When a reporting entity conducts transactions in more than one currency, preparing financial statements in a single currency requires that changes in the relationship between different units of currency be recognized and measured. ASC 830, Foreign Currency Matters, uses the following two distinct processes to express all of a reporting entity’s transactions in a single reporting currency.
  • Foreign currency measurement–This is the process by which an entity expresses, in its functional currency, transactions whose terms are denominated in a foreign currency. Changes in functional currency amounts that result from the measurement process are called transaction gains or losses and are included in net income.
  • Foreign currency translation–This is the process of expressing a foreign entity’s functional currency financial statements in the reporting currency. Changes in reporting currency amounts that result from the translation process are called translation adjustments and are included in the cumulative translation adjustment account, which is a component of other comprehensive income.
This chapter addresses the income tax accounting issues associated with foreign currency matters and the hedging of investments in foreign subsidiaries. See PwC’s Foreign currency guide for detailed discussion of foreign currency matters.

13.1.1 General translation/remeasurement process

The reporting currency is the currency in which a reporting entity prepares its financial statements. The functional currency is the currency of the primary economic environment in which the entity operates. Accordingly, foreign entities that maintain their financial statements in a functional currency that is different than the reporting currency need to translate their financial statements each reporting period into the enterprise’s reporting currency. This is accomplished through the following:
  • All transactions in, or denominated in, a currency other than the functional currency are remeasured into the functional currency of the foreign entity using the current exchange rate for monetary accounts (e.g., cash, accounts receivable, accounts payable and long-term debt) and historical rates for nonmonetary accounts (e.g., fixed assets, inventory), assuming the foreign entity maintains its books in a currency other than the functional currency. Accordingly, for monetary accounts, changes in the exchange rate between the initial recording and the remeasurement date will give rise to foreign currency gain or loss.
  • The functional currency financial statements are translated into the reporting currency using the “current rate method.” The effect of changes in the exchange rate between the foreign entity’s functional currency and the reporting currency is recognized in the reporting entity’s cumulative translation adjustment (CTA). Under the “current rate method” of translation:
    • Assets and liabilities are translated using the current exchange rate at the balance sheet date
    • Capital accounts (e.g., common and preferred shares) are translated at the historical exchange rates (i.e., the exchange rates in effect when the transactions occurred)
    • Income statement accounts are translated at the exchange rate on the date the income or expense was recognized (use of the weighted average exchange rate during the period is generally appropriate)

13.1.2 Deferred taxes related to the translation/remeasurement process

ASC 740 generally requires deferred taxes to be provided on temporary differences between the book carrying values and the tax bases of assets and liabilities. That general principle is considered in determining the appropriate tax accounting for temporary differences relating to foreign currency translation and transactions. The process for determining deferred taxes related to foreign operations differs depending on whether the functional currency is the local currency or something other than the local currency. When the local currency is different from the functional currency, the guidance for recognizing deferred taxes depends on the nature of the individual foreign assets and liabilities as either monetary or nonmonetary as further discussed in TX 13.5. When the local currency is the functional currency, deferred tax assets and liabilities are measured under ASC 740 for the temporary differences between the functional currency financial statement carrying amounts of assets and liabilities and their related functional currency tax bases in the foreign jurisdiction. The individual functional currency deferred tax assets and liabilities are then translated into the reporting currency using current exchange rates at the balance sheet date.
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