What Is FAS 52 for Foreign Currency Translation?

Financial Accounting Standard 52 (FAS 52), now part of the Financial Accounting Standards Board’s (FASB) Codification as ASC 830, Foreign Currency Matters, provides the rules for U.S. companies with international operations. The objective of ASC 830 is to ensure a company’s foreign entities’ financial results are presented in a way that portrays their economic performance within the consolidated financial statements of the U.S. parent company.

This framework provides a standardized method for converting the financial statements of foreign subsidiaries from their local currency into U.S. dollars. The process is necessary for preparing consolidated financial statements that include all of a company’s operations.

Determining the Functional Currency

The first step under ASC 830 is determining the functional currency for each of a company’s foreign operations. The functional currency is the currency of the primary economic environment where an entity generates and expends cash. This determination is based on an evaluation of several economic factors and is not necessarily the currency of the country where the foreign entity is located.

Management must analyze economic indicators to identify the functional currency. These indicators include:

• The currency that most influences sales prices for goods and services.
• The currency of the country whose competitive forces and regulations mainly determine sales prices.
• The currency that influences the costs of labor, materials, and other expenses.
• The currency in which the foreign entity secures financing.
• The volume and nature of intercompany transactions with the parent company.

A high volume of transactions and a deep interrelationship with the parent may suggest the parent’s currency is the functional currency.

The Translation Method

The translation method is applied when a foreign entity’s local currency is also its functional currency. This process converts the functional currency financial statements into the reporting currency of the U.S. parent company, which is typically the U.S. dollar.

All assets and liabilities on the balance sheet are translated using the current exchange rate at the balance sheet date. Equity accounts, like common stock and additional paid-in-capital, are translated at the historical exchange rates from the dates those transactions occurred.

Revenues and expenses on the income statement are translated using a weighted-average exchange rate for the period. The net effect of using different rates for the balance sheet and income statement creates a gain or loss. This gain or loss, known as the Cumulative Translation Adjustment (CTA), is recorded in Other Comprehensive Income (OCI) and does not affect the company’s net income.

The Remeasurement Method

The remeasurement method is required when a foreign entity’s books are in a local currency different from its functional currency. This often occurs when a foreign operation is a direct extension of the parent company, making the U.S. dollar the functional currency.

Monetary assets and liabilities, which are amounts fixed in terms of currency units like cash, accounts receivable, and accounts payable, are remeasured using the current exchange rate at the balance sheet date.

Non-monetary assets and liabilities, like inventory and property, are remeasured using historical exchange rates from the dates they were acquired. Related income statement accounts, such as cost of goods sold and depreciation, use these same historical rates. Any gain or loss from this process is recognized directly in the company’s net income for the period.

Accounting for Hyperinflationary Economies

Special rules apply to foreign entities in hyperinflationary economies, defined as those with a cumulative inflation rate of approximately 100% or more over three years. In such an environment, the local currency is considered too unstable to be a reliable measure of financial performance.

Under U.S. GAAP, the financial statements of an entity in a hyperinflationary economy must be remeasured into the parent company’s reporting currency, such as the U.S. dollar. This requirement overrides the standard functional currency determination and requires using the remeasurement method.

This approach differs from some international standards that may first restate local currency statements for purchasing power changes before translation. For U.S. reporting purposes, the financial statements are directly remeasured into the stable reporting currency.