statement prepared in the functional currency of each foreign entity into the reporting currency of the parent entity.
- Consolidate the individual translated statements of cash flows.
The effects of exchange rate changes, or translation gains and
losses, are not the same as the effects of transaction gains and losses and should
not be presented or calculated in the same manner. Effects of exchange rate changes
may directly affect cash receipts and payments but do not directly result in cash
flows themselves.
Because unrealized transaction gains and losses arising from the
remeasurement of foreign-currency-denominated monetary assets and liabilities on the
balance sheet date are included in the determination of net income, such amounts
should be presented as a reconciling item between net income and net cash from
operating activities (either on the face of the statement under the indirect method
or in a separate schedule under the direct method). Subsequently, any cash flows
arising from the settlement of the foreign-currency-denominated asset and liability
should be presented in the statement of cash flows as an operating, investing, or
financing activity on the basis of the nature of such cash flows.
Translation gains and losses, however, are recognized in OCI and are
not included in cash flows from operating, investing, or financing activities.
The effects of exchange rate changes on cash, cash equivalents, and
amounts generally described as restricted cash or restricted cash equivalents should
be shown as a separate line item in the statement of cash flows as part of the reconciliation of beginning and ending cash balances. This issue was discussed in paragraph 101 of the Basis for Conclusions of FASB Statement 95, which stated, in
part:
The effects of exchange rate
changes on assets and liabilities denominated in foreign currencies, like
those of other price changes, may affect the amount of a cash receipt or
payment. But exchange rate changes do not themselves
give rise to cash flows, and their effects on items other than cash thus
have no place in a statement of cash flows. To achieve its
objective, a statement of cash flows should reflect the reporting currency
equivalent of cash receipts and payments that occur in a foreign currency.
Because the effect of exchange rate changes on the reporting currency
equivalent of cash held in foreign currencies affects the change in an
enterprise’s cash balance during a period but is not a cash receipt or
payment, the Board decided that the effect of exchange
rate changes on cash should be reported as a separate item in the
reconciliation of beginning and ending balances of cash. [Emphasis
added]
In a manner consistent with the implementation guidance in ASC
830-230-55-15, the effect of exchange rate changes on cash and cash equivalents is
the sum of the following two components:
-
For each foreign operation, the difference between the exchange rates used in translating functional currency cash flows and the exchange rate at year-end multiplied by the net cash flow activity for the period measured in the functional currency.
-
The fluctuation in the exchange rates from the beginning of the year to the end of the year multiplied by the beginning cash balance denominated in currencies other than the reporting currency.
Example 1 in ASC 830-230-55-1 through 55-15 illustrates the
computation of the effect of exchange rate changes on cash:
ASC
830-230
Illustrations
Example 1: Statement
of Cash Flows for Manufacturing Entity With Foreign
Operations
55-1 This
Example illustrates a statement of cash flows under the
direct method for a manufacturing entity with foreign
operations. The illustrations of the reconciliation of net
income to net cash provided by operating activities may
provide detailed information in excess of that required for
a meaningful presentation. Other formats or levels of detail
may be appropriate for particular circumstances.
55-2 The
following is a consolidating statement of cash flows for the
year ended December 31, 19X1, for Entity F, a multinational
U.S. corporation engaged principally in manufacturing
activities, which has two wholly owned foreign subsidiaries
— Subsidiary A and Subsidiary B. For Subsidiary A, the local
currency is the functional currency. For Subsidiary B, which
operates in a highly inflationary economy, the U.S. dollar
is the functional currency.
55-3 The
entity would make the following disclosure.
Cash in excess of daily requirements is invested in
marketable securities consisting of U.S. Treasury
bills with maturities of three months or less. Such
investments are deemed to be cash equivalents for
purposes of the statement of cash flows.
55-4 Summarized in the
following tables is financial information for the current
year for Entity F, which provides the basis for the
statement of cash flows presented in paragraph
830-230-55-2.
55-5 The
U.S. dollar equivalents of one unit of local currency
applicable to Subsidiary A and to Subsidiary B are as
follows.
55-6 The computation of the
weighted-average exchange rate for Subsidiary A excludes the
effect of Subsidiary A’s sale of inventory to the parent
entity at the beginning of the year discussed in paragraph
830-230-55-10(a).
55-7
Comparative statements of financial position for the parent
entity and for each of the foreign subsidiaries are as
follows.
55-8
Statements of income in local currency and U.S. dollars for
each of the foreign subsidiaries are as follows.
55-9 All of
the following transactions were entered into during the year
by the parent entity and are reflected in the preceding
financial statements:
- The parent entity invested cash in excess of daily requirements in U.S. Treasury bills. Interest earned on such investments totaled USD 35.
- The parent entity sold excess property with a net book value of USD 35 for USD 150.
- The parent entity’s capital expenditures totaled USD 450.
- The parent entity wrote down to its estimated net realizable value of USD 25 a facility with a net book value of USD 75.
- The parent entity’s short-term debt consisted of commercial paper with maturities not exceeding 60 days.
- The parent entity repaid long-term notes of USD 200.
- The parent entity’s depreciation totaled USD 340, and amortization of intangible assets totaled USD 10.
- The parent entity’s provision for income taxes included deferred taxes of USD 90.
- Because of a change in product design, the parent entity purchased all of Subsidiary A’s beginning inventory for its book value of USD 160. All of the inventory was subsequently sold by the parent entity.
- The parent entity received a dividend of USD 22 from Subsidiary A. The dividend was credited to the parent entity’s income.
- The parent entity purchased from Subsidiary B USD 270 of merchandise of which USD 45 remained in the parent entity’s inventory at year-end. Intra-entity profit on the remaining inventory totaled USD 15.
- The parent entity loaned USD 15, payable in U.S. dollars, to Subsidiary B.
- Entity F paid dividends totaling USD 120 to shareholders.
55-10 All
of the following transactions were entered into during the
year by Subsidiary A and are reflected in the above
financial statements. The U.S. dollar equivalent of the
local currency amount based on the exchange rate at the date
of each transaction is included. Except for the sale of
inventory to the parent entity (the transaction in [a]),
Subsidiary A’s sales and purchases and operating cash
receipts and payments occurred evenly throughout the
year.
- Because of a change in product design, Subsidiary A sold all of its beginning inventory to the parent entity for its book value of LC 400 (USD 160).
- Subsidiary A sold equipment for its book value of LC 275 (USD 116) and purchased new equipment at a cost of LC 600 (USD 258).
- Subsidiary A issued an additional LC 175 (USD 75) of 30-day notes and renewed the notes at each maturity date.
- Subsidiary A issued long-term debt of LC 400 (USD 165) and repaid long-term debt of LC 250 (USD 105).
- Subsidiary A paid a dividend to the parent entity of LC 50 (USD 22).
55-11 The
following transactions were entered into during the year by
Subsidiary B and are reflected in the preceding financial
statements. The U.S. dollar equivalent of the local currency
amount based on the exchange rate at the date of each
transaction is included. Subsidiary B’s sales and operating
cash receipts and payments occurred evenly throughout the
year. For convenience, all purchases of inventory were based
on the weighted-average exchange rate for the year.
Subsidiary B uses the first-in, first-out (FIFO) method of
inventory valuation.
- Subsidiary B had sales to the parent entity as follows.
- Subsidiary B sold equipment with a net book value of LC 200 (USD 39) for LC 350 (USD 14). New equipment was purchased at a cost of LC 500 (USD 15).
- Subsidiary B borrowed USD 15 (LC 500), payable in U.S. dollars, from the parent entity.
- Subsidiary B repaid LC 1,000 (USD 35) of long-term debt.
55-12
Statements of cash flows in the local currency and in U.S.
dollars for Subsidiary A and Subsidiary B are as
follows.
55-13 A
reconciliation of net income to net cash provided by
operating activities follows.
55-14 The following is the
computation of cash received from customers and cash paid to
suppliers and employees as reported in the consolidating
statement of cash flows for Entity F appearing in paragraph
830-230-55-2.
55-15 The
following is the computation of the effect of exchange rate
changes on cash for Subsidiary A and Subsidiary B.
9.7 Other Disclosure Considerations
Entities should also consider the foreign currency presentation and disclosure requirements in ASC topics other than ASC 830 and, if applicable, those in SEC guidance.
9.7.1 SEC Considerations
The SEC staff has historically encouraged registrants to provide supplemental disclosures about how the reporting entity is affected by foreign operations and foreign currencies. For instance, in FRR 6 (codified in Section 501.09 of the Codification of Financial Reporting Policies), the staff gave several examples of the types of disclosures registrants should consider including in their MD&A (although the staff did not specify the preferred nature and location of such disclosures). These supplemental disclosures include:
- “[I]nformation enabling an evaluation of the amounts and certainty of cash flows from operations and a registrant’s ability to generate adequate amounts of cash to meet its need for cash (liquidity) as well as an assessment of the impact of events that have had, or may have, a material effect on trends of operating results.”
- “[D]isplay of net investments by major functional currency.”
- “[A]nalysis of the translation component of equity (either by significant functional currency or by geographical areas used for segment disclosure purposes).”
- “[F]unctional currencies used to measure significant foreign operations or the degree of exposure to exchange rate risks (which exists for all companies engaged in foreign operations, regardless of their functional currencies), in order to enable investors to assess the impact of exchange rate changes on the reporting entity.”
In addition, the staff cited two examples of instances in which registrants should consider providing additional disclosures:
- When there is an “indication that all or some of [a foreign operation’s] cash flows are generally not available to meet the company’s other short-term needs for cash.” Such disclosures should be disaggregated enough to “meaningfully address liquidity and capital resource considerations,” and entities should especially consider disclosing the nature of their intra-entity financing in such situations.
- When the reporting entity has “significant foreign operations in highly inflationary economies.”
Further, the SEC staff has indicated1 that, when providing quantitative disclosures regarding foreign currency
adjustments, registrants should:
-
“[R]eview [MD&A] and the notes to financial statements to ensure that disclosures are sufficient to inform investors of the nature and extent of the currency risks to which the registrant is exposed and to explain the effects of changes in exchange rates on its financial statements.”
-
Describe in their MD&A “any material effects of changes in currency exchange rates on reported revenues, costs, and business practices and plans.”
-
Identify “the currencies of the environments in which material business operations are conducted [when] exposures are material.”
-
“[Q]uantify the extent to which material trends in amounts are attributable to changes in the value of the reporting currency relative to the functional currency of the underlying operations [and analyze] any materially different trends in operations or liquidity that would be apparent if reported in the functional currency.”
-
Identify, to the extent they are material, “unhedged monetary assets, liabilities or commitments denominated in currencies other than the operation’s functional currency, and strategies for management of currency risk.”
In assessing whether it needs to provide disaggregated financial information about its foreign operations in MD&A, a registrant should take into account more than just the percentage of consolidated revenues, net income, or assets contributed by foreign operations. The registrant also should consider how the foreign operations might affect the consolidated entity’s liquidity. For example, a foreign operation that holds significant liquid assets may be exposed to exchange-rate fluctuations or restrictions that could affect the registrant’s overall liquidity.
9.7.2 Non-GAAP Measures
Constant currency is a method used to eliminate the effects of exchange rate fluctuations of international operations in a registrant’s determination of financial performance. For example, when presenting its MD&A, a registrant with material operations in various countries should disclose the impact of material exchange rates. To do so, the registrant may use a constant exchange rate between periods for translation, which would remove the effect of fluctuations in foreign exchange rates.
The presentation of financial results in a constant currency is considered a non-GAAP measure.
C&DIs — Non-GAAP Financial
Measures
Question
104.06
Question:
Company X has operations in various foreign countries
where the local currency is used to prepare the
financial statements which are translated into the
reporting currency under the applicable accounting
standards. In preparing its MD&A, Company X will
explain the reasons for changes in various financial
statement captions. A portion of these changes will be
attributable to changes in exchange rates between
periods used for translation. Company X wants to isolate
the effect of exchange rate differences and will present
financial information in a constant currency — e.g.,
assume a constant exchange rate between periods for
translation. Would such a presentation be considered a
non-GAAP measure under Regulation G and Item 10(e) of
Regulation S-K?
Answer: Yes.
Company X may comply with the reconciliation
requirements of Regulation G and Item 10(e) by
presenting the historical amounts and the amounts in
constant currency and describing the process for
calculating the constant currency amounts and the basis
of presentation. [Jan. 11, 2010]
Since constant-currency amounts are non-GAAP measures, the registrant should include the appropriate non-GAAP disclosures to isolate the effects of the exchange rate differences for (1) the historical amounts and (2) the amounts in constant currency. The disclosure of the non-GAAP measure should describe both the basis of presentation and how the constant-currency amounts were computed. Note that if a registrant only discloses the impact of exchange rates as part of its explanation of the period-to-period fluctuation between two GAAP amounts, such disclosure would not constitute a non-GAAP measure (e.g., foreign currency fluctuations resulted in $XX of the change in net revenue).
For more information about non-GAAP measures, see Deloitte’s Roadmap Non-GAAP Financial Measures and
Metrics.
9.7.3 Risks and Uncertainties
ASC 275-10
50-18 Concentrations,
including known group concentrations, described below
require disclosure if they meet the criteria of
paragraph 275-10-50-16. (Group concentrations exist if a
number of counterparties or items that have similar
economic characteristics collectively expose the
reporting entity to a particular kind of risk.) Some
concentrations may fall into more than one of the
following categories:
-
Concentrations in the volume of business transacted with a particular customer, supplier, lender, grantor, or contributor. The potential for the severe impact can result, for example, from total or partial loss of the business relationship. For purposes of this Subtopic, it is always considered at least reasonably possible that any customer, grantor, or contributor will be lost in the near term.
-
Concentrations in revenue from particular products, services, or fund-raising events. The potential for the severe impact can result, for example, from volume or price changes or the loss of patent protection for the particular source of revenue.
-
Concentrations in the available sources of supply of materials, labor, or services, or of licenses or other rights used in the entity’s operations. The potential for the severe impact can result, for example, from changes in the availability to the entity of a resource or a right.
-
Concentrations in the market or geographic area in which an entity conducts its operations. The potential for the severe impact can result, for example, from negative effects of the economic and political forces within the market or geographic area. For purposes of this Subtopic, it is always considered at least reasonably possible that operations located outside an entity’s home country will be disrupted in the near term.
50-19 Concentrations of financial instruments, and other concentrations not described in the preceding paragraph, are not addressed in this Subtopic. However, these other concentrations may be required to be disclosed pursuant to other Topics, such as Subtopic 825-10.
50-20 Disclosure of
concentrations meeting the criteria of paragraph
275-10-50-16 shall include information that is adequate
to inform users of the general nature of the risk
associated with the concentration. For those
concentrations of labor (see paragraph 275-10-50-18(c))
subject to collective bargaining agreements and
concentrations of operations located outside of the
entity’s home country (see paragraph 275-10-50-18(d))
that meet the criteria in paragraph 275-10-50-16, the
following specific disclosures are required:
-
For labor subject to collective bargaining agreements, disclosure shall include both the percentage of the labor force covered by a collective bargaining agreement and the percentage of the labor force covered by a collective bargaining agreement that will expire within one year.
-
For operations located outside the entity’s home country, disclosure shall include the carrying amounts of net assets and the geographic areas in which they are located.
This Subtopic does not, however, prohibit entities from also stating in disclosures of concentrations related to customers, grantors, or contributors or operations located outside the entity’s home country that the entity does not expect that the business relationship will be lost or does not expect that the foreign operations will be disrupted if such is the case.
50-21 Adequate information about some concentrations may already be presented in other parts of the financial statements. For example, adequate information about assets or operations located outside the entity’s home country may be included in disclosures made to comply with Subtopic 280-10. In accordance with the guidance in this Subtopic, such information need not be repeated.
As noted above, ASC 275 requires entities to provide disclosures about risks and
uncertainties resulting from certain concentrations, including concentrations
associated with foreign operations and therefore with exposure to foreign
exchange risk. In addition, SEC Regulation S-K, Item 303, requires SEC
registrants to disclose in their MD&A any known trends, events, or
uncertainties that are reasonably likely to have a material effect on their
liquidity, capital resources, or results of operations.
SEC Considerations
The SEC staff has also historically provided informal
guidance for registrants with foreign operations that may be subject to
material risks and uncertainties, such as political risks, currency
risks, and business climate and taxation risks. The staff has reminded
registrants that the effects on their consolidated operations of an
adverse event related to these risks may be disproportionate to the size
of their foreign operations. Therefore, the staff has historically
encouraged registrants to discuss in their MD&A any trends, risks,
and uncertainties related to their operations in individual countries or
geographic areas and to supplement such disclosures with disaggregated
financial information about those operations.
In addition, SEC Regulation S-K, Items 305 and 503(c),
require registrants to disclose risks, including risk factors and market
risks. The SEC staff has emphasized that registrants should present
tailored risk factors in their filings and avoid using boilerplate
language. Registrants should consider whether to provide more specific
discussion and enhanced explanations of how the risks could materially
affect their business. This discussion may be supplemented with
quantitative information that puts the risks in context.
Footnotes
Chapter 10 — Key Differences Between U.S. GAAP and IFRS Accounting Standards — Foreign Currency
Chapter 10 — Key Differences Between U.S. GAAP and IFRS Accounting Standards — Foreign Currency
10.1 Overview
The primary sources of guidance on accounting for foreign currency matters are
ASC 830 under U.S. GAAP and IAS 21 and IAS 29 under IFRS® Accounting
Standards. Throughout this chapter, terminology applicable to both U.S. GAAP and
IFRS Accounting Standards is used, depending on the applicable guidance (e.g.,
“foreign entity” in U.S. GAAP versus “foreign operation” in IFRS Accounting
Standards).
The table below summarizes commonly encountered differences between the
accounting for foreign currency matters under U.S. GAAP and that under IFRS
Accounting Standards.
Subject | U.S. GAAP | IFRS Accounting Standards |
---|---|---|
Determination of the functional currency | There is no hierarchy of factors for entities to consider in determining the functional currency. | There is a hierarchy of factors for entities to consider in determining the functional currency. Paragraph 9 of IAS 21 states that the two primary factors to consider are (1) the currency that mainly influences the entity’s pricing of goods and services and (2) the currency that mainly influences the costs of providing goods or services. Paragraphs 10 and 11 of IAS 21 specify the secondary factors. |
Translations when there is a change in functional currency | The effect of a change in functional currency that is unrelated to a highly inflationary economy depends on whether the change is from the reporting currency to a foreign currency or vice versa. A change from the reporting currency to a foreign currency is accounted for prospectively from the date of the change. By contrast, a change from a foreign currency to the reporting currency is accounted for on the basis of the translated amounts at the end of the previous period. | The effect of a change in functional currency that is unrelated to a hyperinflationary economy is accounted for prospectively from the date of the change. A change in functional currency should be recognized as of the date on which it
is determined that there has been a change in the underlying
events and circumstances relevant to the reporting entity
that justifies a change in the functional currency. For
convenience, and as a practical matter, there is a practice
of using a date at the beginning of the most recent period
(annual or interim, as the case might be). |
Transaction gains and losses related to AFS debt securities | Transaction gains or losses related to AFS debt securities are reported in OCI. | Transaction gains or losses related to AFS debt securities are reported in earnings. |
Recognition of deferred taxes for temporary differences related to nonmonetary
assets and liabilities associated with changes in the
exchange rate | No deferred tax is recognized for temporary differences caused by changes in the exchange rate for nonmonetary assets and liabilities when the local currency amount is remeasured to the functional currency. For additional discussion, see Chapter 8 of this Roadmap as well as
Chapter 9 of
Deloitte’s Roadmap Income
Taxes. | Deferred tax is recognized for temporary differences caused by changes in the exchange rate for nonmonetary assets and liabilities when the local currency amount is remeasured to the functional currency. |
Translation process for multitiered organizations | Organizations typically apply the step-by-step method. | Entities have a policy choice between the step-by-step method and the direct
method.1 |
Parent and investee with different fiscal-year-end dates — differences in exchange rates | An entity may elect a policy of either disclosing, or both disclosing and recognizing, material intervening events. For more information, see Section 3.3.1 of this Roadmap as well as
Section 11.1.3 of Deloitte’s Roadmap
Consolidation — Identifying a Controlling
Financial Interest. | Under IFRS 10 and IAS 28, a reporting entity is required to prepare financial statements of the subsidiary or equity method investee for the date of the reporting entity’s financial statements unless it is impractical to do so. If it is impractical, the difference can be no greater than three months and adjustments should be made for significant post-balance-sheet changes in exchange rates up to the date of the consolidated financial statements. |
Identifying what qualifies as a partial disposal that may result in a reclassification or reattribution of the CTA | Only changes in a parent’s ownership interest (equity investments in a
foreign entity) may be treated as partial disposals that
result in a reclassification or reattribution of the
CTA. Accordingly, the sale or liquidation of the net assets within a foreign entity
would not result in a release or reattribution of the CTA
(unless it results in a complete or substantially complete
liquidation of the foreign entity). | Do not distinguish between partial disposals of investments in and those within a foreign operation. Accordingly, an entity can elect either the proportionate or absolute reduction approach as an accounting policy and, if applicable, can choose how the absolute reduction approach is applied. |
CTA associated with retained interest when significant influence is lost | Under U.S. GAAP, upon a loss of significant influence, the proportionate amount
of the CTA is reclassified from equity to earnings; the
remaining CTA balance is reclassified in the carrying value
of the retained interest. However, if the equity security is
subsequently measured at fair value, the impact on the
income statement of losing significant influence may be the
same under U.S. GAAP as it is under IFRS Accounting
Standards. U.S. GAAP would differ from IFRS Accounting
Standards in situations in which the retained interest is
measured at cost minus impairment, if any, plus or minus
changes resulting from observable price changes in an
orderly transaction (the measurement alternative). | Upon a loss of significant influence, the entire CTA associated with the investment is reclassified from equity to earnings regardless of the measurement applied to the retained interest. |
Impact of CTA on the measurement of impairment losses of foreign investees held for disposal | In certain circumstances, entities are required to include related CTA in the carrying amount of an investment in a foreign entity that is being evaluated for impairment. See Section 5.5 for further discussion. | Entities are not permitted to include related CTA in the carrying amount of an investment in a foreign operation that is being evaluated for impairment. See paragraphs BC37 and BC38 of IFRS 5 for further details about this issue. |
Identifying whether an economy is highly inflationary (hyperinflationary) | There is a prescribed criterion for determining whether an economy is highly inflationary (i.e., the absolute rate of inflation) that, when met, results in highly inflationary accounting “in all instances.” | There are no prescribed criteria that result in automatic hyperinflationary treatment; rather, paragraph 3 of IAS 29 provides several judgment-based indicators related to determining whether an economy is hyperinflationary. |
Commencing accounting for highly inflationary (hyperinflationary) economies | Commence the requisite accounting on the first day of the next reporting period in which it becomes subject to a highly inflationary economy (see Section 7.3). | IAS 29 requires that an entity commence the requisite accounting from the beginning of the reporting period in which it becomes subject to a hyperinflationary economy. |
Translations of foreign entities whose functional currency is the currency of a highly inflationary (hyperinflationary) economy | Previously issued foreign entity financial statements should not be restated. That is, the effects of a highly inflationary economy are accounted for prospectively. Further, the financial statements of the foreign entity are remeasured for consolidation purposes as if the immediate parent’s reporting currency were its functional currency. | Restatement of the foreign operation’s financial statements is required before translation (purchasing power adjustments are made retrospectively). That is, the effects of a hyperinflationary economy are accounted for retrospectively. Further, the financial statements of the foreign operation are translated into the presentation currency by using the closing rate as of the balance sheet date. |
Economies that cease to be highly inflationary (hyperinflationary) | The functional currency accounting bases for nonmonetary assets and liabilities are determined by translating the reporting currency amounts as of the date of change into the local currency at current exchange rates. | The functional currency accounting bases for nonmonetary assets and liabilities are the unit currency amount at the end of the previous reporting period. |
Footnotes
1
While neither U.S. GAAP nor IFRS
Accounting Standards contain explicit guidance on
the mechanics of the consolidation process for
multitiered organizations, differing interpretations
have emerged regarding the determination of CTA. Two
of the approaches that have emerged for translating
the financial results of multitiered organizations
are as follows:
-
Step-by-step method — Under this method, the financial results of each foreign entity (operation) would first be translated into the functional currency of its intermediate parent, which would in turn be translated into the functional currency of its intermediate parent (if any). Ultimately, the financial results of the foreign entity (operation) would be translated into the reporting (presentation) currency of the consolidated reporting entity.
-
Direct method — Under this method, the financial results of a foreign entity (operation) are directly translated into the reporting (presentation) currency of the consolidated reporting entity.
Appendix A — Sample SEC Comments: Foreign Currency
Appendix A — Sample SEC Comments: Foreign Currency
A.1 Foreign Currency Comment Letters
The SEC staff’s comments on quantitative disclosures related to foreign currency
adjustments reflect published staff views1 on the topic, under which registrants should:
-
“[R]eview management’s discussion and analysis and the notes to financial statements to ensure that disclosures are sufficient to inform investors of the nature and extent of the currency risks to which the registrant is exposed and to explain the effects of changes in exchange rates on its financial statements.”
-
Describe in their MD&A “any material effects of changes in currency exchange rates on reported revenues, costs, and business practices and plans.”
-
Identify “the currencies of the environments in which material business operations are conducted [when] exposures are material.”
-
“[Q]uantify the extent to which material trends in amounts are attributable to changes in the value of the reporting currency relative to the functional currency of the underlying operations [and analyze] any materially different trends in operations or liquidity that would be apparent if reported in the functional currency.”
The extracts in this publication that reflect these topics have been reproduced
from comments published on the SEC’s Web site that were issued on or after June
1, 2013. In instances in which there were numerous comments on the same topics,
only certain comments have been included. Dollar amounts and information
identifying registrants or their businesses have been redacted from the
comments.
For a discussion of SEC comment letters on additional topics and
information about the SEC review process, see Deloitte’s Roadmap SEC Comment Letter
Considerations, Including Industry Insights.
A.2 Examples of SEC Comments
A.2.1 Determination of Functional Currency
The following are examples of SEC staff comments that registrants have received
about the determination of their functional currency:
-
We note you have activities and operations in [Country A] and store inventory in [Country B]. Please disclose your accounting policies for foreign currency translation and related impacts to your financial statements such as the aggregate transaction gain or loss included in determining net income or explain to us why disclosure is not necessary. Refer to ASC 830.
-
We note your significant foreign operations and that you are a [Country A] corporation reporting your financial statements in U.S. dollars. In future filings, please revise this note to disclose your functional currency as well as those of your significant foreign subsidiaries. Disclose your policy for determining the functional currency of foreign entities, and describe your accounting for foreign currency transactions i.e., transactions denominated in a currency different from the functional currency. In addition, disclose your policy for foreign currency translation. Refer to ASC 235-10-50-1, ASC Topic 830 and FRC 501.09.b.
-
You disclose that your functional currency is the U.S. dollar. Please tell us the basis for your conclusion including all the factors you considered. In your response, tell us how you applied the guidance of FASB ASC 830-10-45-3 to 45-6 and 830-10-55-3 to 55-7, as applicable. Please also tell us the currency in which your cash and bank deposits are denominated.
-
You disclose that the U.S. dollar is your functional currency; however, we note that all of your current operations are outside of the U.S. Using the guidance in ASC 830-10-45 and ASC 830-10-55 please tell us how you determined your functional currency.
-
Please refer to the following disclosure in the last paragraph on page [XX] under the risk factor “Fluctuations in Foreign Currency Exchange Rates Could Negatively Affect Our Profitability:”
-
“ . . . we have substantial operations in [Country A] and a significant portion of our premiums and investment income in [Country A] is received in [LC]. Most claims and expenses associated with our operations in [Country A] are also paid in [LC] and we primarily purchase [LC]-denominated assets to support [LC]-denominated policy liabilities.”
You disclose herein, however, that [Country A] is an exception to your use of the local currency as the functional currency and that “multiple functional currencies exist in [Country A].” Tell us why the [LC] is not the functional currency for your [Country A] operations and what you mean by “multiple functional currencies exist” in [Country A]. In your response, tell us what you determined the functional currencies to be for your [Country A] operations, and include an analysis supporting your determination under ASC 830-10-45 and ASC 830-10-55. -
-
Pursuant to ASC 830-10-45-2, please help us better understand how you determined that the U.S. dollar is the currency of the primary economic environment in which you operate and in which you primarily generate and expend cash. Please specifically address your consideration of ASC 830-10-55-3 through 55-5. We note that your disclosures . . . indicate that you have not generated any revenues in the U.S. and that all of your long-lived assets are located in [Country A].
For more information about an entity’s determination of its functional
currency, see Section 2.3.
A.2.2 Change in Functional Currency
Because changes in functional currency are expected to be
infrequent, the SEC staff will often ask registrants for additional
information about the related facts and circumstances, including an
explanation of how the registrant considered each factor associated with the
change.
Regardless of the underlying reason for a change in
functional currency, the SEC has indicated in published interpretations2 that although a registrant is not required to do so under ASC 830, it
“should consider the need to disclose the nature and timing of the change,
the actual and reasonably likely effects of the change, and economic facts
and circumstances that led management to conclude that the change was
appropriate.” In addition, the registrant should discuss in its MD&A the
“effects of those underlying economic facts and circumstances on the
registrant’s business.” When registrants fail to do so, the staff may
request additional disclosures about the underlying reason for the change
and the associated effects. The following are examples of comments that
registrants have received about changes in their functional currency:
-
We note that you changed the functional currency of your subsidiaries in [Countries] from the U.S. dollar to local currencies. Please tell us the facts and circumstances that resulted in the change in functional currency, including your consideration of each factor outlined in ASC 830-10-55-5. If material, please also expand your disclosures in MD&A to discuss the actual and reasonably likely effects of the change, the economic facts and circumstances that led management to conclude that the change was appropriate, and any effects of those underlying economic facts and circumstances on your business in those countries.
-
[W]e note that as a result of the Acquisition, you reevaluated your functional currency accounting conclusions. Due primarily to your new legal entity organization structure, global cash management and raw material sourcing strategies, you determined that the functional currency of certain subsidiaries operating outside of the United States is the local currency of the respective subsidiaries. For the Predecessor period, your reporting currency was the U.S. dollar as [Company B] management determined that the U.S. dollar was the functional currency of [Company B’s] legal entities and this functional currency was appropriate for the [Company B’s] organizational legal entity structure and the economic environment in which [Company B] operated during the period covered by the Predecessor consolidated and combined financial statements. With reference to ASC 830-10-45-3 through 45-6, please provide a thorough analysis that demonstrates the appropriateness of the functional currency of your subsidiaries in both the Successor and Predecessor periods.
-
We note your disclosure that “effective February [XX, XXXX], [Company A’s] functional currency changed to the United States dollar.” Please explain to us the facts and circumstances that resulted in the change in functional currency, including your consideration of each factor outlined in ASC 830-10-55-5.
-
We note your disclosure that “[Company A’s] functional currency changed to the United States dollar.” Please explain to us the facts and circumstances that resulted in the change in the functional currency, including your consideration of each factor outlined in ASC 830-10-55-5.
For more information about the determination of an entity’s functional
currency, see Section 2.4.
A.2.3 MD&A Disclosures and Disclosures About Risks and Uncertainties
The foreign operations of many registrants are subject to material risks and
uncertainties that should be disclosed, including those related to the
foreign jurisdiction’s political environment, its business climate,
currency, and taxation. The effects on a registrant’s consolidated
operations of an adverse event related to these risks may be
disproportionate in relation to the size of the registrant’s foreign
operations. Therefore, the registrant’s segment information or MD&A may
need to describe the trends, risks, and uncertainties related to its
operations in individual countries or geographic areas and possibly
supplement such disclosures with disaggregated financial information about
those operations.
A registrant’s assessment of whether it needs to provide disaggregated financial information about its foreign operations in its MD&A would need to take into account more than just the percentage of consolidated revenues, net income, or assets contributed by foreign operations. The registrant also should consider how the foreign operations might affect the consolidated entity’s liquidity. For example, a foreign operation that holds significant liquid assets may be exposed to exchange-rate fluctuations or restrictions that could affect the registrant’s overall liquidity.
The staff continues to ask registrants to provide early-warning disclosures to
help financial statement users understand these items and how they
potentially affect the financial statements. For additional information
about early-warning disclosures, see Section 3.1 of Deloitte’s Roadmap
SEC Comment Letter
Considerations, Including Industry Insights.
The following are examples of comments that registrants have received about
disclosures in MD&A:
-
Please tell us how you determined it was unnecessary to provide quantitative disclosures about foreign currency exchange risk. Please refer to Item 305 of Regulation S-K.
-
We note your disclosure in the final paragraph of this section that you maintain credit relationships with large financial institutions. Please expand your disclosure in one or more separate risk factors to more fully describe the risks related to currency and exchange rate controls, regulation, inflation or deflation, and fiscal and monetary policies in the foreign countries where you will maintain such credit relationships.
-
With reference to the risk factors associated with your foreign operations as discussed on pages [XX] and [XX], please disclose the nature and extent of any legal or economic restrictions on the ability of your subsidiaries or affiliates to transfer funds to you in the form of cash dividends, loans or advances and the impact such restrictions have had or are expected to have on your ability to meet cash obligations. Furthermore, please disclose the following:
-
The amount of foreign cash you have as compared to your total amount of cash as of each of the balance sheet dates presented. Disclose whether or not you would need to accrue and pay taxes if these amounts are repatriated; and Disclose, if true, that you do not intend to repatriate these amounts.
-
-
We note your disclosure . . . that foreign currency exchange losses increased expenses and that you use the [Currency] as your functional currency. If material, please include a risk factor addressing any exposure you may have as a result of changes in foreign currency rates.
-
We note your risk factor . . . related to the value of the currencies in countries where you operate against the U.S. dollar and its effect on your financial results reported in U.S. dollar terms. As such, fluctuations in foreign exchange rates could affect your financial results reported in U.S. dollar terms without giving effect to any underlying change in your business or results of operations. Please fully expand your discussion of results of operations to separately quantify for each period presented the amount of the change in revenues and expenses that is due to foreign currency translations.
-
With regards to any material foreign operations, please tell and disclose the following: . . .
-
Disclose any material foreign currency exchange differences during each period in accordance with ASC 830
-
-
We note you were able to achieve sales growth during fiscal 2015 despite $[X.X] million of adverse impact from the effects of foreign exchange. Please tell us whether you also experienced an offsetting impact to cost of sales for such strengthened US dollar, as you indicate gross margin was also adversely impacted by foreign exchange and there appears to be no discussion of the impact to your total cost of sales. Additionally, tell us what consideration you gave to providing a constant currency disclosure to quantitatively illustrate the impact of changes in foreign currency rates between periods.
-
We note your disclosure that the weakening of the U.S. dollar against the [LC] contributed to the change in net sales and cost of sales for the year ended December [XX, XXXX] compared to the year ended December [XX, XXXX]. In addition, you also disclose that the strengthening of the U.S. dollar against the [LC] impacted other expenses, net for the year ended December [XX, XXXX] compared to the year ended December [XX, XXXX]. Please clearly explain the disclosure surrounding the foreign currency impact on your operations, specifically how the U.S. dollar strengthened and weakened against the [LC] within the same year.
-
We note that foreign currency exchange rates materially impacted your consolidated statements of income and consolidated statements of comprehensive income. Please expand your disclosure to provide the disclosures required by Item 305 of Regulation S-K, including a discussion of the specific foreign currency rate exposures that represent the primary risk of loss.
-
We note your disclosure which states $[XX] billion (of the total $[XX] billion reflected on your balance sheet) of cash, cash equivalents and marketable securities is held off-shore by foreign subsidiaries. We further note your charge relating to your [Country A] deconsolidation included $[XXX] million of cash held in [Country A]. In addition, we note your risk factor disclosure which states you maintain cash balances in a number of foreign countries with exchange and other controls including [Countries A–H]. In future filings, please expand your liquidity section to provide disclosure of the amounts and foreign jurisdictions where the majority of your cash, cash equivalents and marketable securities is located. In addition, provide separate disclosure of the amounts and locations of cash, cash equivalents and marketable securities held in foreign jurisdiction subject to exchange controls.
-
In your disclosure here and on page [XX], please tell us how you considered the disclosures required by Item 303(a)(3)(iii) of Regulation S-K. For example, in [Segment A] you only disclose that sales increased due to significant increases in . . . plant, . . . equipment and parts sales. . . .Further, where material, the effects of offsetting developments or events should be disclosed and, where changes are a result of several factors, you should disclose the relative extent of each material factor contributing to the increase or decrease. For example, in the second paragraph you disclose that international sales continue to be negatively impacted by the strengthening of the U.S. dollar compared to currencies in many of the countries in which you operate. In future filings, to the extent material, please quantify the impact of currency changes on your international sales and identify for investors the countries where your sales were most significantly affected by foreign currency fluctuations.
-
We note your disclosure throughout the document referencing foreign subsidiaries and foreign operations. Your accounting policies do not appear to address your accounting for foreign currency matters. In future filings, please provide the disclosures required by FASB ASC 830.
-
Clarify whether there is any material impact from foreign currency exchange adjustments, acquisitions or dispositions during any period presented and if so, disclose them separately and explain what they are.
Section A.2.4 below also includes discussion of comments
that registrants may receive about MD&A disclosures and disclosures
about risks and uncertainties. For more information about MD&A
disclosures and disclosures about risks and uncertainties, see Section 9.7.
A.2.4 Accounting and Disclosure Considerations Related to Operations in Certain Countries
The SEC staff continues to focus on accounting and disclosure considerations
related to the economic and political environment in certain countries,
including Venezuela, Russia, Belarus, Ukraine, and Argentina. Business
operations in Venezuela, Russia, Belarus, Ukraine, and Argentina may give
rise to accounting and disclosure questions about (1) which exchange rate is
appropriate for remeasurement, (2) whether such operations should be
deconsolidated or considered impaired, and (3) uncertainties or exposures
resulting from the general economic and political environment or specific
business relationships that should be disclosed. The following are examples
of comments that registrants have received about their accounting and
disclosures related to operations in these countries:
-
We note the disclosures . . . regarding the monetary and certain nonmonetary assets located in Venezuela and Argentina. For each country, please address the following and expand your disclosure to clarify the following points:
-
Tell us the nature of your operations in Venezuela and Argentina (e.g., manufacturing, importing, marketing, selling, etc.) and the nature of the activities conducted between those operations and your non-Venezuelan and non-Argentine operations;
-
Clarify how the economic situation in Venezuela and Argentina impacts your liquidity, including the extent of intercompany receivables due from your Venezuelan and Argentine subsidiaries;
-
Quantify the amount of monetary and nonmonetary assets in Venezuela and Argentina by significant asset grouping, (i.e., cash, inventories, PP&E, intercompany accounts, etc.). In this regard, we note your current disclosure only discusses your net asset position and amounts in accumulated foreign currency translation adjustments; and
-
Discuss the factors you are currently monitoring in determining to continue consolidating your Venezuelan operations, the status of those factors and any associated uncertainties.
-
-
We note your disclosures that the conflict between Russia and Ukraine and inflationary and supply chain issues have impacted your operating results during the current period and it appears you expect these issues may continue to impact your future results. Please enhance your disclosures to more fully address the following:
-
Quantify decreases in sales related to lower shipments to customers in Russia and Ukraine;
-
Disclose and discuss trends in costs related to energy, raw materials and freight, including the percentage increases you experienced during each period, whether costs are continuing to increase or stabilizing, and your expectations regarding trends in your costs and the factors you believe may impact trends;
-
Disclose and discuss the reasons why certain segments appear to have the ability to pass through increased costs to customers and others do not;
-
Disclose any material impact of import or export bans on products or commodities, including energy from Russia, used in your business, or sold by you, including the current and anticipated impact on your business, taking into account the availability of materials, costs of needed materials, costs and risks associated with transportation, and the impact on margins and customers; and
-
Discuss any actions you have taken mitigate the impact of the conflict between Russia and Ukraine and inflationary and supply chain issues on your business.
-
-
We note the disclosures . . . regarding your operations or those of companies with which you do business is conducted through facilities located in [Russia/Belarus/Ukraine]. Please describe the direct or indirect impact of Russia’s invasion of Ukraine on your business. In addition, please also consider any impact:
-
resulting from sanctions, limitations on obtaining relevant government approvals, currency exchange limitations, or export or capital controls, including the impact of any risks that may impede your ability to sell assets located in Russia, Belarus, or Ukraine, including due to sanctions affecting potential purchasers;
-
resulting from the reaction of your investors, employees, customers, and/or other stakeholders to any action or inaction arising from or relating to the invasion, including the payment of taxes to the Russian Federation; and
-
that may result if Russia or another government nationalizes your assets or operations in Russia, Belarus, or Ukraine.
-
If the impact is not material, please explain why.
-
For more information about highly inflationary economies,
see Chapter 7.
For more information about disclosures that the SEC may require as a result
of the Russia-Ukraine conflict, see the SEC’s Sample Letter to Companies Regarding Disclosures
Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain
Issues.
A.2.5 Translation Adjustments
The following are examples of comments that registrants have received about
foreign currency translation adjustments:
-
We note your line item, “Other comprehensive income/(loss)” in your consolidated statements of comprehensive income . . . [w]e further note your disclosure . . . that other comprehensive income (loss), consists of the cumulative foreign currency translation adjustment and unrealized gain (loss) on available-for-sale securities. Please tell us your consideration of providing other comprehensive income/(loss) in a single continuous financial statement or in two separate but consecutive financial statements. Refer to FASB ASC 220-10-45.
-
In future filings, please provide an analysis of the changes in the cumulative translation adjustment, as appropriate, consistent with the guidance in ASC 830-30-45-18 through 20.
-
We note your presentation of the change in the foreign currency translation adjustment includes the related tax benefit. Please describe for us the transactions and circumstances that resulted in recognizing a tax benefit related to the foreign currency translation adjustment. Refer to ASC 220-10-45-16 and ASC 830-30-40-1.
-
Please revise your accounting policy disclosure to address how you account for the translation adjustments that result from the process of translating your financial statements from the [functional currency] to the [reporting currency]. Please refer to the guidance in ASC 830-30-45. Also disclose the impact of translation adjustments and include an analysis of the changes in the accumulated amount of translation adjustments. Please refer to the guidance in paragraphs 830-30-45-12 and 830-30-50-1.
-
Please expand your discussion and analysis of your consolidated financial results to include other comprehensive (loss) income as it relates to comprehensive income. For example, provide a discussion and analysis of the foreign currencies generating the foreign currency adjustments for the periods presented.
-
Your consolidated statement of income and comprehensive income for the fiscal year ended June [XX, XXXX] and the disclosures in Note [X] indicate that foreign currency translation adjustments reduced your comprehensive income by $[XX] during this period. Given the significance of this amount to your total comprehensive income for the period, please tell us and revise the notes to your financial statements in future filings to disclose the changes in foreign currency exchange rates that resulted in this significant foreign currency translation adjustment for the period.
-
Please expand your discussion and analysis of your consolidated results of operations to include other comprehensive (loss) income as it relates to comprehensive income. Specifically, we note that the components of other comprehensive loss resulted in the recognition of comprehensive income of $[XX] million as compared to consolidated net income of $[XX] million for fiscal year [XXXX] primarily due to currency translation and changes in the fair value of interest rate hedges accounted for as cash flow hedges. For currency translation adjustment, please provide a comprehensive discussion and analysis of the foreign currencies and transactions generating the foreign currency translation adjustments.
-
We note that foreign currency translations adjustments materially impacted the change in comprehensive income from [year 1] to [year 2]. Please expand your discussion and analysis to provide a comprehensive discussion and analysis of the foreign currencies and transactions that led to the adjustments recognized.
-
We note that other comprehensive loss resulted in a decrease to total comprehensive income of [XX]% for fiscal year [XXXX], which far exceeds the impact for the other periods presented. Please expand your disclosure to provide a comprehensive discussion and analysis of the foreign currencies and transactions generating the foreign currency adjustments that led to the adjustment recognized.
-
We note that you recorded $[XX] billion in foreign currency translation losses which materially affected other comprehensive income for the year ended March [XX, XXXX]. Please expand your disclosure in future filings to discuss the nature and timing of the facts or circumstances that led to the significant translation loss. Please also discuss the changes in foreign currency rates and the related foreign operations which related to the translation loss. Please provide us with your proposed disclosures.
-
For the three months ended [XXXX], we note you present a foreign currency translation adjustment gain of [XXXX] in the Condensed Consolidated Statements of Operations and Comprehensive Loss compared to a foreign currency translation adjustment loss of [XXXX] in the Condensed Consolidated Statements of Changes in Stockholder’s Equity. We also note you describe the foreign currency translation adjustment as a gain in other disclosure. Please amend your [XXXX] Form 10-Q to correctly present your foreign currency translation for each period presented.
A.2.6 Statement of Cash Flows — Foreign Currency
The SEC staff often issues comments to registrants when the effects of having
international operations are presented or disclosed elsewhere (e.g., within
the income statement, MD&A, or the notes to the financial statements)
but the effects are not apparent in the statement of cash flows. The
following are examples of comments that registrants have received about
their statements of cash flows:
-
We note you have international operations. Please tell us how you have complied with the guidance set forth in ASC 830-230-45-1 as it relates to your cash flow presentation.
-
We note your Consolidated Statements of Cash Flows does not include a line item for the effect of exchange rate changes in cash. Please tell us if applicable to you and how you complied with the guidance set forth in ASC 830-230-45-1 as it relates to your cash flow presentation.
For more information about foreign currency matters related to the statement
of cash flows, see Section 9.6.
Footnotes
Appendix B — Titles of Standards and Other Literature
Appendix B — Titles of Standards and Other Literature
AICPA Literature
Technical Questions and Answers
Section 2210.27,
“Construction of Asset — Foreign Currency Transaction Gains/Losses”
FASB Literature
ASC Topics
ASC 205, Presentation of
Financial Statements
ASC 220, Income Statement
— Reporting Comprehensive Income
ASC 235, Notes to
Financial Statements
ASC 250, Accounting
Changes and Error Corrections
ASC 255, Changing
Prices
ASC 275, Risks and
Uncertainties
ASC 320, Investments —
Debt Securities
ASC 321, Investments —
Equity Securities
ASC 323, Investments —
Equity Method and Joint Ventures
ASC 326, Financial
Instruments — Credit Losses
ASC 330,
Inventory
ASC 350, Intangibles —
Goodwill and Other
ASC 360, Property, Plant,
and Equipment
ASC 450,
Contingencies
ASC 460,
Guarantees
ASC 470, Debt
ASC 480, Distinguishing
Liabilities From Equity
ASC 505, Equity
ASC 605, Revenue
Recognition
ASC 606, Revenue From
Contracts With Customers
ASC 715, Compensation —
Retirement Benefits
ASC 718, Compensation —
Stock Compensation
ASC 740, Income
Taxes
ASC 805, Business
Combinations
ASC 810,
Consolidation
ASC 815, Derivatives and
Hedging
ASC 820, Fair Value
Measurement
ASC 830, Foreign Currency
Matters
ASC 835, Interest
ASC 842, Leases
ASC 845, Nonmonetary
Transactions
ASU
ASU 2016-13, Financial
Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments
IFRS Literature
IAS 21, The Effects of
Changes in Foreign Exchange Rates
IAS 28, Investments in
Associates
IAS 29, Financial Reporting
in Hyperinflationary Economies
IFRS 5, Non-Current Assets
Held for Sale and Discontinued Operations
IFRS 10, Consolidated
Financial Statements
SEC Literature
FRM
Topic No. 6, “Foreign
Private Issuers and Foreign Businesses”
Regulation S-K
Item 10(e), “General: Use of
Non-GAAP Financial Measures in Commission Filings”
Item 303, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”
Item 305, “Quantitative and
Qualitative Disclosures About Market Risk”
Item 503(c), “Prospectus
Summary, Risk Factors, and Ratio of Earnings to Fixed Charges: Risk
Factors”
Regulation S-X
Rule 3-20, “Currency for
Financial Statements”
Other SEC Literature
Financial Reporting Release
No. 6, Codification of Financial Reporting Policies
The Division of
Corporation Finance: Frequently Requested Accounting and Financial
Reporting Interpretations and Guidance
Superseded Literature
FASB Statements
No. 52, Foreign Currency
Translation
No. 95, Statement of Cash
Flows
No. 158, Statement of
Financial Accounting Standards No. 158 Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans — an amendment of
FASB Statements No. 87, 88, 106, and 132(R)
Appendix C — Abbreviations
Appendix C — Abbreviations
Abbreviation
|
Description
|
---|---|
AFS
|
available for sale
|
AICPA
|
American Institute of Certified Public
Accountants
|
AOCI
|
accumulated other comprehensive income
|
APIC
|
additional paid-in capital
|
ARO
|
asset retirement obligation
|
ASC
|
FASB Accounting Standards Codification
|
ASU
|
FASB Accounting Standards Update
|
BRL
|
Brazilian real
|
BsF
|
Venezuelan Bolivar
|
C&DI
|
SEC Compliance and Disclosure Interpretation
|
CAD
|
Canadian dollar
|
CECL
|
current expected credit loss
|
CTA
|
cumulative translation adjustment
|
DTA
|
deferred tax asset
|
DTL
|
deferred tax liability
|
EITF
|
Emerging Issues Task Force
|
EU
|
European Union
|
EUR
|
euro
|
FAS
|
FASB Statement of Financial Accounting
Standard
|
FASB
|
Financial Accounting Standards Board
|
FC
|
foreign currency
|
FIFO
|
first in, first out
|
FRR
|
SEC Financial Reporting Release
|
FVTNI
|
fair value through net income
|
GAAP
|
generally accepted accounting principles
|
GBP
|
British pound sterling
|
HFI
|
held for investment
|
HFS
|
held for sale
|
HTM
|
held to maturity
|
IAS
|
International Accounting Standard
|
IFRS
|
International Financial Reporting
Standard
|
IMF
|
International Monetary Fund
|
IPTF
|
International Practices Task Force
|
IRS
|
Internal Revenue Service
|
JPY
|
Japanese yen
|
LC
|
local currency
|
MD&A
|
Management’s Discussion and Analysis
|
MXN
|
Mexican peso
|
NCI
|
noncontrolling interest
|
NRV
|
net realizable value
|
OCA
|
SEC Office of the Chief Accountant
|
OCI
|
other comprehensive income
|
PCAOB
|
Public Company Accounting Oversight
Board
|
PLN
|
Polish zloty
|
PP&E
|
property, plant, and equipment
|
ROU
|
right of use
|
SDR
|
special drawing right
|
SEC
|
Securities and Exchange Commission
|
UK
|
United Kingdom
|
USD
|
U.S. dollar
|
VIE
|
variable interest entity
|
WEO
|
World Economic Outlook
|
ZAR
|
South African rand
|
Appendix D — Roadmap Updates for 2024
Appendix D — Roadmap Updates for 2024
The table below summarizes the substantive
changes made in the 2024 edition of this Roadmap.
Section
|
Title
|
Description
|
---|---|---|
4.4.1.2
|
Before the
Adoption of ASU 2016-13 — Impairment of Debt Securities
|
Section
deleted because ASU 2016-13 is now effective for all
entities. Previous Section 4.4.1.3 renumbered to 4.4.1.2 and
“After the Adoption of ASU 2016-13” removed from section
title.
|
4.11.1
4.11.2
|
Leases
|
Deleted sections related to guidance before
and after the adoption of ASC 842, since ASC 842 is now
effective for all entities.
|
Sample SEC
Comments: Foreign Currency
|
Added
discussion of SEC comments related to the Russia-Ukraine
conflict.
|