If your reporting entity has subsidiaries that prepare financial statements in a different currency, you'll need to convert those statements into your reporting currency before you can consolidate. This article is a primer on the concepts and the framework from ASC 830, the US GAAP standard governing foreign currency matters.
This article is for educational context only. For authoritative guidance, refer directly to ASC 830 or consult your accounting advisor.
Translation vs. remeasurement
Two different processes are commonly confused:
Translation — Converting a foreign entity's functional currency financial statements into the reporting currency. The resulting differences flow to the Cumulative Translation Adjustment (CTA) account within other comprehensive income (OCI).
Remeasurement — Converting transactions recorded in a currency other than the entity's functional currency into its functional currency. The resulting differences are transaction gains or losses, which hit net income.
Order of operations: If a foreign entity's books aren't kept in its functional currency, per ASC 830-10-45-17 you remeasure first (into the functional currency), then translate (into the reporting currency).
Key definitions
- Reporting currency — The currency your parent entity uses to prepare its consolidated financial statements.
- Functional currency — The currency of the primary economic environment in which a given entity operates — typically, where it primarily generates and spends cash (ASC 830-10-20).
- Foreign currency — Any currency other than the functional currency of the operation being discussed.
- Foreign entity — A distinct and separable operation whose financial statements are prepared in a currency other than the reporting currency, and that is consolidated, combined, or accounted for under the equity method.
- Distinct and separable operation — An operation that can be clearly distinguished from the rest of the reporting entity for operational and financial reporting purposes, and for which a meaningful set of financial statements is routinely prepared.
ASC 830 framework
The figure below summarizes the key steps in applying ASC 830.
Step 3 : Determining functional currency
An entity may have more than one distinct and separable operation (divisions, branches, etc.), and if those operations work in different economic environments, they may each have their own functional currency (ASC 830-10-45-5).
ASC 830-10-55 provides guidance on the factors to consider — both individually and collectively — when determining a functional currency. At a high level, these factors look at where the entity's economic activity actually lives:
| Indicator | Suggests foreign currency | Suggests parent's currency |
|---|---|---|
| Cash flows | Local to the foreign entity, not directly affecting parent | Directly affect the parent and readily remittable |
| Sales prices | Set by local competition or regulation, not sensitive to FX | Sensitive to FX; driven by worldwide competition |
| Sales market | Primarily local (with possible exports) | Primarily in the parent's country or denominated in parent's currency |
| Expenses | Primarily local costs | Primarily sourced from the parent's country |
| Financing | Denominated locally; self-supporting from operations | From the parent or parent's currency; operations can't service debt standalone |
| Intra-entity activity | Low volume, limited interrelationship with parent | High volume, tightly interrelated with parent |
Long-term view matters most. Per KPMG's Foreign Currency Handbook, the functional currency determination should be based on long-term considerations — not short-term conditions like startup economics. Once established, it shouldn't change unless facts and circumstances significantly change.
Step 4: Remeasure foreign currency transactions
When an entity records a transaction in a currency that isn't its functional currency, that transaction must be remeasured into the functional currency. How the remeasurement works depends on whether the resulting balance is monetary or non-monetary:
Monetary assets and liabilities (cash, A/R, A/P, long-term debt, etc.):
- Represent amounts that will be settled in a currency other than the functional currency
- Re-measured at each reporting period using current exchange rates
- Resulting gains and losses flow to net income in the current period
Non-monetary assets and liabilities (inventory, PP&E, etc.):
- Don't require future settlement at a specific FX rate
- Measured using historical exchange rates at the date of the transaction
- All subsequent accounting (depreciation, impairment, LCM, etc.) is measured in the functional currency
Step 5: Translate financial statements
Once an entity's financials are in its functional currency, they're translated into the reporting currency. Different account types translate at different rates:
| Account type | Translation rate |
|---|---|
| Assets and liabilities | Period-end spot rate |
| Income statement accounts | Weighted average rate for the period |
| Equity accounts (other than change in retained earnings) | Historical rates |
Layered consolidations: ASC 830 applies to each layer of a consolidation, starting at the lowest level of the organizational structure. Translate each foreign entity's statements into the functional currency of its immediate parent, not directly into the ultimate reporting currency.
Where translation differences go: Gains and losses from exchange rate differences during translation (and their associated tax effects) are recorded in the CTA account — a separate component of Accumulated Other Comprehensive Income (AOCI) within shareholders' equity.