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1.3 Framework for the application of ASC 830
Publication date: 31 May 2022
us Foreign currency guide
Depending on the scope and structure of its consolidated operations, a reporting entity may have transactions denominated in a foreign currency (which need to be measured in a functional currency), and it may have foreign entities (which need to be translated into the reporting currency). To prepare consolidated financial statements, all amounts denominated in foreign currencies should be either measured or translated (or both) into the reporting currency.
Figure FX 1-4 summarizes the key steps in the application of ASC 830. An understanding of the various defined terms is critical to navigating the ASC 830 framework.
Figure FX 1-4
Framework for the application of ASC 830
Framework for the application of ASC 830
Step 1: Identify the reporting entity’s reporting currency
ASC 830-10-20 provides the definitions of reporting entity and reporting currency.
Definitions from ASC 830-10-20
Reporting Currency: The currency in which a reporting entity prepares its financial statements.
Reporting Entity: An entity or group whose financial statements are being referred to. Those financial statements reflect any of the following:
- The financial statements of one or more foreign operations by combination, consolidation, or equity accounting
- Foreign currency transactions.
The reporting currency is often the currency of the country in which the reporting entity is located, but it does not have to be. A private reporting entity may select any currency for its reporting currency. For example, a foreign private issuer may choose to prepare financial statements in US dollars for purposes of reporting to investors in the United States. In that case, its reporting currency is the US dollar. Rule 3-20 of Regulation S-X requires US incorporated registrants to present their financial statements in U.S dollars, with limited exceptions.
Step 2: Identify the reporting entity’s foreign entities
A foreign entity is a distinct and separable operation that is combined, consolidated, or accounted for using the equity method of accounting and has a functional currency other than the reporting entity’s reporting currency.
FX 2 discusses identifying a reporting entity’s distinct and separable operations.
Step 3: Determine the functional currency of each distinct and separable operation
The functional currency of a distinct and separable operation is a question of fact. An operation does not choose its functional currency. ASC 830-10-20 provides a definition of functional currency.
Definition from ASC 830-10-20
Functional Currency: 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.
The determination of a distinct and separable operation’s functional currency may be straightforward. For example, the functional currency of a distinct and separable operation integrated within a particular country with self-contained operations would likely be the currency of that country. Similarly, the US dollar is typically the functional currency of an operation that is a direct and integral component or extension of a US parent’s operations. However, the determination of the functional currency of a distinct and separable operation is often complex and may require significant judgment. It is not common for the functional currency of a distinct and separable operation to change, unless there are significant changes in external economic facts and circumstances. See FX 3 for further information on factors to consider in determining the functional currency.
In addition, ASC 830 contains specific provisions for determining the functional currency of a foreign entity operating in a country with a highly inflationary economy. See FX 6 for further information on the applicable considerations if a foreign entity operates in a highly inflationary economy.
Step 4: Measure foreign currency transactions
When an operation has transactions denominated in a currency other than its functional currency, they must be measured in the functional currency. Changes in the expected functional currency cash flows caused by changes in exchange rates are included in net income in the period. ASC 830-10-20 defines foreign currency transactions.
Definition from ASC 830-10-20
Foreign Currency Transactions: Transactions whose terms are denominated in a currency other than the entity’s functional currency. Foreign currency transactions arise when a reporting entity [or distinct and separable operation] does any of the following:
- Buys or sells on credit goods or services whose prices are denominated in foreign currency
- Borrows or lends funds and the amounts payable or receivable are denominated in foreign currency
- Is a party to an unperformed forward exchange contract
- For other reasons, acquires or disposes of assets, or incurs or settles liabilities denominated in foreign currency.
Foreign currency transactions are initially recorded in an operation’s functional currency. Subsequent measurement of foreign currency transactions will depend on whether the transaction gives rise to an account balance that is monetary or nonmonetary.
- Monetary assets and liabilities
Monetary assets and liabilities, such as cash, accounts receivable, accounts payable, and long-term debt, create foreign currency exchange rate risk as they represent amounts that will be settled with counterparties in a currency other than an operation’s functional currency. Monetary assets and liabilities are measured at the end of each reporting period based on the then current exchange rates. This measurement gives rise to foreign currency gains and losses, which are recorded in current period net income.
- Nonmonetary assets and liabilities
Nonmonetary assets and liabilities, such as inventory and property, plant, and equipment, do not require future settlement or adjustment. Nonmonetary assets and liabilities are initially measured using historical exchange rates. All aspects of the ongoing accounting for these items (e.g., depreciation, impairment, lower of cost or market) should be measured in terms of the operation’s functional currency.
See FX 4 for further information on the measurement of foreign currency transactions.
Step 5: Translate financial statements of foreign entities
Foreign currency translation is the process of expressing a foreign entity’s financial statements in the reporting currency of the reporting entity. The purpose of translation is to express a foreign entity’s functional currency financial statements in terms of the reporting currency. Thus, when a reporting entity’s financial statements include the results of foreign entities, the reporting entity must translate the foreign entity’s financial statements before they can be consolidated.
The financial statements of a foreign entity should be translated into the functional currency of its immediate parent company based on the nature of the account as follows:
- The period-end spot rate for assets and liabilities
- The weighted average exchange rate for income statement accounts
- Historical exchange rates for equity accounts (except for the change in retained earnings during the year, which is the result of the income statement translation process)
Once the reporting entity has translated its foreign entity financial statements, it should record these amounts in its consolidated financial statements. We refer to the “immediate” parent, as ASC 830 should be applied to each individual layer of a consolidation, beginning with the lowest level of the consolidated reporting entity’s organizational structure. Gains and losses (and the associated tax effect) from the effect of exchange rate differences in translation are recorded in the CTA account. CTA is a separate component of accumulated other comprehensive income (OCI) in shareholders’ equity.
See FX 5 for further information on foreign currency financial statement translation.
Question FX 1-1 addresses how to translate financial statements when a foreign entity does not maintain its financial statements in its functional currency.
Question FX 1-1
How should the financial statements of a foreign entity that does not maintain its financial statements in its functional currency be translated?
How should the financial statements of a foreign entity that does not maintain its financial statements in its functional currency be translated?
PwC response
A foreign entity may choose (or be required by law) to maintain its books and records in a local currency that is not its functional currency. In accordance with ASC 830, before the local currency financial statements (prepared in accordance with US GAAP) are translated to the reporting entity’s reporting currency, they should be “remeasured” (so called because they were already measured in the local currency, which may have created transaction gains and losses) into the foreign entity’s functional currency. This remeasurement should provide results comparable to those that would have occurred had the entity used its functional currency to maintain its records.
Step 6: Release the cumulative translation adjustment into net income, as applicable
ASC 830-30-40-1 requires CTA to be reclassified from equity to net income “upon sale or upon complete or substantially complete liquidation of an investment in a foreign entity.” Therefore, when disposing of any foreign operation, it is important to understand if that foreign operation constitutes a foreign entity, or is a component of a foreign entity. Acquiring control of a foreign operation in a step acquisition may also require that CTA be released to net income.
See FX 8 for further information on acquisitions and dispositions of foreign operations.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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