Financial Reporting Alert 10-4, SEC Staff Announcement on Foreign Currency Issues About Venezuela’s Highly Inflationary Status
March 31, 2010
This Financial Reporting Alert updates Financial Reporting Alert 10-1, Venezuela’s Currency Exchange Controls and Highly Inflationary Status, to reflect interim guidance1 announced by the SEC staff at the March 18, 2010, EITF meeting (the “EITF meeting”) and to address other accounting issues that entities may encounter related to Venezuela’s highly inflationary status (note that in this Financial Reporting Alert, the term “entity” refers to the immediate parent of a Venezuelan subsidiary2). As indicated in Financial Reporting Alert 10-1, entities with a year-end or quarter-end as of December 31, 2009, that had not previously considered Venezuela’s economy to be highly inflationary should consider Venezuela’s economy to be highly inflationary as of January 1, 2010. In addition, there are multiple exchange rates for converting the Venezuelan Bolivar Fuerte (BsF) into the U.S. dollar (USD). One such rate is the government’s official exchange rate. A parallel exchange rate, which currently differs from the official exchange rate by a significant amount, may also be legally available to companies. The availability of multiple rates that differ significantly has caused a number of financial reporting issues for companies.
The issues discussed in this Alert arise from the following circumstances (which are discussed in greater detail in Financial Reporting Alert 10-1):
- The use of an exchange rate for remeasuring USD-denominated balances held by a Venezuelan subsidiary that is different from the exchange rate that was used to translate the financial statements of that Venezuelan subsidiary into the USD reporting currency before Venezuela became a highly inflationary economy.
- The use of an exchange rate to remeasure BsF-denominated monetary assets and liabilities after Venezuela’s economy became highly inflationary that is different from the translation rate used before it became highly inflationary.
- The selection of an exchange rate to be used for remeasuring BsF-denominated transactions to the functional currency established when Venezuela’s economy became highly inflationary.
SEC Staff Announcement
The SEC staff’s announcement at the EITF meeting outlined financial reporting and disclosure requirements for situations in which an entity (before adoption of highly inflationary accounting) uses one rate to remeasure certain USD- denominated balances held by its Venezuelan subsidiary and then subsequently translates the subsidiary’s financial statements at another rate. The entity’s use of different rates for remeasurement and translation results in reported balances for financial reporting purposes that differ from the underlying USD-denominated values. The announcement provided the following examples to frame the issue:
First, assume that at a period end prior to January 1, 2010 (for a calendar year entity), a U.S. entity’s Venezuelan subsidiary held $10 million of cash denominated in U.S. dollars. Further assume that at the period end, the parallel rate was 5 Bolivars to every 1 U.S. dollar and the official rate was 2 Bolivars to every 1 U.S. dollar. Upon the remeasurement of the U.S. denominated cash to Bolivars and the subsequent translation of the Venezuelan subsidiary’s financial statements, an entity would have reported cash of $25 million[*] for financial reporting purposes.
[*] The $25 million is calculated as follows. First, the $10 million of cash is remeasured using the parallel rate to 50 million BsF. Subsequently, the 50 million BsF is translated back to U.S. dollars using the official rate of 2 Bolivars to 1 U.S. Dollars, resulting in a translated reported balance of $25 million.
Second, assume that at a period end prior to January 1, 2010 (for a calendar year entity), a U.S. entity’s Venezuelan subsidiary held $15 million of accounts payable denominated in U.S dollars (please also assume the exchange rates are the same as in the example above). Upon the remeasurement of the U.S. denominated accounts payables to Bolivars and the subsequent translation of the Venezuelan subsidiary’s financial statements, an entity would have reported accounts payable of $37.5 million[**] for financial reporting purposes.
[**] The $37.5 million is calculated as follows. First, the $15 million of accounts payable is remeasured using the parallel rate to 75 million BsF. Subsequently, the 75 million BsF is translated back to U.S. dollars using the official rate of 2 Bolivars to 1 U.S. dollars, resulting in a translated reported balance of $37.5 million.
The SEC staff believes that, in financial statements for reporting periods ending before an entity’s application of highly inflationary accounting to its Venezuelan subsidiaries (e.g., for reporting periods ending before January 1, 2010), an entity should provide certain minimum disclosures when there are material differences between amounts recorded for financial reporting purposes and the actual USD-denominated amounts. The announcement lists the following:
Disclosure of the rates used for remeasurement and translation.
A description of why the actual U.S. dollar denominated balances differ from the amounts reported for financial reporting purposes, including the reasons for using two different rates with respect to remeasurement and translation.
The magnitude of the difference between the amounts reported for financial reporting purposes versus the underlying U.S. dollar denominated values [and where those amounts are located in the financial statements3].
To the extent possible, disclosure of the amount that will be recognized through the income statement (as well as the impact on the other financial statements) as part of highly inflationary accounting beginning in 2010.
The SEC staff acknowledged at the EITF meeting that some registrants had already filed their 2009 Forms 10-K. Such filers would not be obligated to amend their Form 10-K filings to provide such disclosures.
Financial Reporting Requirements Upon Application of Highly Inflationary Accounting
On January 1, 2010, upon its application of highly inflationary accounting under ASC 830-10-45-114 (formerly paragraph 11 of Statement 525), a USD reporting entity must remeasure the financial statements of its Venezuelan subsidiaries as if the subsidiaries’ functional currency were the entity’s reporting currency (e.g., the USD). Because an entity’s application of this accounting results in the use by the entity and its Venezuelan subsidiaries of the same functional currency, the entity must eliminate any differences between (1) the amounts of any USD -denominated balances recorded by the Venezuelan subsidiaries and (2) the amounts reported in the entity’s consolidated financial statements. In such circumstances, the SEC staff believes that the entity, upon its application of highly inflationary accounting, should recognize such differences in its earnings unless it can demonstrate that it previously recorded such differences as part of its cumulative-translation adjustment (CTA). If such amounts were previously recorded in its CTA, then any adjustment required upon an entity’s transition to highly inflationary accounting would be reflected as an adjustment to the CTA. The staff also emphasized that such differences should be recognized at the time the entity adopts highly inflationary accounting.
Under the guidance in the announcement, on January 1, 2010, upon its adoption of highly inflationary accounting, the entity in the examples above would adjust the $25 million cash reflected in its consolidated balance sheet to $10 million. Likewise, the $37.5 million accounts payable balance would be adjusted to $15 million. The resulting $15 million and $22.5 million adjustments to cash and accounts payable, respectively, would be recognized as a foreign exchange loss (gain) in the entity’s first quarter Form 10-Q filing unless the registrant can document that the difference or differences were previously recognized as a CTA (in which case the difference(s) should be recognized as an adjustment to the CTA).
Issues Not Addressed in the Announcement
The issues discussed below may be encountered in practice but were not specifically addressed in the announcement.
Issue 1: Remeasurement of BsF-Denominated Revenues and Expenses, and BsF-Denominated Monetary Balances, Into the Reporting/Functional Currency After the Transition to Highly Inflationary Accounting
An entity with a Venezuelan subsidiary may face a number of operational challenges when it applies ASC 830 in reporting periods in which the Venezuelan economy is deemed highly inflationary. As long as the Venezuelan economy is considered highly inflationary, the entity must remeasure the financial statements of its Venezuelan subsidiaries as if the subsidiaries’ functional currency were the entity’s reporting currency (see ASC 830-10-45-11). As a result of this change, each Venezuelan subsidiary must account for all BsF-denominated transactions as foreign-currency-denominated transactions, which, under ASC 830, must be remeasured each reporting period into the subsidiary’s new functional currency (e.g., the USD), with changes in foreign currency rates related to BsF-denominated monetary balances recognized in the income statement. To perform such remeasurement, the entity needs to consider an appropriate exchange rate at which the BsF transactions could be settled, which may be difficult to determine in practice. Note that USD-denominated monetary balances would no longer be subject to the remeasurement guidance in ASC 830 because these balances are now denominated in the Venezuelan subsidiary’s functional currency.
ASC 830-20-30-3 (formerly paragraph 27(a) of Statement 52) states that the applicable exchange rate to use for such remeasurement is the rate at which a transaction could be settled on the transaction date. This principle may be difficult to apply in practice because (1) past experience may indicate that most of the Venezuelan BsF-denominated transactions will never be settled in USD and (2) in Venezuela’s multiple exchange rate environment, a single rate may not be available for settlement of all types of transactions or balances. For example, although the subsidiary may expect to remit dividends to its parent at an official rate, it may engage in other BsF-denominated transactions (e.g., sales contracts, employee related costs, other locally incurred overhead expenses) that are unlikely to receive approval from Venezuela’s Commission for the Administration of Foreign Exchange (CADIVI) for settlement at the official rate. Also, for periods after the 2010 devaluation6 of the BsF, different “official” rates may apply depending on whether the transaction qualifies for the “essentials” rate or the “nonessentials” rate.
We believe the ASC 830 framework did not contemplate economic environments in which multiple exchange rates were accessible in these circumstances; therefore, the process for selecting an appropriate exchange rate for remeasurement in this environment is inherently dependent on an entity’s judgment and must reflect an entity’s specific facts and circumstances. For example, an entity should consider what exchange rates are accessible for settlement of its BsF- denominated transactions. Although special approvals are required from CADIVI to use the official rates to exchange currency, the parallel rate could possibly be viewed as a free-floating rate. It may be unlikely that Venezuelan subsidiaries can settle their BsF-denominated transactions, including BsF-denominated monetary assets and liabilities, at the official rate. Therefore, if it is uncertain whether BsF-denominated transactions and monetary balances would ultimately receive approval to be settled in USDs at an official rate, the entity may conclude that it is more appropriate to use the parallel rate to remeasure those transactions or balances.
In contrast, an entity may conclude it is appropriate to use an official rate for remeasurement when past experience indicates that substantially all of its BsFs received from local sales are expected to be converted into USDs at the official rate (for settlement of USD payables and future dividends to its parent). Therefore, when it determines the exchange rate to use for remeasurement of its revenues and expenses, the entity may want to consider the exchange rate it will ultimately use to remeasure the cash receipts or payments associated with those transactions.
Because of the level of judgment required for such remeasurement, entities with material Venezuelan subsidiaries should consider consulting with their professional advisor. Furthermore, entities should provide transparent disclosures about their remeasurement method in their financial statements.
Issue 2: BsF-Denominated Monetary Assets and Liabilities
As discussed in Issue 1 above, as long as the Venezuelan economy is considered highly inflationary, the Venezuelan subsidiary must account for all BsF-denominated transactions as foreign-currency-denominated transactions. Under ASC 830, such transactions are required to be remeasured each reporting period into the subsidiary’s new functional currency (e.g., the USD), with changes in foreign currency rates related to BsF-denominated monetary balances recognized in the income statement. Before the Venezuelan economy was considered highly inflationary, the BsF-denominated transactions were only translated (i.e., not remeasured) into the reporting currency of the Venezuelan subsidiary’s parent.
Some entities may have used one exchange rate before the transition to highly inflationary accounting to translate BsF -denominated monetary assets and liabilities and then, upon adoption of highly inflationary accounting, used a different exchange rate to remeasure those BsF-denominated monetary balances. Thus, the same underlying BsF balance was reported at different USD equivalent amounts immediately before and after the adoption of highly inflationary accounting. We believe that, upon adoption of highly inflationary accounting, the reporting entity should record any difference as a foreign exchange transaction gain or loss in the period of adoption. This conclusion is consistent with the principle in ASC 830 (described in paragraphs 122–124 of the Basis for Conclusions in Statement 52) that requires changes in exchange rates that affect functional currency cash flows to be reflected in earnings.
Assume that the parallel rate is 5 BsF per USD, and the official rate is 2 BsF per USD. Entity V, a Venezuelan subsidiary of Entity U, a calendar-year-end U.S. reporting entity, records accounts receivable of 1,000 BsF on December 31, 2009. Entity U determines that the official rate is appropriate for translation of Entity V’s financial statements and reports the accounts receivable balance at $500 in its December 31, 2009, consolidated balance sheet. When the Venezuelan economy becomes highly inflationary on January 1, 2010, the entity determines that the parallel rate should be used to remeasure its BsF transactions (i.e., revenues, local operating expenses, accounts receivables) to the newly determined USD reporting/functional currency. Accordingly, the entity adjusts the accounts receivable balance from $500 to $200 on January 1, 2010. We believe the $300 difference should be recorded as a foreign currency transaction loss on January 1, 2010 (i.e., upon transition to highly inflationary accounting for the Venezuelan subsidiary).
The FASB recently added an Issue to the EITF’s agenda to discuss certain matters related to foreign currency, including the accounting for multiple exchange rates in Venezuela. The SEC announcement is intended to provide interim guidance to entities on some of the issues discussed above until the EITF completes its deliberations (as discussed in Deloitte’s March 2010 EITF Snapshot).
1 SEC staff announcement, “Foreign Currency Issues.” The SEC staff announcement (the "announcement") has not yet been published by the FASB staff. The quoted material in this Financial Reporting Alert is taken from the version of the announcement included with the EITF meeting materials. The final wording may differ from what is quoted herein.
2 Note also that in this Financial Reporting Alert, the term “Venezuelan subsidiary” encompasses Venezuelan entities that are either consolidated or accounted for as equity method investments.
3 At the EITF meeting, the SEC staff indicated that it will clarify this disclosure to remove the term “magnitude” and to require entities to disclose the line items in the financial statements in which the amounts reported for financial reporting purposes differ from the underlying USD-denominated values.
4 FASB Accounting Standards Codification Subtopic 830- 10, Foreign Currency Matters: Overall.
5 FASB Statement No. 52, Foreign Currency Translation.
6 Refer to Financial Reporting Alert 10-1 for additional background on devaluation of the BsF.