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Translating the financial results of a foreign entity in a way that provides relevant information requires a relatively stable unit of measure. When the functional currency of a foreign entity is a local currency that is experiencing high inflation, the translated financial information becomes less relevant. For example, in an economy with a high rate of inflation, it may be difficult for financial statement users to determine whether an increase in sales revenue reported in the local currency is due to an increase in the level of sales, or relates to inflation. In addition, translating foreign entity financial statements prepared in the currency of a highly inflationary economy can introduce volatility unrelated to operating performance into the financial statements of the reporting entity when historical cost balances of long-lived assets are translated at inflated exchange rates. Given these concerns, ASC 830 requires that the functional currency of a foreign entity be changed to the reporting currency of its parent when an economy becomes highly inflationary.
This chapter discusses how to determine whether an economy is highly inflationary and the resulting accounting implications. See TX 13.6 for information on indexed net operating losses in highly inflationary economies.
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