Foreign Currency Remeasurement vs. Translation: ASC 830 for the CPA Exam

Foreign Currency Accounting Under ASC 830

ASC 830 governs the translation of foreign currency financial statements and the accounting for foreign currency transactions. For the CPA FAR exam, candidates must understand the distinction between remeasurement and translation, how to determine the functional currency, and the mechanics of both the temporal method and the current rate method. This is a high-frequency exam topic that often appears in task-based simulations.

Functional Currency Determination

The functional currency is the currency of the primary economic environment in which the entity operates -- typically the currency in which the entity primarily generates and expends cash. ASC 830-10-55 provides indicators to help determine the functional currency:

Cash flow indicators: If cash flows are primarily in the foreign currency and do not directly affect the parent's cash flows, the functional currency is the foreign currency.
Sales price indicators: If sales prices are primarily determined by local competition or regulation rather than by worldwide competition or international prices, the functional currency is the foreign currency.
Sales market indicators: If there is an active local sales market for the entity's products, the functional currency is the foreign currency.
Expense indicators: If labor, materials, and other costs are primarily local, the functional currency is the foreign currency.
Financing indicators: If financing is primarily in the foreign currency and generated by the entity's operations, the functional currency is the foreign currency.
Intercompany indicators: If intercompany transactions are low volume, the functional currency is the foreign currency.

If the indicators point to the parent's reporting currency as the functional currency, remeasurement is required. If the indicators point to the local foreign currency, translation is required.

Remeasurement: The Temporal Method

Remeasurement is used when the functional currency is the reporting currency (the parent's currency) but the books are maintained in a foreign currency. The temporal method applies the following exchange rates:

Monetary assets and liabilities (cash, receivables, payables, debt): current exchange rate at the balance sheet date.
Nonmonetary assets and liabilities carried at historical cost (inventory at cost, fixed assets, intangible assets, prepaid expenses): historical exchange rates.
Nonmonetary assets carried at fair value (inventory at market when lower than cost): current exchange rate.
Revenues and expenses: weighted-average exchange rate for the period, except for expenses related to nonmonetary assets (such as depreciation, amortization, and cost of goods sold), which use historical rates.
Common stock and additional paid-in capital: historical exchange rates.

Remeasurement gains and losses are recognized in current period income. The balancing amount needed to make the trial balance work is the remeasurement gain or loss, reported in the income statement.

Translation: The Current Rate Method

Translation is used when the functional currency is the foreign currency. Under the current rate method:

All assets and liabilities: current exchange rate at the balance sheet date.
Revenues and expenses: weighted-average exchange rate for the period (or the exchange rate at the date of the transaction if practicable).
Common stock and additional paid-in capital: historical exchange rates.
Dividends: exchange rate on the date of declaration.

Translation adjustments (the balancing amount) are not recognized in income. Instead, they are reported in other comprehensive income as a cumulative translation adjustment (CTA) and accumulated in the equity section of the balance sheet.

When Both Methods Apply

In some cases, an entity's books are maintained in a currency other than its functional currency, and the functional currency is also different from the parent's reporting currency. In this situation, remeasurement is performed first (from the books' currency to the functional currency using the temporal method), and then translation is performed (from the functional currency to the reporting currency using the current rate method).

Foreign Currency Transactions

When an entity enters into a transaction denominated in a foreign currency, it records the transaction at the spot rate on the transaction date. At each balance sheet date, foreign currency monetary items are remeasured at the current spot rate, and any exchange gains or losses are recognized in income. Settlement of the transaction at a rate different from the recorded rate also produces a gain or loss.

Highly Inflationary Economies

When a foreign entity operates in a highly inflationary economy (cumulative inflation of approximately 100% or more over three years), ASC 830 requires that the reporting currency be treated as the functional currency, regardless of the economic indicators. This means remeasurement (temporal method) is used, and gains and losses flow through income rather than OCI.

Exam Preparation Tips

Memorize which exchange rates apply to each financial statement line item under both the temporal method and the current rate method.
Know that remeasurement gains and losses go to income, while translation adjustments go to OCI (CTA).
Be able to determine the functional currency based on the economic indicators provided in a question.
Practice computing remeasurement gains or losses and translation adjustments as balancing figures.
Remember the highly inflationary economy rule: the parent's currency becomes the functional currency, requiring remeasurement.