Accounting for Foreign Currency Publication Date: September 2020
Accounting for Foreign Currency
Copyright © 2020 by
DELTACPE LLC
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Course Description
In today’s modern economy, the growth of foreign operations is continuing upward and the number of companies
with foreign operations has expanded. For example, a company often operates in different economic and currency
environments to stay competitive in the global marketplace. Thus, it must have a process for reporting foreign
currency balances to address several financial reporting issues, such as determining functional currencies,
accounting for foreign currency transactions, and translating its foreign entity’s financial statements. ASC 830
Foreign Currency Matters provides guidance for transactions denominated in a foreign currency, and for
operations undertaken in a foreign currency environment. This course covers key aspects of the guidance and
includes specific examples to illustrate its application. Relevant references to and excerpts from ASC 830 are
discussed throughout the course.
Field of Study Accounting
Level of Knowledge Intermediate
Prerequisite None
Advanced Preparation None
Learning Objectives
After completing this section, you should be able to:
1. Recognize key areas of guidance in ASC 830 Foreign Currency Matters
2. Identify steps to remeasure foreign currency transactions to the functional currency
3. Identify steps to translate foreign currency financial statements to the reporting currency
Table of Contents
I. Basic Principles of ASC 830 .................................................................................. 1
A. Scope and Scope Exceptions ........................................................................................... 1
B. The Accounting Model for Foreign Currency Matters ...................................................... 2
Example 1: The Translation Process of Foreign Currency Transactions and Financial Statements ............4
II. Determine the Functional Currency ................................................................... 5
A. General Rules ................................................................................................................. 5
B. Classes of Foreign Operations ......................................................................................... 6
C. Factors in Determining the Functional Currency .............................................................. 8
Example 2: Determination of the Functional Currency ...............................................................................9
D. Highly Inflationary Environment ................................................................................... 10
Example 3: Determination of Highly Inflation ......................................................................................... 10
E. Change in the Functional Currency ................................................................................ 11
Example 4: Change in Functional Currency ............................................................................................. 12
Example 5: Functional Currency Changes Because the Economy is No Longer Highly Inflationary ........ 13
The SEC’s View on Changes in Functional Currency................................................................................. 14
Review Questions – Section 1 .............................................................................. 16
III. Remeasure Foreign Currency Transactions to the Functional Currency ........... 17
A. General Rules ............................................................................................................... 17
Example 6: Remeasurement Requirements ............................................................................................. 17
B. Selection of Exchange Rates for Remeasurement .......................................................... 18
Monetary Accounts ........................................................................................................................... 18
Nonmonetary Accounts ..................................................................................................................... 18
C. Transaction Gains or Losses .......................................................................................... 20
Example 7: Determining Transaction Gains or Losses ............................................................................. 20
D. Foreign Currency Transactions ...................................................................................... 22
1. Property, Plant and Equipment .................................................................................................. 22
Example 8: Depreciation of Fixed Assets ................................................................................................. 22
2. Inventories.................................................................................................................................. 23
Example 9: Write-down of Inventory Measured Using FIFO ................................................................... 23
3. Debt ............................................................................................................................................ 24
4. Debt and Equity Securities ......................................................................................................... 25
Trading Debt Securities ............................................................................................................................... 26
Available-for-Sale Debt Securities ............................................................................................................... 26
Held-to-Maturity Debt Securities ................................................................................................................ 26
Equity Securities .......................................................................................................................................... 27
5. Foreign Currency Leases ............................................................................................................ 27
Lessee Accounting ....................................................................................................................................... 27
Lessor Accounting ........................................................................................................................................ 28
Comprehensive Illustration: Remeasurement of Foreign Currency Transactions to the
Functional Currency .......................................................................................................... 29
1. Accounts Receivable................................................................................................................... 29
2. Inventory .................................................................................................................................... 30
3. Held-to-Maturity Debt Securities ............................................................................................... 31
4. Foreign Subsidiary Accounts ...................................................................................................... 33
Review Questions – Section 2 .............................................................................. 34
IV. Translate Foreign Currency Financial Statements............................................ 36
A. General Rules ............................................................................................................... 36
B. Selection of Exchange Rates for Translation .................................................................. 37
Example 10: Exchange Rate When Exchangeability is Lacking Temporarily ........................................... 38
1. Balance Sheet ............................................................................................................................. 39
2. Income Statement ...................................................................................................................... 39
3. Cash Flow Statement.................................................................................................................. 39
C. Translation Adjustments ............................................................................................... 39
Example 11: Reporting Gains or Losses ................................................................................................... 40
D. Highly Inflationary Environment ................................................................................... 40
E. Derecognition ............................................................................................................... 42
1. Disposition of a Foreign Entity ................................................................................................... 42
Example 12: Reporting Translation Adjustments .................................................................................... 43
2. Partial Sale of Ownership Interest ............................................................................................. 44
Example 13: Partial Sale of Ownership Interest ...................................................................................... 45
Release of Cumulative Translation Adjustment Decision Tree ................................................................... 46
3. Cumulative Translation Adjustment in Impairment Assessment .............................................. 47
Example 14: Impairment Assessment ...................................................................................................... 47
Comprehensive Illustration: Translation of Foreign Entity Financial Statements ................ 48
V. Other Matters ................................................................................................. 51
A. Intercompany Profits .................................................................................................... 51
Example 15: Elimination of Intercompany Profits ................................................................................... 51
B. Hedging ........................................................................................................................ 52
C. Disclosures .................................................................................................................... 54
1. Aggregate Transaction Gains or Losses ...................................................................................... 54
2. Cumulative Translation Adjustments ......................................................................................... 54
3. Exchange Rate Changes .............................................................................................................. 54
4. Footnote Disclosure ................................................................................................................... 55
5. Excluding a Foreign Entity from Financial Statements ............................................................... 56
The SEC’s View on Disclosures, if the U.S. Dollar is Not the Reporting Currency ..................................... 56
D. Difference between U.S. GAAP and IFRS ....................................................................... 57
Determination of Functional Currency .............................................................................................. 58
Highly Inflationary Economy .............................................................................................................. 59
Review Questions – Section 3 .............................................................................. 60
Glossary ............................................................................................................... 61
Index ................................................................................................................... 63
Review Question Answers ................................................................................... 64
Review Questions − Section 1 ........................................................................................... 64
Review Questions − Section 2 ........................................................................................... 65
Review Questions − Section 3 ........................................................................................... 68
1
I. Basic Principles of ASC 830
A. Scope and Scope Exceptions
Financial statements are intended to effectively communicate financial information about the performance,
financial position, and cash flows of a reporting entity to investors and creditors and other parties. Thus, 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. That is, the reporting entity must prepare financial statements in a single
reporting currency. If the foreign statements have any accounts expressed in a currency other than their own,
they have to be converted into the foreign statement's currency prior to translation into U.S. dollars or any other
reporting currency.
According to ASC 830, a reporting entity is an entity or group whose financial statements are being referred to.
Those financial statements reflect any of 1) the financial statements of one or more foreign operations by
combination, consolidation, or equity accounting 2) foreign currency transactions. Reporting currency is the
currency in which an entity prepares its financial statements
ASC 830 Foreign Currency Matters (formerly FAS 52 Foreign Currency Translation) provides accounting and
reporting requirements for converting transactions and financial statements from a foreign currency to the
reporting currency. ASC 830 applies to the financial statements of ALL entities prepared in conformity with U.S.
generally accepted accounting principles (GAAP), whether the U.S. dollar or a foreign currency is the reporting
currency. That is, a foreign entity may report in its local currency in conformity with U.S. GAAP. For example, a
Chinese entity whose reporting currency is the Chinese yuan but reports in conformity with U.S. GAAP should
follow the requirements of ASC 830.
According to ASC 830, a foreign entity is an operation (for example, subsidiary, division, branch, joint venture, and
so forth) whose financial statements are both: 1) prepared in a currency other than the reporting currency of the
reporting entity 2) combined or consolidated with or accounted for on the equity basis in the financial statements
of the reporting entity.
ASC 830-10-15-3 specifies that ASC 830 applies to:
✓ Foreign currency transactions, including imports and exports denominated in a currency other than the
company's functional currency.
✓ Foreign currency financial statements of divisions, branches, and other investees included in the financial
statements of a U.S. company by consolidation, combination, or the equity method.
2
According to ASC 830, 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.
ASC 830-10-15-7 indicates that ASC 830 does NOT apply to the translation of financial statements for purposes
other than consolidation, combination, or the equity method. For example, it does not cover translation of the
financial statements of a reporting entity from its reporting currency into another currency for the convenience
of readers accustomed to that other currency. ASC 830-20-15-2(a) also states that ASC 830 does NOT apply to
transactions involving derivative instruments. The derivatives guidance is codified in ASC 815 Derivatives and
Hedging.
B. The Accounting Model for Foreign Currency Matters
It is important to know that before applying ASC 830, a foreign entity's financial statements must be prepared in
accordance with GAAP. ASC 830 requires two accounting tasks for reporting foreign currency balances:
1. Foreign currency remeasurement: This is the process of expressing transactions denominated in a foreign
currency in its functional currency.
2. Foreign currency translation: This is the process of converting a foreign entity’s functional currency
financial statements into the reporting currency for preparing the reporting entity's (consolidated)
financial statements.
The following diagram illustrates the two distinct processes:
As shown in the example above, a U.S.-based conglomerate has a subsidiary in Norway that keeps its books and
records using the krone (Kr) (its local currency). But its primary operations involve Eurozone entities. Accordingly,
to prepare the consolidated financial statements, the parent first must remeasure all unsettled transactions of
the subsidiary from kroner to functional currency (euros). It then must translate those remeasured amounts into
reporting currency (U.S. dollars).
A key distinction between remeasurement and translation is:
U.S.
Reporting currency
(consolidated statements)
$
Eurozone
Functional currency
€
Norway
Local currency
(books of the subsidiary)
Kr
Step 1:
Remeasurement
Step 2:
Translation
3
• Transaction gains or losses, changes in functional currency amounts resulting from the remeasurement
process, are recognized in the income statement (net income from continuing operations) in the period
in which the exchange rate changes (affecting earnings).
• Translation adjustments, changes resulting from the process of converting financial statements from the
entity's functional currency into the reporting currency, are included in other comprehensive income
(affecting equity).
According to ASC 830, the exchange rate is 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.
The following table summarizes the difference between remeasurement and translation.
Foreign currency
remeasurement
The process of expressing transactions
denominated in a foreign currency in its
functional currency.
Cash flow
consequence
Affects
earnings
Foreign currency
translation
The process of expressing in the reporting
currency of the enterprise those amounts that
are denominated or measured in a different
currency
No cash flow
consequence
Affects
equity
It is presumed under ASC 830 that the reporting currency for a company is U.S. dollars; however, it is possible that
the reporting currency may be other than U.S. dollars.
The objectives of remeasurement and translation are to:
✓ Provide information that is generally compatible with the expected economic effects of a rate change on
an entity's cash flows and equity; and
✓ Reflect in consolidated statements the financial results and relationships as measured in its functional
currency.
The key steps in accomplishing the objectives include:
Determine the functional currency: An essential purpose in translating foreign currency is to preserve the
financial performance and relationships expressed in the foreign currency. This is achieved by using the foreign
entity's functional currency.
Details are discussed in the “Determine the Functional Currency” chapter.
Determine the functional currency
Remeasure foreign currency transactions to the functional currency
Translate foreign currency financial
statements
4
Remeasure foreign currency transactions: Once the functional currency of an entity is identified, transactions
denominated in a currency other than its functional currency should be measured in the functional currency.
Details are discussed in the “Remeasure Foreign Currency Transactions” chapter.
Translate foreign currency financial statements: After the remeasurement process is complete, the financial
statements stated in the functional currency should be translated to the reporting currency via the current rate
method.
Details are discussed in the “Translate Foreign Currency Financial Statements” chapter.
Since the FASB released its initial guidance on foreign currency in 1981, there have been very few amendments
within ASC 830.
Example 1: The Translation Process of Foreign Currency Transactions and Financial Statements
Smith Corp., a U.S. company, has a Mexican subsidiary, PETRO, whose records are maintained in Mexican pesos.
However, due to other factors, the functional currency for the subsidiary is actually Canadian dollars. The accounts
of PETRO must be remeasured into Canadian dollars before the financial statements are then translated into the
reporting entity's currency (in this case, U.S. dollars). An ensuing translation gain or loss from Mexican pesos to
Canadian dollars is included in the remeasured net income.
However, if PETRO’s functional currency was instead the Mexican peso, there is only a need to translate to the
reporting currency (U.S. dollars).
Finally, if PETRO's functional currency was the same as that of the reporting entity, Smith, remeasurement is only
from the Mexican peso to the reporting currency (U.S. dollars).
5
II. Determine the Functional
Currency “The assets, liabilities, and operations of a foreign entity must be measured using the functional currency of that
entity.”
ASC 830-10-45-2
A. General Rules
The FASB believes that the most meaningful measurement unit for the assets, liabilities, and operations of an
entity is the currency in which it primarily conducts its business, assuming that currency has reasonable stability.
Thus, ASC 830-10-45-2 requires that the assets, liabilities, and operations of a foreign entity be measured in the
functional currency of that entity.
A reporting entity must determine the functional currency of each foreign entity (distinct and separable operation)
included in its consolidated financial statements. The choice of functional currency often depends on the
relationship between the reporting entity (parent) and foreign operation (subsidiary). However, if the currency of
the primary economic environment is highly inflationary, the parent's reporting currency should be adopted.
The functional currency should not change unless there are significant changes in economic facts and
circumstances. Changes in the functional currency should be reported prospectively from the date of change.
Therefore, previously issued financial statements are NOT restated for a change in the functional currency.
This chapter addresses the following key principles of determining the functional currency:
✓ Classes of Foreign Operations
✓ Factors in Determining the Functional Currency
✓ Highly Inflationary Environment
✓ Change in the Functional Currency
6
B. Classes of Foreign Operations
For purposes of determining functional currency, ASC 830-10-45-4 divides foreign operations into two broad
classes:
1. Self-contained and integrated within a particular country or economic environment: If a foreign
subsidiary's activities are situated within one country, are basically self-contained, and do not rely on the
parent's economic environment, the subsidiary's functional currency is the currency of the country in
which it is located. For example, if a U.S. company has a foreign subsidiary in France that is an independent
entity and received cash and incurred expenses in euros, the euro is the functional currency.
2. Direct and integral component or extension of the parent entity’s operations: If the foreign subsidiary's
daily activities are a direct and important element of the parent's operations and environment, the
parent's currency will be the functional currency. 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 example:
− Significant assets may be acquired from the parent entity or otherwise by expending dollars
− The sale of assets may generate dollars that are available to the parent
− Financing is primarily by the parent or otherwise from dollar sources
An entity may have more than one distinct and separable operation (e.g., branch, division). If those operations
are conducted in different economic settings, they may have different functional currencies. 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.
• A single subsidiary of a financial institution might have relatively self-contained and integrated operations
in each of several different countries.
According to ASC 830-10-55-6, in those circumstances, each operation may be considered to be an entity, and,
based on the facts and circumstances, each operation might have a different functional currency. PwC believes
that an entity should demonstrate all of the following characteristics to conclude that an operation within an
entity is distinct and separable.
7
Characteristics of a Distinct and Separable Operation
Operation is distinct and separable Operation is not distinct and separable
Separate operations
Operations are managed independently and
can be separated, both operationally and
for financial reporting purposes, from the
reporting entity’s other operations
Operations are not managed independently
or cannot be separated, either
operationally or for financial reporting
purposes, from the reporting entity’s other
operations
Assets and liabilities
Assets and liabilities of the operation can be
separated from those of the reporting
entity’s other operations and relate directly
to the operation’s activities
Assets and liabilities of the operation
cannot be separated from those of the
reporting entity’s other operations, the
operation holds only certain assets and
liabilities (e.g., receivables and inventory),
or they hold assets and liabilities that relate
directly to a reporting entity’s other
operations
Financial statements
A meaningful set of all-inclusive financial
statements could be routinely prepared for
the operation
The operation cannot produce financial
statements or produces a limited set of
financial statements
Source: PwC, Foreign currency, June 2019
The different operating and economic characteristics of various types of foreign operations will be distinguished
in their accounting. FAS 52 states that:
• The economic effects of an exchange rate change on an operation that is relatively self-contained and
integrated within a foreign country relate to the net investment in that operation. Translation
adjustments that arise from consolidating that foreign operation do NOT impact cash flows and are NOT
included in net income.
• The economic effects of an exchange rate change on a foreign operation that is an extension of the
parent's domestic operations relate to individual assets and liabilities and impact the parent's cash flows
directly. Accordingly, the exchange gains and losses in such an operation are included in net income.
• Contracts, transactions, or balances that are, in fact, effective hedges of foreign exchange risk will be
accounted for as hedges without regard to their form.
8
C. Factors in Determining the Functional Currency
It is important to determine the functional currency because remeasurement and translation are both based on
the functional currency of the entity. An entity’s functional currency is usually the currency of the primary
economic environment in which the entity operates. According to ASC 830-10-45-6, 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 of a particular foreign operation should be assessed in relation to the stated objectives for foreign
currency translation.
When an entity carries out major operations in more than one currency, management must determine which
currency to use as the functional currency. ASC 830-10-55-5 provides the following economic factors that should
be considered individually and collectively when determining a foreign operation’s functional currency:
Indicator
Foreign Subsidiary’s Currency as
Functional Currency
Parent’s Currency as Functional
Currency
Cash Flow
Cash flows related to the foreign entity’s
assets and liabilities are primarily in the
foreign currency and do not directly affect
the parent entity’s cash flows.
Cash flows related to the foreign entity’s
assets and liabilities directly affect the
parent’s cash flows currently and are
readily available for remittance to the
parent entity.
Selling Price
Selling prices arise from local factors such
as competition and government law
rather than exchange rates.
Selling prices are influenced by
international factors such as worldwide
competition and international prices.
Sales Market There is a strong local sales market. The sales market is primarily in the
parent's country.
Expenses
Manufacturing costs or services are
typically incurred locally and denominated
in foreign currency.
Manufacturing and service costs are
mostly component costs obtained from
the parent's country.
Financing
Financing is secured locally and
denominated in local currency. Funds
obtained are adequate to meet debt
obligations.
Financing is mainly provided by the
parent or denominated in the parent’s
currency.
Intercompany
Transactions
Intercompany transactions are few. There
is no major interrelationship between the
parent and the foreign entity.
Intercompany transactions are high. A
substantial interrelationship exists
between the parent and foreign entity.
9
Example 2: Determination of the Functional Currency
MAX Corp. is a U.S. company that uses the U.S. dollar as its reporting currency. Sino is a wholly-owned subsidiary
of MAX located in China, which functions as a manufacturing facility of MAX.
Consider the following facts regarding Sino:
• MAX manufactures parts for one of its products at a facility in the U.S., packages the parts, and ships them
to Sino for assembly.
• Sino has a manufacturing facility in Guangzhou, China. This facility receives the parts from MAX. Sino’s
employees assemble the parts into the final product. They also test them to ensure that the quality of the
product meets MAX’s standards.
• Sino then ships the completed product back to MAX for sale to customers.
• The local currency of Sino is the yuan.
• MAX funds the expenses of Sino each month, plus a small margin.
What is the functional currency of Sino?
Solution:
According to ASC 830-10-45-4, when a foreign subsidiary is a direct and integral component or extension of the
parent entity’s operations, the parent's currency will be the functional currency. That is, the foreign subsidiary's
daily activities are a direct and important element of the parent's operations and environment.
Sino is a direct and integral extension of USA Corp’s operations because Sino’s assembly is considered a direct and
important element of MAX’s operations. Besides, Sino’s manufacturing costs are mostly component costs
obtained from MAX. Finally, Sino cannot operate without financing from MAX. Therefore, the functional currency
of Sino is the U.S. dollar, the reporting currency of its parent, MAX.
10
D. Highly Inflationary Environment
According to ASC 830-10-45-11, a highly inflationary economy is one that has cumulative inflation of
approximately 100% or more over a 3-year period. A currency in a highly inflationary environment is not
considered stable enough to serve as a functional currency and the more stable currency of the reporting parent
is to be used instead. In other words, the financial statements of a foreign entity in a highly inflationary economy
must be remeasured as if the functional currency were the reporting currency.
The International Monetary Fund of Washington, D.C. publishes information about the international inflation
rates.
ASC 830-10-45-12 explains that 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%, the economy is considered highly
inflationary in all instances. In other words, the inflation rate must be increasing at an average rate of
about 26% per year for three consecutive years, given compounding. Projections cannot be used to
overcome the presumption that an economy is highly inflationary.
• if that calculation results in the cumulative rate being less than 100%, 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.
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 should be
applied with judgment.
The following example illustrates the application of ASC 830-10-45-12.
Example 3: Determination of Highly Inflation
ASC 830-10-55-23
The following Cases illustrate the application of 830-10-45-12:
• Case A: The cumulative 3-year inflation rate exceeds 100%
• Case B: The cumulative 3-year inflation rate drops below 100% but no evidence suggests that drop is other
than temporary.
• Case C: The cumulative 3-year inflation rate drops below 100% after having spiked above 100%.
Case A: Cumulative 3-Year Inflation Rate Exceeds 100%
ASC 830-10-55-24
11
Country A’s economy at the beginning of 20X9 continues to be classified as highly inflationary because the
cumulative 3-year rate is in excess of 100% (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.
Fiscal Year X1 X2 X3 X4 X5 X6 X7 X8
Annual inflation rate 9% 8% 12% 17% 33% 52% 30% 15%
Cumulative three-year rate (a) 32% 42% 74% 137% 163% 127%
(a) Amounts are calculated as a compounded three-year inflation rate.
Case B: Cumulative 3-Year Inflation Rate Drops Below 100%
ASC 830-10-55-25
Country B’s economy at the beginning of 20X9 should continue to be classified as highly inflationary even though
the cumulative 3-year rate is less than 100% (see the following table) because there is no evidence to suggest that
the drop below the 100% cumulative rate is other than temporary and the annual rate of inflation during the
preceding 8 years has been high.
Fiscal Year X1 X2 X3 X4 X5 X6 X7 X8
Annual inflation rate 15% 28% 46% 41% 35% 29% 23% 21%
Cumulative three-year rate (a) 115% 164% 178% 146% 114% 92%
(a) Amounts are calculated as a compounded three-year inflation rate.
Case C: Cumulative 3-Year Inflation Rate Drops Below 100% After Spike
ASC 830-10-55-26
Country C’s economy at the beginning of 20X9 should no longer be classified as highly inflationary because the
cumulative 3-year rate is less than 100% (see the following table) and the historical inflation rates suggest that
the prior classification resulted from an isolated spike in the annual inflation rate.
Fiscal Year X1 X2 X3 X4 X5 X6 X7 X8
Annual inflation rate 5% 6% 4% 7% 12% 55% 18% 6%
Cumulative three-year rate (a) 16% 18% 25% 86% 105% 94%
(a) Amounts are calculated as a compounded three-year inflation rate.
E. Change in the Functional Currency
There should be consistent use of the functional currency unless significant economic changes required a change.
ASC 830 does not provide guidance on identifying significant changes in economic facts and circumstances.
However, changes in economic facts or circumstances that are considered significant are rare. E&Y identified the
following examples that may necessitate the functional currency to change:
12
✓ A foreign entity that sells only parent-produced products assumes all manufacturing functions itself.
✓ A foreign entity that sells its products only to its parent establishes a significant local sales market for
those products.
✓ The currency mix of the revenue for a given foreign entity changes.
✓ An entity with predominantly USD-based revenue changes to predominantly euro-based revenue due to
the shift in targeted consumer groups.
Moreover, when a country experiences high rates of inflation, ASC 830-10-45-11 requires a change in functional
currency (a functional currency other than the reporting currency). That is, the parent's reporting currency should
be adopted. As an example, in a highly inflationary economy, any assets recently acquired at higher prices due to
inflation will appear significantly larger than assets purchased only a few years prior.
Example 4: Change in Functional Currency
A&E, located in Mexico, is a wholly-owned subsidiary of Johnson Corp. The U.S. dollar is Johnson’s functional
currency and A&E has previously identified the peso as its functional currency. The functional currency was
identified because A&E’s sales and purchases were denominated primarily in peso, as were all of its labor costs.
During the second quarter, A&E’s operations began to change. A&E’s sales decreased due to a loss of some sizable
contracts while Johnson’s sales increased due to new significant contracts. To meet its sales orders, Johnson began
using A&E’s manufacturing facilities. A&E shut down its sales department since it will no longer need to generate
its own sales and more than 70% will originate from Johnson’s operations. Johnson has built a new facility to
produce the materials needed. As of the end of the fiscal year, A&E began receiving all materials from Johnson
instead of from suppliers.
Based on the changes in A&E’s business, it expects cash inflows and outflows, except for wages, primarily to be
denominated in U.S. dollars. A&E’s functional currency may have changed because of the following significant
changes in economic facts and circumstances:
• The currency of revenues has changed from the peso to primarily the US dollar. This change does not
seem to be short-term as the sales department was closed down.
• The currency of cash outflows for materials has changed to the US dollar. As Johnson has built a new
facility to produce these materials, this change does not seem to be short-term either.
• The position of A&E’s operations within Johnson’s overall operating strategy has changed, from a
relatively self-contained operating entity to an extension of Johnson’s manufacturing operation.
As discussed, once a determination of the functional currency is made, that decision should be consistently used
for each foreign entity unless significant changes in economic facts and circumstances indicate clearly that the
functional currency has changed. Changes resulting from economic factors (e.g. inflation) should not be
considered a change in accounting principles. Thus, previously issued financial statements should NOT be restated
for any change in the functional currency in accordance with ASC 830-10-45-7. In other words, a change in the
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functional currency is treated as a change in estimate. Such change is accounted for on a prospective basis (only
over current and future years).
In general, entities should follow these requirements for a change in functional currency:
1. Change from reporting currency to foreign currency: ASC 830-10-45-9 indicates that the adjustment
attributable to a currency-rate translation of nonmonetary assets as of the date of the change should be
reported in other comprehensive income.
ASC 830-10-45-9 does NOT apply to circumstances in which the functional currency changes from the
reporting currency to a foreign currency because the economy is no longer highly inflationary. Instead, ASC
830-10-45-15 should be followed.
2. Change from foreign currency to reporting currency: ASC 830-10-45-10 indicates that translation
adjustments for prior periods should NOT be removed from equity.
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 should 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.
A change in accounting estimate is accounted for on a prospective basis (only over current and future years.) It
should NOT be accounted for by restating or retrospectively adjusting amounts reported in financial statements
of prior periods or by reporting pro forma amounts for prior periods.
As discussed, ASC 830-10-45-15 specifically applies to functional currency changes from the reporting currency to
a foreign currency due to a change in an inflationary economy. When an entity’s subsidiary’s functional currency
changes from the reporting currency back to the local currency because the economy ceases to be considered
highly inflationary, the entity should restate the functional currency accounting bases of nonmonetary assets and
liabilities at the date of the change as follows:
✓ The reporting currency amounts at the date of change should be translated into the local currency at
current exchange rates.
✓ The translated amounts should become the new functional currency accounting basis for the
nonmonetary assets and liabilities
ASC 830 provides the following example to illustrate the application of ASC 830-10-45-15.
Example 5: Functional Currency Changes Because the Economy is No Longer Highly Inflationary
ASC 830-10-55-13
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, 20X1. 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, 20X5, 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
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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 on
December 31, 20X5, the equipment is reported at USD 5,000 (foreign currency basis measured at the historical
exchange rate).
ASC 830-10-55-14
As of the beginning of 20X6, 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, 20X6, 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, the new functional currency accounting basis and
related depreciation would subsequently be translated into U.S. dollars at current and average exchange rates,
respectively.
The Securities and Exchange Commission (SEC) indicates that registrants 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 SEC also noted that ASC 830 does not prescribe specific disclosures about a change in functional currency.
However, the SEC believes that disclosures in the financial statements and MD&A may be necessary to permit an
investor to understand the foreign operations and their impact on the registrant's results of operations, liquidity,
and cash flows.
Details of the SEC’s view on changes in functional currency are addressed below.
The SEC’s View on Changes in Functional Currency
Excerpt from the SEC publication Division of Corporation Finance: Frequently Requested Accounting and Financial
Reporting Interpretations and Guidance
D. Changes in Functional Currency
FASB Statement No. 52, Foreign Currency Translation [ASC 830], requires the assets, liabilities, and operations of
a foreign operation to be measured using the functional currency of that foreign operation. The functional
currency is the currency of the primary economic environment in which the entity operates, normally the currency
in which the operation generates and expends cash. Appendix A to SFAS 52 provides guidance for determination
of the functional currency. Once the functional currency has been determined, SFAS 52 requires that
determination to be used consistently unless significant changes in economic facts and circumstances indicate
clearly that the functional currency has changed.
Registrants 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. Registrants with foreign operations in economies that have adopted
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the Euro currency should make similar evaluations. Determination of the functional currency is also required when
the economy in which a foreign operation is located ceases to be highly inflationary.
The staff would expect a registrant's analysis to focus on factors that affect the specific foreign operation's cash
flows. For example, problems in an Asian economy could cause local currency cash flow sources to severely
diminish for a self-contained foreign operation and clearly indicate a different primary currency. Conversely, these
problems generally would not indicate a change in functional currency for a foreign operation that is an integral
component or extension of the parent company's operations. The staff generally will be skeptical that currency
exchange rate fluctuations alone would cause a self-contained foreign operation to become an extension of the
parent company. Remeasurement of assets and results using the registrant's reporting currency in lieu of
determining the functional currency is appropriate only when the foreign operations are in a highly inflationary
economy as defined by SFAS 52.
SFAS 52 does not prescribe specific disclosures about a change in functional currency. However, the staff believes
that disclosures in the financial statements and MD&A may be necessary to permit an investor to understand the
foreign operations and their impact on the registrant's results of operations, liquidity, and cash flows. Registrants
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.
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Review Questions – Section 1 1. In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, what is the
foreign subsidiary's functional currency?
A. The currency in which the subsidiary maintains its accounting records
B. The currency of the country in which the subsidiary is located
C. The currency of the country in which the parent is located
D. The currency of the environment in which the subsidiary primarily generates and expends cash
2. What is the currency in which the parent company prepares its financial statements?
A. The functional currency
B. The reporting currency
C. The historical currency
D. The base currency
3. The economic effects of a change in foreign exchange rates on a relatively self-contained and integrated
operation within a foreign country relate to the net investment by the reporting enterprise in that operation.
What can be said about the translation adjustments that arise from the consolidation of that operation?
A. They directly affect cash flows but should not be reflected in income
B. They directly affect cash flows and should be reflected in income
C. They do not directly affect cash flows and should not be reflected in income
D. They do not directly affect cash flows but should be reflected in income
4. Which of the following is considered a highly inflationary environment?
A. A cumulative inflation rate of 100% or more over a three-year period
B. A cumulative inflation rate of 50% per year over a five-year period
C. A cumulative inflation rate of 25% per year over a four-year period
D. A cumulative inflation rate of 15% per year over a two-year period
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III. Remeasure Foreign Currency
Transactions to the Functional Currency “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.”
ASC 830-10-45-17
A. General Rules
Common foreign currency transactions denominated in a currency other than the entity’s functional currency
arise when a reporting entity:
1. Buys or sells on credit goods or services whose prices are denominated in foreign currency,
2. Borrows or lends funds and the amounts payable or receivable are denominated in foreign currency,
3. Is a party to an unperformed forward exchange contract,
4. Acquires or disposes of assets denominated in foreign currency, or
5. Incurs or settles liabilities.
For example, foreign currency transactions may result in receivables or payables fixed in the amount of foreign
currency to be received or paid. If books and records of a foreign entity are not maintained in the functional
currency, foreign currency transactions must be remeasured into the functional currency. For example, the U.S.
dollar has been designated as the functional currency for a Mexican subsidiary, but books and records at the
subsidiary are recorded using the Mexican peso. In this case, remeasurement is required since the subsidiary’s
book of records is maintained in peso instead of its functional currency (U.S. dollar).
The objective of the remeasurement process is to generate the same result as if the entity's books and records had
been kept in the functional currency. To achieve the objective, ASC 830-10-45-17 requires entities to account for
its monetary and nonmonetary assets and liabilities that are not denominated in the functional currency. ASC 830-
20-30-1 states that at the date a foreign currency transaction is recognized, each asset, liability, revenue, expense,
gain, or loss arising from the transaction should be measured initially in the functional currency of the recording
entity using the current exchange rate.
If exchangeability between two currencies is temporarily lacking at the transaction date or balance sheet date,
ASC 830-20-30-2 requires the use of the first subsequent rate at which exchanges could be made. If the lack of
exchangeability is other than temporary, the propriety of consolidating, combining, or accounting for the foreign
operation by the equity method should be carefully considered.
Example 6: Remeasurement Requirements
Johnson Corp. is a U.S. company. Johnson’s functional currency is the U.S. dollar.
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Johnson borrows 3,000,000 Swiss francs from a bank in Switzerland in the form of a note payable bearing interest
at 8% per annum. This is a foreign currency transaction entered into by Johnson resulting in recognition of
monetary assets and liabilities denominated in a foreign currency (cash, note payable, and interest payable).
Therefore, remeasurement is required.
B. Selection of Exchange Rates for Remeasurement
Monetary Accounts
Monetary accounts are remeasured at the current exchange rate. Monetary accounts include assets and liabilities
whose amounts are fixed or determinable without reference to future prices of specific goods or services.
Examples include cash, short- or long-term accounts receivable and notes receivable in cash, short- or long-term
accounts payable and notes payable in cash, and inventories carried at market, and marketable securities carried
at fair value.
At each balance sheet date, balances related to monetary assets and liabilities should be remeasured to reflect
the current exchange rate. This measurement gives rise to foreign currency transaction gains or losses; the
increase or decrease in expected functional currency cash flows. For example, if the exchange rate changes
between the date of a purchase or sale and the time of actual payment or receipt, a foreign exchange transaction
gain or loss arises.
Details about transaction gains or losses are discussed in the “Transaction Gains or Losses” section.
Nonmonetary Accounts
Nonmonetary accounts should be remeasured using historical exchange rates (i.e. the exchange rate at the date
of the nonmonetary account originated). Nonmonetary accounts include assets and liabilities other than
monetary ones. The economic significance of nonmonetary accounts depends heavily on the value of specific
goods and services. According to ASC 255 Changing Prices, nonmonetary assets include all of the following:
✓ Goods held primarily for resale or assets held primarily for direct use in providing services for the
business of the entity
✓ Claims to cash in amounts dependent on future prices of specific goods or services
✓ Residual rights such as goodwill or equity interests
Nonmonetary liabilities include both of the following:
✓ Obligations to furnish goods or services in quantities that are fixed or determinable without reference
to changes in prices.
✓ Obligations to pay cash in amounts dependent on future prices of specific goods or services.
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Examples include inventories, investments in common stocks, property, plant and equipment, and liabilities for
rent collected in advance.
It is important to note that nonmonetary assets and liabilities are NOT subsequently remeasured. Once purchased
or incurred, nonmonetary assets and liabilities are recorded in the functional currency of the purchaser. Likewise,
amounts recognized in the income statement related to nonmonetary assets and liabilities (e.g. cost of goods sold,
depreciation) are accounted for in the functional currency of the purchaser.
ASC 830-10-45-18 lists the following common balance sheet and income statement accounts that should be
remeasured using historical exchange rates.
Accounts to Be Remeasured Using Historical Exchange Rates
• Equity securities without readily determinable
fair values accounted for in accordance with
paragraph 321-10-35-2. The historical rate to
be used shall be the exchange rate as of the
later of the acquisition date or the most recent
date on which the equity security was adjusted
to fair value in accordance with paragraphs
321-10-35-2 through 35-3, if applicable
(Amended by ASU 2019-04 Codification
Improvements to Topic 326, Financial
Instruments—Credit Losses, Topic 815,
Derivatives and Hedging, and Topic 825,
Financial Instruments)
• Inventories carried at cost
• Prepaid expenses such as insurance,
advertising, and rent
• Property, plant, and equipment
• Accumulated depreciation on property, plant,
and equipment
• Patents, trademarks, licenses, and formulas
• Goodwill
• Other intangible assets
• Deferred charges and credits, except deferred
income taxes and policy acquisition costs for life
insurance companies
• Deferred income
• Common stock
• Preferred stock carried at issuance price
• Examples of revenues and expenses related to
nonmonetary items:
− Cost of goods sold
− Depreciation of property, plant, and
equipment
− Amortization of intangible items such as
goodwill, patents, licenses, etc.
− Amortization of deferred charges or credits
except for deferred income taxes and
policy acquisition costs for life insurance
companies
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C. Transaction Gains or Losses
Transaction gains or losses should be included in the income statement (net income from continuing operations)
for the period in which the exchange rate changes. This accounting treatment was adopted because transaction
gains or losses on remeasurement affect functional currency cash flows.
However, ASC 830-20-35-3 requires that transaction gains or losses on the following foreign currency transactions
should NOT be included in determining net income. Instead, they should be reported in the same manner as
translation adjustments (reported in other comprehensive income):
1. Foreign currency transactions engaged in net investment hedges in a foreign entity, beginning as of the
designation date. A foreign currency transaction is deemed a hedge of an identifiable foreign currency
commitment provided BOTH of the following two conditions exist:
✓ The foreign currency commitment is firm; and
✓ The foreign currency transaction is intended as a hedge.
A net investment hedge protects against adverse movement of exchange rates impacting any foreign
currency exposure. A foreign currency hedge can, for example, involve either fair value or cash flow
hedges in foreign currency or a net investment in a foreign business activity when there is concern over
the impact that a devaluation of a foreign currency would have on the entity’s investment in an overseas
subsidiary.
Details about foreign currency hedge are discussed in the “Hedging” section.
2. Intra-entity foreign currency transactions that are of a long-term investment nature (settlement is not
planned or anticipated in the foreseeable future), when the entities to the transactions are consolidated,
combined, or accounted for under the equity method in the reporting company's financial statements.
Reporting requirements of translation adjustments are discussed in the “Translation Adjustments” section.
Example 7: Determining Transaction Gains or Losses
Example 7-1
On September 14, 20X2, ABC Company bought goods from an unaffiliated foreign company for 30,000 units of the
foreign company's local currency. On that date, the spot rate was $.57. ABC paid the bill in full on March 27, 20X3,
when the spot rate was $.64. The spot rate was $.68 on December 31, 20X2. ABC should report as a foreign
currency transaction loss $3,300 in its income statement for the year ended December 31, 20X2, calculated as
follows:
Liability—12/31/20X2: 30,000 × $.68 $20,400
Liability—9/14/20X2: 30,000 × $.57 17,100
Foreign currency transaction loss at 12/31/20X2: 30,000 × $.11 $ 3,300
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Example 7-2
On September 1, a U.S. company bought foreign goods requiring payment in euros (EUR) in 30 days after their
receipt. The title to the merchandise passed on November 15. The goods were still in transit on November 30, the
fiscal year-end. The exchange rates were:
September 1: USD 1 = EUR 2.2
November 15: USD 1 = EUR 2.0
November 30: USD 1 = EUR 2.1
The transaction was recorded on November 15, when title to the merchandise passed, and was recorded at an
exchange rate of USD 1 = EUR 2.0 (i.e., it would cost $.5 to buy one euro). On November 30, the exchange rate
increased to 2.1 euros (it would cost less than $.5 to buy one euro). Because the dollar equivalent of the liability
declined from November 15 to November 30, it gave rise to a gain included in income from continuing operations.
Example 7-3
An exchange gain or loss takes place when the exchange rate changes between the purchase and payment dates.
Merchandise is purchased for 300,000 euros. The exchange rate is 3 euros to 1 U.S. dollar. The journal entry is:
Purchases $100,000
Accounts payable $100,000
300,000 euros/3 = $100,000
When the goods are paid for, the exchange rate is 3.5 euros to 1 U.S. dollar. The journal entry is:
Accounts payable $100,000
Cash $85,714
Foreign exchange gain 14,286
300,000 euros/3.5 = $85,714
The $85,714, using an exchange rate of 3.5 to 1, can buy 300,000 euros. The transaction gain is the difference
between the cash required of $85,714 and the initial liability of $100,000.
Example 7-4
Klemer Corporation bought merchandise for 240,000 pesos when the exchange rate was 12 pesos to a dollar. The
journal entry expressed in dollars follows:
Purchases $20,000
Accounts payable $20,000
When the merchandise is paid for, the exchange rate changes to 15:1. The journal entry in dollars is:
Accounts payable $20,000
Cash $18,667
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Foreign exchange gain $ 1,333
At a 15:1 exchange rate, $18,667 can buy 240,000 pesos. The difference between $18,667 and the initial
liability of $20,000 represents a foreign exchange gain. If payment is made when the exchange rate is below 12
pesos to a dollar, a foreign exchange loss would arise.
D. Foreign Currency Transactions
1. Property, Plant and Equipment
Property, plant and equipment whose values change substantially over time are considered nonmonetary assets.
When property, plant and equipment are acquired in a foreign currency, they should be recorded in the functional
currency using the exchange rate on the date of purchase. They should NOT be subsequently remeasured for
changes in exchange rates during the period they are held.
The entity should perform the impairment evaluation using its functional currency. Impairment testing may result
in a functional currency impairment or a reversal of local currency impairments. That is, when an entity keeps its
books and records in a currency other than its functional currency (local currency), it is possible that an asset is
not impaired for its local currency books, but is impaired for its functional currency financial statements (or vice
versa). In this case, an entity should either record or reverse impairment charges to produce its functional currency
financial statements.
Example 8: Depreciation of Fixed Assets
TEX Corp. is a U.S. company with a U.S. dollar functional currency. ViTa is a foreign entity of TEX located in
Switzerland. ViTa keeps its books and records in the local currency, Swiss franc (CHF). However, management
determined its functional currency is the euro (EUR).
ViTa purchased machinery for CHF 600,000 on January 1, 20X5 when the exchange rate was EUR 1.2 = CHF 1. The
machinery has a useful life of five years.
How should ViTa account for annual depreciation expense in the currency of its books and records, Swiss franc,
and its functional currency (EUR)?
Solution:
ViTa should record the machinery using the exchange rate in effect at the date of purchase.
CHF 600,000 × [1.2 EUR / 1 CHF] = EUR 720,000.
ViTa should also calculate annual depreciation using the exchange rate in effect on the date of purchase. The
following table shows the calculation of the annual depreciation expense.
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CHF EUR
Purchase price CHF 600,000 EUR 720,000
Useful life 5 years 5 years
Annual depreciation 120,000 144,000
Changes in exchange rates subsequent to the purchase of the machinery do NOT affect depreciation or the
carrying amount of the machinery in the functional currency financial statements.
2. Inventories
Inventory measured using the subsequent measurement guidance in ASC 330-10 in an entity’s books of record
that are maintained in a foreign currency requires special application of ASC 830.
ASC 830-10-55-8 requires that 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, the historical cost in the
functional currency should be evaluated for impairment under the subsequent measurement guidance using the
functional currency, which 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. Similarly, 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 to market in the functional currency
statements, that functional currency amount should continue to be the carrying amount in the functional currency
financial statements until the inventory is sold or a further write-down is necessary. That is, the write-down should
not be reversed until the inventory is sold.
ASC 830-10-55-9 states that an inventory write-down may occur if the value of the currency in which the books of
record are maintained has declined in relation to the functional currency between the date the inventory was
acquired and the date of the balance sheet. However, such a write-down may not be necessary. For example, a
write-down may not be necessary for inventory measured using the first-in, first-out (FIFO) methodology if the
net realizable value expressed in the local currency has increased sufficiently so that net realizable value exceeds
its historical cost measured in the functional currency.
ASC 830 provides the following example to illustrate the application of ASC 830-10-55-9 (Amended by ASU 2015-
11 Inventory).
Example 9: Write-down of Inventory Measured Using FIFO
ASC 830-10-55-15
The following cases illustrate the remeasurement of inventory that is measured using FIFO and is not recorded in
the functional currency:
a. Historical cost in functional currency exceeds net realizable value in functional currency (Case A)
b. Net realizable value in functional currency exceeds historical cost in functional currency (Case B)
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ASC 830-10-55-16
Cases A and B share all of the following assumptions:
a. BR is the currency in which the books of record are maintained.
b. FC is the functional currency.
c. When the rate is BR 1 = FC 2.40, a foreign subsidiary of a U.S. entity purchases a unit of inventory at a cost
of BR 500 (measured in functional currency, FC 1,200).
d. At the foreign subsidiary’s balance sheet date, the current rate is BR 1 = FC 2.00.
Case A: Historical Cost in Functional Currency Exceeds Net Realizable Value in Functional Currency
ASC 830-10-55-18
Assume the net realizable value of the unit of inventory is BR 560 (measured in functional currency, FC 1,120).
Because net realizable value as measured in the functional currency (FC 1,120) is less than historical cost as
measured in the functional currency (FC 1,200), an inventory write-down of FC 80 is required in the functional
currency financial statements.
Case B: Net Realizable Value in Functional Currency Exceeds Historical Cost in Functional Currency
ASC 830-10-55-19
Assume the net realizable value at the foreign subsidiary’s balance sheet date is BR 620. Because net realizable
value as measured in the functional currency (BR 620 x FC 2.00 = FC 1,240) exceeds historical cost as measured in
the functional currency (BR 500 x FC 2.40 = FC 1,200), an inventory write-down is not required in the functional
currency financial statements.
3. Debt
When a debt is denominated in a currency other than its functional currency, it should initially be measured using
the exchange rate in effect at the issuance date. Because a debt is a monetary liability, the debt balance is
remeasured in the functional currency each reporting date using the exchange rate in effect at the reporting date.
Debt premium, discount, and debt issuance costs should be included in the balance measured in the reporting
entity’s functional currency since they are part of the carrying amount of the debt. By measuring the premium,
discount, and issuance costs at current exchange rates, an entity ensures that a level of effective yield in the
foreign currency is maintained.
ASC 830 does not identify the rates at which amortization of the discounts or premiums should be reported in the
income statement. However, PwC believes that it is acceptable to record amortization for a period using the
average spot rate for that period since the amortization is occurring throughout the period.
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An exchange of debt instruments between or a modification of a debt instrument resulting in more than a 10%
change in cash flows is treated as an extinguishment and issuance of new debt (the 10% test). When a debt
instrument is modified such that the currency of the debt changes, the change in currency should be included in
the cash flows as part of the 10% test. To convert the cash flows on the new debt into the currency of the original
debt, PwC identifies two acceptable methods:
1. Use the spot rate in effect at the debt modification date, or
2. Use the forward rates corresponding to the payment date of each cash flow (e.g. interest payment and
principal).
4. Debt and Equity Securities
The accounting for a foreign currency denominated investment security is based on its classification under ASC
320 Investments – Debt Securities or ASC 321 Investments – Equity Securities.
Debt securities are financial instruments evidencing a creditor relationship with a company or government.
Examples are redeemable preferred stock, corporate bonds, municipal bonds, U.S. government obligations,
convertible debt, collateralized mortgage obligations, strips, and commercial paper. Debt securities do not include
futures contracts and option contracts. ASC 320-10-25-1 classifies debt securities into one of the following three
categories:
1. Trading Debt Securities
2. Available-for-Sale Debt Securities
3. Held-to-Maturity Debt Securities
In accordance with ASU 2016-01 Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement
of Financial Assets and Financial Liabilities, equity securities are no longer classified as trading or available for sale.
The following table summarizes the treatment of foreign currency denominated investment securities.
Trading Debt Securities Nonmonetary
Changes in fair value due to both the market
factors and the foreign currency exchange rate
fluctuations are reflected in net income.
Available-for-Sale Debt Securities Nonmonetary
Changes in fair value due to both the market
factors and the foreign currency exchange rate
fluctuations are reported in other comprehensive
income.
Held-to-Maturity Debt Securities Monetary Foreign currency transaction gains or losses are
included in net income.
Equity Securities Nonmonetary
Changes in fair value due to both the market
factors and the foreign currency exchange rate
fluctuations are reflected in net income.
Each security is discussed in the following sections.
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Trading Debt Securities
Trading debt securities (not classified as held-to-maturity) are bought and held primarily for sale in the near term
(usually three months or less). Trading debt securities are considered nonmonetary assets since the amount
received depends on the future prices of specific goods or services. Thus, these debt securities do NOT give rise
to transaction gains and losses. However, trading debt securities should be subsequently measured at fair value,
with changes in fair value (including changes in market price and foreign currency exchange rates) reflected in net
income (presented separately in the income statement).
Available-for-Sale Debt Securities
Available-for-sale debt securities are not held for short-term profits, nor are they to be held to maturity.
Therefore, they are in between trading and held-to-maturity classifications. In other words, investments in debt
securities not classified as trading debt securities or as held-to-maturity debt securities should be classified as
available-for-sale debt securities.
Available-for-sale debt securities are considered nonmonetary assets since the amount received depends on
future prices of specific goods or services. Thus, these debt securities do NOT give rise to transaction gains and
losses. However, according to ASC 830-20-35-6, the entire change in the fair value of foreign currency
denominated available-for-sale debt securities due to both the market factors (e.g. interest rate, credit risk) and
the foreign currency exchange rate fluctuations should be reported in other comprehensive income.
Upon the adoption of ASU 2016-13 Financial Instruments—Credit Losses (Topic 326): Measurement of Credit
Losses on Financial Instruments, 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, should be reported in other
comprehensive income.
For public business entities, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019. For
entities other than public business entities, ASU 2016-13 is effective for fiscal years beginning after December 15,
2022.
Held-to-Maturity Debt Securities
Held-to-maturity debt securities are securities that entities purchase and have the positive intent and ability to
hold those securities to maturity. These securities are considered monetary assets since the amount received at
maturity is fixed and does not depend on future prices.
Held-to-maturity debt securities in the balance sheet are presented under noncurrent assets at amortized cost.
However, those securities maturing within one year are presented under current assets. An example is a 30-year
bond that is maturing next year (its thirtieth year).
Foreign currency transaction gains or losses are recognized in the income statement for the period in which the
exchange rate changes.
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Equity Securities
Upon the adoption of ASU 2016-01, equity securities are no longer be eligible for trading or available-for-sale
classification. Entities must measure these equity securities (including other ownership interests, such as
partnerships and unincorporated joint ventures) at fair value, with changes in fair value (including changes in
market price and foreign currency exchange rates) reflected in net income. For equity investments that do not
have readily determinable fair values, an entity may elect the measurement alternative to measure those
investments at cost minus impairment.
The FASB issued ASU 2019-04 Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic
815, Derivatives and Hedging, and Topic 825, Financial Instruments to clarify that foreign currency denominated
equity securities using the measurement alternative are considered nonmonetary assets. Thus, they should be
remeasured at historical exchange rates. In addition, the amendments clarify that the rate used should be the
historical exchange rate as of the later of the acquisition date or the most recent date on which the equity security
was adjusted to fair value in accordance with ASC 321-10-35-2 through 35-3, if applicable.
5. Foreign Currency Leases
Lessee Accounting
Under ASC 842 Leases, lessees classify leases as either finance lease or operating lease. Both financing and
operating leases create an asset (right-of-use) and a liability. Lessees must recognize a right-of-use asset and a
lease liability as of the lease commencement date for all leases except for a lease term of 12 months or less. In
general, at the commencement date, the cost of the right-of-use asset consists of all of the following:
✓ The amount of the initial measurement of the lease liability
✓ Any lease payments made to the lessor at or before the commencement date, minus any lease incentives
received
✓ Any initial direct costs incurred by the lessee
When computing the right-of-use asset and lease liability for a foreign currency denominated lease, the present
value of lease payments, payments made to the lessor at or before the commencement date, lease incentives,
and initial direct costs are measured in the functional currency using the exchange rate at the lease
commencement date (or the date the cash flow is paid or received, if before lease commencement).
According to ASC 842-20-55-10, the right-of-use asset is a nonmonetary asset while the lease liability is a
monetary liability. Therefore, in accordance with ASC 830 on foreign currency matters, when accounting for both
operating and finance leases denominated in a foreign currency, if remeasurement into the lessee’s functional
currency is required:
• The right-of-use asset is remeasured using the exchange rate as of the commencement date
• The lease liability is remeasured using the current exchange rate
Lease expense comprises of two elements:
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1. Amortization expense (of the right-of-use asset) is remeasured using the exchange rate on the lease
commencement date.
2. Interest expense (associated with interest on the lease liability) is remeasured using the average exchange
rate during the period in which it is incurred.
Lessor Accounting
ASC 842 requires lessors to classify leases as one of three types of leases: sales-type, direct financing, or operating
lease.
Sales-type Lease
In a sales-type lease, a lessor should derecognize the leased asset and recognize:
• A net investment (lease receivable + unguaranteed residual asset) at the commencement date
• Selling profit or selling loss arising from the lease at the commencement date
• Interest income on the net investment over the lease term
ASC 255-10-55-7A indicates that since the unguaranteed residual asset arising from a sales-type lease or a direct
financing lease is not a claim to a fixed sum of money, it is a nonmonetary item. Thus, when computing the net
investment in a foreign currency denominated lease, the lease payments and the unguaranteed residual asset are
measured in the functional currency using the exchange rate at the lease commencement date.
Because selling profit or loss and interest income are monetary items, they should be measured in the functional
currency using the average exchange rate during the period in which it is recognized. The net investment is a
monetary asset that should be remeasured at the end of each reporting period using the exchange rate at that
date.
Direct Financing Lease
In a direct financing lease, a lessor should derecognize the leased asset and recognize:
• A net investment (lease receivable + unguaranteed residual asset) at the commencement date
• Selling loss arising from the lease at the commencement date
• Interest income on the net investment over the lease term
The net investment is measured in the same manner as a sales-type lease adjusted for selling profit and initial
direct costs. That is, when computing the net investment in a foreign currency denominated lease, the lease
payments and the unguaranteed residual asset are measured in the functional currency using the exchange rate
at the lease commencement date.
Selling profit and initial direct costs are deferred at the commencement date and included in the measurement of
the net investment in the lease. These amounts and interest income should be recognized over the lease term
and measured in the functional currency using the average exchange rate during the period in which it is
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recognized. Losses on sale should be recognized using the impairment guidance for inventory or property, plant,
and equipment, as applicable.
The net investment is a monetary asset that should be remeasured at the end of each reporting period using the
exchange rate at that date.
Operating Lease
A lessor should recognize the lease payments as rental revenue over the lease term on a straight-line basis using
the average exchange rate during the period in which it is recognized.
Comprehensive Illustration: Remeasurement of
Foreign Currency Transactions to the Functional
Currency
1. Accounts Receivable
A U.S. company sells merchandise to a customer in Italy on 10/1/20X6, for 20,000 euros (EUR). The exchange rate
is 1 EUR to $.40. Hence, the transaction is valued at $8,000 (20,000 euros × $.40). The terms of sale require
payment in four months. The journal entry for the sale is:
10/1/20X6
Accounts receivable—Italy $8,000
Sales $8,000
Accounts receivable and sales are measured in U.S. dollars at the transaction date using the spot rate.
Even though the accounts receivable are measured and reported in U.S. dollars, the receivable is fixed in
euros. Hence, a transaction gain or loss can occur if the exchange rate changes between the date of sale
(10/1/20X6) and the settlement date (2/1/20X7).
Because the financial statements are prepared between the transaction date (date of sale) and settlement
date, receivables denominated in a currency other than the functional currency (U.S. dollar) must be
restated to reflect the spot rate on the balance sheet date. On 12/31/20X6, the exchange rate is 1 euro
equals $.45. Thus, 20,000 euros are now valued at 9,000 (20,000 × $.45). In consequence, the accounts
receivable denominated in euros should be increased by $1,000.
The journal entry to do this on 12/31/20X6 is:
Accounts receivable—Italy $1,000
Foreign exchange gain $1,000
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The income statement for the year ended 12/31/20X6 shows an exchange gain of $1,000. It should be
pointed out that sales is not affected by the exchange gain because sales relates to operational activity.
On 2/1/20X7, the spot rate is 1 EUR equals $.43. The journal entry is:
Cash $8,600*
Foreign exchange loss $ 400
Accounts receivable—Italy $9,000
* 20,000 euros × $.43 = $8,600
The 20X7 income statement presents an exchange loss of $400.
2. Inventory
On January 15, 20X7, ABC Company, which uses a perpetual inventory system, shipped merchandise costing
$45,000 to XYZ Company, a German company, for 100,000 euros (EUR). On February 15, 20X7, ABC Company
received a draft for 100,000 euros from XYZ Company. The draft was immediately converted. The spot rates were
as follows:
1 EUR =
Buying Rate Selling Rate
January 15, 20X7 0.60 0.65
January 31, 20X7 0.65 0.70
February 15, 20X7 0.55 0.60
Assuming that monthly statements are prepared, ABC Company will make the following journal entries:
1/15/20X7 Accounts receivable
[100,000 euros × $.60] $60,000
Sales $60,000
1/15/20X7 Cost of goods sold $45,000
Inventory $45,000
1/31/20X7 Accounts receivable $ 5,000
[100,000 euros × ($0.65 - $0.60)
Transaction gain or loss $ 5,000
2/15/20X7 Cash [100,000 euros × 0.55] $55,000
Transaction gain or loss $10,000
Accounts receivable [$60,000 +
$5,000]
$65,000
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3. Held-to-Maturity Debt Securities
TMC Corp. is a U.S. company with a U.S. dollar (USD) functional currency.
On October 1, 20X6, TMC pays 95,000 euros (EUR) for a 10-year bond issued by Motoren with a par value of
100,000 euros. The bond pays a coupon of 8% semi-annually. TMC bought the bond at a discount with an effective
interest rate of 8.5%. TMC classifies its Motoren bond as held-to-maturity debt security.
The following table summarizes the exchange rate on the date TMC purchased the Motoren bond and on the date
of its financial statements and the average exchange rate for the reporting period.
Date Exchange Rate
October 1, 20X6 EUR 1 = USD 1.48
December 31, 20X6 EUR 1 = USD 1.42
Average exchange rate for Q4 20X6 EUR 1 = USD 1.44
How should TMC measure and record this foreign currency transaction?
Solution:
TMC should record the purchase of the Motoren bond in its functional currency using the exchange rate on the
purchase date. The held-to-maturity debt security is purchased for 95,000 euros. The exchange rate is 1 euro to
1.48 U.S. dollars. The journal entry is:
Investment in held-to-maturity security USD 140,600
Cash USD 140,600
EUR 95,000 × (EUR 1 / USD 1.48) = USD 140,600
The following is a simplified bond amortization table in EUR showing the initial purchase on October 1, 20X6, and
the interest accrual and discount amortization for the period ending December 31, 20X6. Assume that:
• No principal and interest payments were made during the period
• The discount is amortized on a straight-line basis
EUR Balance as
of 10/1/20X6
EUR Quarterly
entries
EUR Balance as
of 12/31/20X6
Bond principal amount 100,000 100,000
Discount 5,000 4,875
Discount amortization 125
Interest accrual 2,000
Carrying amount 95,000 95,125
To generate its December 31, 20X6 financial statements, TMC should record the interest accrual and amortization
of the discount on its Motoren bond using the average exchange rate for Q4 20X6 (1.44). The journal entry is:
32
Accrued interest receivable USD 2,880
Investment in held-to-maturity security USD 180
Interest income USD 2,880
Interest income (discount amortization) USD 180
The quarterly accrued interest: EUR 2,000 × (EUR 1 / USD 1.44) = USD 2,880
The amortization of the bond discount: EUR 125 × (EUR 1 / USD 1.44) = USD 180
The interest accrual and held-to-maturity security are monetary assets. Thus, they should be measured using the
rate on December 31, 20X6.
The Interest Accrual
The difference between the accrued interest recorded using the average exchange rate and the accrued interest
balance using the exchange rate on December 31, 20X6 should be recognized in the income statement as a foreign
currency transaction gain or loss.
Accrued interest
on 12/31/X6
(EUR)
Exchange rate on
12/31/X6
Accrued interest
on 12/31/X6
(USD)
Recorded accrued
interest balance
(USD)
Foreign currency
transaction
gain/(loss)
EUR 2,000 EUR 1 = USD 1.42 USD 2,840 USD 2,880 (USD 40)
To record the difference between measuring the quarterly interest accrual of EUR 2,000 at the average exchange
rate during the quarter (EUR 1 = USD 1.44) and the period end exchange rate (EUR 1 = USD 1.42), TMC makes the
following adjustment:
Foreign currency transaction loss USD 40
Accrued interest receivable USD 40
The Bond
TMC classified the bond as a held-to-maturity security. Thus, it is a monetary asset and should be measured at the
December 31, 20X6 spot rate.
Bond carrying
amount on
12/31/X6 (EUR)
Exchange rate on
12/31/X6
Bond carrying
amount on
12/31/X6 (USD)
Recorded bond
carrying amount
(USD)
Foreign currency
transaction
gain/(loss)
EUR 95,125 EUR 1 = USD 1.42 USD 135,078 USD 140,780 (USD 5,702)
As a result of measuring the carrying amount of the bond using the December 31, 20X6 exchange rate, TMC makes
the following adjustment:
Foreign currency transaction loss USD 5,702
Investment in held-to-maturity security USD 5,702
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4. Foreign Subsidiary Accounts
FNC is a wholly-owned German subsidiary of multinational corporations. The functional currency is U.S. dollars
(USD). The following accounts, for the year ended December 31, 20X7, are stated in euros.
Rent expense 150,000
Allowance for doubtful accounts 60,000
Patent amortization expense* 85,000
* Acquired on March 23, 20X5
The exchange rates for the euros (EUR) for various dates and time periods are as follows:
Date Exchange Rate
March 23, 20X5 EUR 1 = USD 0.65
December 31, 20X7 EUR 1 = USD 0.55
Average for the year ended December 31, 20X7 EUR 1 = USD 0.60
The remeasured accounts in U.S. dollars are as follows:
EUR
Exchange
Rate USD
Rent expense 150,000 0.60 $ 90,000
Allowance for
doubtful accounts 60,000 0.55 33,000
Patent
amortization
expense 85,000 0.65 55,250
295,000 $178,250
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Review Questions – Section 2 5. Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one
month after the goods were received at Fogg's warehouse. Between the receipt of goods and the time of payment,
the exchange rates changed in Fogg's favor. How should the resulting gain be included in Fogg's financial
statements?
A. As a component of income from continuing operations
B. As revenue
C. As a deferred credit
D. As an item of other comprehensive income
6. On September 22, 20X2, Yumi Corp. purchased merchandise from an unaffiliated foreign company for 10,000
units of the foreign company's local currency. On that date, the spot rate was $.55. Yumi paid the bill in full on
March 20, 20X3, when the spot rate was $.65. The spot rate was $.70 on December 31, 20X2. What amount should
Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, 20X2?
A. $0
B. $500
C. $1,000
D. $1,500
7. Which of the following statements regarding foreign exchange gains and losses is TRUE (where the exchange
rate is the ratio of units of the functional currency to units of the foreign currency)?
A. An exchange gain occurs when the exchange rate increases between the date a payable is recorded and
the date of cash payment.
B. An exchange gain occurs when the exchange rate increases between the date a receivable is recorded and
the date of cash receipt.
C. An exchange loss occurs when the exchange rate decreases between the date a payable is recorded and
the date of the cash payment.
D. An exchange loss occurs when the exchange rate increases between the date a receivable is recorded and
the date of the cash receipt.
8. On October 1, 20X5, Mild Co., a U.S. company, purchased machinery from Grund, a German company, with
payment due on April 1, 20X6. If Mild's 20X5 operating income included NO foreign currency transaction gain or
loss, which of the following might be TRUE?
A. The transaction could have resulted in an unrecorded gain.
B. The transaction could have been denominated in U.S. dollars.
35
C. The transaction could have caused a foreign currency gain to be reported as a contra account against
machinery.
D. The transaction could have caused a foreign currency translation gain to be reported in other
comprehensive income.
9. On October 1, Velec Co., a U.S. company, contracted to purchase foreign goods requiring payment in euros 1
month after their receipt at Velec's factory. Title to the goods passed on December 15. The goods were still in
transit on December 31. Exchange rates were one dollar to 1.06 euros, 1.04 euros, and 1.05 euros on October 1,
December 15, and December 31, respectively. How should Velec account for the exchange rate fluctuation?
A. As a loss included in net income from continuing operations
B. As a gain included in net income from continuing operations
C. As an extraordinary gain
D. As a loss included in other comprehensive income
10. How are gains or losses on foreign exchange contracts typically recognized?
A. On the balance sheet in the year that the exchange rate changes
B. In current earnings in the year that the exchange rate changes
C. Immediately
D. All of the above
11. When remeasuring foreign currency financial statements into the functional currency, which of the following
items would be remeasured using historical exchange rates?
A. Inventories carried at cost
B. Equity securities reported at fair values
C. Bonds payable
D. Accrued liabilities
12. How should gains from remeasuring a foreign subsidiary's financial statements from the local currency into its
functional currency be reported?
A. As a deferred foreign currency transaction gain
B. In other comprehensive income
C. As revenue
D. As a part of continuing operations
36
IV. Translate Foreign Currency Financial
Statements “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.”
ASC 830-10-10-1
A. General Rules
Separate entities within a company that operate in different currency environments may prepare financial
statements in their respective functional currencies. The functional currency financial statements of all entities
consolidated or accounted for by the equity method must be translated into a single unit of measure (the reporting
currency of the reporting entity). This process is referred to as foreign currency translation, which is different than
remeasuring foreign entity financial statements.
As discussed, if a foreign entity’s books and records are not maintained in its functional currency, the reporting
entity must remeasure the financial statements into its functional currency before translating the foreign entity’s
financial statements into the reporting currency. For example, a parent maintains its financial statements in U.S.
dollars and owns a foreign subsidiary whose functional currency is British pounds. If some or all of the foreign
subsidiary's records are kept in euros, its financial statements must be remeasured from euros into British pounds
before translation into U.S. dollars.
The objectives of translation include:
✓ Preserving the operating results and relationships measured in the foreign currency;
✓ Providing information in consolidated financial statements about the financial performance of each
foreign consolidated entity; and
✓ Providing information on the anticipated effects of changes in exchange rates on cash flow and equity.
The following table summarizes the steps a reporting entity should take to translate the financial statements of
its foreign entities into its reporting currency
Books and records are NOT
maintained in functional
currency
1. Remeasure the financial statements into its functional
currency.
2. Recognize transaction gains or losses in income statement.
3. Translate the financial statements from the functional
currency to the reporting currency.
4. Include translation adjustments in other comprehensive
income.
37
Books and records are
maintained in functional
currency
1. Translate the financial statements from the functional
currency to the reporting currency.
2. Include translation adjustments in other comprehensive
income.
In most cases, assets and liabilities are translated at the current exchange rate at the balance sheet date. Revenue
and expenses are usually translated at the weighted-average exchange rate for the period. Translation
adjustments are reported as a part of comprehensive income and ultimately as a separate component of
stockholders' equity as accumulated other comprehensive income. Foreign currency transaction gains and losses
are reported in the income statement.
B. Selection of Exchange Rates for Translation
FASB mandates the current rate method when the functional currency is the foreign currency, which is the usual
case. The current method that translates at current exchange rates is required under ASC 830 (except when there
is a highly inflationary environment, to be discussed shortly).
The current method ensures that financial relationships remain the same in both local currency and reporting
currency. To accomplish this goal, ASC 830-30-45-3 requires that all elements of financial statements in the foreign
entity's functional currency to be translated to the parent's reporting currency using a current exchange rate as
follows:
1. For assets and liabilities, the entity should use the exchange rate at the balance sheet date.
2. For revenues, expenses, gains, and losses, the entity should use the exchange rate at the dates on which
those elements are recognized.
According to ASC 830, the current exchange rate is 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.
ASC 830-30-45-3 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 that are included in revenues and expenses. That is, not the rates on the dates the related items
originated).
Finally, a reporting entity should NOT adjust its financial statements for a rate change that occurs after the date
of its financial statements. However, the entity should follow disclosure requirements as addressed in the
“Disclosures” section.
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The following table summarizes exchange rates used to translate the financial statements of a foreign entity.
Exchange Rates for Translation
Assets and Liabilities Current exchange rate at the balance sheet date
Shareholders’ Equity
Historical exchange rates on the date the transactions are recognized,
except for the retained earnings during the year, which is translated
at the weighted average of the historical rates used to translate each
period’s income statement
Income Statement Exchange rate at the date the income or expense was recognized
If exchangeability between two currencies is temporarily lacking at the transaction date or balance sheet date,
ASC 830-30-45-9 requires the use of the first subsequent rate at which exchanges could be made. If the lack of
exchangeability is other than temporary, the propriety of consolidating, combining, or accounting for the foreign
operation by the equity method should be carefully considered.
ASC 830 provides the following example to illustrate the application of ASC 830-10-45-9.
Example 10: Exchange Rate When Exchangeability is Lacking Temporarily
ASC 830-30-55-1
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:
a. On December 29, 20X8, the currency market was open and foreign currencies were traded. The exchange rate
was FC 1.68 = USD 1.00.
b. On December 30, 20X8, Israeli banks were officially open but foreign exchange trading was suspended until
January 2, 20X9. A devaluation to occur on January 2, 20X9, was announced. Most businesses were closed for
the holidays.
c. On December 31, 20X8, banks were closed.
d. On January 1, 20X9, banks were closed.
e. On January 2, 20X9, foreign exchange transactions were executed but left unsettled until the following day
when a new rate was to be established.
f. On January 3, 20X9, 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, 20X9, the first subsequent
rate, is the appropriate rate to use for translating the December 31, 20X8, financial statements.
39
1. Balance Sheet
Balance sheet items (all assets and liabilities) are translated at the current exchange rate at the balance sheet
date. Shareholders’ equity accounts (e.g. preferred stock, additional paid-in capital) are translated using the
historical exchange rates on the date they are recognized by both the parent and subsidiary, which presumably
would be the same date. For example, common stock issued is translated at the rate in effect on the date of
issuance. Since retained earnings represent accumulated net income, it is translated at the weighted average of
the historical rates used to translate each period’s income statement.
2. Income Statement
In the usual case (when high inflation does not exist), income statement items (revenue, expenses, gains, and
losses) are translated at the exchange rate at the dates those items are recognized. Because translation at the
exchange rates at the dates of many revenues, expenses, gains, and losses is usually impractical, ASC 830-10-55-
10 allows the use of averages or other methods of approximation. An appropriately weighted-average exchange
rate for the fiscal year is typically used in translating income statement items. Average rates used should 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, the entity could translate individual
revenue and expense accounts for each month at the month’s average rate. The translated amounts for each
month should then be combined for the annual totals. Average quarterly or monthly rates may be used if
significant revenues and expenses occur at particular times during the year.
3. Cash Flow Statement
In the statement of cash flows, cash flows are translated based on the exchange rates in existence at the time of
the cash flows. If reasonable and practical, a weighted-average rate for the year may be used, as long as the result
is similar. Disclosure should be made in the statement of cash flows for the impact of any exchange rate changes
on cash flow.
C. Translation Adjustments
A translation adjustment occurs only if the foreign entity's functional currency is different from that of the parent.
If a foreign entity's functional currency is the U.S. dollar and the parent's currency is also the U.S. dollar, translation
adjustment is NOT required.
According to ASC 830-30-45-12, translation adjustments resulting from translating the foreign entity's financial
statements into the reporting currency should be reported in other comprehensive income. As discussed, a gain
or loss on a foreign currency transaction that hedges a net investment in a foreign entity is reported in the same
manner as a translation adjustment. In this case, the translation loss or gain should be reported in accumulated
other comprehensive income.
40
Translation adjustments can be viewed as unrealized gains or losses. Therefore, they are reported in cumulated
other comprehensive income and are reclassified to net income only when there is a sale or liquidation of the
investment in the foreign entity.
Details of sale or liquidation of an investment in a foreign entity are discussed in the “Disposition of a Foreign
Entity” section.
Example 11: Reporting Gains or Losses
Blake Company's wholly-owned subsidiary, David Company, keeps its records in euros. Because David Company's
branch offices are located in Switzerland, its functional currency is the Swiss franc. Remeasurement of David
Company's 20X2 financial statements resulted in an $8,700 gain, and translation of its financial statements
resulted in a $9,200 gain. Blake should report as a foreign exchange gain $8,700 in its income statement for the
year ended December 31, 20X2. The translation gain of $9,200 should be included in “other comprehensive
income” and the cumulative translation adjustment, which is a separate component of stockholders' equity.
D. Highly Inflationary Environment
As discussed, the foreign entity's financial statements in a very inflationary environment are unstable and should
be remeasured as if the functional currency were the reporting currency. Consequently, if a foreign entity's
financial statements in a highly inflationary economy are expressed in a currency different from the reporting
currency, they have to be remeasured into the reporting currency.
If the U.S. dollar is used directly as the functional currency because of high inflation, balance sheet conversion
would be as follows:
• Cash, receivables, and payables are converted at the foreign exchange rate in effect at the balance sheet
date.
• Other assets and liabilities are converted at foreign exchange rates (historical rates) in effect at the date
of transaction, except that the exchange rate in effect at the balance sheet date is used to translate assets
and liabilities that are accounted for based on current prices, such as marketable securities carried at
market and estimated warranty obligations.
When the U.S. dollar is used as the functional currency because of high inflation, translation of income statement
items is based on the weighted average rate for the period. However, revenues and expenses that relate to assets
and liabilities translated at historical rates should be translated at such historical rates. Examples are depreciation
on fixed assets, amortization expense on intangible assets, and amortized revenue arising from deferred revenue.
In a highly inflationary environment in a foreign country requiring the use of the reporting currency directly,
transaction gains or losses from converting foreign currency financial statements into reporting currency financial
statements are recognized in the income statement.
41
Finally, ASC 830-10-45-16 addresses the consequences for the recognition of deferred tax benefits when a foreign
entity in a highly inflationary economy adopts the reporting currency of its parent as its functional currency. That
is, ASC 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. Thus, deferred tax benefits attributable to
any such indexing that occurs after the change in functional currency to the reporting currency should 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 are realized as deductions for tax purposes.
The following exhibit presents a portion of an annual report regarding foreign operations in a highly inflationary
environment.
2015 GE Annual Report
Venezuela
The results of our Venezuelan businesses have been reported under highly inflationary accounting since the
beginning of 2010, at which time the functional currency of our Venezuelan entities was changed from the bolivar
to the U.S. dollar.
Our activities related to Venezuela generated revenues of less than one percent of consolidated revenues,
consisting of both exports to and operations within the country. The majority of these revenues are denominated
in U.S. dollars and euro but we also transact in bolivars for certain businesses.
For our operations in Venezuela, determining the appropriate exchange rate for remeasurement of bolivar-
denominated net monetary assets into U.S. dollars continues to be subject to uncertainty. As of December 31,
2015, the Venezuelan government operated three different exchange mechanisms: the government-operated
CENCOEX (the official exchange mechanism), the government-operated auction-based SICAD mechanism and an
open market Marginal Currency System (SIMADI). The SIMADI mechanism is intended to operate with fewer
restrictions and its exchange rate on December 31, 2015, was approximately 198 bolivars per U.S. dollar compared
to SICAD at 13.5 bolivars per U.S. dollar.
At the end of each period, we remeasure the net monetary assets of our Venezuelan businesses using the rate we
expect to settle them at, including through the payment of dividends. The industries in which these businesses
operate were not selected for participation in any SICAD auctions during 2015. In light of continued uncertainty
regarding availability of exchange mechanisms and decreasing liquidity in those mechanisms, we completed an
extensive review of each of our business activities within Venezuela during the fourth quarter of 2015. Based on
that review, we decided to reduce certain business activities in Venezuela and to begin accessing the SIMADI
market to obtain U.S. dollars, to the extent possible, for our residual Oil & Gas and Power operations. Our
Appliances business in Venezuela, which is conducted through an equity method investment, similarly concluded
that the SIMADI exchange mechanism provides the most appropriate rate for measuring its net monetary assets.
We also concluded, based on our review, consolidating our remaining Venezuelan operations remains
appropriate.
42
Use of the SIMADI rate to remeasure our Venezuelan net monetary assets at December 31, 2015, resulted in
exchange rate losses of $83 million. Restructuring and impairment charges of $12 million also were recorded
during the fourth quarter of 2015 as a result of the review discussed above. Net monetary assets subject to
remeasurement at the SIMADI rate were approximately $5 million at December 31, 2015, including approximately
$3 million within our Appliances equity method investment. In addition to our bolivar- denominated net monetary
assets, we also have non-bolivar credit exposures of approximately $292 million at December 31, 2015, and
recoverable amounts of non-monetary assets in Venezuela of approximately $89 million at December 31, 2015,
which consists principally of inventory and property, plant and equipment.
E. Derecognition
1. Disposition of a Foreign Entity
Upon sale of complete or substantially complete liquidation of an investment in a foreign entity, ASC 830-30-40-
1 requires the cumulative translation adjustment balance associated with that foreign entity to be:
✓ Removed from the stockholders' equity section
✓ Reported as part of the gain or loss on sale or liquidation of the investment in the income statement for
the period during which the sale or liquidation occurs
ASC 830-30-40-1A clarifies that a sale of an investment in a foreign entity includes:
1. Circumstances that result in the loss of a controlling financial interest in a foreign entity (that is,
irrespective of any retained investment); and
2. An acquirer obtaining control of an acquiree in which it held an equity interest immediately before the
acquisition date (also called a step acquisition)
To qualify as a “substantial” liquidation, generally at least 90% of the assets and liabilities of a foreign entity should
be liquidated. Therefore, PwC suggests that the following transactions do NOT represent a substantially complete
liquidation:
Payment of periodic dividends to the parent out of a foreign subsidiary’s net income
Payment of liquidating dividends in amounts less than a significant portion of the investment’s assets (i.e.,
less than 90% of the assets)
Changing the nature of an intercompany advance from permanent (i.e., similar to capital) to debt intended
to be settled in the foreseeable future
ASC 830-30-40-4 indicates that under ASC 220-20 Comprehensive Income, 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. ASC
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830-30-40-1 does not alter the period in which a gain or loss on sale or liquidation is recognized under existing
GAAP.
The following examples illustrate the application of 830-30-40-1.
Example 12: Reporting Translation Adjustments
Example 12-1
Johnson Corp. is a U.S. company. ENG is a wholly-owned subsidiary of Johnson located in the U.K. Johnson reduces
its ownership in ENG from 100% to 51%. Johnson still retained a controlling financial interest in ENG and should
continue to consolidate it.
How should Johnson report the cumulative translation adjustment account balance associated with ENG?
Solution:
According to ASC 830-30-40-1, a reporting entity can only remove the cumulative translation adjustment account
balance associated with that foreign entity from equity and recognize it in the income statement upon sale or
upon complete or substantially complete liquidation of an investment in a foreign entity. ASC 830-30-40-1A
clarifies that a sale of an investment in a foreign entity includes circumstances that result in the loss of a controlling
financial interest in a foreign entity (that is, irrespective of any retained investment).
In this case, the event is NOT qualified as a sale of an investment in a foreign entity since Johnson still retains
control of ENG. Accordingly, the cumulative translation adjustment related to ENG should remain in equity.
Example 12-2
Star West Corp. holds a 35% ownership interest in an equity method investment that is a foreign entity.
Subsequent to the initial investment, Star West acquires an additional 30% ownership interest in the equity
method investee, and as a result, now controls and consolidates the foreign entity.
How should Star West report the cumulative translation adjustment related to the foreign equity method
investment?
Solution:
According to ASC 830-30-40-1, a reporting entity can only remove the cumulative translation adjustment account
balance associated with that foreign entity from equity and recognize it in the income statement upon sale or
upon complete or substantially complete liquidation of an investment in a foreign entity. ASC 830-30-40-1A
clarifies that a sale of an investment in a foreign entity includes an acquirer obtaining control of an acquiree in
which it held an equity interest immediately before the acquisition date (e.g. step acquisitions).
In this case, the event is qualified as a sale of an investment in a foreign entity since Star West controls the foreign
entity through the step acquisition. Accordingly, Star West should remove the cumulative translation adjustment
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related to the foreign equity method investment from equity and recognize it in the income statement upon the
acquisition of the additional 30% interest.
2. Partial Sale of Ownership Interest
If a reporting entity sells a portion of a foreign entity that is accounted for using the equity method, and its retained
interest will also be accounted for using the equity method, it should recognize a pro rata portion of the
cumulative translation adjustment account attributable to the equity method investment when measuring the
gain or loss on the sale as prescribed by ASC 830-30-40-2.
The following table lists these levels of interest or influence and the corresponding valuation and reporting
method that companies must apply to the investment.
Three Levels of Influence and Accounting Methods
Percentage of
Ownership 0% −−−−−−− 20% 20% −−−−−− 50% 50−−−−−−−100%
Level of Influence Little or None Significant Control
Valuation Method Fair Value Method Equity Method Consolidation
When the sale of part of an equity method investment that is a foreign entity results in the loss of significant
influence, the cumulative translation adjustment account balance remaining after the pro rata recognition in net
income should become part of the cost method carrying value. ASC 323-10-35-37 and 35-39 provide guidance on
how to account for the pro rata portion of the cumulated translation adjustment component of equity attributable
to the remaining investment as follows:
ASC 323-10-35-37
Paragraph 323-10-35-39 provides guidance on how an investor shall account for its proportionate share of an
investee’s equity adjustments for other comprehensive income in all of the following circumstances:
a. A loss of significant influence
b. A loss of control that results in accounting for the investment in accordance with Topic 321
c. Discontinuation of the equity method for an investment in a limited partnership because the conditions in
paragraph 970-323-25-6 are met for accounting for the investment in accordance with Topic 321.
ASC 323-10-35-39
In the circumstances described in paragraph 323-10-35-37, an investor’s proportionate share of an investee’s
equity adjustments for other comprehensive income shall be offset against the carrying value of the investment
at the time significant influence is lost. To the extent that the offset results in a carrying value of the investment
that is less than zero, an investor shall both:
a. Reduce the carrying value of the investment to zero
b. Record the remaining balance in income
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ASC 830-30-40-3 clarifies that 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 830-30-40-1 are met.
Example 13: Partial Sale of Ownership Interest
Dale Corp. is a U.S. company. EPS Corp. is a foreign entity of Dale. Dale has a 40% investment in EPS using the
equity method of accounting.
Dale sells a portion of its 40% ownership interest in EPS reducing its investment to 30%. Dale still retains significant
influence.
At the date of sale, Dale’s cumulative translation adjustment account balance related to EPS is a debit balance of
$80,000.
How should Dale account for its cumulative translation adjustment in EPS upon the sale of a portion of its
investment?
Solution:
According to ASC 830-30-40-2, Dale should recognize a proportionate share of the cumulative translation
adjustment in net income. Therefore, Dale recognizes the pro rata portion as 25% (the decrease in ownership
from 40% to 30%) of the $80,000 cumulative translation adjustment account balance, or $20,000 in net income.
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Release of Cumulative Translation Adjustment Decision Tree
ASU 2013-05 provides the following flowchart to illustrate the cumulative translation adjustment derecognition
guidance in ASC 830-30-40-1 through 40-4 for the derecognition of certain subsidiaries or groups of assets within
a foreign entity and for changes in an investment in a foreign entity.
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3. Cumulative Translation Adjustment in Impairment Assessment
ASC 830-30-45-13 requires an entity that has committed to a plan to dispose of an equity method investment or
a consolidated investment in a foreign entity that will cause the cumulative translation adjustment attributable to
that entity to be reclassified to net income should include the cumulative translation adjustment as part of the
carrying amount of the investment when evaluating that investment for impairment.
Additionally, ASC 830-30-45-15 states that an entity should 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.
The following example illustrates the application of ASC 830-30-45-13.
Example 14: Impairment Assessment
Penny Corp. uses the U.S. dollar as its functional currency. Forest Inc. uses the euro as its functional currency.
On January 1 20X8, Penny invests $800 for a 30% ownership interest in Forest, which will be accounted for as an
equity method investment. For simplicity, the investment cost equals 30% of Forest's net book value.
Penny recognizes its share of:
• Forest’s net income for the year ended December 31, 20X8 ($200)
• The adjustment from the translation of Forest’s financial statements from the euro to the U.S. dollar (debit
of $40)
A roll-forward of the equity method investment account from the initial investment to the balance at 31 December
31, 20X8 follows:
Initial investment $800
Share of 20X8 net income 200
Share of translation adjustment (40)
$960
On December 31, 20X8, Penny commits to a plan to sell its equity method investment in Forest for $900. The
investment is sold on March, 15 20X9 for $900. The impairment test is calculated as follows:
Carrying amount of investment in Forest $960
Add: *Cumulative translation adjustment debit balance 40
Adjusted carrying amount 1,000
Fair value (900)
Impairment loss $100
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Carrying amount before impairment write-down $960
Impairment write-down (100)
Carrying amount of investment in Forest at December 20X8 $860
Accounting at the date of sale March 15, 20X9
Sale proceeds $900
Less: Asset carrying amount (860)
Cumulative translation adjustment reclassification entry (40)
Loss on disposal $0
* According to ASC 830-30-40-1, cumulative translation adjustment is reclassified into net income only upon a sale or upon a
complete or substantially complete liquidation of the foreign entity. Thus, this entry is used only for measuring impairment.
Comprehensive Illustration: Translation of Foreign
Entity Financial Statements
AGI Corp., a U.S. company, uses the U.S. dollar (USD) as its reporting currency. Novo is considered a foreign entity
of AGI located in Denmark with a functional currency of the euro (EUR). Novo maintains its books and records in
krone (DKK). Its DKK financial statements are shown below.
Balance on 1/1/x8
Balance on 12/31/x8
Balance Sheet (DKK) (DKK)
Cash 20,000 23,000
Net property, plant and equipment (PP&E) 8,000 7,000
Total assets 28,000 30,000
Common stock 18,000 18,000
Retained earnings 10,000 12,000
Total shareholders’ equity 28,000 30,000
Income Statement 12/31/x8
Gross profit 3,000
Depreciation (1,000)
Net income 2,000
Retained earnings at 1/1/x8 10,000
Retained earnings at 12/31/x8 12,000
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For simplicity, there is no opening balance in AGI’s cumulative translation adjustment account related to its
investment in Novo assuming that the 1/1/x8 exchange rate has not changed since AGI acquired Novo.
How should AGI translate Novo’s DKK financial statements for inclusion in its USD consolidated financial
statements?
Solution: Novo’s DKK financial statements should first be remeasured into its functional currency (EUR), and then
translated into the reporting currency (USD).
The following exchange rates are used to remeasure and translate Novo’s financial statements. Retained earnings
is translated using the historical exchange rate since we have assumed that exchange rates prior to 1/1/x8 had
not changed.
DKK to EUR EUR to USD
Current exchange rate as of 12/31/x8 DKK 1 = EUR 1.20 EUR 1 = USD 1.13
Current exchange rate as of 12/31/x7 DKK 1 = EUR 1.50 EUR 1 = USD 1.09
Weighted average exchange rate DKK 1 = EUR 1.18 EUR 1 = USD 1.10
Historical exchange rate in effect at the date the
common stock was issued and PP&E was purchased DKK 1 = EUR 1.15 EUR 1 = USD 1.09
REMEASUREMENT TRANSLATION
Balance Sheet DKK
Balance Exchange Rate EUR
Balance Exchange Rate USD
Balance
Cash 23,000 DKK 1 = EUR 1.20 27,600 EUR 1 = USD 1.13 31,188
Net PP&E 7,000 DKK 1 = EUR 1.15 8,050 EUR 1 = USD 1.13 9,097
Total assets 30,000 35,650 40,285
Common stock 18,000 DKK 1 = EUR 1.15 20,700 EUR 1 = USD 1.09 22,563
Retained earnings 12,000 14,950 16,330
Translation adjustment (See Table A) - - 1,392
Total shareholders’ equity 30,000 35,650 40,285
REMEASUREMENT TRANSLATION
Income Statement DKK
Balance Exchange Rate EUR
Balance Exchange Rate USD
Balance
Gross profit 3,000 DKK 1 = EUR 1.18 3,540 EUR 1 = USD 1.10 3,894
Depreciation (1,000) DKK 1 = EUR 1.15 (1,150) EUR 1 = USD 1.10 (1,265)
Foreign exchange gain (See Table B) - 1,060 1,166
Net income 2,000 3,450 EUR 1 = USD 1.10 3,795
Retained earnings at 1/1/x8 10,000 DKK 1 = EUR 1.15 11,500 EUR 1 = USD 1.09 12,535
Retained earnings at 12/31/x8 12,000 14,950 16,330
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The translation adjustment of USD 1,392 above results from translating from EUR to USD. The translation
adjustment is calculated as follows:
Table A: Calculation of Translation Adjustment (from EUR to USD)
EUR balances as of 1/1/x8 Change in exchange rate
Cumulative Translation Adjustment USD Balance
Net assets at 1/1/x8 32,200 1.13 – 1.09 = 0.04 1,288
Net income for the year 3,450 1.13 – 1.10 = 0.03 104
1,392
The foreign exchange gain of EUR 1,060 results from the remeasurement from British pounds to euros and is
included in income. It is calculated as follows:
Table B: calculation of Foreign Exchange Gain (from DKK to EUR)
DKK balances as of 12/31/x8 Change in exchange rate
Foreign Exchange Gain EUR Balance
Net monetary assets at 1/1/x8 20,000 1.20 – 1.15 = 0.05 1,000
Gross profit for the year 3,000 1.20 – 1.18 = 0.02 60
1,060
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V. Other Matters
A. Intercompany Profits
ASC 830-30-45-10 indicates that to eliminate intercompany profits that are attributable to sales or other transfers
between entities that are consolidated, combined, or accounted for by the equity method, the reporting entity
should use the exchange rate in existence at the dates of the sales or transfers. However, a reasonable average
or estimated rate is permitted. Since the elimination of intercompany profits should be based on the exchange
rates at the dates of sale or transfer, subsequent changes in the exchange rates should NOT affect the elimination
process.
The following example illustrates the application of ASC 830-30-45-10.
Example 15: Elimination of Intercompany Profits
AME Corp. is a U.S. company that uses the U.S. dollar as its reporting currency. BRI is a wholly-owned subsidiary
of AME located in London.
On January 15, 20X8, AME sells inventory for $500,000 (cost $200,000) to BRI whose functional currency is the
pound. Upon the sale, AME realizes an intercompany profit of $300,000 ($500,000 — $200,000).
As of March 31, 20X8, the inventory has not yet been sold.
The following table summarizes the exchange rate on the date the company sold the inventory and on the date
of its financial statements.
Date Exchange Rate
January 15, 20X8 $1=£0.5
March 31, 20X8 $1=£0.8
How should AME account for the inventory sale in its consolidated financial statements for the quarter ended
March 31, 20X8?
Solution:
In order to properly compute the intercompany profit amount to be eliminated in consolidation, the inventory
recorded on BRI’s books needs to be separated into two components. The inventory recorded in BRI: £200,000
1. Cost component: £100,000 ($200,000 x (£0.5/$1.0))
2. Intercompany profit component: £150,000 ($300,000 x (£0.5/$1.0))
According to ASC 830-30-45-10, translation of intercompany profits and the elimination of such intercompany
profits on sales or transfers between entities should be based on the exchange rates at the dates of sale or
transfer. Therefore, the exchange rate of $1=£0.5 as of January 15, 20X8 is used. The intercompany profit
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component of £150,000 is translated at the historical rate into $300,000 which equals the intercompany profit
amount recognized by AME. These two balances are fully eliminated in consolidation.
The cost component of £100,000 is translated at the current exchange rate as of March 31, 20X8. This results in
the inventory amount of $125,000 [£100,000 ÷ (£0.8/$1.0)] recognized in the consolidated balance sheet.
B. Hedging
An entity may enter into hedging transactions to minimize the adverse effects of changes in exchange rates on
cash flows and net income. An entity's aim is to recognize a gain or loss from the hedge in the same period as the
loss or gain on the risk being hedged. The process will result in an overall reduction of risk for the entity. Foreign
currency transaction gains and losses on assets and liabilities, denominated in a currency other than the entity's
functional currency, can be hedged if the U.S. company enters into a forward exchange contract or a foreign
currency option.
Forward exchange contracts are contracts where the entity agrees to purchase an amount of foreign currency at
a specific date in the future at a specific exchange rate. Forward contracts can be difficult to create, have higher
fees, are highly customized, and may be hard exchange given their highly specific criteria.
According to ASC 815, a forward contract is an executory contract in which the parties involved agree to the terms
of a purchase and a sale of a stated amount of a commodity, foreign currency, or financial instrument, but delivery
or settlement is at a stated future date. Accordingly, a forward contract involves a commitment today to purchase
a product on a specific future date at a price determined today.
Foreign currency options give the purchaser the right to buy or sell the currency, but not the obligation, during a
specified period of time. Currency options are very flexible, and one of the most common ways for corporations
to hedge against adverse or unexpected movements in exchange rates. Currency options may be quoted in one
of two ways:
1. American terms, in which a currency is quoted in terms of the U.S. dollar per unit of foreign currency and
may be exercised at any time up to and including the expiration date; and
2. European terms, in which the U.S. dollar is quoted in terms of units of foreign currency per U.S. dollar,
and may be exercised on the expiration date of the option only, while American style options.
Options in general provide a way to reduce the risk of a loss and also the chance of a benefit from a favorable
exchange rate change.
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ASC 815-10-05 and ASC 815-20-25 permit hedge accounting for foreign currency derivatives only if the following
conditions are satisfied:
✓ The derivative is used to hedge either a fair value exposure or a cash flow exposure.
✓ The derivative is highly effective in offsetting changes in the fair value or cash flows. A highly effective
hedge would be one where the changes in the hedged item are nearly offset by the changes in the hedging
instrument.
✓ The derivative is documented as a hedge.
A fair-value exposure exists if changes in exchange rates can affect the fair value of assets or liabilities. If the
exposure is not hedged, it must have the potential to affect net income. A fair value hedge also may exist for
foreign currency firm commitments. A cash flow exposure exists if changes in exchange rates can affect the
amount of cash flow that will be realized from a transaction, where changes in cash flow are reflected in net
income.
To use hedge accounting, derivatives must be designated as either a fair value hedge or a cash flow hedge. An
entity may use either a fair value hedge or a cash flow hedge for:
1. Recognized foreign currency assets and liabilities.
2. Foreign currency firm commitments.
Hedges of forecasted foreign currency transactions can only qualify for a cash flow hedge. Gains or losses on fair
value hedges are recognized immediately in net income, whereas gains or losses on cash flow hedges are included
in other comprehensive income.
To use hedge accounting, the hedge must be expected to be highly effective in offsetting gains and losses on the
items being hedged. Critical terms of the hedging instrument, such as currency type, amount, and settlement date
should match those of the hedged item. The hedging entity should document the:
• Hedged item;
• Hedging instrument;
• Nature of risk;
• Means of assessing the hedging instrument's effectiveness; and
• Management's objectives and strategies for undertaking the hedge.
Derivative and hedge accounting can be a highly complex topic. Please review ASC 815 for more information.
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C. Disclosures
1. Aggregate Transaction Gains or Losses
ASC 830-20-45-1 requires entities to disclose the aggregate transaction gain or loss included in the determination
of net income for the period in either the financial statements or notes to the financial statements. Specifically,
disclosures in notes to the financial statements should include transaction gains or losses reclassified to other
income statement components, such as interest income and expense, sales, and cost of sales. ASC 830-20-45-2
states that banks and dealers in foreign exchange may disclose these transaction gains or losses as dealer gains or
losses rather than as transaction gains or losses.
According to ASC 830-740-45-1, 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.
2. Cumulative Translation Adjustments
An entity is required to disclose and analyze the changes in the accumulated amount of translation adjustments
reported in equity during the period. According to ASC 830-30-45-18, this analysis of changes in cumulative
translation adjustment should be reported 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
ASC 830-30-45-20 requires the analysis to include, at a minimum:
1. Beginning and ending amount of cumulative translation adjustments
2. The aggregate adjustment for the period resulting from translation adjustments and gains and losses from
certain hedges (e.g. net investment hedge in a foreign operation) and intra-entity balances (those of a
long-term investment nature)
3. The amount of income taxes for the period allocated to translation adjustments
4. 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.
3. Exchange Rate Changes
According to ASC 830-30-45-16, a reporting entity’s financial statements should NOT be adjusted for a rate change
that occurs:
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• 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.
However, ASC 830-20-50-2 requires the entity to disclose the following information:
1. Significant effects on unsettled balances pertaining to foreign currency transactions
2. Consideration of changes in unsettled transactions from the date of the financial statements to the date
the rate changed
3. The fact that it is not practicable to determine such changes (if applicable)
In general, such disclosure is not required only if the entity does NOT have any unsettled foreign currency
transactions. Disclosure of significant effects on unsettled foreign currency transactions of subsequent exchange
rate changes is necessary because the changes affect the remeasurement of these transactions resulting in
transaction gains or losses (i.e. cash flow consequence). However, a subsequent rate change that affects only the
translation process does not have the same impact since translation adjustments are recorded in equity (i.e. lack
of cash flow consequence). Thus, disclosure of a subsequent rate change that affects only the translation process
usually is not considered necessary.
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 830-20-50-3 encourages management to include an
analysis and discussion of the effects of rate changes on the reported results of operations. Such disclosures may
include:
✓ The mathematical effects of translating revenue and expenses at rates that are different from those used
in a preceding period
✓ The economic effects of rate changes, such as the effects on selling prices, sales volume, and cost
structures
4. Footnote Disclosure
Footnote disclosure is required of:
• Profits earned from overseas. This also includes the amount of foreign earnings in excess of amounts
received in the U.S.
• Foreign currency transaction gains or losses, including that associated with forward exchange contracts.
• The impact on unsettled balances regarding foreign currency transactions.
• Cumulative translation adjustments are reported in stockholders' equity. This includes the reasons for the
change in the balance from the beginning to the end of the year.
• Gains or losses arising from hedging a foreign currency position.
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• Effect of exchange rate changes on operating results and financial position. This disclosure includes the
impact of a change in exchange rates from the prior year to the current year associated with the
translation of revenues and expenses. It also includes the effect of a change in exchange rate on revenue
and cost components, such as sales volume, sales price, and cost of sales. The nature of restated figures
should be noted.
• A significant change in exchange rate taking place after year-end and before the audit report date. This is
a subsequent event disclosure.
5. Excluding a Foreign Entity from Financial Statements
In some cases, a foreign entity may be excluded from consolidated or combined financial statements. This may
arise if serious political problems exist in the foreign country (e.g., civil war) or if exchange restrictions are
extremely restrictive, inhibiting any reliability to exchange rates. In this situation, the profits of a foreign activity
should be included in the financial statements only to the degree of receipt of unrestricted cash. When the foreign
entity is excluded from the financial statements, proper disclosure should be made of the reasons therefor, other
pertinent information, and dollar effect. Such disclosure may be in a supplemental schedule or in a footnote form.
The SEC’s View on Disclosures, if the U.S. Dollar is Not the Reporting Currency
Excerpt from the SEC Division of Corporation Finance Financial Reporting Manual
6620 Disclosures, if the U.S. Dollar is Not the Reporting Currency [S-X 3-20]
While not specifically referring to SFAS 52 [ASC 830], S-X 3-20 is designed to be conceptually consistent with that
standard. Assets and liabilities are translated at the period end exchange rate and the income statement is
translated at the weighted average annual exchange rate. The translation effects of exchange rate changes are
included as a separate component of equity.
6620.1 The currency used to prepare financial statements must be displayed prominently on the face of the
financial statements.
6620.2 The currency in which dividends are declared, if different from the reporting currency, must be disclosed.
6620.3 A description of material exchange restrictions or controls relating to the reporting currency, and the
currency of the issuer's domicile or the currency in which the issuer will pay dividends, if different, must be
provided.
6620.4 A five-year history of exchange rates setting forth rates at period end, average, highs and lows, must be
disclosed. [Item 3.A of Form 20-F] The noon buying rate in New York City for cable transfers in foreign currencies
as certified for customs purposes by the Federal Reserve Bank in New York can be obtained via the internet at:
http://www.newyorkfed.org/markets/fxrates/historical/home.cfm.
See the Division of Corporation Finance’s C&DIs for Exchange Act Forms, Question 110.01.
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6620.5 Dollar equivalent or convenience translations are generally not permitted, except that a convenience
translation may be presented only for the most recent fiscal year and interim period. Translation should be made
at the exchange rate on the balance sheet date or most recent date practicable, if materially different. The rate
used for the convenience translation should generally be the rate that the issuer would use if dividends were to
be paid in U.S. dollars.
6620.6 An issuer filing a registration statement on Form F-3 that incorporates financial statements previously filed
on Form 20-F does not need to amend or otherwise modify these statements to reflect a more current exchange
rate in presenting the convenience translation.
6620.7 While S-X 3-20 allows foreign private issuers to prepare financial statements in the currency it believes is
appropriate, it does not address financial statements of acquirees or equity investees. However, these financial
statements can be prepared either in the same currency as the issuer or in the currency that normally is used for
the preparation of such entities’ financial statements. Accordingly, a domestic issuer can prepare financial
statements of an acquiree or investee in U.S. dollars. (Last updated: 12/31/2010)
D. Difference between U.S. GAAP and IFRS
Increasing globalization coupled with related regulations continues to put pressure on moving towards a common
global accounting framework – International Financial Reporting Standards (IFRS) as currently, more than 100
countries use IFRS. Several similarities exist between U.S. GAAP and IFRS with respect to accounting for foreign
currency translation issues. For example, both U.S. GAAP and IFRS:
✓ The functional currency is defined as the currency of the primary economic environment in which the
entity operates, this is normally the currency of the environment in which the entity generates and
expends cash
✓ Remeasurement into the functional currency before translation into the reporting currency is required
✓ Assets and liabilities are translated at the period-end rate and income statement amounts generally are
translated at the average rate, with the exchange differences reported in equity
✓ Transactions that are not denominated in an entity’s functional currency are foreign currency
transactions. Exchange differences arising on translation are usually recognized in profit or loss
✓ Certain foreign exchange effects related to net investments in foreign operations should be accumulated
in shareholders’ equity (i.e., the cumulative translation adjustment portion of other comprehensive
income)
✓ The identification of a highly inflationary economy is required, however, there are some differences
between the two standards as discussed below.
Although there are similarities between U.S. GAAP and IFRS with respect to accounting for foreign currency
translation issues, there are also differences. The significant differences between U.S. GAAP and IFRS include:
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Determination of Functional Currency
IAS 21 The Effects of Changes in Foreign Exchange Rates contains a hierarchical structure of indicators (including
primary and secondary indicators) on the determination of the functional currency. As discussed, ASC 830
indicates that several indicators should be considered to determine the entity’s functional currency. However,
those indicators are not set up in a hierarchical structure. In other words, there is no priority given to any of the
following ASC 830 indicators, unlike IFRS. Instead, an entity should evaluate all relevant information and exercise
its judgment in determining the functional currency.
Criteria to Determine Functional Currency
ASC 830
To determine the functional currency of a foreign operation, an entity should consider the following indicators (without distinguishing between primary and secondary): 1. Cash flows generated by the assets and liabilities of the foreign operation are primarily in the foreign
currency and do not directly affect the parent’s cash flows
2. Sales prices of the foreign operation’s products or services are:
• Determined more by local competition or government regulation than by worldwide competition and international prices and
• Not generally responsive on a short-term basis to changes in exchange rates
3. There is an active local sales market for the foreign operation’s products or services
4. The foreign operation uses primarily local labor, material and other costs to produce its products or render its services
5. The financing is primarily denominated in the foreign currency and cash flows generated by the foreign operation are sufficient to service existing and anticipated financing obligations
6. The foreign operation has a low volume of intercompany transactions and no extensive inter-relationship of operations with the parent
7. The parent’s currency would generally be the functional currency if the foreign entity is a holding company or shell company for holding investments, obligations, intangible assets
IAS 21
The following factors are considered in determining an entity’s or operation’s functional currency:
1. Primary Indicators:
• The currency that mainly influences sales prices
• The currency of the country whose competitive forces and regulations mainly determine sales prices; and
• The currency that mainly influences labor, material and other costs
2. Secondary Indicators:
• The currency in which funds from financing activities are generated; and
• The currency in which receipts from operating activities are usually retained
Although US GAAP and IFRS contain different criteria in determining an entity’s functional currency, both ASC 830
and IAS 21 generally result in the same conclusion. Moreover, under IFRS, an entity may decide to present its
financial statements in a currency other than its functional currency (presentation currency). U.S. GAAP does not
address whether an entity may have more than one reporting currency. However, like IFRS, the SEC indicated that
a foreign private issuer may select any reporting currency that the issuer deems appropriate.
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Highly Inflationary Economy
As discussed, ASC 830 describes that a highly inflationary economy is one that has cumulative inflation of
approximately 100% or more over a 3-year period. Once an economy reaches a three-year period cumulative
inflation of 100%, it is automatically considered highly inflationary. IFRS does not establish an absolute rate at
which hyperinflation (highly inflationary) is deemed to arise. Instead, IAS 29.3 Financial Reporting in
Hyperinflationary Economies provides a list of characteristics that might indicate hyperinflation, including when
the cumulative inflation rate over three years is approaching or exceeds 100%. Examples of indicators
(characteristics) of a hyperinflationary economy include:
• The general population keeps its wealth in non-monetary assets or a stable foreign currency
• Sales account receivables are indexed to inflation until collection
• interest rates, wages and prices are linked to a price index
As discussed, under ASC 830, when an entity’s functional currency is the currency of a highly inflationary economy,
the financial statements are required to be remeasured as if the functional currency were the reporting currency,
with resulting exchange differences recognized in income. In contrast, IFRS requires that the functional currency
be maintained. However, local functional currency financial statements (current and prior period) is restated in
terms of the measuring unit current at the balance sheet date.
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Review Questions – Section 3 13. How should translation gains and losses resulting from translating foreign currency financial statements into
U.S. dollars be treated?
A. As a deferred item in the balance sheet
B. As an ordinary item in the income statement for losses but a deferred item in the balance sheet for gains
C. As an ordinary item in the income statement
D. In other comprehensive income
14. Which of the following is debited to other comprehensive income (OCI)?
A. Discount on convertible bonds that are dilutive potential common stock
B. Premium on convertible bonds that are dilutive potential common stock
C. Cumulative foreign currency translation loss
D. Organizational costs
15. What does a forward contract involve?
A. A commitment today to purchase a product on a specific future date at a price to be determined sometime
in the future.
B. A commitment today to purchase a product some time during the current day at its present price.
C. A commitment today to purchase a product on a specific future date at a price determined today.
D. A commitment today to purchase a product only when its price increases above its current exercise price.
16. Which of the following is NOT required to be footnoted?
A. Profits earned from domestic earnings
B. Foreign currency transaction gains or losses, including that associated with forward exchange contracts
C. The impact on unsettled balances regarding foreign currency transactions
D. Cumulative translation adjustments reported in stockholders' equity
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Glossary
Conversion. The exchange of one currency for another.
Denominate. To pay or receive in the same foreign currency. The account can be denominated only in one
currency (e.g., Euros). It is a real account (asset or liability) fixed in terms of a foreign currency regardless of the
exchange rate.
Exchange ratio. The ratio of one unit of a currency to that of another at a given date. If a temporary lack of
exchangeability exists between the two currencies at the transaction date or balance sheet date, the first rate
available thereafter should be used.
Foreign currency. A currency other than the functional currency of a business. For example, the dollar could be
a foreign currency for a foreign entity. Composites of currencies (e.g., special drawing rights) may be used to
establish prices or denominate amounts of loans.
Foreign currency transactions. Transactions in which the terms are denominated in a currency other than the
entity’s functional currency. Foreign currency transactions occur when a company (1) purchases (imports) or sells
(exports) on credit merchandise or services the prices being denominated in a foreign currency; (2) buys or sells
assets or incurs or settles liabilities denominated in foreign currency; (3) takes out or gives international loans in
which the amounts payable or receivable are denominated in a foreign currency; (4) is a participant in an
unperformed forward exchange contract; and (5) borrows or lends money, and the amounts payable or
receivable are expressed in a foreign currency.
Foreign currency statements. Financial statements using as the measuring unit of a functional currency other than
the reporting currency of the business.
Foreign entity. An operation (e.g., division, subsidiary, branch, joint venture) whose financial statements are
prepared in a currency other than the reporting currency of the reporting entity.
Foreign currency translation. Stating in a company’s reporting currency those amounts denominated or
measured in a different currency.
Functional currency. A company’s functional currency is the currency of the primary economic environment in
which the company operates. It is usually the currency of the environment in which the business mostly receives
and pays cash. Once determined, the functional currency should be used consistently unless significant changes
clearly indicate a change. Note: The currency of a highly inflationary environment (three-year rate of 100% or
more) is not stable enough to be used for this purpose. In such circumstances, the U.S. dollar is the functional
currency. The functional currency of a foreign operation may be the same as that of a related affiliate where a
foreign activity is a “key” component or extension of a related affiliate. If remeasurement (restatement) of a
subsidiary’s foreign currency financial statements is required before translation can be accomplished (i.e., when
the functional currency is the U.S. dollar), a transaction gain or loss results.
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Local currency. The currency of a particular foreign country.
Monetary assets and liabilities. Cash, receivables, and obligations to pay a fixed amount of debt.
Measure. Translating into a currency other than the original reporting currency. Foreign financial statements are
expressed in U.S. dollars by using the relevant exchange rate.
Nonmonetary items. All balance sheet items except for cash, claims to cash, and cash obligations.
Reporting currency. The currency the business prepares its financial statements in, typically U.S. dollars.
Spot Rate. The exchange rate for immediate delivery of currencies exchanged.
Translation adjustments. Adjustments derived from translating financial statements from the entity’s functional
currency into the reporting one.
Transaction gain or loss. Transaction gain or loss is produced from redeeming receivables/payables that are
fixed in terms of amounts of foreign currency received/paid. An example is a French subsidiary having a
receivable denominated in Euros from a Swiss customer. A transaction gain or loss takes place when there is a
change in exchange rates between the functional currency and the currency in which a foreign currency
transaction is denominated.
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Index
A net investment hedge, 20 Available-for-sale debt securities, 26 Balance sheet, 39 Cash flow statement, 39 Cumulative translation adjustments, 54 Debt, 24 Debt securities, 25 Derecognition, 42 Disposition of a foreign entity, 42 Equity securities, 27 Footnote disclosure, 55 Foreign currency financial statements, 1 Foreign currency transactions, 1 Foreign entity, 1 Functional currency, 8 Hedging, 52
Held-to-maturity debt securities, 26, 31 Highly inflationary economy, 10, 40 Income statement, 39 Intercompany profits, 51 Inventory, 23, 30 Lease, 27, 28, 29 Monetary accounts, 18 Nonmonetary accounts, 18 Property, plant and equipment, 22 Remeasurement, 17 Reporting currency, 1 Spot rate, 20, 24, 25, 29, 30, 32, 34, 66 Trading debt securities, 26 Transaction gains or losses, 20 Translation, 36 Translation adjustment, 39
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Review Question Answers
Review Questions − Section 1
1. In preparing consolidated financial statements of a U.S. parent company with a foreign subsidiary, what is the
foreign subsidiary's functional currency?
A. Incorrect. The currency in which the subsidiary maintains its accounting records may not be the currency
indicated by the salient economic indicators, such as cash flows, sales prices, sales markets, expenses,
financing, and intercompany transactions.
B. Incorrect. The currency of the country in which the subsidiary is located may not be the currency indicated
by the salient economic indicators, such as cash flows, sales prices, sales markets, expenses, financing,
and intercompany transactions.
C. Incorrect. The currency of the country in which the parent is located may not be the currency indicated
by the salient economic indicators, such as cash flows, sales prices, sales markets, expenses, financing,
and intercompany transactions.
D. Correct. The method used to convert foreign currency amounts into units of the reporting currency is the
functional currency translation approach. It is appropriate for use in accounting for and reporting the
financial results and relationships of foreign subsidiaries in consolidated statements. This method
identifies the functional currency of the entity (the currency of the primary economic environment in
which the foreign entity operates), measures all elements of the financial statements in the functional
currency, and uses a current exchange rate for translation from the functional currency to the reporting
currency.
2. What is the currency in which the parent company prepares its financial statements?
A. Incorrect. The functional currency is the primary currency used by the subsidiary and is usually not the
same as the parent company currency.
B. Correct. The parent company will translate the subsidiary’s currency into the parent company’s reporting
currency.
C. Incorrect. Historical currency is not accurate. However, using historical exchange rates during financial
statement preparation will occur.
D. Incorrect. ‘Base currency’ is not a description used with foreign currency transactions.
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3. The economic effects of a change in foreign exchange rates on a relatively self-contained and integrated
operation within a foreign country relate to the net investment by the reporting enterprise in that operation.
What can be said about the translation adjustments that arise from the consolidation of that operation?
A. Incorrect. When an operation is relatively self-contained, the assumption is that translation adjustments
do not affect cash flows.
B. Incorrect. Translation adjustments do not affect cash flows.
C. Correct. ASC 830 concludes that foreign currency translation adjustments for a foreign operation that is
relatively self-contained and integrated within its environment do not affect cash flows of the reporting
enterprise and should be excluded from net income. When an operation is relatively self-contained, the
cash generated and expended by the entity is normally in the currency of the foreign country, and that
currency is deemed to be the operation's functional currency.
D. Incorrect. Translation adjustments should be included in other comprehensive income, not recognized in
income.
4. Which of the following is considered a highly inflationary environment?
A. Correct. A cumulative rate exceeding 100% over 3 years meets the definition of a highly inflationary
economy, and as such, requires a change in the translation method to reporting currency instead of the
functional currency.
B. Incorrect. This rate is too low and is likely too low even if other pertinent information about the economic
factors is considered because the rate falls below the highly inflationary level.
C. Incorrect. Several economies during normal growth may exceed a 25% level, so the value is too low.
D. Incorrect. This rate is much too low to be considered highly inflationary.
Review Questions − Section 2
5. Fogg Co., a U.S. company, contracted to purchase foreign goods. Payment in foreign currency was due one
month after the goods were received at Fogg's warehouse. Between the receipt of goods and the time of payment,
the exchange rates changed in Fogg's favor. How should the resulting gain be included in Fogg's financial
statements?
A. Correct. This foreign currency transaction resulted in a payable denominated in a foreign currency. The
favorable change in the exchange rate between the functional currency and the currency in which the
transaction was denominated should be included in determining net income for the period in which the
exchange rate changed. It should be classified as a component of income from continuing operations
because it does not meet the criteria for classification under any other caption in the income statement.
B. Incorrect. Gains or losses from exchange or translation of foreign currencies are usual in nature and may
be expected to recur in the course of customary and continuing business activities. However, they are not
recorded as revenue.
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C. Incorrect. The gain should not be deferred but should be recognized in the period in which the exchange
rate changed.
D. Incorrect. Translation adjustments, not transaction gains and losses, are included in other comprehensive
income.
6. On September 22, 20X2, Yumi Corp. purchased merchandise from an unaffiliated foreign company for 10,000
units of the foreign company's local currency. On that date, the spot rate was $.55. Yumi paid the bill in full on
March 20, 20X3, when the spot rate was $.65. The spot rate was $.70 on December 31, 20X2. What amount should
Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, 20X2?
A. Incorrect. A loss resulted when the spot rate increased.
B. Incorrect. $500 results from using the spot rates at 12/31/20X2 and 3/20/20X3.
C. Incorrect. $1,000 results from using the spot rates at 9/22/20X2 and 3/20/20X3.
D. Correct. Monetary accounts (e.g. cash, accounts receivable, accounts payable) are remeasured at the
current exchange rate. The resulting gain or loss should ordinarily be included in determining net income.
It is the difference between the spot rate on the date the transaction originates and the spot rate at year-
end. Thus, the 20X2 transaction loss for Yumi Corp. is $1,500 [($0.55 - $0.70) x 10,000 units].
7. Which of the following statements regarding foreign exchange gains and losses is TRUE (where the exchange
rate is the ratio of units of the functional currency to units of the foreign currency)?
A. Incorrect. The payable will become more expensive in the functional currency, resulting in a loss.
B. Correct. A foreign currency transaction gain or loss (commonly known as a foreign exchange gain or loss)
is recorded in earnings. When the amount of the functional currency exchangeable for a unit of the
currency in which the transaction is fixed increases, a transaction gain or loss is recognized on a receivable
or payable, respectively. The opposite occurs when the exchange rate (functional currency to foreign
currency) decreases.
C. Incorrect. The payable will become less expensive in the functional currency, resulting in a gain.
D. Incorrect. An exchange gain occurs.
8. On October 1, 20X5, Mild Co., a U.S. company, purchased machinery from Grund, a German company, with
payment due on April 1, 20X6. If Mild's 20X5 operating income included NO foreign currency transaction gain or
loss, which of the following might be TRUE?
A. Incorrect. Foreign currency transaction gains and losses are ordinarily operating items.
B. Correct. The terms of a foreign currency transaction are denominated in a currency other than the
functional currency. A fluctuation in the exchange rate between the functional currency and the other
currency is a gain or loss that ordinarily should be included in determining net income when the exchange
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rate changes. If Mild Co.'s functional currency is the U.S. dollar and the transaction was denominated in
U.S. dollars, no foreign currency transaction gain or loss occurred.
C. Incorrect. Foreign currency transaction gains and losses not included in the determination of net income
(certain intercompany transactions and certain hedges) are reported in other comprehensive income.
D. Incorrect. Translation expresses in the reporting currency amounts denominated in the functional
currency. Because the U.S. dollar is presumably the reporting and the functional currency of Mild Co., no
translation is required.
9. On October 1, Velec Co., a U.S. company, contracted to purchase foreign goods requiring payment in euros 1
month after their receipt at Velec's factory. Title to the goods passed on December 15. The goods were still in
transit on December 31. Exchange rates were one dollar to 1.06 euros, 1.04 euros, and 1.05 euros on October 1,
December 15, and December 31, respectively. How should Velec account for the exchange rate fluctuation?
A. Incorrect. The strengthening of the dollar resulted in a gain.
B. Correct. ASC 830 requires that a receivable or payable denominated in a foreign currency be adjusted to
its current exchange rate at each balance sheet date. The transaction gain or loss arising from this
adjustment should ordinarily be reflected in current income. Because title passed on December 15, the
liability fixed in euros should have been recorded on that date at the 1.04 euro exchange rate. The increase
to 1.05 euros per dollar at year-end decreases the dollar value of the liability and results in a transaction
gain. Such a gain is ordinarily treated as a component of income from continuing operations.
C. Incorrect. Extraordinary items are infrequent and unusual in nature. Exchange rates change frequently.
Besides, the FASB discontinued the accounting treatment for extraordinary items to reduce the cost and
complexity of preparing financial statements.
D. Incorrect. The transaction resulted in a gain, not a loss, and it would not be included in other
comprehensive income.
10. How are gains or losses on foreign exchange contracts typically recognized?
A. Incorrect. Foreign exchange gains or losses are not reflected on the balance sheet.
B. Correct. Gains and losses will be reported in current earnings, as a foreign exchange loss or gain.
C. Incorrect. Foreign exchange gains should be reflected in the financial statements at the completion of the
contract and at balance sheet dates.
D. Incorrect. Only one of the answers is correct. When financial statement dates fall between the transaction
and final settlement date, gains and losses should be recorded.
11. When remeasuring foreign currency financial statements into the functional currency, which of the following
items would be remeasured using historical exchange rates?
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A. Correct. GAAP requires the current rate of exchange to be used for remeasuring certain balance sheet
items and the historical rate for other balance sheet items. Nonmonetary balance sheet items and related
revenue, expense, gain, and loss accounts are remeasured at the historical rate. Monetary accounts are
remeasured at the current rate. Inventories valued at cost are nonmonetary items and are measured at
historical rates.
B. Incorrect. Equity securities reported at fair values are monetary items valued at the current rate.
C. Incorrect. Bonds payable are monetary items valued at the current rate.
D. Incorrect. Accrued liabilities are monetary items valued at the current rate.
12. How should gains from remeasuring a foreign subsidiary's financial statements from the local currency into its
functional currency be reported?
A. Incorrect. The gain is not deferred.
B. Incorrect. A gain arising from translation, not remeasurement, is reported in other comprehensive
income.
C. Incorrect. They should be recorded as a different line item in the statements, not as revenue.
D. Correct. If the books of record of a foreign entity are maintained in a currency other than the functional
currency, ASC 830 requires that the foreign currency amounts first be remeasured into the functional
currency and then translated using the current rate method into the reporting currency. The gain arising
from remeasurement should be reported as part of continuing operations.
Review Questions − Section 3
13. How should translation gains and losses resulting from translating foreign currency financial statements into
U.S. dollars be treated?
A. Incorrect. Translations gains and losses are reported in a different section of the statements, not as a
deferred account.
B. Incorrect. Translation losses and gains are treated the same.
C. Incorrect. Transaction gains and losses are treated as ordinary income, not translation gains or losses.
D. Correct. Any resulting translation gains or losses should be included in other comprehensive income until
they are actually realized.
14. Which of the following is debited to other comprehensive income (OCI)?
A. Incorrect. A discount on bonds is a contra account to bonds payable in the liability section of the balance
sheet.
B. Incorrect. A premium on bonds is a contra account to bonds payable in the liability section.
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C. Correct. When the currency used to prepare a foreign entity's financial statements is its functional
currency, the current rate method is used to translate the foreign entity's financial statements into the
reporting currency. The translation gains and losses arising from applying this method are reported in OCI
in the consolidated statements and are not reflected in income. Accumulated OCI is a component of equity
displayed separately from retained earnings and additional paid-in capital in the statement of financial
position. Because a cumulative foreign currency translation loss reduces the balance, it is a debit item.
D. Incorrect. Organizational costs are expensed when incurred.
15. What does a forward contract involve?
A. Incorrect. The price of a forward contract is determined on the day of commitment, not some time in the
future.
B. Incorrect. Performance is deferred in a forward contract, and the price of the product is not necessarily
its present price. The price can be any price determined on the day of commitment.
C. Correct. A forward contract is an executory contract in which the parties involved agree to the terms of a
purchase and a sale, but performance is deferred. Accordingly, a forward contract involves a commitment
today to purchase a product on a specific future date at a price determined today.
D. Incorrect. A forward contract is a firm commitment to purchase a product. It is not based on a contingency.
Also, a forward contract does not involve an exercise price (exercise price is in an option contract).
16. Which of the following is NOT required to be footnoted?
A. Correct. Disclosures should include profits from overseas, includes the amount of foreign earnings in
excess of amounts received in the United States.
B. Incorrect. Transaction gains and losses should be disclosed, along with gains or losses from hedging a
foreign currency position.
C. Incorrect. All impacts from unsettled balances must be disclosed in the footnotes, along with any
significant changes in exchange rates that take place after year-end and before the audit report date.
D. Incorrect. This should include the reason for the changes in the balance from the beginning to the end of
the year.