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Overview
To facilitate the proper analysis of foreign operations by financial statement users, transac­
tions and financial statements denominated in foreign currencies must be expressed in a common
currency (i.e., U.S. dollars). Preparing financial statements in a single currency requires the entity
to recognize and measure changes in the relationship between different units of currency. The
GAAP governing the translation of foreign currency financial statements and the accounting for
foreign currency transactions are found in ASC 830.
The guidance in ASC 830 was issued in 1981 and has not changed significantly since that
time. The guidance makes four assumptions. It assumes the reporting entity:
1. Is located in the United States,
2. Uses the U.S. dollar as its reporting currency,
3. Is an operating company with a functional currency in U.S. dollars, and
4. Provides support to its foreign operations.
However, in today’s global economy, some U.S. reporting entities are merely holding
companies with no significant operations. This results in the four assumptions listed above no
longer being true and has created challenges in applying the guidance. To prepare consolidated
financial statements, amounts denominated in foreign currencies should be:
• Remeasured in the reporting currency and/or
• Translated into the reporting currency.
These two processes are outlined in the exhibit below.
Subtopic Process Description of Process Reporting Changes
ASC 830-20 Remeasurement Used to measure amounts that are Transaction gains and losses
denominated in a foreign currency reflected in net income.
other than it is functional currency
ASC 830-30 Translation Used to translate a foreign entity’s Translation adjustments
financial information to the recorded in a cumulative
reporting currency when the translation account, a
foreign entity’s financial records component of other
are maintained in its functional comprehensive income.
currency.

The objectives of translation are to provide:

1. Information relative to the expected economic effects of rate changes on an enterprise’s
cash flows and equity
2. Information in consolidated statements relative to the financial results and relationships of
each individual foreign consolidated entity as reflected by the functional currency of each
reporting entity.
(ASC 830-10-10-2)
These are the steps in the process to achieve these goals:
Step 1: Determine the functional currency of each foreign entity.
Step 2: Remeasure into its functional currency the account balances of each entity not
denominated in the entity’s functional currency.
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Step 3: Translate financial statements of foreign entities to the reporting currency of the
parent company
Step 4: Evaluate whether the cumulative translation account should be released into net
income.
To understand and apply the guidance in ASC 830, it is important to understand the
definitions below.

DEFINITIONS OF TERMS

Source: ASC 830, Glossaries. See Appendix A, Definition of Terms, for additional terms relevant
to this topic: Net Realizable Value and Not-for-Profit Entity.
Attribute. The quantifiable characteristic of an item that is measured for accounting
purposes. For example, historical cost and current cost are attributes of an asset.
Exchange Rate. The ratio between a unit of one currency and the amount of another currency
for which that unit can be exchanged at a particular time.
Foreign Currency. A currency other than the functional currency of the reporting entity
being referred to (for example, the U.S. dollar could be a foreign currency for a foreign entity).
Composites of currencies, such as the Special Drawing Rights on the International Monetary Fund
(SDR), used to set prices, denominate amounts of loans, and the like have the characteristics of
foreign currency for purposes of applying ASC 830.
Foreign Currency Statements. Financial statements that employ as the unit of measure a
functional currency that is not the reporting currency of the enterprise.
Foreign Currency Transactions. Transactions whose terms are denominated in a currency
other than the reporting entity’s functional currency. Foreign currency transactions arise when an
enterprise (1) buys or sells goods or services on credit whose prices are denominated in foreign
currency, (2) borrows or lends funds and the amounts payable or receivable are denominated in
foreign currency, (3) is a party to an unperformed forward exchange contract, or (4) for other
reasons, acquires or disposes of assets or incurs or settles liabilities denominated in foreign
currency.
Foreign Currency Translation. The process of expressing in the enterprise’s reporting
currency amounts that are denominated or measured in a different currency.
Foreign Entity. An operation (for example, subsidiary, division, branch, joint venture, and so
forth) whose financial statements are both:

1. Prepared in a currency other than the reporting currency of the reporting entity
2. 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, the currency of the environment in which the entity primarily generates
and expends cash.
Local Currency. The currency of a particular country being referred to.
Noncontrolling Interest. The portion of equity (net assets) in a subsidiary not attributable,
directly or indirectly, to a parent. A noncontrolling interest is sometimes called a minority
interest.
Reporting Currency. The currency used by the entity to prepare its financial statements.
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Reporting Entity. An entity or group of entities whose financial statements are being referred
to. Those financial statements reflect (1) the financial statements of one or more foreign operations
by combination, consolidation, or equity method accounting; (2) foreign currency transactions; or
(3) both.
Transaction Gain or Loss. Transaction gains or losses result from a change in exchange
rates between the functional currency and the currency in which a foreign currency transaction is
denominated. They represent an increase or decrease in (1) the actual functional currency cash
flows realized upon settlement of foreign currency transactions and (2) the expected functional
currency cash flows on unsettled foreign currency transactions.
Translation Adjustments. Translation adjustments result from the process of translating
financial statements from the entity’s functional currency into the reporting currency.

CONCEPTS, RULES, AND EXAMPLES

Determining the functional currency. Before the financial statements of a foreign branch,
division, or subsidiary are translated into U.S. dollars, the management of the U.S. entity must
determine which currency is the functional currency of the foreign entity. Once determined, the
functional currency cannot be changed unless economic facts and circumstances have clearly
changed. Additionally, previously issued financial statements are not restated for any changes in
the functional currency. (ASC 830-10-45-7) The functional currency decision is crucial, because
different translation methods are applied which may have a material effect on the U.S. entity’s
financial statements.
FASB defines functional currency but does not list definitive criteria that, if satisfied, would
with certainty result in the identification of an entity’s functional currency. Rather, realizing that
such criteria would be difficult to develop, FASB listed various factors that were intended to give
management guidance in making the functional currency decision. These factors include:

1. Cash flows. Do the foreign entity’s cash flows directly affect the parent’s cash flows and
are they immediately available for remittance to the parent?
2. Sales prices. Are the foreign entity’s sales prices responsive to exchange rate changes and
to international competition?
3. Sales markets. Is the foreign entity’s sales market the parent’s country or are sales
denominated in the parent’s currency?
4. Expenses. Are the foreign entity’s expenses incurred primarily in the parent’s country?
5. Financing. Is the foreign entity’s financing primarily from the parent or is it denominated
in the parent’s currency?
6. Intercompany transactions. Is there a high volume of intercompany transactions between
the parent and the foreign entity?
(ASC 810-55-5)

If the answers to the questions above are predominantly yes, the functional currency is the
reporting currency of the parent entity (i.e., the U.S. dollar). If the answers are predominantly no,
the functional currency would most likely be the local currency of the foreign entity, although it is
possible for a foreign currency other than the local currency to be the functional currency.
Once the functional currency is determined, the entity proceeds to steps 2 or 3. The flowchart
below explains how to make that decision.
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Translation When Foreign Entity Maintains Financial Records in Its Functional

Currency
Current rate method. All assets and liabilities are translated at the exchange rate at the
balance sheet date. Revenues and expenses are translated at rates in effect when the transactions
occur, but those that occur evenly over the year may be translated at the weighted-average rate for
the year. (ASC 830-30-45-3)
The Codification recognizes the detailed record-keeping may be burdensome and, therefore,
allows averages or other approximations. (ASC 830-10-55-10) Note that weighted-average, if
used, must take into account the actual pace and pattern of changes in exchange rates over the
course of the year, which will often not be varying at a constant rate throughout the period nor, in
many instances, monotonically increasing or decreasing over the period. When these conditions
do not hold, it is incumbent upon the reporting entity to develop a weighted-average exchange rate
that is meaningful under the circumstances. When coupled with transactions (sales, purchases,
etc.) that also have not occurred evenly throughout the year, this determination can become a fairly
complex undertaking, requiring careful attention. (ASC 830-10-55-11)
The theoretical basis for the current rate method is the “net investment concept,” wherein the
foreign entity is viewed as a separate entity in which the parent invested, rather than being
considered part of the parent’s operations. FASB’s reasoning was that financial statement users
can benefit most when the information provided about the foreign entity retains the relationships
and results created in the environment (economic, legal, and political) in which the entity operates.
Converting all assets and liabilities at the same current rate accomplishes this objective.
The rationale for this approach is that foreign-denominated debt is often used to purchase
assets that create foreign-denominated revenues. These revenue-producing assets act as a natural
hedge against changes in the settlement amount of the debt due to changes in the exchange rate.
The excess (net) assets—which are the U.S. parent entity’s net equity investment in the foreign
operation—will, however, be affected by this foreign exchange risk, and this effect is recognized
by the parent.
Translation When a Foreign Entity Maintains Financial Records in a Currency Other
Than Its Functional Currency
Remeasurement method. The remeasurement method has also been referred to as the
monetary/nonmonetary method. This approach is used when the foreign entity’s accounting
records are not maintained in the functional currency. (ASC 830-10-55-17) This method translates
monetary assets (cash and other assets and liabilities that will be settled in cash) at the current rate.
Nonmonetary assets, liabilities, and stockholders’ equity are translated at the appropriate historical