Audit and Enterprise Risk Services
Foreign Currency Exchange Accounting Implications of Recent Government Actions in Venezuela
Financial Reporting Alert 14-1
This alert discusses considerations related to accounting and disclosure under U.S. GAAP in connection with the foreign currency exchange environment in Venezuela for the quarter or year ended March 31, 2014, including views that the SEC staff recently expressed in informal discussions.
The Commission for the Administration of Foreign Exchange (CADIVI) until recently controlled the sale and purchase of foreign currency in Venezuela and set an official exchange rate of 6.3 Venezuelan bolivar fuertes (BsF) to 1 U.S. dollar (USD) (the “official rate”). In 2013, the Venezuelan government authorized certain companies that operate in designated industry sectors to exchange a limited volume of bolivars for dollars at a bid rate established via weekly auctions under the Complementary System of Foreign Currency Acquirement (“SICAD 1”). These auctions became weekly starting in October 2013, and in late December 2013, the Venezuelan government authorized the Central Bank of Venezuela to begin publishing the average exchange rate resulting from the weekly SICAD 1 auction (the exchange rate determined at auctions during that time was approximately 11.3 BsF to 1 USD).
Effective January 24, 2014, additional changes to the country’s foreign exchange system were enacted by the Venezuelan government. The law (Convenio Cambiario 25) expanded the types of transactions that may be subject to the weekly SICAD 1 auction process while retaining the official rate of 6.3 BsF to 1 USD. In January 2014, the Venezuelan government also announced the replacement of CADIVI with a new foreign currency administration, the National Center for Foreign Commerce (CENCOEX). An entity may seek approval to transact through the CENCOEX mechanism at the official rate; however, we understand that certain transactions may be approved at the latest published SICAD 1 rate depending on an entity’s facts and circumstances.
In February 2014, the Venezuelan government announced plans for another currency exchange mechanism (“SICAD 2”), which:
· Is expected to provide a greater supply of USD from sources other than the Venezuelan government.
· Is expected to allow all sectors and companies to participate.
· Is regulated by the Venezuelan government.
· Permits USD to be offered in cash or bonds.
The SICAD 2 rate is intended to more closely resemble a market-driven exchange rate than the rates provided by Venezuela’s other regulated exchange mechanisms (i.e., the official rate and the SICAD 1 rate). SICAD 2 became effective on March 24, 2014, and yielded an exchange rate significantly higher than the rates established through the other regulated exchange mechanisms. The SICAD 2 exchange rate closed at 50.86 BsF to 1 USD on March 31, 2014, compared with a closing rate of 10.70 BsF to 1 USD established at the last SICAD 1 auction in March 2014.
Thus, as of March 31, 2014, an entity may be able to convert BsF to USD at one of three legal exchange rates obtained via the following four exchange rate mechanisms:
· CENCOEX (official rate).
· CENCOEX (latest published SICAD 1 rate).
· SICAD 1 auction (SICAD 1 rate).
· SICAD 2 auction (SICAD 2 rate).
Remeasurement in an Environment With Multiple Exchange Rates
Since 2010, Venezuela has been considered a highly inflationary economy; accordingly, an entity must remeasure the financial statements of its Venezuelan subsidiaries as if the subsidiaries’ functional currency were the entity’s reporting currency (see ASC 830-10-45-111). As a result, each Venezuelan subsidiary of an entity that reports under U.S. GAAP must account for all BsF-denominated transactions as foreign-currency-denominated transactions, which, under ASC 830, must be remeasured each reporting period into the subsidiary’s functional currency (e.g., USD), with changes in foreign currency rates related to BsF-denominated monetary balances recognized in the income statement. ASC 830-20-30-3 indicates that to perform such remeasurement, entities should use the applicable rate(s) at which a transaction could settle as of the transaction date to translate and record the transaction. Given the existence of multiple exchange rates, it may be difficult for entities to make this determination in practice.
For the period ended December 31, 2013, entities reporting under U.S. GAAP generally used the official rate to remeasure BsF-denominated transactions in the financial statements of Venezuelan subsidiaries since that rate was the only legal exchange rate available to most entities. Given recent developments, there are now multiple exchange mechanisms and published exchange rates potentially available for remeasurement, beginning with the reporting period ended March 31, 2014. Accordingly, entities 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 an 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. As of March 31, 2014, an entity may not have experience with settling transactions at either the SICAD 1 or SICAD 2 exchange rate 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.
When determining the most appropriate exchange rate(s) for remeasurement of its Venezuelan operating subsidiary’s BsF-denominated monetary balances, an entity may find the following process helpful:
· Identify those transactions for which the Venezuelan government has granted approval to obtain USD at the official, SICAD 1, or SICAD 2 rate (including BsF-denominated monetary assets that will be required to settle approved USD-denominated liabilities) and remeasure by using the preapproved exchange rate(s).
· For any remaining USD-denominated liabilities (i.e., those for which the Venezuelan government has not yet granted approval to settle by using USD obtained at the official, SICAD 1, or SICAD 2 rate), determine which mechanisms the entity can access to obtain USD and remeasure the volume of BsF-denominated monetary assets needed to obtain those USD at the exchange rates that the entity expects to use when it settles the USD-denominated payables.
· Remeasure any remaining net BsF-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.
Classified Balance Sheet Consideration
Entities with classified balance sheets should consider whether classifying certain BsF-denominated monetary assets as current is still appropriate in light of the present economic environment in Venezuela. 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 BsF-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 requires to operate over the course of one year or its operating cycle.
Deconsolidation and Impairment Considerations
Volume restrictions on exchange activity in Venezuela (either explicit or in-substance), in conjunction with the uncertainties of obtaining approval for foreign exchange through the established exchange mechanisms, may cause an entity to question whether there is an other-than-temporary lack of exchangeability associated with its Venezuelan operations. Entities should consider the guidance in ASC 830-20-30-2, which states, in part:
If the lack of exchangeability [between two currencies] 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.
The mere existence of such exchange restrictions does not in and of itself create a presumption that an entity should deconsolidate its Venezuelan operations, nor does the ability to exchange some volume of currency create a presumption that continued consolidation of Venezuelan operations is appropriate. An entity must make such a determination on the basis of its specific facts and circumstances.
Even if an entity ultimately concludes that deconsolidation is appropriate, it still must determine (1) the date to use for deconsolidation and (2) the appropriate exchange rate to use for remeasuring its deconsolidated investment and any other outstanding monetary balances that are no longer eliminated in consolidation. Regardless of whether consolidation is still considered appropriate, an entity should assess whether the severity of the foreign currency exchange controls represents a triggering event that would require it to assess its Venezuelan investments, long-lived assets, and any other outstanding balances of its Venezuelan operations for impairment.
Similarly, entities that hold investments in Venezuelan operations accounted for under the equity and cost methods as well as available-for-sale Venezuelan debt or equity securities should assess whether an other-than-temporary impairment resulting from the operating and economic uncertainties in Venezuela may exist as of the balance sheet date (e.g., March 31, 2014).
Need for Robust Disclosure
In an environment with multiple legally accessible exchange rates, the basis for certain accounting decisions (e.g., the determination of the appropriate exchange rate(s) to use for remeasurement) may not be entirely clear. Accordingly, it is critical that entities provide robust disclosure in the notes to the financial statements as well as in the Description of Business, Risk Factors, and MD&A sections of their SEC filings. Entities should also clearly document their accounting conclusions and the underlying rationale as part of their internal control environment review and assessment process.
The SEC staff indicated in informal discussions that a registrant should consider additional disclosures related to its Venezuelan operations if such disclosures are material. The following are consistent with our understanding of disclosures recommended by the SEC staff:
· The overall environment in Venezuela 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 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 Venezuelan operations. This includes the nature of the entity’s activities in Venezuela (e.g., imports, manufacturing, and size of operations) and other meaningful financial information, such as disaggregated financial information about the Venezuelan operations (e.g., summarized balance sheets, income statements, and cash flow statements). The entity should also describe the possible effects of Venezuela’s foreign exchange limitations or restrictions on the entity’s operations, including how such limitations or restrictions may affect the entity’s liquidity, cash flows, or debt covenants.
· The Venezuelan government’s actions regarding exchange rates, including current volume restrictions or limitations on foreign exchange and how such restrictions or limitations affect the entity’s ability or inability to settle transactions at the official, SICAD 1, or SICAD 2 rate. The entity should also describe how those restrictions or limitations affect the application of the entity’s accounting policies.
· The exchange rate(s) used for remeasurement and the basis for judgments made in determining the rate(s), including:
o 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.
o Any volume restrictions or limitations on a particular exchange rate.
o Any assumptions used in the determination of the appropriate exchange rate.
o Any risks or uncertainties related to the entity’s ability to settle at the exchange rate selected.
o A description of the use of any exchange rates that differ from those used in prior reporting periods (e.g., changing from the official rate to the SICAD 1 rate or SICAD 2 rate, or both).
In addition to the above, we believe that 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 official, SICAD 1, or SICAD 2 rate for remeasurement and (2) the financial statement line item in which the gain or loss is recorded.
· The amount of BsF that is awaiting government approval for settlement at the official, SICAD 1, or SICAD 2 rate and the time that has elapsed since such approval was requested.
· If applicable, the basis for the entity’s decision to deconsolidate its investment in Venezuelan operations because the lack of exchangeability in Venezuela is other than temporary. Similar disclosure is encouraged when an entity has concluded that (1) the lack of exchangeability is temporary and
Because of the complexity of these accounting and disclosure issues, we encourage entities with Venezuelan operations to consult with their accounting advisers and legal counsel.
For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”