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8.3 Disposition of a foreign operation
Publication date: 31 May 2022
us Foreign currency guide
The guidance in ASC 830 related to the reclassification of the CTA account balance to net income reflects a compromise between the guidance regarding the recognition of accumulated CTA balances in ASC 830 and the loss of control concepts in the consolidation guidance in ASC 810-10. ASC 830-30-40-3 precludes the reclassification of a CTA account balance for a derecognition event that occurs within a foreign entity (derecognition of a part of a foreign entity) unless the event is a complete or substantially complete liquidation of the foreign entity. However, CTA should be recognized in net income when a reporting entity ceases to have a controlling financial interest in the foreign entity, even if the reporting entity retains a noncontrolling interest.
The foreign currency accounting effects of a disposition differ for foreign operations that are foreign entities versus those that are not (i.e., operations that are not distinct and separable). See FX 2 for information on determining whether a foreign operation is distinct and separable.
8.3.1 Disposition of a foreign entity
When a reporting entity disposes of a foreign entity, ASC 830 requires the reporting entity to recognize the accumulated CTA balance associated with that foreign entity in the income statement as part of the gain or loss on the sale.
Upon sale or upon complete or substantially complete liquidation of an investment in a foreign entity, the amount attributable to that entity and accumulated in the translation adjustment component of equity shall be both:
- Removed from the separate component of equity
- Reported as part of the gain or loss on sale or liquidation of the investment for the period during which the sale or liquidation occurs.
This guidance should be applied when a reporting entity ceases to have a controlling financial interest in the foreign entity even if the reporting entity retains a noncontrolling interest.
Example FX 8-1 illustrates the application of ASC 830-30-40-1, when a reporting entity deconsolidates a foreign entity, subsequent to disposing of a portion of its ownership.
EXAMPLE FX 8-1
Disposition of a portion of a foreign entity – reporting entity deconsolidates foreign entity
Disposition of a portion of a foreign entity – reporting entity deconsolidates foreign entity
USA Corp is a US registrant. Britannia PLC is a foreign entity of USA Corp located in the United Kingdom.
USA Corp reduces its ownership in Britannia PLC from 100% to 40%. USA Corp determines that it should deconsolidate Britannia PLC based on the guidance in ASC 810.
Should USA Corp remove the accumulated CTA account balance associated with Britannia PLC from equity and recognize it in the income statement?
Analysis
Yes. Since USA Corp no longer holds a controlling financial interest in Britannia PLC, it is deemed to have disposed of 100% of its interest in Britannia and acquired a 40% interest in Britannia. Consequently, USA Corp must reclassify 100% of the related CTA balance to net income.
Example FX 8-2 illustrates the application of ASC 830-30-40-1, when a reporting entity continues to consolidate a foreign entity, subsequent to disposing of a portion of its ownership.
EXAMPLE FX 8-2
Disposition of a portion of a foreign entity — reporting entity still consolidates foreign entity
Disposition of a portion of a foreign entity — reporting entity still consolidates foreign entity
USA Corp is a US registrant. Britannia PLC is a foreign entity of USA Corp located in the United Kingdom.
USA Corp reduces its ownership in Britannia PLC from 100% to 51%. USA Corp determines that it retained a controlling financial interest in Britannia PLC and should continue to consolidate it.
Should USA Corp remove the accumulated CTA account balance associated with Britannia PLC from equity and recognize it in the income statement?
Analysis
No. Since USA Corp retains control of the foreign entity, all of the accumulated CTA balance associated with the foreign entity should remain in equity.
Example FX 8-3 illustrates the application of ASC 830-30-40-1, when a reporting entity disposes of a portion of a legal entity.
EXAMPLE FX 8-3
Disposition of a portion of a legal entity that (portion) represents a foreign entity
Disposition of a portion of a legal entity that (portion) represents a foreign entity
USA Corp is a US registrant. USA Corp has a European foreign subsidiary, European Corp, which comprises two distinct and separable operations, European Manufacturing Co and European Sales Co, each of which meets the definition of a foreign entity.
European Corp sells European Sales Co for cash to an unrelated entity.
Should USA Corp reclassify the accumulated CTA account balance associated with European Sales Co to net income?
Analysis
Yes. Since European Sales Co meets the definition of a foreign entity, the associated accumulated CTA balance should be reclassified from equity to net income upon its sale.
8.3.1.1 Substantially complete liquidation of a foreign entity
As discussed above, the sale of a controlling financial interest in a foreign entity leads to the reclassification of accumulated CTA to net income. In addition, a complete or substantially complete liquidation of the net assets of a foreign entity would also lead to the reclassification of accumulated CTA to net income.
We believe the phrase “substantially complete” liquidation, as used in ASC 830-30-40-1, means a significant portion of the investment will be liquidated. Although not a bright line, we believe that at least 90% of the net assets of a foreign entity must be liquidated for a substantially complete liquidation to have occurred.
Accordingly, 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
What happens to the proceeds from a substantially complete liquidation of a foreign entity may also help determine whether the CTA account should be released into net income. The circumstances in which the CTA account may be released include the following:
- The net proceeds are sent to the parent company
- The net proceeds are not reinvested, but are simply held as cash in the bank account of the sold/liquidated subsidiary
- The net proceeds are reinvested in a different business from that of the old liquidated subsidiary
In some circumstances, a reporting entity may conclude that a sale or complete liquidation has occurred in form, but not in substance, and as a result, the CTA should not be released into net income. Examples of such circumstances include the following:
- Reinvesting or planning on reinvesting the sales proceeds in another subsidiary in substantially the same line of business or industry as the one that was sold or liquidated
- Reinvesting the sales proceeds to effect a change in product lines
- Reinvesting the sales proceeds in activities directly related to the restructuring of a business
As a general rule, we would not expect that a reporting entity would reclassify accumulated CTA from equity to net income for the same foreign entity more than once. Therefore, if the net assets of a foreign entity are liquidated but the reporting entity plans to continue the activity of that foreign entity going forward, a substantially complete liquidation of the foreign entity has likely not occurred and the CTA balance should not be reclassified from equity to net income.
Example FX 8-4 illustrates the application of the guidance regarding whether complete, or substantially complete, liquidation has occurred as a result of the sale of assets of a foreign entity.
EXAMPLE FX 8-4
Sale of assets of a foreign entity
Sale of assets of a foreign entity
USA Corp is a US registrant. Britannia PLC is a foreign entity of USA Corp located in the United Kingdom.
Britannia PLC sells a group of assets constituting a business comprising 95% of its net assets, and accordingly deconsolidates the business. The sales proceeds are retained by Britannia PLC to be reinvested in similar assets.
Should USA Corp reclassify the accumulated CTA account balance associated with Britannia PLC from equity to net income?
Analysis
No. While the transaction was, in form, a liquidation of substantially all of Britannia PLC’s net assets, the substance of the transaction reflects a continuation of Britannia PLC’s historical business. Therefore, the CTA account balance should remain in equity.
Example FX 8-5 illustrates the application of the guidance regarding whether complete, or substantially complete, liquidation has occurred as a result of the dissolution of a foreign entity.
EXAMPLE FX 8-5
Dissolution of a foreign entity
Dissolution of a foreign entity
USA Corp is a US registrant. Britannia PLC is a foreign entity of USA Corp located in the United Kingdom.
USA Corp decides to cease the operations of Britannia PLC and directs it to sell 95% of its net assets and remit the proceeds to USA Corp. USA Corp intends to sell the remaining assets of Britannia PLC and has no intent of reinvesting in similar activities.
Should USA Corp reclassify the accumulated CTA account balance associated with Britannia PLC from equity to net income?
Analysis
Yes. Since the asset sale represents a substantially complete liquidation of a foreign entity, USA Corp should reclassify the entire accumulated CTA balance associated with Britannia PLC from equity to net income. Further, the impact of future exchange rate changes on the remaining 5% of net assets should not be recorded to CTA. Essentially, this results in Britannia PLC becoming an extension of its parent, USA Corp, along with Britannia PLC assuming the functional currency of USA Corp.
Substantially complete liquidations when disposition occurs over time
When a reporting entity intends to dispose of a foreign entity over time, it should determine when the liquidation process of the foreign entity begins. This determination should be based on the facts and circumstances surrounding the disposition. For example, if a reporting entity establishes a formal plan to dispose of a foreign entity in stages, and there is limited uncertainty regarding the completion of each stage, it may be appropriate to recognize the accumulated CTA balance in net income when the liquidation is substantially complete, which would be based on the foreign entity’s assets at the outset of the planned disposal. However, if no formal plan is initiated, each disposal round should be measured against the foreign entity’s assets at the date of each disposal event. This would delay the achievement of a substantial liquidation until a single sale represented at least 90% of the remaining assets.
8.3.2 Disposition of a legal entity in a multi-tiered legal entity organization (including holding companies)
As discussed in FX 2, a foreign entity can be comprised of numerous legal entities if those legal entities are engaged in similar operations. The sale of a legal entity within such a foreign entity should not result in the recognition of the accumulated CTA account balance in net income when it is not a substantial liquidation of the foreign entity. Example FX 8-6 illustrates the application of this guidance.
EXAMPLE FX 8-6
Sale of a second-tier foreign operation
Sale of a second-tier foreign operation
USA Corp is a US registrant. USA Corp has a first-tier European operating subsidiary, European Corp, which has a wholly-owned second-tier subsidiary, Deutsche AG. Although European Corp and Deutsche AG are separate legal entities, they are not distinct and separable operations, and are therefore considered a single foreign entity.
European Corp sells 100% of its interest in Deutsche AG and distributes the proceeds to USA Corp.
Should USA Corp reclassify the accumulated CTA account balance associated with the foreign entity from equity to net income?
Analysis
No. Unless the disposition of Deutsche AG represents a complete, or substantially complete liquidation of the entire foreign entity (i.e., Deutsche AG represents substantially all of the foreign entity), the accumulated CTA account balance should remain in equity.
8.3.3 Disposition of a foreign operation accounted for using the equity method
As discussed in FX 5, the financial statements of an equity-method investee with a functional currency different from the reporting entity’s reporting currency must be translated into the reporting currency. An equity-method investment in a foreign operation may be a standalone foreign entity or it may be part of a larger foreign entity. The guidance in ASC 830-30-40-1 regarding the recognition of an accumulated CTA balance upon the disposition or complete or substantially complete liquidation of an investment in a foreign entity also applies to the disposition or liquidation of an equity-method investment.
If a reporting entity sells its entire ownership interest in an equity-method investment that is an investment “within” a foreign entity (i.e., the disposition of the equity-method investment did not involve the entire foreign entity), it should not recognize the CTA account balance in net income unless the sale is a substantially complete liquidation of that foreign entity, as discussed in FX 8.3.1.1.
Example FX 8-7 illustrates the guidance in ASC 830-30-40-1 as applied to the disposition of a foreign operation accounted for using the equity method of accounting.
EXAMPLE FX 8-7
Disposition of a foreign operation accounted for using the equity method of accounting
Disposition of a foreign operation accounted for using the equity method of accounting
USA Corp is a US registrant. Nippon Corp is a wholly-owned subsidiary of USA Corp located in Japan. Nippon Corp holds a 50% investment in Honshu Ltd, which it accounts for using the equity method of accounting. Nippon Corp and Honshu Ltd have similar operations (i.e., they are not distinct and separable from one another), and both have a functional currency of Japanese yen. Therefore, they are considered a single foreign entity of USA Corp. Nippon Corp comprises 60%, and Honshu Ltd comprises 40% of the foreign entity’s total assets respectively.
USA Corp directs Nippon Corp to sell its investment in Honshu Ltd and remit the sales proceeds to USA Corp.
Should USA Corp remove the accumulated CTA account balance associated with Honshu Ltd from equity and recognize it in the income statement?
Analysis
No. Since USA Corp’s sale of its indirect investment in Honshu Ltd did not involve the entire foreign entity (i.e., Nippon Corp was not sold), and the sale of 40% of the total assets of the foreign entity does not represent a substantially complete liquidation of the foreign entity, USA Corp should retain the CTA account related to Honshu Ltd in equity.
8.3.3.1 Equity method investments that represent a foreign entity
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 accumulated CTA account attributable to the equity method investment when measuring the gain or loss on the sale as prescribed by ASC 830-30-40-2.
Excerpt from ASC 830-30-40-2
If a reporting entity sells part of its ownership interest in an equity method investment that is a foreign entity, a pro rata portion of the accumulated translation adjustment component of equity attributable to that equity method investment shall be recognized in measuring the gain or loss on the sale.
Example FX 8-8 illustrates the accounting for the CTA account balance upon the disposition of a portion of an equity method investment that represents a foreign entity.
EXAMPLE FX 8-8
Disposition of a portion of an equity method investment that represents a foreign entity
Disposition of a portion of an equity method investment that represents a foreign entity
USA Corp is a US registrant. USA Corp has a 40% investment in European Corp that it accounts for using the equity method of accounting. European Corp is a foreign entity of USA Corp.
USA Corp reduces it investment to 30% by selling a portion of its investment in European Corp. At the date of sale, USA Corp’s CTA account balance associated with European Corp is a credit balance of USD 100.
How should USA Corp account for its CTA account balance in European Corp upon the sale of a portion of its investment?
Analysis
USA Corp should recognize 25% of the USD 100 CTA account balance, or USD 25, in net income. This is the pro rata portion of CTA related to the decrease in ownership from 40% to 30%.
Alternatively, if the reporting entity sells part of an ownership interest in an equity method investment that is part of a larger foreign entity (i.e., an investment “within” a foreign entity), the CTA account balance should not be recognized in the income statement, unless the disposition represented the complete, or substantially complete, liquidation of the foreign entity that holds the equity method investment.
8.3.3.2 Retained interest is not accounted for using the equity method
When a reporting entity sells a portion of an equity method investment and, as a result, can no longer exercise significant influence over an investee as described in ASC 323-10-15-6, it should discontinue accruing its share of the income or losses of the investee for its investment as it no longer qualifies for the equity method. Going forward, the retained interest should be accounted for under the guidance in ASC 321.
Upon the application of ASC 321, the remaining CTA account balance should be reclassified to the carrying value. Provided the equity security does not qualify for a measurement alternative in ASC 321, the retained equity interests should be carried at fair value with changes in value recorded in net income. Any initial difference between the investment's carrying value and fair value should be recognized in net income. If the retained equity interest does not have a readily determinable fair value, it may be eligible for the measurement alternative discussed in LI 2.3.2. See LI 2.4.2 for information on accounting for a decrease in level of equity ownership under ASC 321.
ASC 323-10-35-37 and ASC 323-10-35-39 provide guidance on how to account for the investor's proportionate share of the investee's equity adjustments for other comprehensive income.
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 loss of significant influence
- A loss of control that results in accounting for the investment in accordance with Topic 321
- 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.
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:
- Reduce the carrying value of the investment to zero
- Record the remaining balance in income.
Example FX 8-9 illustrates the accounting for the CTA account balance upon the disposition of a portion of an equity method investment in a foreign entity, with the retained interest being accounted for under the guidance in ASC 321.
EXAMPLE FX 8-9
Disposition of a portion of an equity-method investment in a foreign operation
Disposition of a portion of an equity-method investment in a foreign operation
USA Corp is a US registrant. USA Corp has a 40% investment in Nippon Corp that it accounts for using the equity method of accounting. Nippon Corp is a foreign entity of USA Corp.
USA Corp reduces its investment to 10% by selling a portion of its investment in Nippon Corp. At the date of sale, USA Corp’s CTA account balance associated with Nippon Corp is a debit balance of USD 100.
How should USA Corp account for its CTA balance in Nippon Corp upon the sale of a portion of its investment?
Analysis
USA Corp should recognize 75% of the USD 100 CTA account balance, or USD 75, in net income. This is the pro rata portion of CTA related to the decrease in ownership from 40% to 10%. The remaining USD 25 balance of CTA would be reclassified out of OCI to USA Corp’s remaining investment in Nippon Corp.
Upon the application of ASC 321, USA Corp would adjust the investment's carrying amount to fair value and any difference between the carrying value and fair value would be recognized in net income.
8.3.4 Long-term intercompany advances
As discussed in ASC 830-20-35-3(b), foreign currency gains and losses on intercompany transactions that are of a long-term-investment nature (i.e., those for which settlement is not planned or anticipated) should not be included in the income statement. Instead, any gain or loss on the measurement of a long-term advance should be included in the CTA account in consolidation.
When a reporting entity decides to sell a foreign operation, and the sale is expected to result in the repayment of an intercompany advance that has been previously designated by the reporting entity as being of a long-term-investment nature, the reporting entity should begin to record foreign currency gains and losses on the intercompany advance in net income, rather than CTA. As soon as repayment of a long-term advance becomes foreseeable, foreign currency gains and losses related to the measurement of that advance in a reporting entity’s functional currency should be recorded in net income. We believe it would be unusual to conclude that the repayment of a loan is only foreseeable on the day that the loan is repaid.
See FX 7.5 for information on long-term advances.
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