Financial Reporting Alert 10-8, Foreign Currency Exchange Accounting Implications of Recent Government Actions in Venezuela
Updated March 28, 2011 (Originally released July 8, 2010)
On December 30, 2010, the Venezuelan government issued a decree that eliminated the official "essentials rate" of exchange of BsF 2.60 per U.S. dollar. Entities are reminded that Venezuela continues to be considered a highly inflationary economy. Therefore, in accordance with ASC 830, an entity must remeasure the financial statements of a Venezuelan subsidiary as if the subsidiary's functional currency were the reporting currency. In performing this remeasurement, the entity must use the applicable rate at which a particular transaction could be settled on the transaction date (see ASC 830-20-30-3). Entities that had previously used the BsF 2.60 rate for remeasurement purposes will need to evaluate how many, if any, BsF-denominated transactions will be settled at the BsF 2.60 rate as of December 31, 2010. The official rate of BsF 4.30 per U.S. dollar and the SITME rate of approximately BsF 5.30 per U.S. dollar were not affected by the decree.
As discussed in this Financial Reporting Alert, because of the uncertainties associated with the recent events and evolving political climate in Venezuela, it continues to be important for entities to provide robust disclosures about their Venezuelan operations in their SEC filings.
This Financial Reporting Alert provides an update on potential accounting implications resulting from recent actions taken by the Venezuelan government (“the government”) regarding foreign currency exchange controls.
Pursuant to certain Venezuelan foreign currency exchange control regulations (“exchange regulations” or “regulations”), the Central Bank of Venezuela (BCV) centralizes the purchase and sale of foreign currency in the country. Under these regulations, the purchase and sale of foreign currency must be made at one of two “official” rates of exchange: (1) “the essentials rate” at BsF1 2.60 per U.S. dollar and (2) “the nonessentials rate” at BsF 4.30 per U.S. dollar. (Refer to Deloitte’s Financial Reporting Alert 10-12 for addition background information.)
As originally enacted, the exchange regulations imposed strict criminal and economic sanctions on the use of methods other than those officially designated for the exchange of Venezuelan currency with other currency. However, they exempted the purchase and sale of securities, including national public debt bonds (DPNs) denominated in BsF and bonds issued by the government that are denominated in U.S. dollars. This exemption for transactions in certain securities created an indirect “parallel” foreign currency exchange market in Venezuela that enabled entities to use brokers to obtain foreign currency without having to purchase the currency from the Commission for the Administration of Foreign Exchange (CADIVI) at one of the official rates. The average rate of exchange in the parallel market varied but generally was higher than the official rates.
The government has publicly stated that it believes the parallel market has been a primary cause of Venezuela’s continuing runaway inflation and, accordingly, in May 2010 it enacted reforms to its exchange regulations to close down the parallel market. It did so by declaring that foreign-currency-denominated securities issued by Venezuelan entities, including the government, were included in the definition of foreign currency, thus making the BCV the only institution that could legally authorize the purchase or sale of foreign currency bonds and thereby excluding nonauthorized brokers from the foreign exchange market.
In early June 2010, the government introduced additional regulations, including currency exchange bands, under a newly regulated system (the SITME3) controlled by the BCV. Entities domiciled in Venezuela can access the SITME by buying U.S. dollar–denominated securities through banks authorized by the BCV. The SITME imposes volume restrictions on an entity’s trading activity, limiting such activity to a maximum equivalent of $50,000 per day, not to exceed $350,000 in a calendar month. This limitation is noncumulative, meaning that an entity cannot carry over unused volume from one month to the next (e.g., if an entity obtains the U.S. dollar equivalent of $300,000 in one month, it will not be able to avail itself of a $400,000 equivalent in the following month).
The SITME began on June 9, 2010, with the BCV establishing a weighted average implicit exchange rate of approximately 5.3 BsF per U.S. dollar. The average daily volume of the SITME market since it opened has been approximately $28.5 million (total transaction volume as of June 30, 2010, was $398 million). Foreign exchange transactions not conducted through CADIVI (using one of the two official exchange rates) or SITME may not comply with the amended exchange regulations and could therefore be considered illegal.
These latest modifications to Venezuela’s foreign exchange system may raise a number of accounting concerns, which are discussed below.
As discussed in Deloitte’s Financial Reporting Alert 10-4,4 Venezuela is currently considered a highly inflationary economy; accordingly, an entity must remeasure the financial statements of its Venezuelan subsidiaries as if the subsidiaries’ functional currency were the entity’s reporting currency (see ASC 830-10-45-115). As a result, 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 functional currency (e.g., the U.S. dollar), with changes in foreign currency rates related to BsF-denominated monetary balances recognized in the income statement. ASC 830-20-30-3 (formerly paragraph 27(a) of Statement 526) indicates that to perform such remeasurement, entities should use the applicable rate at which a transaction could settle as of the transaction date to translate and record the transaction. With the existence of two official rates and the SITME rate, it may be difficult for entities to make this determination in practice.
An entity may have previously concluded it was legally able to access the parallel market and therefore use the parallel rate to remeasure foreign currency transactions that occurred before the enactment of the amended exchange regulations, provided that the transactions met all applicable criteria for use of that rate. It is our understanding that after the enactment of the amended exchange regulations (and cessation of the parallel market), the only foreign currency exchange processes legally available to entities operating in Venezuela are (1) the exchange of currency, through the CADIVI, at one of the official rates for exchange or (2) the exchange of currency, through the SITME, at the exchange rate specified by the BCV. Because the use of an exchange rate created through an illegal market is not supported under U.S. GAAP for remeasuring foreign currency transactions, we believe an entity should not use the parallel market rate to remeasure foreign currency transactions occurring after the enactment of the amended exchange regulations if the entity concludes that use of the parallel market is in violation of the amended exchange regulations and therefore considered illegal. (Entities should consult with their legal counsel regarding any such determination.) Accordingly, we believe entities should use one of the foreign currency exchange rate mechanisms that comply with the amended exchange regulations to remeasure foreign-currency-denominated transactions occurring after enactment of the amended exchange regulations. Entities should select an appropriate rate on the basis of their relevant facts and circumstances. In determining which exchange rate to use, entities should consider the daily and monthly volume restrictions imposed by SITME that are described above. Furthermore, entities should carefully assess their ability to use one of the two official rates to settle transactions (e.g., dividends) when determining the rate to use for remeasurement purposes.
Consolidation Versus Deconsolidation Considerations
As discussed above, the strict volume restrictions on exchange activity conducted through the SITME process imposed by the amended exchange regulations, in conjunction with the uncertainties of obtaining approval for foreign exchange at one of the official rates, may cause an entity to question whether an other-than-temporary lack of exchangeability exists for its Venezuelan operations. Entities should consider the guidance in ASC 830-20-30-2 (formerly paragraph 26 of Statement 52), which states:
If exchangeability between two currencies is temporarily lacking at the transaction date or balance sheet date, the first subsequent rate at which exchanges could be made shall be used for purposes of this Subtopic. If the lack of exchangeability is other than temporary, the propriety of consolidating, combining, or accounting for the foreign operation by the equity method in the financial statements of the reporting entity shall be carefully considered. [Emphasis added]
The mere existence of such exchange restrictions does not in and of itself create a presumption that an entity should deconsolidate its Venezuelan operations, nor does the ability to exchange some volume of currency create a presumption that continued consolidation of Venezuelan operations is appropriate. An entity must make such a determination on the basis of its specific facts and circumstances. Even if an entity ultimately concludes that deconsolidation is appropriate, it still must determine (1) the date to use for deconsolidation and (2) the appropriate exchange rate to use for remeasuring its deconsolidated investment. Regardless of whether deconsolidation is considered appropriate, an entity should assess whether the severity of the foreign currency exchange controls represents a triggering event that would require an entity to assess its Venezuelan investments, long-lived assets, and any other outstanding balances of its Venezuelan operations for impairment.
Similarly, entities that hold investments in Venezuelan operations accounted for under the equity and cost methods, as well as available-for-sale Venezuelan debt or equity securities, should assess whether an other-than-temporary impairment may exist as of the balance sheet date (e.g., June 30, 2010) resulting from the operating and economic uncertainties in Venezuela.
Entities with classified balance sheets should also consider whether classifying certain BsF-denominated monetary assets as current is still appropriate in light of the present economic environment in Venezuela, particularly if they encounter difficulties in converting such assets into U.S. dollars. Such determination will depend on an entity’s facts and circumstances and its ability to obtain necessary approvals to convert such balances at an appropriate exchange rate in the volume it requires to operate.
Necessity for Robust Disclosure
The recent actions taken by the government have created situations in which the accounting guidance is not entirely clear (e.g., determining the appropriate exchange rate to use for remeasurement); accordingly, it is critical that entities provide robust disclosure both in the notes to the financial statements and in the description of business, risk factors, and MD&A sections of SEC filings. An entity should also clearly document its accounting conclusions and the underlying rationale as part of its internal control environment review and assessment process. The list below, although not comprehensive, highlights the information an entity should consider providing in its next interim or annual filing. An entity should:
- Disclose the government’s actions regarding exchange rates, including current volume restrictions on foreign exchange imposed by the government and how such restrictions affect the entity’s ability to settle transactions at either the official rates or SITME rate (or parallel rate for transactions that occurred before the enactment of the amended exchange regulations). Also describe how those restrictions affect application of the entity’s accounting policies.
- Disclose the exchange rate(s) used for remeasurement, and describe the use of an exchange rate or rates that differ from those used in prior reporting periods (e.g., changing from the parallel rate to the SITME rate). If multiple exchange rates are being used, disclose the criteria used to make the distinction and provide information on the relative significance of the various exchange rates.
- Disclose the amount of any foreign exchange gain or loss that arises from using either the official rate(s) or the SITME rate for remeasurement and identify the financial statement line item in which the gain or loss is recorded.
- If the exchange rate or rates used for the period differ from rates used in prior reporting periods (e.g., changing from the parallel rate to the SITME rate), disclose the impact of the different exchange rate(s) on the applicable carrying amounts in the balance sheet.
- If applicable, describe the basis for the entity’s decision to deconsolidate its investment in Venezuelan operations because the lack of exchangeability in Venezuela is other than temporary. Similar disclosure is encouraged when an entity has concluded that the lack of exchangeability is considered temporary and that continued consolidation of its Venezuelan operations is appropriate.
- Disclose the amount of the entity’s net monetary assets and liabilities, disaggregated by the currency (e.g., BsF, U.S. dollars) in which they are denominated.
- Disclose disaggregated financial information about the Venezuelan operations — e.g., summarized balance sheets, income statements, and cash flow statements. Describe the possible effects of Venezuela’s foreign exchange restrictions on an entity’s operations, including how such restrictions may affect the entity’s liquidity and cash flows.
- Disclose the amount of BsF pending government approval for settlement at either of the official rates or the SITME rate and the length of time the request or requests have been pending.
Because of the complexity of these accounting and disclosure issues, we encourage entities with Venezuelan operations to consult with their accounting advisers and SEC counsel.
1 Bolivar fuertes.
2 Financial Reporting Alert 10-1, Venezuela’s Currency Exchange Controls and Highly Inflationary Status.
3 Sistema de Transacciones con Tiìtulos en Moneda Extranjera.
4 Financial Reporting Alert 10-4, SEC Staff Announcement on Foreign Currency Issues Related to Venezuela's Highly Inflationary Status.
5 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”
6 FASB Statement No. 52, Foreign Currency Translation.