Considerations when Accounting for Other Comprehensive Income in a Foreign Currency Functional Subsidiary
Those of you familiar with ASC 830-30 (or more commonly known as FAS 52 Foreign Currency Translation) will recognize that as a rule all activity on the income statement is translated at the current income statement rate, assets and liabilities at the month end rate, and equity at its historic rate. The delta between the income statement rate and the balance sheet rate ends up recorded in Cumulative Translation Adjustment (CTA) as a change in equity. The rule set is so reliable a simple proof can and has been used as a control by corporate accounting organizations to support the amount of CTA recorded in a given period.
In preparation for the advanced FAS 52 (ASC 830) training course recently offered we prepared a translation example for a local currency functional subsidiary which hedged its non-functional currency anticipated cash flows under ASC 815 (FAS 133). The parent was USD reporting and we wanted to demonstrate how the foreign subsidiary’s results would consolidate into USD. One of the exercises of this example included “proofing” the CTA results upon consolidation. When the CTA proof did not produce the results expected, we had to investigate further how the items in equity were treated in the consolidation process. What we found was the component of Other Comprehensive Income (OCI) related to cash flow hedges wasn’t following the rules as we would have expected.
Inputs to OCI were being captured at the ISR (income statement rate) in one period and subsequent reclassifications to the P&L in a later period used the later period’s ISR. The OCI value changed in the same fashion inventory or deferred revenue changes its USD value while held in a foreign subsidiary. In effect, creating a CTA impact on the OCI balance. Was this appropriate or should OCI be reclassified at the original historic values? We approached the FASB informally and ran the issue past an ASC 830 expert together with an ASC815 expert and confirmed that indeed a CTA adjustment is created by the timing of inflows and outflows related to OCI.
Soon after preparing this course an audit firm challenged a client indicating that the reclassification of OCI to earnings must come through consolidation at the original historic rate. This would have required the company to override the translation process whereby all income statement activity is translated at the ISR. Thus, required tracking individual gains and losses back to USD based on the date each element of OCI had been recorded. However we were able to mitigate this situation and no changes were required as originally proposed by the audit firm.
We advise all clients to first determine if this situation impacts your organization and prepare how you will address this situation if it is highlighted as a part of your audit review.