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5.5 Exchange rates
Publication date: 31 May 2022
us Foreign currency guide
ASC 830-30-45 provides guidance on selecting an exchange rate at which to translate a foreign entity’s financial statements.
All elements of financial statements shall be translated by using a current exchange rate as follows:
- For assets and liabilities, the exchange rate at the balance sheet date shall be used.
- For revenues, expenses, gains, and losses, the exchange rate at the dates on which those elements are recognized shall be used.
This guidance 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 are included in revenues and expenses (that is, not the rates on the dates the related items originated).
For purposes of translation of financial statements referred to in this Subtopic, 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.
In the absence of unusual circumstances, the exchange rate applicable to conversion of a currency for purposes of dividend remittances shall be used to translate foreign currency statements.
The rate applicable to dividend remittances is considered more meaningful for translation than any other rate because that is the rate indicative of ultimate cash flows from the foreign entity to the reporting entity.
When the balance sheet date of a foreign entity differs from that of the reporting entity, ASC 830-30-45-8 requires that the rate in effect at the balance sheet date of the foreign entity be used to translate the foreign entity’s financial statements.
The financial statements should not be adjusted for post-balance-sheet exchange rate changes except when the exchangeability between two currencies is temporarily lacking as discussed in FX 5.5.2.
5.5.1 Use of average exchange rates
Income statement items should be translated using the exchange rate in effect at the date the item was recognized; however, ASC 830-10-55-10 and ASC 830-10-55-11 allow management to use an average exchange rate to translate income statement items.
Literal application of the standards in this Subtopic might require a degree of detail in record keeping and computations that could be burdensome as well as unnecessary to produce reasonable approximations of the results. Accordingly, it is acceptable to use averages or other methods of approximation. For example, because translation at the exchange rates at the dates the numerous revenues, expenses, gains, and losses are recognized is generally impractical, an appropriately weighted average exchange rate for the period may be used to translate those elements. Likewise, the use of other time- and effort-saving methods to approximate the results of detailed calculations is permitted.
Average rates used shall 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, individual revenue and expense accounts for each quarter or month may be translated at that quarter’s or that month’s average rate. The translated amounts for each quarter or month should then be combined for the annual totals.
The use of an average exchange rate may result in a difference between intercompany revenues and expenses. See FX 7 for information on the elimination of intercompany transactions.
5.5.2 Lack of exchangeability at the balance sheet date
ASC 830-20-30-2 discusses what to do if an exchange rate is temporarily unavailable at the transaction date or the end of a reporting period.
If exchangeability between two currencies is temporarily lacking at the transaction date or balance sheet date, the first subsequent rate at which exchanges could be made shall be used for purposes of this Subtopic. If the lack of exchangeability is other than temporary, the propriety of consolidating, combining, or accounting for the foreign operation by the equity method in the financial statements of the reporting entity shall be carefully considered.
The financial statements should not otherwise be adjusted for post-balance-sheet rate changes.
When the lack of exchangeability does not appear to be temporary, a reporting entity should consider whether consolidation, combination, or equity accounting of a foreign operation with a large number of transactions denominated in the non-exchangeable currency is appropriate. A lack of exchangeability is often a precursor to an economy becoming highly inflationary. See FX 6 for information on highly inflationary economies and FX 8.5 for information on deconsolidating a foreign entity.
5.5.3 Multiple exchange rates
While most exchange rates fluctuate in accordance with the supply of and demand for foreign currencies, some countries have exchange controls that affect the availability of and exchange rates for foreign currencies. The degree of exchange controls can vary. When there is a high degree of exchange controls that are expected to continue for a period that is other than temporary, it may not be clear which exchange rate, if any, should be used for remeasurement and translation purposes. In such circumstances, transparent disclosure should be made concerning the reporting entity’s exposure (measured in the reporting currency) to the foreign currency in question and the exchange rates that are being utilized.
The IPTF meets and discusses significant issues with the SEC staff including exchange controls. The minutes for these meetings should be considered when assessing the impact of significant exchange controls.
A country may introduce a “preference” exchange rate or a “penalty” exchange rate for its currency. A preference rate is favorable when compared to other available rates; a penalty rate is unfavorable when compared to other available rates. Preferential or penalty rates are pre-determined rates, typically subject to specified requirements and available only for specified transactions, determined by a foreign government. A distinct and separable operation with foreign currency transactions in a currency of a foreign economy that has a preferential or penalty rate should assess its particular facts and circumstances to determine whether the transactions should be measured at either the preferential or penalty rate.
Items qualifying for a preference rate are usually items considered essential for the citizens of the country. A reporting entity usually has to apply for governmental approval to acquire the preference rate; approval is not guaranteed. Judgment may be required to assess, based on prior experience with a particular product in a particular country, whether a transaction will qualify for the preference rate. Monetary assets and liabilities denominated in currencies other than a foreign entity’s function currency that relate to transactions that qualify for the preference or penalty rate should generally be remeasured at the relevant preference or penalty rate because it reflects the amounts expected to be received or paid upon their collection or payment. However, the dividend remittance rate should generally be used to translate the financial statements of a foreign entity.
If an unsettled intercompany transaction is subject to and remeasured using a preference or penalty rate, using the dividend remittance rate for translation will result in a difference between intercompany receivables and payables. Example FX 5-6 illustrates this situation.
EXAMPLE FX 5-6
Translating an intercompany transaction recorded using a preference rate
USA Corp is a US registrant that uses the US dollar (USD) as its reporting currency.
USA Corp has a consolidated subsidiary that is a foreign entity in which the functional currency is the local currency (LC).
USA Corp sells 3 units of inventory to the foreign entity at USD 100/per unit when the official rate that is used to pay dividends is 6.25 LC = 1 USD and there is a preference rate of 5.5 LC = 1 USD available for the importation of the inventory item. Upon importation, the inventory is immediately sold to a third party at a profit, but at period end, the intercompany balance between USA Corp and the foreign entity has not been settled.
How are the intercompany balance sheet accounts reflected in the consolidated financial statements of USA Corp?
Analysis
As a result of the intercompany sale of inventory, USA Corp should record an intercompany receivable of USD 300 while the foreign entity would measure its intercompany payable in its functional currency financial statements using the preference rate, which results in an intercompany payable of LC 1,650.
To translate the foreign entity’s financial statements into USD, USA Corp uses the official rate, which results in an intercompany payable of USD 264. Therefore, there would be a mismatch between the USD intercompany receivable (USD 300) on USA Corp’s books and the translated USD intercompany payable (USD 264) on the foreign entity’s books. ASC 830-30-45-7 allows a reporting entity to record an additional receivable equal to this difference (USD 36), which reflects the USD amount of the exchange rate subsidy that the foreign government is effectively providing.
Unfortunately, not all multiple exchange rate problems can be satisfactorily solved by mechanical application of the approach described in Example FX 5-6, which is presumably why ASC 830-30-45-6 refers to translation of foreign currency financial statements at the dividend remittance rate “in the absence of unusual circumstances.” The SEC staff has indicated that given certain facts and circumstances, it may be appropriate to translate a foreign entity’s financial statements using an exchange rate other than the dividend rate. However, deviations from the dividend remittance rate should occur only in situations in which there is significant distortion in exchange rates due to temporary and unusual economic factors, and would necessitate transparent disclosure.
5.5.4 Alternative exchange mechanisms
Occasionally, in economies that have implemented exchange controls, governments will allow alternative exchange mechanisms to exist. These governments allow these exchange mechanisms to exist in order to provide relief to entities importing goods into the country, without having to acknowledge the devaluation of their official exchange rates. Venezuela allowed such a mechanism to exist for a period of time, known as the “Parallel Rate.” As of February 2020, Argentina allows such a mechanism to exist, known as the “Blue Chip Swap Rate.”
There are many derivations of these mechanisms. One derivation that has been used is effected through the purchase of a US Dollar-denominated security onshore with local currency, transfer of the security offshore, and sale of the security offshore for US Dollars. The buy and sell of the security creates an implied exchange rate. Once US Dollars have been received, the reporting entity can either hold the US Dollars offshore to hedge against devaluation of the local currency or may be able to use the US Dollars to relieve US Dollar-denominated obligations.
When these alternative exchange mechanisms exist, the question as to whether the implied exchange rate determined by this mechanism can be used to measure transactions denominated in other than the foreign entity’s functional currency is often asked. This determination can be very complex and requires a detailed understanding of how the mechanism is designed to work, as well as a detailed understanding of the currency and security laws of the applicable country.
5.5.5 Black market rates
When restrictive exchange controls exist, a black market for a foreign currency may exist. Black market rates are established by unauthorized dealers in foreign exchange, often in violation of government regulation, and are invariably higher than the official rate for the same currency. The volume of transactions at black market rates may be limited, and most businesses do not normally obtain funds at these rates.
The black market exchange rate should not be used to apply the provisions of ASC 830 as it is not a legally recognized rate. Rather, as noted in FX 5.5, a reporting entity should generally use the dividend remittance rate to translate the financial statements of its foreign entities because it is the rate indicative of the ultimate cash flows from the foreign entity to the reporting entity.
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