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3.4 Foreign plans
Publication date: 31 Oct 2023
us Pensions guide
ASC 715 does not include special provisions applicable to pension arrangements outside the US. If those arrangements are in substance similar to pension plans in the US, they are subject to the provisions of ASC 715.
ASC 715 establishes standards of financial reporting and accounting for an employer that offers pension benefits to its employees in the form of a plan (as described at PEB 1.2). Pension benefits are defined in ASC 715-30-20 as "periodic (usually monthly) payments made pursuant to the terms of the pension plan to a person who has retired from employment or to that person's beneficiary."
ASC 715 applies to any arrangement (written or unwritten) that is similar in substance to a pension plan regardless of the form or means of financing.
3.4.1 Foreign plans — foreign currency translation
Companies with foreign pension plans where the local currency is the sponsor’s functional currency need to account for foreign currency translations of pension and pension-related amounts in AOCI that are reclassified to net income.
ASC 830, Foreign Currency Matters, governs foreign currency translation. Refer to FSP 21 and our Foreign currency guide for guidance on foreign currency translation.
The guidance in ASC 830, Foreign Currency, predates the guidance in ASC 220, Comprehensive Income, and does not contain explicit guidance for the translation of amounts of other comprehensive income. Conceptually, AOCI can be likened to a separate category of retained earnings, but existing accounting guidance is unclear concerning the exchange rate that an enterprise would use to translate the activity in other comprehensive income for a particular period arising from the reclassification of amounts from AOCI into net income (see FX 5.3).
We believe there are two acceptable approaches to accounting for the foreign currency translation under ASC 830 when pension items are reclassified from AOCI to net income: (1) the historical rate approach and (2) the current rate approach. Selection of an approach is an accounting policy decision that should be applied consistently.
Although we believe both the historical rate approach (described in PEB 3.4.1.1) and the current rate approach (described in PEB 3.4.1.2) are acceptable under GAAP, we believe the historical rate approach is preferable. The arguments in support of the historical rate approach appear to be more conceptually sound (i.e., that AOCI is analogous to retained earnings and that reclassification adjustments are not "recognition" events). However, we acknowledge that the use of the historical rate approach gives rise to practical challenges in tracking the historical exchange rates associated with the AOCI amounts that are subject to reclassification to net income. We believe that a number of approaches (averaging, first-in, first-out, etc.) to simplify that process could be acceptable (see PEB 3.4.1.1).
3.4.1.1 Foreign plans — the historical rate approach
Under the historical rate approach, the amount of AOCI reclassified to net income each period would be translated from the functional currency of the foreign operation to the reporting currency at the historical exchange rate in effect at the time the prior service costs/credits, net gain or loss, and transition asset/obligation were initially recognized in OCI.
This approach is consistent with the principles in ASC 220, which defines OCI as revenues, expenses, gains, and losses that under GAAP are included in comprehensive income but excluded from net income. In the context of ASC 220, the initial recognition of pension-related amounts in OCI (i.e., the change in equity — or net assets —not arising from owner transactions), and not the reclassification adjustment, is the income recognition event that triggers translation into the reporting currency.
Based on this view, a reclassification from one component of income (OCI) to another (net income, and, in turn, retained earnings) is merely a recycling of amounts previously recognized and translated at the exchange rate in effect at the time those amounts were previously recognized. Therefore, the exchange rate used to translate an item recognized in OCI should not change when that item is later reclassified to net income.
This approach is also consistent with the treatment of retained earnings under ASC 830. The amount of net income that an entity reports each period is translated at the exchange rates in effect during that period. Once translated, that net income accumulates in retained earnings and is not subsequently retranslated at a current rate (i.e., retained earnings balances do not fluctuate from period to period based on changes in exchange rates). Similarly, amounts accumulated in AOCI are not retranslated. Therefore, AOCI amounts that are reclassified to net income should not be retranslated in the period they are recorded in net income.
Implementation and tracking—historical rate approach
Amounts in AOCI may be amortized and recognized in net periodic benefit expense over many future years. As a result, entities that adopt the historical rate approach will need to develop processes to track the foreign currency rates in effect in each period when prior service costs/credits and gains or losses are added to AOCI. Entities will also need to develop policies to determine the "layer" of AOCI that is reclassified into the income statement.
We believe that there are many reasonable approaches that entities might adopt to track the historical rates to be used when reclassifying amounts from AOCI to net income. For example, an entity might adopt a policy of reclassifying AOCI amortization on a FIFO basis, such that the first dollar of AOCI loss reclassified would be translated at the exchange rate in effect when the first dollar of loss was recognized in AOCI. Alternatively, an entity might adopt a policy of developing a blended historical average rate for all amounts in AOCI, and this rate would be updated each time new amounts are added to AOCI. Entities should elect an approach and consistently follow it.
3.4.1.2 Foreign plans — the current rate approach
Under the current rate approach, the amount of AOCI reclassified to net income each period would be translated from the functional currency of the foreign operation to the reporting currency at the current exchange rate in effect for the period in which the reclassification adjustment is reflected in net income (typically the average exchange rate for the period, since pension expense is reflected ratably over the period). As an underlying concept in ASC 830 is for the foreign operation to determine its components of income and expense using its functional currency, and then for those amounts to be translated to the reporting currency, this approach would reflect all components of the foreign operation’s net pension costs at the same current period average rates.
When applying the current rate approach, differences arise from applying the historical rate to the pension-related AOCI balance and the current rate for the related amortization. Although there is no specific accounting guidance for the differences that arise when applying the current rate approach, we believe the difference should be recorded in the AOCI balance as part of the cumulative foreign currency translation adjustment (CTA) and tracked separate from the pension-related AOCI balances.
ASC 830-30-40-1 requires the CTA balance in AOCI to be recognized in income only upon sale of the foreign entity to which it relates or when actions result in the complete or substantially complete liquidation of the investment. As such, it would not be appropriate to amortize the difference that arises from applying the current rate approach into the income statement the way that the deferred gains/losses and prior service costs/credits are amortized out of AOCI and into income.
3.4.2 Foreign plans — foreign currency remeasurement
If an entity's local books of record are not maintained in its functional currency, ASC 830, Foreign Currency Matters, requires remeasurement into the functional currency prior to translation of the financial statements into the reporting currency (if different than the functional currency). See FX 5.4. The intent is to produce the same result as if the entity's records were initially maintained in the functional currency. As a result, entities with pension plans denominated in a currency that differs from their functional currency should remeasure the net pension plan asset or obligation into the functional currency. Fluctuations in exchange rates from one pension measurement date to the next will affect the overall change in the net pension asset or obligation (which is considered a foreign currency-denominated payable or receivable from the perspective of the functional currency) due to foreign exchange movements. However, existing guidance is not explicit on how to account for these foreign exchange movements on the net pension asset or obligation balances. We believe those exchange rate movements can either be reflected in current earnings consistent with the broad guidance in FX 5.4 (see PEB 3.4.2.2) or recognized as a component of experience gains and losses under ASC 715 (see PEB 3.4.2.1).
Under either approach, for purposes of measuring a pension obligation, the remeasurement should generally be performed using the current exchange rate in order to produce the same result as if the entity's local books of record had initially been recorded in the functional currency. However, we are also aware that some entities perform this remeasurement using historical exchange rates because they consider pension obligations to be nonmonetary for purposes of ASC 830-10-45-18. This interpretation is based, in part, on analogy to ASC 255-10-55-1, which describes pension obligations (other than fixed amounts payable to a fund) as nonmonetary liabilities. We would not take exception to use of this historical rate interpretation for purposes of the remeasurement process.
3.4.2.1 Foreign currency remeasurement — OCI approach
Under ASC 830, it is necessary to recognize currently in income all exchange gains and losses from remeasurement of monetary assets and liabilities that are not denominated in the functional currency. However, ASC 830 does not include detailed guidance on determining whether an asset or liability is considered monetary or nonmonetary. To assist in making this determination for pension assets and obligations, proponents of this approach analogize to ASC 255-10-55-1, which lists many common balance sheet accounts and denotes each as being either monetary or nonmonetary. That listing includes accrued pension obligations and notes that fixed amounts payable to a pension fund are monetary and all other amounts are nonmonetary.
For the portion of the pension obligation that is nonmonetary, it is not appropriate to recognize exchange gains and losses from remeasurement in income under ASC 830. Instead, they should be treated as part of the adjustment to other comprehensive income under ASC 715.
In addition, the remeasurement of the net pension asset or obligation into the functional currency is not fundamentally different from a situation in which a US employer's pension plan holds foreign currency-denominated investments. In that situation, the employer would be required under ASC 715 to treat all movements in the value of the investment as net pension gain or loss in other comprehensive income, and would not be permitted to strip out any gain or loss associated with foreign currency movements and recognize those currently in income.
ASC 320-10-35-36 addresses an analogous situation with respect to available-for-sale (AFS) debt securities that are denominated in a foreign currency. The guidance addresses whether the entire change in the fair value of foreign currency-denominated AFS debt securities should be reported in other comprehensive income, or whether the portion attributable to changes in foreign exchange rates should be reported currently in earnings. The guidance states that the entire change in value of the securities, other than the amount recorded in the allowance for credit losses, should be reflected in other comprehensive income. The exchange rate movements are just one component of the overall change in fair value of the security in functional currency terms and, therefore, should be treated as similar to other changes in fair value.
3.4.2.2 Foreign currency remeasurement—income statement approach
ASC 830 does not provide explicit guidance on how to determine whether an asset or liability is considered monetary or nonmonetary. ASC 255-10-55-1 should not be considered binding in making this determination because this guidance was not written to interpret ASC 830 and did not amend ASC 830. Further, ASC 255-10-55-1 says that not all of the accrued pension obligation would be considered to be nonmonetary. This would seem to necessitate an allocation of the obligation between monetary and nonmonetary. Based on the definition of a monetary liability in ASC 255, the nonmonetary portion might reasonably be the portion of the obligation that was determined with reference to future salaries. That portion may be insignificant, depending on the demographics of the plan's participants. Accordingly, a practical approach is to consider the entire obligation to be monetary. This would be consistent with IFRS. IAS 21, The Effects of Changes in Foreign Exchange Rates, explicitly states in IAS 21.16 that pensions and other employee benefits to be paid in cash are monetary items. There is no discussion in IAS 21 that suggests the need to bifurcate the item into monetary and nonmonetary portions.
It is reasonable to consider pension obligations as monetary liabilities under ASC 830 because:
- ASC 830 does not provide guidance for determining whether an asset or liability is monetary or nonmonetary
- IFRS is clear that pension and other employee benefits are monetary items
- There are practical issues associated with applying an ASC 255 approach
Thus, any foreign currency movements associated with the net pension asset or obligation should be reflected currently in income.
3.4.2.3 Foreign currency remeasurement — AOCI
Unlike the net pension asset or obligation, the AOCI balances associated with a pension plan sponsored by a foreign subsidiary whose functional currency is not the local currency should not be remeasured to current exchange rates each period. Rather, they should be maintained at the historical exchange rates as if the local books were maintained in the functional currency. These balances do not reflect amounts actually owed to participants (or due from the plan), but rather are just deferrals of historical activity. As remeasurement treats these amounts as if they were always recorded in the functional currency, there is no need to adjust the amounts recorded historically in that currency. Similarly, amortization of amounts out of AOCI into income should be calculated at the historical rates.
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