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5.4 Translation—foreign entity maintains books in currency other than functional currency
Publication date: 31 May 2022
us Foreign currency guide
As discussed in FX 5.2, when a foreign entity maintains its books and records in a currency other than its functional currency (e.g., if the tax laws in a country require the local currency to be used for books and records), the reporting entity should first remeasure the foreign entity’s financial statements into the foreign entity’s functional currency and then translate the foreign entity’s functional currency financial statements into the reporting currency.
5.4.1 Remeasurement of financial statements maintained in a foreign currency
When an entity remeasures its financial statements, it should apply the guidance for foreign currency transactions. Monetary assets and liabilities are remeasured using exchange rates at the end of the reporting period, nonmonetary assets and liabilities are remeasured using the exchange rate on the date the item was initially recognized (i.e., the historical rate). This remeasurement process is intended to produce the same results as if the foreign entity maintained its books and records in its functional currency. See FX 4.4.1 for information on differentiating monetary and nonmonetary accounts.
Example FX 5-2 illustrates the process of financial statement translation when a foreign entity’s books and records are not maintained in its functional currency.
EXAMPLE FX 5-2
Remeasurement and translation of foreign entity financial statements maintained in a currency other than a foreign entity’s functional currency
Remeasurement and translation of foreign entity financial statements maintained in a currency other than a foreign entity’s functional currency
USA Corp is a US registrant that uses the US dollar (USD) as its reporting currency.
Britannia PLC is a wholly-owned subsidiary of USA Corp located in the United Kingdom. It is a distinct and separable operation of USA Corp and has a functional currency of the euro (EUR); therefore, it meets the definition of a foreign entity of USA Corp.
Britannia PLC maintains its books and records in GBP. Its GBP financial statements are shown below.
Balance sheet
Balance on 1/1/X2 |
Balance on 12/31/X2 |
|
Cash |
GBP 10,000 |
GBP 13,000 |
Net PP&E |
GBP 10,000 |
GBP 9,000 |
Total assets |
GBP 20,000 |
GBP 22,000 |
Common stock |
GBP 10,000 |
GBP 10,000 |
Retained earnings |
GBP 10,000 |
GBP 12,000 |
Total shareholders’ equity |
GBP 20,000 |
GBP 22,000 |
Income statement
12/31/X2 |
||
Gross profit |
GBP 3,000 |
|
Depreciation |
(GBP 1,000) |
|
Net income |
GBP 2,000 |
|
Retained earnings at 1/1/X2 |
GBP 10,000 |
|
Retained earnings at 12/31/X2 |
GBP 12,000 |
There is no opening balance in USA Corp’s CTA account related to its investment in Britannia PLC because we have assumed that the 1/1/X2 exchange rate has not changed since USA Corp acquired Britannia PLC.
How should USA Corp translate Britannia PLC’s GBP financial statements for inclusion in its USD consolidated financial statements?
Analysis
Britannia PLC’s GBP financial statements should first be remeasured into EUR, Britannia PLC’s functional currency, and then translated into USD, the reporting currency.
The following exchange rates are used to remeasure and translate Britannia PLC’s financial statements. Retained earnings is translated using the historical exchange rate because we have assumed that exchange rates prior to 1/1/X2 had not changed.
GBP to EUR |
EUR to USD |
|
Current exchange rate as of 12/31/X2 |
GBP 1 = EUR 1.20
|
EUR 1 = USD 1.13
|
Current exchange rate as of 12/31/X1
|
GBP 1 = EUR 1.50
|
EUR 1 = USD 1.09
|
Weighted average exchange rate
|
GBP 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
|
GBP 1 = EUR 1.15
|
EUR 1 = USD 1.09
|
Remeasurement |
Translation |
|||||
GBP balance |
Exchange rate |
EUR balance |
Exchange rate |
USD balance |
||
Cash
|
GBP 13,000
|
GBP 1 = EUR 1.20
|
EUR 15,600
|
EUR 1 = USD 1.13
|
USD 17,628
|
|
Net PP&E
|
GBP 9,000
|
GBP 1 = EUR 1.15
|
EUR 10,350
|
EUR 1 = USD 1.13
|
USD 11,696
|
|
Total assets
|
GBP 22,000
|
EUR 25,950
|
USD 29,324
|
|||
Common stock
|
GBP 10,000
|
GBP 1 = EUR 1.15
|
EUR 11,500
|
EUR 1 = USD 1.09
|
USD 12,535
|
|
Retained earnings
|
GBP 12,000
|
EUR 14,450
|
USD 15,780
|
|||
Translation adjustment
|
—
|
—
|
USD 1,009
|
|||
Total shareholders’ equity
|
GBP 22,000
|
EUR 25,950
|
USD 29,324
|
|||
Gross profit
|
GBP 3,000
|
GBP 1 = EUR 1.18
|
EUR 3,540
|
EUR 1 = USD 1.10
|
USD 3,894
|
|
Depreciation
|
(GBP 1,000)
|
GBP 1 = EUR 1.15
|
(EUR 1,150)
|
EUR 1 = USD 1.10
|
(USD 1,265)
|
|
Foreign exchange gain
|
—
|
EUR 560
|
EUR 1 = USD 1.10
|
USD 616
|
||
Net income (loss)
|
GBP 2,000
|
EUR 2,950
|
USD 3,245
|
|||
Retained earnings, beginning of year
|
GBP 10,000
|
GBP 1 = EUR 1.15
|
EUR 11,500
|
EUR 1 = USD 1.09
|
USD 12,535
|
|
Retained earnings, end of year
|
GBP 12,000
|
EUR 14,450
|
USD 15,780
|
|||
The translation adjustment of USD 1,009 above results from translating from EUR to USD. The translation adjustment is calculated as follows:
EUR balances |
Change in exchange rate |
CTA account balance |
|
Net assets, beginning of year
|
EUR 23,000
|
1.13 – 1.09 = 0.04
|
USD 920
|
Net income for the year
|
EUR 2,950
|
1.13 – 1.10 = 0.03
|
USD 89
|
USD 1,009
|
The foreign exchange gain of EUR 560 results from the remeasurement from British pounds to euros and is included in income. It is calculated as follows:
GBP balances |
Change in exchange rate |
Foreign exchange gain |
|
Net monetary assets, beginning of year
|
GBP 10,000
|
1.20 – 1.15 = 0.05
|
EUR 500
|
Gross profit for the year
|
GBP 3,000
|
1.20 – 1.18 = 0.02
|
EUR 60
|
EUR 560
|
5.4.1.1 Remeasurement of assets
The accounting treatment of foreign currency denominated assets depends on whether the assets are monetary or nonmonetary. Assets such as prepaid expenses and deferred charges are often nonmonetary assets; they do not involve future settlement in a foreign currency. Assets such as a deposit or accounts receivable, for which future settlement in a foreign currency is expected, are monetary assets. See FX 4.4.1 for information on differentiating monetary and nonmonetary assets.
Foreign currency denominated monetary and nonmonetary assets should both be initially measured using the exchange rate in effect on the date the asset is created. Foreign currency denominated monetary assets are subsequently measured using the exchange rate in effect at the end of each reporting period. Foreign currency denominated nonmonetary assets are not subsequently adjusted for changes in exchange rates.
Example FX 5-3 illustrates how to account for foreign currency denominated assets other than inventory. See FX 5.4.1.2 for the accounting for foreign currency denominated inventory.
EXAMPLE FX 5-3
Accounting for foreign currency prepaid expenses and other assets
Canadian Corp is a Canadian reporting entity that uses the Canadian dollar as its reporting currency.
Mexico SA is a distinct and separable operation of Canadian Corp located in Mexico. Canadian Corp has determined that Mexico SA’s functional currency is the US dollar (USD); however, Mexico SA maintains its books and records in the local currency, the Mexican peso (MXN).
The table below summarizes Mexico SA’s prepaid expense and other asset balances at December 31, 20X1, whether each is a monetary or nonmonetary asset as determined by Mexico SA’s management, and the exchange rate on the date each asset was recognized.
Asset account |
MXN balance |
Monetary or nonmonetary asset |
Exchange rate on the date the asset was recognized |
Deposit on office space
|
MXN 500,000
|
Monetary
|
USD 1 = MXN 10
|
Prepaid rent
|
MXN 200,000
|
Nonmonetary
|
USD 1 = MXN 14
|
Prepaid utility contract
|
MXN 150,000
|
Nonmonetary
|
USD 1 = MXN 14
|
Prepaid insurance
|
MXN 450,000
|
Nonmonetary
|
USD 1 = MXN 14
|
Loan receivable from unaffiliated party
|
MXN 100,000
|
Monetary
|
USD 1 = MXN 16
|
The exchange rate on December 31, 20X1 is USD 1 = MXN 12.
What is the balance of Mexico SA’s prepaid expenses and other assets at December 31, 20X1 in its functional currency, the US dollar?
Analysis
Mexico SA should remeasure the monetary assets using the exchange rate at December 31, 20X1. The nonmonetary assets are not remeasured; they are measured at the exchange rate on the date the asset was recognized.
Asset account |
MXN balance |
Exchange rate |
USD balance |
Deposit on office space
|
MXN 500,000
|
USD 1 = MXN 12
|
USD 41,667
|
Prepaid rent
|
MXN 200,000
|
USD 1 = MXN 14
|
USD 14,286
|
Prepaid utility contract
|
MXN 150,000
|
USD 1 = MXN 14
|
USD 10,714
|
Prepaid insurance
|
MXN 450,000
|
USD 1 = MXN 14
|
USD 32,143
|
Loan receivable from unaffiliated party
|
MXN 100,000
|
USD 1 = MXN 12
|
USD 8,333
|
5.4.1.2 Remeasurement of inventory
Inventory should be remeasured into a foreign entity’s functional currency using the exchange rate on the date it is acquired. The cost of goods sold associated with inventory recorded in a foreign currency is the amount at which it was initially recorded (i.e., the functional currency balance recorded on the date it was acquired).
Example FX 5-4 illustrates the accounting for inventory purchased in a currency other than a distinct and separable operation’s functional currency.
EXAMPLE FX 5-4
Remeasurement of inventory balances
Canadian Corp is a Canadian reporting entity that uses the Canadian dollar as its reporting currency.
Mexico SA is a distinct and separable operation of Canadian Corp located in Mexico. Canadian Corp has determined that Mexico SA’s functional currency is the US dollar (USD); however, Mexico SA maintains its books and records in the local currency, the Mexican peso (MXN).
Mexico SA purchases inventory from a supplier in Tijuana, Mexico. Inventory purchases are invoiced and paid in Mexican pesos. Given the even pattern of purchases and the lack of significant volatility in the MXN/USD exchange rate, the MXN denominated inventory purchases are remeasured into the USD functional currency using the average monthly exchange rate.
Mexico SA applies a first-in, first-out (FIFO) inventory costing methodology. On October 1, 20X1, Mexico SA’s Mexican peso inventory balance is MXN 750,000, representing 75,000 units. The following table shows Mexico SA’s inventory purchases in October through December 20X1 and the average monthly exchange rate for each of those months.
Month |
Inventory units |
Inventory purchases |
Average exchange rate |
|
October
|
30,000
|
MXN 300,000
|
USD 1 = MXN 14
|
|
November
|
50,000
|
MXN 500,000
|
USD 1 = MXN 16
|
|
December
|
45,000
|
MXN 450,000
|
USD 1 = MXN 18
|
|
125,000
|
MXN 1,250,000
|
On December 31, 20X1, Mexico SA has 100,000 units on hand that are carried at MXN 1,000,000 in the MXN books and records.
What is Mexico SA’s ending inventory balance on December 31, 20X1 in its functional currency, the US dollar?
Analysis
Since Mexico SA uses a FIFO inventory costing methodology, the December 31, 20X1 inventory balance comprises the following:
Month of inventory purchase |
Units |
MXN balance |
Average exchange rate |
USD balance |
|
October
|
5,000
|
MXN 50,000
|
USD 1 = MXN 14
|
USD 3,571
|
|
November
|
50,000
|
MXN 500,000
|
USD 1 = MXN 16
|
USD 31,250
|
|
December
|
45,000
|
MXN 450,000
|
USD 1 = MXN 18
|
USD 25,000
|
|
100,000
|
MXN 1,000,000
|
USD 59,821
|
Mexico SA’s December 31, 20X1 ending inventory balance is USD 59,821.
LIFO inventory costing methodology
When a foreign entity uses a last-in, first-out (LIFO) inventory costing methodology, its functional currency inventory LIFO layers should be recorded and measured at the exchange rate on the date the inventory is acquired (or the LIFO layer is created).
The LIFO reserve account is a contra inventory account calculated as the difference between the FIFO inventory cost and LIFO inventory cost. For inventory balances recorded in a local currency other than the foreign entity’s functional currency, the LIFO reserve must be remeasured. A local currency LIFO reserve is calculated as the difference between the local currency inventory balance using FIFO and the local currency inventory balance using LIFO. In the same way, the functional currency LIFO reserve is calculated as the difference between the functional currency inventory balance using FIFO and the functional currency inventory balance using LIFO.
Lower of cost or market
ASC 830-10-55-8 provides guidance for applying the lower of cost or market test when an entity maintains its books and records in a currency other than its functional currency (e.g., the currency of the local economy).
The guidance on the subsequent measurement of inventory in Subtopic 330-10 requires special application when the books of record are not kept in the functional currency. Inventories carried at cost in the books of record in another currency should be first remeasured to cost in the functional currency using historical exchange rates. Then, historical cost in the functional currency should be evaluated for impairment under the subsequent measurement guidance using the functional currency. Application of the subsequent measurement guidance in functional currency may require a write-down in the functional currency statements even though no write-down has been made in the books of record maintained in another currency. Likewise, a write-down in the books of record may need to be reversed if the application of the subsequent measurement guidance in the functional currency does not require a write-down. If inventory has been written down in the functional currency statements, that functional currency amount shall continue to be the carrying amount in the functional currency financial statements until the inventory is sold or a further write-down is necessary. An asset other than inventory may sometimes be written down from historical cost. Although different measurement guidance may be used to determine that write-down, the approach described in this paragraph might be appropriate. That is, a write-down may be required in the functional currency statements even though not required in the books of record, and a write-down in the books of record may need to be reversed before remeasurement to prevent the remeasured amount from exceeding functional currency historical cost.
Example FX 5-5 illustrates how to determine whether a lower of cost or market allowance is required when an entity maintains its books and records in its local currency.
EXAMPLE FX 5-5
Assessing the need for a lower of cost or market allowance when books and records are maintained in a local currency
Canadian Corp is a Canadian reporting entity that uses the Canadian dollar as its reporting currency.
Mexico SA is a distinct and separable operation of Canadian Corp located in Mexico. Canadian Corp has determined that Mexico SA’s functional currency is the US dollar (USD); however, Mexico SA maintains its books and records in the local currency, the Mexican peso (MXN).
Mexico SA purchases inventory from a supplier in Tijuana, Mexico. Inventory purchases are invoiced and paid in Mexican pesos. Given the even pattern of purchases and the lack of significant volatility in the MXN/USD exchange rate, the MXN denominated inventory purchases are remeasured into the USD functional currency using the average monthly exchange rate.
On December 31, 20X1, Mexico SA’s Mexican peso inventory has a carrying amount and replacement cost of MXN 1,000,000 and MXN 1,020,000, respectively. The carrying amount and replacement cost of the inventory in Mexico SA’s functional currency, the US dollar, are USD 59,821 and USD 56,830, respectively.
Should Mexico SA record a lower of cost or market allowance on its Mexican peso inventory, either in (1) the local currency, the Mexican peso, or (2) its functional currency, the US dollar?
Analysis
Mexico SA should not record a lower of cost or market allowance on its Mexican peso inventory in its local currency books because the replacement cost of MXN 1,020,000 exceeds the recorded balance of MXN 1,000,000.
Mexico SA should, however, record a lower of cost or market allowance on its Mexican peso inventory in its functional currency books because the replacement cost of USD 56,830 is lower than the recorded balance of USD 59,821.
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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