Topic: Accounting Issues Relating to the Introduction of the European Economic and Monetary Union (EMU)

Transcription

1 Topic No. D-71 Topic: Accounting Issues Relating to the Introduction of the European Economic and Monetary Union (EMU) Dates Discussed: May 21, 1998; July 23, 1998; September 23 24, 1998; November 18 19, 1998 Effective January 1, 1999, the EMU will create a single Eurocurrency (the Euro) for its member countries. Effective that date, the exchange rates between national currencies of the participating countries 1 will be irreversibly fixed against the Euro. During the transition period (January 1, 1999 through December 31, 2001), depending on the specific national laws of the respective member countries, entities may be required to report their financial statements in the Euro, in their national currency, or in both currencies. In addition, during this transition period, entities will be faced with situations in which they receive financial information in both the Euro and the EMU member national currency units. A. Upgrading Information Systems Software In connection with the introduction of the Euro, entities will have to undertake projects to adapt their information systems software for the Euro. Some of the upgrade costs will involve changes to allow for dual-currency reporting during the transition period, changes to deal with converting amounts to the Euro, and changes to deal with rounding issues (including changes to the number of decimal places). In addition to costs incurred to convert internal-use computer software, companies will be required to incur other costs 1 As part of the EMU, a single currency (the Euro) will replace the national currencies of Austria (schilling), Belgium (franc), Finland (markka), France (franc), Germany (mark), Ireland (punt), Italy (lira), Luxembourg (franc), the Netherlands (guilder), Portugal (escudo), and Spain (peseta). Page 1

2 associated with converting to the Euro, such as costs incurred to make physical modifications to fixed assets (for example, to include a new symbol on keyboards and to change vending machines and ATM machines so that they are able to handle a new currency). The FASB staff has been asked whether expenditures that are necessary to upgrade or replace internal-use computer software and costs to modify assets to accommodate the introduction of the Euro should, in all cases, be expensed as incurred, consistent with the consensus that was reached in Issue No , "Accounting for the Costs Associated with Modifying Computer Software for the Year 2000." The FASB staff believes that not all costs associated with upgrading or replacing computer software and costs to make physical modifications to fixed assets to accommodate the introduction of the Euro necessarily should be expensed as incurred. The FASB staff believes that those costs should be accounted for in accordance with the entity's existing accounting policies for similar costs. The FASB staff notes that Issue establishes generally accepted accounting principles for costs specifically associated with modifying internal-use software for the year In addition, the FASB staff notes that in March 1998, the AICPA issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Page 2

3 B. Preparation of Comparative Financial Statements for Periods Prior to the Introduction of the Euro The SEC staff has been asked to consider how SEC registrants that change their reporting currency to the Euro should prepare comparative financial statements for periods prior to the introduction of the Euro on January 1, The SEC staff will not object if a registrant presents comparative financial statements for periods prior to January 1, 1999 by recasting previously reported financial statements into Euros using the exchange rate between the Euro and the prior reporting currency as of January 1, This is consistent with the recommendations of the European Commission. When financial statements are stated in a currency different from the one used in previous filings with the SEC, SEC Regulation S-X, Rule 3-20(e), Currency for Financial Statements of Foreign Private Issuers, requires a registrant to recast its financial statements as if the newly adopted currency had been used since at least the earliest period presented. The SEC staff has interpreted this provision to require a methodology consistent with FASB Statement No. 52, Foreign Currency Translation. That is, the income statement and statement of cash flows should be translated into the new reporting currency using weighted-average exchange rates for the applicable periods, and assets and liabilities should be translated using exchange rates at the end of the applicable periods. However, Rule 3-20(e) did not contemplate the introduction of a new, cross-border currency that would replace multiple existing currencies. Because the Euro did not exist prior to January 1, 1999, the retroactive application of the January 1, 1999 exchange rate Page 3

4 to previously reported financial statements would not result in the remeasurement of previously reported results and would not alter previously reported trends and relationships. The financial statements of multinational registrants that report in different currencies generally are not comparable. Financial statements reported in Euros by recasting based on the January 1, 1999 exchange rate will depict the same trends and relationships among a registrant's accounts as those previously reported prior to the introduction of the Euro. However, investors could inappropriately assume that the financial statements of various registrants that report in Euros are directly comparable. To highlight the potential lack of comparability in periods prior to January 1, 1999, the SEC staff would expect the following disclosures: Each page of the basic financial statements (balance sheet, income statement, statement of cash flows) should indicate that prior-year balances were restated from [the applicable prior reporting currency] into Euros using the exchange rate as of January 1, The notes to the financial statements should disclose the following: The reporting currency that was previously used The methodology used to restate prior-year balances retroactive application of the exchange rate as of January 1, 1999 The exchange rate as of January 1, 1999 A statement that the comparative financial statements reported in Euros depict the same trends as would have been presented if the company had continued to present financial statements in the currency that was previously used A statement that the financial statements for periods prior to January 1, 1999 will not be comparable to the financial statements of other companies that report in Euros and that restated amounts from a different currency than the one previously used by the company. Selected financial data should indicate that balances prior to January 1, 1999 were restated from [the applicable prior reporting currency] into Euros using the exchange rate as of January 1, A cross-reference to the related financial statement disclosure should be provided. Management's Discussion and Analysis should include a headnote that describes the introduction of the Euro, explains that the comparative financial statements reported Page 4

5 in Euros depict the same trends as would have been presented if the company had continued to present financial statements in the currency that was previously used, and discusses the lack of comparability to other companies reporting in Euros that restated amounts from a different currency than the one previously used by the company. A cross-reference to the related financial statement disclosure should be provided. For registrants with financial statement periods not coinciding with the calendar year, the introduction of the Euro will occur during the financial statement period. The SEC staff understands that most countries in the EMU have or are in the process of enacting laws or regulations to prohibit such companies from adopting the Euro in financial statement periods ending prior to January 1, It is unlikely that a registrant in these countries would request adoption of the Euro in financial statements filed in the United States for those periods. In cases where a registrant wishes to adopt the Euro as its reporting currency for financial statement periods ending prior to January 1, 1999, the SEC staff would expect to be consulted. C. Cumulative Foreign Currency Translation Adjustments Translation adjustments arise either from the consolidation of or from using equity method accounting for a net investment in another entity that has a different functional currency from that of the investor. The FASB staff has been asked whether the change in a foreign investee s functional currency to the Euro is an event that triggers income recognition of all or a portion of the balance in the cumulative translation adjustment account or whether the balance in the cumulative translation adjustment account should remain until there is a sale or complete, or substantially complete, liquidation of the investor s investment. Page 5

6 The FASB staff believes that the balance in the cumulative translation adjustment account should remain until there is a sale or complete, or substantially complete, liquidation of the investment in the foreign entity. (The FASB staff notes that FASB Interpretation No. 37, Accounting for Translation Adjustments upon Sale of Part of an Investment in a Foreign Entity, would be applicable for a partial sale of an investment.) The FASB staff refers to paragraphs 14 and 119 of Statement 52, which state that: Upon sale or upon complete or substantially complete liquidation of an investment in a foreign entity, the amount attributable to that entity and accumulated in the translation adjustment component of equity shall be removed from the separate component of equity and shall be reported as part of the gain or loss on sale or liquidation of the investment for the period during which the sale or liquidation occurs.... the Board decided to include the accumulated translation adjustments in net income as part of the net gain or loss from sale or complete or substantially complete liquidation of the related investment. Sale and complete or substantially complete liquidation were selected because those events generally cause a related gain or loss on the net investment to be recognized in net income at that time. That procedure recognizes the unrealized translation adjustment as a component of net income when it becomes realized. Thus, because the changeover to the Euro does not cause the unrealized translation adjustments related to the net investment to become realized, the FASB staff believes that no change should be made to the balance in the cumulative translation adjustment account. The staff further believes that subsequent to January 1, 1999, an investor would continue to translate the financial statements of the investee from the investee s functional currency (that is, the EMU member national currency units or the Euro, as applicable) to the investor s reporting currency, if different from the investee s functional currency, and continue to report translation adjustments, if any, in other comprehensive income. Page 6

7 D. Application of Hedge Accounting During the Transition Period to Preexisting Hedges of Firm Commitments or Anticipated Transactions The FASB staff has been asked whether hedge accounting may continue to be applied in accordance with Statement 52 or FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, or Issue No , "Hedging Foreign Currency Risks with Purchased Options," for a foreign currency contract that is designated as a hedge prior to January 1, 1999 of either a foreign-currency-denominated firm commitment or a foreign-currency-denominated forecasted transaction that will occur or is probable of occurring after January 1, 1999, in the following situations: Situation 1 The foreign currency contract involves two currencies that will participate in conversion to the Euro; for example, a German company with the Deutsche mark as its functional currency that hedges the foreign currency exposure of a French-franc-denominated firm commitment using either a Deutsche mark/french franc forward foreign exchange contract or a purchased option contract to sell French francs for a fixed number of Deutsche marks. The FASB staff believes that for hedges subject to Statement 52 and Issue that were designated prior to the effective date of Statement 133 and for hedges subject to Statement 133, hedge accounting may continue to be applied when a foreign currency contract that involves two currencies that will participate in conversion to the Euro is designated as a hedge of a foreign-currency-denominated firm commitment or an anticipated foreigncurrency-denominated transaction. Because all exchange rate differences between currencies of participating countries are permanent and foreign currency risk between Page 7

8 participating currencies will no longer exist, exchange rate differences on unsettled foreign currency contracts involving two participating currencies will be fixed on January 1, The foreign exchange gain or loss on the hedge contract should continue to be deferred until the firm commitment or anticipated transaction occurs and should be included in the measurement of the related foreign currency transaction. The introduction of the Euro does not alter the original economic purpose of the hedge contract, which is to eliminate fluctuations in the future value of a firm commitment or variability in the future price of an anticipated transaction. The accounting treatment applied in this situation is analogous to the accounting treatment applied in situations in which a company terminates a hedge of a foreign currency firm commitment or an anticipated transaction that continues to be probable of occurring. Paragraph 21 of Statement 52 requires that in situations in which a foreign currency hedge of a firm commitment is terminated before the transaction date of the related commitment, any deferred gain or loss shall continue to be deferred. Issue permits the use of hedge accounting for purchased foreign currency options used to hedge an anticipated transaction provided that the relevant conditions under FASB Statement No. 80, Accounting for Futures Contracts, are met. Paragraph 10 of Statement 80 indicates that if a futures contract that has been accounted for as a hedge is closed before the date of the anticipated transaction, the accumulated changes in value of the contract shall continue to be carried forward and included in the measurement of the related transaction. However, Statement 52 and Statement 80 indicate that losses shall not be deferred if it is estimated that deferral would lead to recognizing losses in later periods. Similarly, paragraphs 31 and 32 of Statement 133 indicate that if an entity terminates a cash flow hedge of a Page 8

9 foreign-currency-denominated forecasted transaction, the net gain or loss shall remain in accumulated other comprehensive income and be reclassified into earnings in the same period(s) during which the hedged forecasted transaction affects earnings. Situation 2 The foreign currency contract involves one currency that will participate in conversion to the Euro and one currency that will not participate in conversion to the Euro; for example, a French company that has the French franc as its functional currency that hedges the foreign currency exposure of an anticipated U.S. dollar-denominated transaction with a purchased option contract to sell U.S. dollars for a fixed number of French francs. Another example is a U.S. company that hedges the foreign currency exposure of an Italian-lira-denominated firm commitment using a U.S. dollar/italian lira forward exchange contract. The FASB staff believes that under Statement 52, Statement 133, and Issue 90-17, hedge accounting may continue to be applied when a foreign currency contract that involves one currency that will participate in conversion to the Euro and one currency that will not participate in conversion to the Euro is designated as a hedge of a foreign-currencydenominated firm commitment or an anticipated foreign-currency-denominated transaction. In situations in which a currency that will participate in conversion to the Euro is designated as a cross hedge of an exposure denominated in another currency (as permitted by the relevant guidance), the requirements in Statement 52, Statement 133, or Issue 90-17, for high effectiveness or correlation of changes in value of the hedging instrument and hedged item must continue to be satisfied for hedge accounting to be applied during the transition period. Because the national currency will be expressed in Page 9

10 units of the Euro during the transition period, and because the Euro may be more or less volatile relative to the currency being hedged than were any one of the national currencies that will be converted to the Euro, the level of correlation of changes in value of the hedging instrument and the hedged item may differ before and after January 1, E. Designation of a Contract Denominated in Euros (or a National Currency of a Participating Country) as a Hedge of a Net Investment or Firm Commitment Denominated in a National Currency of a Participating Country Entities that hedge either net investments in foreign operations or foreign-currencydenominated firm commitments may wish to designate a contract denominated in the Euro or a national currency of a country participating in conversion to the Euro as a hedge of an exposure denominated in a second currency that will also participate in conversion to the Euro. For example, during the transition period, a U.S. company that has overseas operations may wish to designate a Euro-denominated foreign currency forward contract or a foreign-currency-denominated asset or liability as a hedge of a lira-denominated exposure, such as a net investment in an Italian subsidiary or a lira-denominated firm commitment. Similarly, a U.S. company that has overseas operations may wish to designate a Belgian-franc-denominated foreign currency forward contract or a foreigncurrency-denominated asset or liability as a hedge of Deutsche-mark-denominated exposure, such as a net investment in a German subsidiary or a Deutsche-mark denominated firm commitment. The FASB staff has been asked whether, during the transition period beginning January 1, 1999, a foreign currency forward contract or an asset or a liability denominated in the Euro or a national currency that will participate in conversion to the Euro may be accounted for as a hedge of foreign currency exposure associated with a net investment in Page 10

11 a foreign operation or a firmly committed transaction that is denominated in a second currency that will also participate in conversion to the Euro under Statement 52. Paragraph 130 of Statement 52 indicates that ordinarily, a transaction that hedges a net investment should be denominated in the same currency as the functional currency of the net investment hedged. However, in some instances, it may not be practical or feasible to hedge in the same currency, and, therefore, a hedging transaction also may be denominated in a currency for which the exchange rate generally moves in tandem with the exchange rate for the functional currency of the net investment hedged. Paragraph 133 of Statement 52 contains similar guidance for hedges of foreign currency firm commitments. Issue No , Hedging of Foreign Currency Exposure with a Tandem Currency, indicates that a tandem currency may not be used to hedge a net investment in a foreign subsidiary solely because it is less expensive than obtaining a contract denominated in the same currency as the net investment. The FASB staff believes that during the transition period beginning January 1, 1999, entities that hedge either net investments in foreign operations or firmly committed transactions may apply hedge accounting in accordance with Statement 52 for a forward contract or for an asset or a liability denominated in either Euros or in a national currency that will be converted to the Euro that is designated as a hedge of a foreign currency transaction denominated in a second currency that will also participate in conversion to the Euro. The FASB staff believes that during the transition period beginning January 1, 1999, the Euro should not be considered a tandem currency for the national currencies of countries Page 11

12 participating in conversion to the Euro. Further, a national currency of one participating country should not be considered a tandem currency for a national currency of another participating country. Rather, the Euro should be viewed as a "surrogate" for the national currencies during the transition period because the exchange rates of participating currencies are irrevocably fixed to the Euro as of January 1, The national currency of each participating country becomes an expression of the Euro, and each national currency should be considered an expression of other national currencies participating in conversion to the Euro. Statement 52 and Issue did not contemplate the introduction of a new currency that would replace numerous existing currencies. Page 12