9.2 Remeasurement

An entity’s functional currency is determined by considering each of the economic factors in ASC 830-10-55. After considering these factors, management may determine that an entity’s functional currency is the currency of the jurisdiction in which the entity 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 (e.g., a U.K. subsidiary of a U.S. parent might have a local currency of pounds sterling, a functional currency of euros, and a reporting currency of U.S. dollars).

Each balance sheet and income statement account must be measured in an entity’s functional currency for financial reporting purposes. Therefore, if an asset or liability or transaction is denominated in a currency other than the functional currency (e.g., local currency), it must be remeasured from that currency into the functional currency. In addition, if an entity’s books and records are not maintained in the functional currency, the entity must remeasure each balance sheet and income statement account into the functional currency. Therefore, an entity’s book basis in an asset or liability is also established in its functional currency.

ASC 830 provides the following guidance on the rate to be used in remeasuring local currency balance sheet and income statement amounts:

Description	Exchange Rate
Monetary assets and liabilities	Current exchange rate
Nonmonetary assets and liabilities	Historical exchange rate
Revenue and expense items	Weighted-average or historical exchange rate

Remeasurement of various balance sheet and income statement items by using different exchange rates will generally cause the balance sheet to not balance; unlike the translation adjustment, the adjustment required to bring the balance sheet into balance is usually recorded through the income statement as a remeasurement gain or loss, or often referred to as a transaction gain or loss.

Regardless of an entity’s functional currency for financial reporting purposes, its tax return is generally prepared in the local currency. Therefore, an entity’s tax basis in an asset or liability is also typically established in the local currency. As a result, the remeasurement gains and losses noted above generally never enter into the tax computation in the local jurisdiction and, hence, represent a permanent difference, as discussed in more detail below.

Example 9-1

Remeasurement — Monetary

Entity S is a foreign subsidiary of Entity X. The functional currency (FC) of S is the euro, which is not the local currency (LC). Assume the following:

On January 1, 20X1, S obtains a 500,000 LC loan from a third party (i.e., monetary liability) when the exchange rate is 1 LC to 1 FC.
Entity S’s tax basis in the loan is 500,000 LC on January 1, 20X1.
On December 31, 20X1, the exchange rate is 1 LC to 2 FC.
For simplicity, assume that the liability balance has not changed.

On December 31, 20X1, S remeasures the liability from its local-currency-denominated value of 500,000 LC to 1 million FC. The remeasured value results in an unrealized pretax remeasurement loss of 500,000 FC for financial reporting purposes. However, there is no change in book/tax basis difference since the amount required to settle the liability (500,000 LC = 1 million FC ÷ 2) and the tax basis (500,000 LC) has not changed. Therefore, although the fluctuations in the exchange rate resulted in a pretax loss for financial reporting purposes, S would not record any deferred taxes (i.e., remeasurement loss represents a permanent item since it is not deductible for income tax reporting purposes).

Connecting the Dots

Because the tax return is generally prepared in the local currency (and taxable income therefore is determined in the local currency), an entity must also calculate the temporary differences in the local currency to determine the amount that will ultimately result in an increase or decrease to taxes payable in future years.

The inherent assumption in ASC 740 regarding the accounting for temporary differences is that assets will be recovered and liabilities will be settled at their respective book basis, which is determined in the entity’s functional currency. Therefore, if the functional currency is different from the local currency, changes in the exchange rate will also change the amount of local currency revenues necessary to recover or settle the book basis of an asset or liability; however, the local currency tax basis will not have changed. In addition, because temporary differences (i.e., the deductible/taxable difference between the book basis and tax basis) must be determined in the local currency, fluctuations in exchanges will affect the book basis of an asset or liability when calculated in the local currency.

The income tax accounting for nonmonetary and monetary assets and liabilities is discussed in further detail in the next sections.

9.2.1 Nonmonetary Assets and Liabilities

When the functional currency is not the local currency, an entity is required to remeasure, for financial reporting purposes, nonmonetary assets and liabilities (e.g., PP&E) from the local currency into the functional currency by using the historical exchange rate (i.e., the exchange rate that was in effect when the transaction was executed). By using the historical exchange rate to remeasure nonmonetary assets and liabilities, the entity achieves the same result it would have achieved had it entered into the related transactions in its functional currency. Therefore, fluctuations in exchange rates will neither increase nor decrease the carrying amount of nonmonetary assets and liabilities (and will not give rise to remeasurement gains and losses for financial reporting purposes).

Under ASC 740, it is assumed that assets will be recovered and liabilities will be settled at their respective financial reporting carrying amounts. Therefore, if the exchange rate changes after a nonmonetary asset or liability is acquired or incurred, respectively, the amount of local currency needed to recover the asset or settle the liability will also change. However, the tax basis of the asset or liability will not change because it would have been established when the asset was acquired or the liability was incurred (in the local currency). Therefore, changes in the exchange rate result in a difference between the amount of local currency needed to recover the functional-currency-denominated carrying value and the local currency tax basis.

ASC 740-10-25-3(f) prohibits “recognition of a deferred tax liability or asset for differences related to assets and liabilities that, under Subtopic 830-10, are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or indexing for tax purposes.” In other words, deferred taxes are not recorded for basis differences related to nonmonetary assets and liabilities that result from changes in exchange rates.

Although this basis difference technically meets the definition of a temporary difference under ASC 740, the FASB concluded that accounting for it as a temporary difference would result in the recognition of deferred taxes on exchange gains and losses that are not recognized in the income statement under ASC 830. For this reason, the FASB decided to prohibit recognition of the deferred tax consequences for those differences.

However, entities are still required to record deferred taxes for differences between the local currency tax basis and the local currency book basis that do not arise from changes in exchange rates or indexing for tax purposes (e.g., when a nonmonetary asset is depreciated over different periods or at different rates for book and tax purposes). The deferred taxes for these types of basis differences are determined in the local currency and then remeasured into the functional currency at the spot rate. See Example 9-3 for an illustration of this concept.

Example 9-2

Temporary Differences Not Recognized Under ASC 740

Entity S is a foreign subsidiary of Entity P. The FC of S is USD, which is not the LC. Assume the following:

On January 1, 20X1, S purchases a piece of equipment for 500,000 LC when the exchange rate is 1 USD to 1.25 LC (i.e., FC book basis is 400,000 USD).
The equipment is depreciable on a straight-line basis over 10 years for both financial reporting and tax purposes.
The foreign tax basis and book basis in the asset is 500,000 LC (the amount paid to acquire the asset). Therefore, no temporary difference exists at the time of purchase.
The exchange rate on December 31, 20X1, is 1 USD to 1.5 LC.
The tax rate in S’s jurisdiction is 30 percent.

In this example, if S were to sell the equipment for its functional currency book basis of $360,000 ($400,000 historical cost less $40,000 of accumulated depreciation) as of December 31, 20X1, S would not recognize any book gain or loss in its functional currency financial statements. However, S would realize a taxable gain of 90,000 LC in its local tax return, as illustrated in the following table:

The difference between the local-currency-denominated hypothetical sale proceeds and the tax basis meets the definition of a temporary difference. However, because ASC 740-10-25-3(f) prohibits the recognition of deferred taxes associated with differences related to nonmonetary assets and liabilities that are caused by changes in the exchange rate, S should not record deferred taxes for the 90,000 LC basis difference.

In this example, there are no other differences between the local currency book basis and the local currency tax basis of the equipment that would give rise to deferred taxes.

Example 9-3

Temporary Differences Recognized Under ASC 740

Assume the same facts as in the example above, except:

The equipment is depreciated over five years for tax purposes.
The weighted-average exchange rate during 20X1 is 1 USD to 1.35 LC.

As of December 31, 20X1, Entity S measures the deferred taxes related to the equipment, as illustrated in the following table (all amounts are in local currency):

As indicated above, S recognizes a DTL of 15,000 LC (30% of 50,000 LC) as of December 31, 20X1, related to the equipment for the difference between the local currency book basis and local currency tax basis caused by the difference in depreciation methods. The DTL is then remeasured into the functional currency at the reporting-date spot rate. In addition, S recognizes a deferred tax expense of 15,000 LC in 20X1 as a result of the increase in the DTL, which is then remeasured into the functional currency at the weighted-average exchange rate in effect during 20X1. The difference between these two amounts results in a foreign currency transaction gain during 20X1, as illustrated in the following table:

In accordance with ASC 830-740-45-1, S may present the transaction gain as a deferred tax benefit (as opposed to a transaction gain above the line) if that presentation is considered more useful. If the transaction gain is reported in that manner, it would still be included in the aggregate transaction gain or loss for the period to be disclosed as required by ASC 830-20-45-1.

9.2.2 Indexing of the Tax Basis

In addition to fluctuations in the exchange rate, basis differences may arise for nonmonetary assets and liabilities as a result of indexing that is permitted or required under the local tax law. Specifically, certain countries (especially those with economies that are considered highly inflationary) may permit or require taxpayers to adjust the tax basis of an asset or liability to take into account the effects of inflation. The inflation-adjusted tax basis of an asset or liability would be used to determine the future taxable or deductible amounts.

ASC 740-10-25-3(f) prohibits the recognition of a DTL or DTA for tax consequences of “differences related to assets and liabilities that, under Subtopic 830-10, are remeasured from the local currency into the functional currency using historical exchange rates and that result from changes in exchange rates or indexing for tax purposes” (emphasis added).

As discussed in Section 9.2, under ASC 830, assets and liabilities are remeasured when the local currency and the functional currency are not the same. The exception in ASC 740-10-25-3(f) applies only with respect to nonmonetary assets and liabilities when the parent remeasures the foreign entity’s financial statements from the local currency into the functional currency (i.e., by using historical exchange rates). DTAs and DTLs are considered to be monetary assets and liabilities,1 and therefore, the prohibition in ASC 740-10-25-3(f) would not apply to the indexation of NOL carryforwards, if permitted. If the foreign entity’s local currency is the functional currency (i.e., subject to translation rather than remeasurement), the guidance in ASC 740-10-25-3(f) does not apply. The foreign entity would recognize the deferred tax effects of any indexing, and the parent would then translate the resulting deferred taxes into the reporting currency. The example below illustrates this concept.

Example 9-4

Assume that Entity X reports under U.S. GAAP in USD and has operations in a foreign country in which the local currency is the functional currency. Under the foreign jurisdiction’s tax law, the tax basis of depreciable assets increases in accordance with a particular index. That increase is 10 percent at the end of 20X1, and X is therefore able to deduct additional depreciation in current and future years. Further, at the end of 20X1, the basis of depreciable assets is 1,000 FC units for financial reporting purposes and 1,100 FC units for tax purposes after indexing is taken into account. In addition, the foreign tax rate is 50 percent, and the current exchange rate between the foreign currency and the USD is 2 FC to $1.

Entity X would establish a DTA related to the indexation of the tax basis. The DTA is measured in accordance with foreign tax law and is determined on the basis of the deductible temporary difference between the financial reporting basis of the asset (1,000 FC) and the indexed tax basis (1,100 FC). Thus, at the end of 20X1, X would record a DTA of 50 FC ([1,100–1,000] × 50%) in the foreign currency books of record. That DTA would be translated as $25 (50 FC × 0.5) on the basis of the current exchange rate.

Note that in accordance with ASC 740-10-25-3(f), if the functional currency is different from the local currency, the DTA related to the indexed tax basis would not be recognized.

9.2.3 Monetary Assets and Liabilities When the Reporting Currency Is the Functional Currency

As stated above, the exception in ASC 740-10-25-3(f) does not apply to assets and liabilities that are remeasured by using current exchange rates (referred to as “monetary assets and liabilities”). However, when a foreign entity’s functional currency is different from the local currency (e.g., the functional currency is the reporting currency of its parent), the foreign entity’s deferred tax accounting for monetary assets and liabilities depends on whether the asset or liability is denominated in the local currency or the reporting currency.

9.2.3.1 Local-Currency-Denominated Monetary Assets and Liabilities

When a monetary asset or liability is denominated in an entity’s local currency, it must be remeasured into the entity’s functional currency each period by using the current exchange rate for financial reporting purposes. Therefore, when the reporting currency is the functional currency, monetary assets and liabilities denominated in the local currency must be remeasured into the reporting currency at the then-current exchange rate. Fluctuations in the exchange rate between the local currency and the reporting currency will result in (1) changes in the financial-reporting carrying value of the monetary asset or liability and (2) transaction gains and losses for financial reporting purposes.

However, although a pretax gain or loss is recognized for financial reporting purposes, there will be no current or deferred tax expense or benefit. This is because the exchange rate fluctuations will not result in taxable income or loss when the asset is recovered or the liability is settled since the local currency is used to determine taxable income (i.e., those gains and losses exist only when the asset or liability is measured in the functional currency). Further, these exchange rate fluctuations do not contribute to any difference between the book and tax basis of the asset or liability when the book basis is measured in the local currency. Therefore, there are no current or deferred tax consequences related to the transaction gains and losses. Thus, such gains or losses will be permanent items that affect the ETR (i.e., pretax income or loss with no related tax expense or benefit).

Example 9-5

Local-Currency-Denominated Debt

Entity A, a foreign entity located in Canada, has a U.S. parent that uses the USD as its reporting currency. In accordance with ASC 830, A determines that its functional currency is the reporting currency of its parent (USD) and not the local currency, the Canadian dollar (CAD). Entity A’s currency for income tax reporting purposes is the CAD. On September 30, 20X5, A obtains a loan for CAD 100 million from its U.S. parent when the exchange rate is USD 1 to CAD 1.25. The exchange rate on December 31, 20X5, is USD 1 to CAD 1.33.

On September 30, 20X5, the date of the borrowing, A records the loan at its USD-equivalent value of USD 80 million (CAD 100 million ÷ 1.25). Entity A’s tax basis in the borrowing is the initial amount borrowed of CAD 100 million (i.e., the tax basis is the local-currency-denominated amount).

On December 31, 20X5, A remeasures the liability from its local-currency-denominated value of CAD 100 million into USD by using the exchange rate in effect on that date. The remeasured value of USD 75 million (CAD 100 million ÷ 1.33) results in an unrealized pretax transaction gain of USD 5 million for financial reporting purposes, which is the difference between the financial statement carrying value (in USD) on September 30, 20X5, and that on December 31, 20X5.

However, on December 31, 20X5, there is no unrealized gain for tax purposes because there is no difference between the amount required to settle the liability (CAD 100 million) and the tax basis of the liability (CAD 100 million). Since taxable income is determined by using CAD and the loan is denominated in CAD, the balance is unchanged from its original tax basis of CAD 100 million and there is no unrealized gain for tax corresponding to the gain for financial reporting. Therefore, although the fluctuation in the exchange rate resulted in a pretax gain for financial reporting purposes, A would not record any deferred taxes.

Observation

As discussed above, A will have pretax gain or loss on a separate-company basis but will not have any corresponding tax expense or benefit. On a consolidated basis, because the loan is denominated in CAD, there will be an equal and offsetting pretax gain or loss for the U.S. parent. So, on a consolidated basis, there will be no net pretax gain or loss. While such a pretax gain or loss will not have any tax effects for A (since A’s tax return is filed in CAD), there will be a tax effect related to the U.S. parent’s pretax amount since the parent uses USD in filing its tax return. The U.S. parent will have a deferred tax effect related to the CAD-denominated loan since the USD amount required to settle the loan fluctuates from the tax basis of the liability (the USD equivalent of the CAD 100 million when the loan is entered into). In summary, there will be no pretax gain or loss on a consolidated basis (there are equal and offsetting pretax amounts) and no Canadian tax effect for A; however, there will be a tax effect for the U.S. parent, which will affect the ETR.

9.2.3.2 Reporting-Currency-Denominated Monetary Assets and Liabilities

Unlike the local-currency-denominated monetary assets and liabilities discussed above, monetary assets or liabilities denominated in an entity’s reporting currency do not need to be remeasured for financial reporting purposes since they are already denominated in the functional currency. Therefore, in such cases, currency fluctuations do not give rise to pretax transaction gains or losses for financial reporting purposes.

However, fluctuations in the exchange rates will create a difference between the book and tax basis of the asset or liability when the local-currency equivalent of the reporting-currency book basis is compared with the local-currency tax basis. Therefore, although no pretax gain or loss is recognized for financial reporting purposes, current or deferred taxes may be required. Whether a current or deferred tax is required in this situation depends on whether the entity will be taxed on a realized or unrealized basis, as explained below:

Realized basis (or “settlement approach”) — The gain or loss is included in taxable income only on the date the asset is recovered or the liability is settled. The amount of gain or loss is calculated by comparing the initial tax basis of the asset or liability with its tax basis when the asset or liability is recovered or settled, respectively. The initial tax basis of the asset or liability is generally the local-currency equivalent of the reporting-currency carrying value, determined by using the spot rate on the transaction date. The tax basis of the asset or liability upon settlement is generally the local-currency equivalent of the reporting-currency carrying value, determined by using the spot rate on the settlement/recovery date.
Unrealized basis (or “mark-to-spot approach”) — The unrealized gain or loss is included in taxable income each year. The amount of unrealized gain or loss is calculated by comparing the initial tax basis of the asset or liability with its tax basis at the end of each year. The initial tax basis is determined in the same manner as the initial tax basis determined under the settlement approach described above. The tax basis of the asset or liability at the end of each year is generally the local-currency equivalent of the reporting-currency carrying value, determined by using the spot rate in effect at the end of the year.

If a foreign entity is taxed under the settlement approach, it is necessary to calculate a temporary difference and related DTL or DTA as of the end of each reporting period. The amount of deferred taxes required is equal to the difference between the initial tax basis of the asset or liability (in local currency) and the local-currency equivalent of the financial-statement carrying value, determined by using the exchange rate in effect at the end of the year and multiplied by the enacted tax rate expected to apply.

Conversely, for jurisdictions that tax unrealized foreign exchange gains or losses under the mark-to-spot approach, there will generally be no temporary difference since the entire unrealized amount will be included in taxable income as it arises and a corresponding current tax expense or benefit will be recognized.

Because any tax expense or benefit (whether current or deferred) will not have a corresponding pretax book amount, the related tax expense or benefit will generally affect the ETR that should be appropriately disclosed in the footnotes to the financial statements.

Example 9-6

Reporting-Currency-Denominated Debt

Assume the same facts as in Example 9-5, except that the loan is for 100 million denominated in USD, instead of CAD, and Entity A’s tax rate is 30 percent.

On September 30, 20X5, the date of the borrowing, A records the loan at its USD-equivalent value of USD 100 million. Entity A’s initial tax basis in the loan is CAD 125 million, the local-currency equivalent of the amount borrowed, which is calculated by using the exchange rate in effect on the date of the borrowing (USD 100 million × 1.25).

On December 31, 20X5, the financial-reporting carrying value of the loan is still USD 100 million since the loan is denominated in the functional currency. However, the local-currency-equivalent value of the loan has changed to CAD 133 million as a result of the fluctuation in the exchange rate. Therefore, the change in the exchange rate has created an unrealized tax loss of CAD 8 million (equal to the difference between the book and tax basis of the loan when converted into the local currency).

If A is taxed under the settlement approach, it would record a DTA of CAD 2.4 million, which is equal to the tax effect of the difference between the tax basis of the loan and the local-currency-equivalent value on December 31, 20X5, or (CAD 125 million – CAD 133 million) × 30%. The DTA would be recognized at the average exchange rate (to determine the amount to recognize as an income tax benefit) and would then be remeasured at the exchange rate in effect on December 31, 20X5; any difference between the two amounts would be included in the income statement. Under ASC 830-740-45-1, A may present the transaction gain or loss that results from remeasuring the DTA as deferred tax expense or benefit (as opposed to foreign-currency transaction gain or loss) if such presentation is considered 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, which is disclosed in accordance with ASC 830-20-45-1.

Conversely, if A is taxed under the mark-to-spot approach, it would recognize a taxable loss of CAD 8 million and should record a CAD 2.4 million reduction in current tax payable and a CAD 2.4 million income tax benefit.

Observation

In this example, there will be no pretax income for either A or the U.S. parent, nor will there be such income in consolidation (since A, the U.S. parent, and the consolidated financial statements use USD). Further, the U.S. parent in this example (unlike the U.S. parent in Example 9-5) will have no tax effect since the loan is denominated in USD and the U.S. parent files its tax return in USD. However, A will have a tax effect (either current or deferred, depending on Canadian tax law) related to the loan, since it files its tax return in CAD but the loan is denominated in USD.

In summary, in both examples, there is no consolidated pretax gain or loss. (In Example 9-5, there are equal and offsetting pretax amounts; in this example, because the loan is denominated in USD, there is no pretax gain or loss in either A or the U.S. parent.) In each example, there is a tax effect in the consolidated financial statements (and that tax effect affects the ETR, since there is a tax effect with no corresponding pretax amount; however, see Section 9.7 for a possible exception). In Example 9-5, the loan is denominated in CAD so the tax effect is in the U.S. parent; in this example, the loan is denominated in USD so the tax effect is in A.

Footnotes

Paragraph 54 of FASB Statement 52 (not codified).

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