As per the Financial Accounting Standards Board, FASB 52, if an entity’s books of records are not maintained in its functional currency, the financial statements of that entity needs to be re-measured into its functional currency. Re-measurement of functional currency is required prior to translating the financial statements into a reporting currency. The re-measurement process is intended to produce the same result as if the entity had been recording the accounting entries in its functional currency.
I have prepared this document for a Bottling company with a head office in USA with current subsidiary presence in Mexico and future foreign operating entities to follow. this document should serve as a guide for the foreign entities financial statements representation in the consolidated books.
Depending on the scope and structure of its consolidated operations, a reporting entity may have transactions denominated in a foreign currency (which need to be measured in a functional currency), or it may have foreign entities (which need to be translated into the reporting currency). To prepare consolidated financial Statements, all amounts denominated in foreign currencies should be either measured or translated (or both) into the reporting currency.The following figure summarizes the key steps in the application of ASC 830. An understanding of the various defined terms is critical to navigating the ASC 830 framework.
Step 1: Identify the reporting entity’s reporting currencyASC 830-10-20 provides the definitions of reporting entity and reporting currency.
The reporting currency is often the currency of the country in which the reporting entity is located, but it does not have to be. A private reporting entity may select any currency for its reporting currency. For example, a foreign private issuer may choose to prepare financial statements in U.S. dollars for purposes of reporting to investors in the United States. In that case, its reporting currency is the U.S. dollar.Rule 3-20 of Regulation S-X requires U.S. incorporated registrants to present their financial statements in U.S dollars, with limited exceptions.
Step 2: Identify the reporting entity’s foreign entities
A foreign entity is a distinct and separable operation that is combined, consolidated, or accounted for using the equity method of accounting and has a functional currency other than the reporting entity’s reporting currency.
Example: Mexico, Australia, Japan etc.
Step 3: Determine the functional currency of each distinct and separable operationThe functional currency of a distinct and separable operation is a question of fact. An operation does not choose its functional currency.
The determination of a distinct and separable operation’s functional currency may be straightforward. For example, the functional currency of a distinct and separable operation integrated withina particular country with self-contained operations would likely be the currency of that country. Similarly, the U.S. dollar is typically the functional currency of an operation thatis a direct and integral component or extension of a U.S. parent’s operations. However, the determination of the functional currency of a distinct and separable operation is often complex and mayrequire significant judgment. It is not common for the functional currency of a distinct and separable operation to change, unless there are significant changes in external economic facts and circumstances. See FX 3 for further information on factors to consider in determining the functional currency.In addition, ASC 830 contains specific provisions for determining the functional currency of a foreign entity operating in a country with a highly inflationary economy. See FX 6 for further information on the applicable considerations if a foreign entity operates in a highly inflationary economy.
Step 4: Measure foreign currency transactions
When an operation has transactions denominated in a currency other than its functional currency, they must be measured in the functional currency. Changes inthe expected functional currency cash flows caused by changes in exchange rates are included in net income in the period.
Foreign currency transactions are initially recorded in an operation’s functional currency. Subsequent measurement of foreign currency transactions will depend onwhether the transaction gives rise to an account balance that is monetary or non-monetary.
Monetary assets and liabilities
Monetary assets and liabilities, such as cash, accounts receivable, accounts payable, and long-term debt, create foreign currency exchange rate risk as they represent amounts that will be settled with counterparties in a currency other than an operation’s functional currency. Monetary assets and liabilities are measured at the end of each reporting period based on the then current exchange rates. This measurement gives rise to foreign currency gains and losses, which are recorded in current period net income.
Non-monetary assets and liabilities
Non monetary assets and liabilities, such as inventory and property, plant, and equipment, do not require future settlement or adjustment. Non-monetary assets and liabilities are initially measured using historical exchange rates. All aspects of the ongoing accounting for these items (e.g., depreciation, impairment, lower of cost or market) should be measured in terms of the operation’s functional currency.
Step 5: Translate financial statements of foreign entities
Foreign currency translation is the process of expressing a foreign entity’s financial statements in the reporting currency of the reporting entity. The purpose of translation is to express a foreign entity’s functional currency financial statements in terms of the reporting currency.Thus, when a reporting entity’s financial statements include the results of foreign entities, the reporting entity must translate the foreign entity’s financial statements before they can be consolidated.
The financial statements of a foreign entity should be translated into the functional currency of its immediate parent company based on the nature of the account as follows:
The period-end spot rate for assets and liabilities
The weighted average exchange rate for income statement accounts
Historical exchange rates for equity accounts (except for the change in retained earnings during the year, which isthe result of the income statement translation process)
Once the reporting entity has translated its foreign entity financial statements, it should record these amounts in its consolidated financial statements. We refer to the “immediate” parent, as ASC830 should be applied to each individual layer of a consolidation, beginning with the lowest level of the consolidated reporting entity’s organizational structure. Gains and losses (and the associated tax effect) from the effect of exchange rate differences in translation are recorded in the CTA account. CTA is a separate component of accumulated other comprehensive income (OCI) in shareholders’ equity.
Step 6: Release the cumulative translation adjustment into net income, as applicable
ASC 830-30-40-1 requires CTA to be reclassified from equity to net income “upon sale or upon complete or substantially complete liquidation of an investment in a foreign entity.” Therefore, when disposing of any foreign operation, it is important to understand if that foreign operation constitutes a foreign entity, or is a component of a foreign entity. Acquiring control of a foreign operation in a step acquisition may also require that CTA be released to net income.
The high-level solution to re-measure foreign currency transactions and then translate the foreign entity financial statements to Client X’s functional currency which is USD.
The primary advantage of creating a secondary ledger in general ledger is to convert the foreign entities balance to USD using balance level conversion.
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