Foreign Currency Handbook - KPMG

Foreign Currency

Handbook

US GAAP

March 2018 us/frv

Contents

Preface 1. Overview of Accounting for Foreign Currency... ...............................................1 2. Functional Currency..........................................................................................5 3. Foreign Currency Transactions.......................................................................18 4. Translation of Foreign Currency Financial Statements ...................................52 5. Foreign Currency Derivatives and Hedging Foreign Currency Risk................99 6. Income Taxes under ASC Topic 740 ............................................................125 7. Presentation and Disclosures.......................................................................126 Acknowledgments

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Preface

The purpose of KPMG's series of Handbooks is to assist you in understanding the application of US GAAP in practice, and to explain the conclusions that we have reached on many interpretive issues. We expect to update this Handbook as needed based on developments in practice. You will always be able to find the most up-to-date version of this and other KPMG publications on KPMG's Financial Reporting View. Currently Effective Requirements This Handbook takes an in-depth look at the application of ASC Topic 830, Foreign Currency Matters. This publication provides our current interpretations, which are based partly on periodic, informal discussions with the FASB and SEC staffs. Our interpretations may be affected by future guidance issued by the FASB or its staff, the SEC staff, and others involved in the standard-setting process. Organization of the Text Each chapter of this Handbook includes excerpts from the FASB's Accounting Standards Codification? to supplement our interpretive guidance, and illustrative examples that address the specific implementation issues we have identified.

KPMG LLP March 2018

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Section 1 - Overview of Accounting for Foreign Currency

1.000 FASB ASC Topic 830, Foreign Currency Matters (formerly FASB Statement No. 52, Foreign Currency Translation) provides accounting guidance for transactions denominated in a foreign currency, and for operations undertaken in a foreign currency environment.

1.001 In developing the guidance in ASC Topic 830, the FASB acknowledged that an entity may undertake different operations in different economic and currency environments, and that the financial position and results of these operations are best measured in the respective currency of the primary economic environment in which they take place. Statement 52, pars. 75, 78, and 97

1.002 To operationalize this approach, the FASB developed two concepts: ASC Section 830-10-20

? Foreign Entity: An operation (for example, subsidiary, division, branch, joint venture, and so forth) whose financial statements are both (a) prepared in a currency other than the reporting currency of the reporting entity and (b) combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity.

? Functional Currency: The currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment in which an entity primarily generates and expends cash. If this environment is a highly inflationary economy, the parent's functional currency should be used as if it were the entity's functional currency.

1.003 The concepts of foreign entity and functional currency are discussed further in Section 2, Functional Currency, of this guide.

1.004 The functional currency approach requires that two basic accounting tasks are addressed with respect to foreign currency:

? Measurement and recognition of foreign currency transactions of an entity in the entity's functional currency; and

? Translation of an entity's functional currency financial statements, if different from the reporting entity's reporting currency, into the reporting currency for preparing the reporting entity's (consolidated) financial statements.

1.005 A key distinction between measurement and translation under ASC Topic 830 is that the former captures a cash flow consequence due to changes in exchange rates while the latter aggregates financial statements of entities with different functional currencies, or measures an entity's financial statements in a reporting currency other than its functional currency and, thus, lacks a current cash flow consequence. Because of this

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1. Overview of Accounting for Foreign Currency

difference in cash flow consequence, measurement or remeasurement affects earnings and translation affects equity. The objectives of remeasurement and translation are to: ASC paragraph 830-10-10-2

a. Provide information that is generally compatible with the expected economic effects of a rate change on an entity's cash flows and equity, and

b. Reflect in the consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with U.S. generally accepted accounting principles.

1.006 Foreign Currency Transactions. Foreign currency transactions are transactions whose terms are denominated in a currency other than the entity's functional currency. Foreign currency transactions should be accounted for as follows: ASC paragraphs 83020-25-1, 830-20-35-2

? At the date the transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction should be measured and recorded in the entity's functional currency using the exchange rate at which the transaction could be settled at the transaction date.

? At each balance sheet date, recognized monetary assets and liabilities that are denominated in a currency other than the entity's functional currency should be adjusted to reflect the exchange rate at which the related monetary item could be settled at that date.

1.007 Changes in the exchange rate increase or decrease the expected functional currency cash flows on settlement of a transaction and are reflected in the remeasurement of monetary assets and liabilities at each balance sheet date and on settlement. An entity should recognize changes in the exchange rate as foreign currency transaction gains or losses in current income, except for certain intercompany transactions and hedging relationships. Measurement and recognition of foreign currency transactions are discussed in Section 3, Foreign Currency Transactions of this guide.

1.008 Translation of Foreign Currency Financial Statements. To prepare consolidated financial statements, an entity translates all functional currency financial statements into a single reporting currency. The same applies if an entity uses different currencies for reporting purposes and for its functional currency.

1.009 If a foreign entity's functional currency (i.e., the currency of its primary economic environment), differs from the reporting entity's reporting currency, the entity's functional currency cash inflows and outflows can be viewed as economic hedges of each other, and only the reporting entity's net investment in the foreign entity is exposed to exchange risk. Therefore, the FASB concluded that the objectives of ASC Topic 830 are best achieved by translating (a) assets and liabilities at the exchange rate applicable to dividend remittances at the balance sheet date, and (b) revenues, expenses, gains, and losses at the exchange rate at the date on which those elements are recognized or at an appropriately weighted average exchange rate for the period of operations. The use of an

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1. Overview of Accounting for Foreign Currency

end-of-period exchange rate for revenues, expenses, gains, and losses was rejected because it would have required restating prior interim periods or recording a catch-up adjustment in income if rates change. ASC Section 830-30-45

1.010 Under the ASC Topic 830 translation approach, the effect of exchange rate changes on net assets and net income results in translation adjustments. These translation adjustments do not affect reporting currency cash flows until the respective foreign entity is sold or liquidated. The translation adjustments can be viewed as unrealized gains or losses and therefore are not reported in results of operations, but in other comprehensive income and accumulated in the translation adjustment component of equity until realized upon sale, exchange, or liquidation of the foreign entity. Section 4, Translation of Foreign Currency Financial Statements, of this guide provides additional guidance about the accounting for the translation adjustment component of equity upon the sale, exchange, or liquidation of a foreign entity. ASC paragraph 830-30-45-12

1.011 Sometimes an entity's books of record may not be maintained and its financial statements initially may not be prepared in its functional currency (e.g., if its functional currency is not the local currency of the entity's country of residence). Remeasurement of those financial statements into the entity's functional currency technically does not represent a translation of foreign currency financial statements as ASC Topic 830 uses that term, although the remeasurement may be done as part of the consolidation process. Remeasurement represents retroactive application of recognition and measurement principles for foreign currency transactions as discussed in Section 3. Translation of foreign currency financial statements is discussed in Section 4.

1.012 Foreign Currency Derivatives and Hedging Foreign Currency Risk. ASC Topic 815, Derivatives and Hedging, is the primary accounting standard for derivatives and hedging activities.

1.013 A fundamental principle of ASC Topic 815 as it relates to foreign currency hedging was to make the accounting for hedges of foreign currency exposures consistent with the accounting for hedges of other fair value and cash flow exposures. Thus, ASC Topic 815 permits hedge accounting for forecasted foreign-currency-denominated transactions hedged with foreign currency forward contracts or with any other foreign currency derivative contract. In addition, tandem or cross-currency hedging also is permitted. By contrast, conceptual application of a fundamental principle in ASC Topic 815 would have resulted in prohibiting hedge accounting for hedges of net investments in foreign operations, because designating a net investment in a foreign operation as a hedged item would be considered the same as designating a group of dissimilar assets and liabilities as a hedged item, which is not permitted for a fair value or cash flow hedge under ASC Topic 815. However, Statement 52 previously permitted hedge accounting for hedges of net investments in foreign operations, and practice in this area was wellestablished. Because ASC Topic 815 did not comprehensively reconsider the accounting provisions of Statement 52, hedge accounting for hedges of net investments in foreign operations is still permitted. In addition, even though ASC Topic 815 generally prohibits the use of non-derivative instruments as hedging instruments, this practice continues to be permitted for certain foreign currency hedges because such practice previously was

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1. Overview of Accounting for Foreign Currency

followed under Statement 52. Thus, although ASC Topic 815 was seeking consistency, the difference between the hedge accounting models applied to foreign currency exposures and the models applied to other exposures has been accepted. The accounting for foreign currency derivatives and for foreign currency hedges is discussed in Section 5, Foreign Currency Derivatives and Hedging Foreign Currency Risk, of this guide. 1.014 Several other topics related to foreign currency transactions or translation of foreign currency financial statements require specific attention. ASC Topic 740, Income Taxes, provides guidance for the effect on income taxes of changes in exchange rates of a functional currency that differs from the currency in which the tax basis of assets and liabilities is denominated and of translation adjustments. These issues are discussed in Section 7, Foreign Operations of KPMG's Accounting for Income Taxes handbook. ASC Topic 830 and SEC rules and regulations require certain disclosures about foreign currency transactions and foreign operations, which are discussed in Section 7 Presentation and Disclosures, of this guide.

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Section 2 - Functional Currency

Detailed Contents General Principles

Q&A 2.1: Functional Currency of Shell Company Example 2.1: Foreign Entity with Foreign Functional Currency Example 2.2: Foreign Entity with Parent Company's Currency as Functional Currency Example 2.3: More Than One Functional Currency Changing the Functional Currency Example 2.4: Change in Functional Currency Q&A 2.2: Change in Functional Currency Q&A 2.3: Change in Functional Currency Foreign Operations in Highly Inflationary Economies Example 2.5: Computing Cumulative Inflation Rate Q&A 2.4: Fixed Exchange Rate Q&A 2.5: Functional Currency Different from Local Currency Q&A 2.6: Highly Inflationary Economy in Multilevel Group

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