ASC 830, Foreign Currency Matters, tells an entity how to account for two different things. Foreign currency transactions, such as a sale billed in euros by a company that reports in dollars, create exchange gains and losses in income. Foreign operations, such as a subsidiary that keeps its books in pounds, have their financial statements translated into the reporting currency, and the effect goes to other comprehensive income. Most errors come from mixing the two, and the way to avoid mixing them is to settle the functional currency first.
This page paraphrases the Codification and uses the Big 4 guides to check paragraph references. Read the Topic in the FASB Codification for the full text, and have a technical accounting professional apply it to the facts.
What is a functional currency?
The functional currency of an entity is the currency of the primary economic environment in which it operates. It is determined for each entity in a group, so a parent and its subsidiaries can have different ones. The reporting currency is the currency in which the financial statements are presented, normally the dollar for a US reporting entity. The two can differ.
ASC 830-10-55 lists indicators management weighs, covering cash flows, sales prices, sales markets, expenses, financing and intra-entity transactions and arrangements. No single indicator decides, and when the indicators are mixed management uses judgment. The audit file should contain a written analysis for each foreign entity, not a default to the local currency. Once chosen, the functional currency generally stays the same unless the underlying facts change significantly.
How are foreign currency transactions accounted for?
A foreign currency transaction is one whose terms are denominated in a currency other than the entity's functional currency. Under ASC 830-20:
- At the transaction date, each asset, liability, revenue, expense, gain or loss is measured in the functional currency using the exchange rate at which the transaction could be settled on that date (830-20-25-1).
- At each balance sheet date, recognized monetary assets and liabilities denominated in a currency other than the functional currency are adjusted to the rate at which they could be settled at that date.
- The resulting exchange effect is a transaction gain or loss in net income (830-20-35-1).
Monetary items are money or claims to receive or pay a fixed or determinable sum, including cash, receivables, payables and loans. Nonmonetary items such as inventory, property and equipment, goodwill and intangibles stay at their historical-rate amounts and do not create transaction gains and losses.
Exception for long-term intra-entity balances. Foreign currency transaction gains and losses on intra-entity balances that are of a long-term investment nature, where settlement is not planned or anticipated in the foreseeable future, are reported in other comprehensive income as part of the translation adjustment in the consolidated statements (830-20-35-3). The exception applies in consolidation or equity method reporting, not in the separate statements of the entity that holds the balance.
Illustration, transaction gain and loss
Illustrative numbers. A US company with a dollar functional currency sells goods for EUR 50,000 on credit when EUR 1 = $1.10. It records a receivable of $55,000. At year-end EUR 1 = $1.06, so the receivable is remeasured to $53,000 and a $2,000 loss goes to net income. The customer pays in the next year when EUR 1 = $1.08. Cash received is $54,000, so a $1,000 gain is recognized on settlement.
How are foreign operations translated?
When a foreign entity's functional currency differs from the reporting currency, its statements are translated:
- Assets and liabilities are translated at the exchange rate at the balance sheet date.
- Revenues, expenses, gains and losses are translated at the rates in effect when they were recognized. An appropriately weighted average rate for the period may be used (830-30-45-3).
- The effect of translation is not in net income. It is recognized in other comprehensive income and accumulates as the cumulative translation adjustment (CTA) in equity (830-30-45-12).
Because translation uses different rates for the balance sheet and the income statement, the net assets do not roll forward at one rate. The CTA is the balancing figure.
Illustration, translation adjustment
Illustrative numbers. A euro-functional subsidiary begins the year with net assets of EUR 1,000,000, earns EUR 200,000 of income, and pays no dividends. Rates are EUR 1 = $1.10 at the start of the year, $1.15 average for the year and $1.20 at year-end.
| Item | EUR | Rate | USD |
|---|---|---|---|
| Opening net assets | 1,000,000 | 1.10 | $1,100,000 |
| Net income | 200,000 | 1.15 | $230,000 |
| Translation adjustment (OCI) | $110,000 | ||
| Closing net assets | 1,200,000 | 1.20 | $1,440,000 |
Check: $1,100,000 + $230,000 + $110,000 = $1,440,000. The adjustment is also the sum of two effects: opening net assets of EUR 1,000,000 times the $0.10 change in rate is $100,000, and income of EUR 200,000 times the $0.05 difference between the closing and average rates is $10,000.
When the entity sells or substantially liquidates its investment in the foreign entity, the related CTA is removed from equity and included in the gain or loss on sale (830-30-40-1).
What happens in a highly inflationary economy?
A highly inflationary economy is one with cumulative inflation of approximately 100 percent or more over a three-year period (830-10-45-11). A foreign operation in such an economy does not use the local currency as its functional currency. Its statements are remeasured as if the functional currency were the reporting currency of its parent, so a subsidiary of a US parent would typically use the dollar (830-10-45-11 and 45-17). Remeasurement differences go to net income rather than CTA. The Codification has separate rules for the point at which an economy ceases to be highly inflationary, and they carry income tax effects.
How do the cash flow statement and taxes work?
- Cash flows. Foreign currency cash flows are reported at the exchange rates in effect when the cash flows occur, and a weighted average rate may be used if the result is substantially the same (830-230-45-1). The effect of exchange rate changes on cash, cash equivalents and restricted cash held in foreign currencies is shown as a separate part of the reconciliation of the change in cash. Translation adjustments are not cash flows.
- Income taxes. Deferred taxes on translation adjustments, and the outside basis difference in a foreign subsidiary, follow ASC 740, including the ASC 830-740 guidance. Transaction gains and losses on foreign taxes payable are part of the aggregate transaction gain or loss disclosed under ASC 830. See ASC 740 income taxes.
- Equity method investees. An investor with a foreign investee translates the investee's statements, and recognizes its share of the translation adjustment in OCI.
What must be disclosed?
The aggregate transaction gain or loss included in net income is disclosed (830-20-50). An entity with foreign operations also discloses an analysis of the changes in the CTA during the period, which can be given in a separate statement, in the notes or in the statement of changes in equity. That analysis includes amounts transferred from the CTA to net income on a sale of a foreign investment (830-30-50-1).
What do auditors test?
These are practice procedures, not steps the standards name:
- Read the functional currency analysis for each entity. Look for changes in operations, financing or sales markets that might call for revisiting it.
- Obtain the source for closing and average rates, and agree them to an independent published rate.
- Recompute the translation of a sample of balances and the CTA rollforward.
- Test that monetary items are remeasured at the balance sheet date and that gains and losses sit in net income, not OCI, except for long-term intra-entity balances.
- Separate monetary from nonmonetary accounts, and test that only monetary items generate transaction gains and losses.
- Check that CTA is not recognized in net income before a sale or substantial liquidation.
- Ask whether any foreign entity operates in a country that may be highly inflationary.
- Agree the disclosures: the transaction gain or loss and the CTA analysis.
- Tie the effect of exchange rates on cash to the cash flow statement. The cash flow statement examples and statement of cash flows under ASC 230 show the reconciliation.
Frequently asked questions
What is the difference between remeasurement and translation?
Remeasurement restates transactions and balances into an entity's functional currency, and the exchange effect goes to net income. Translation converts a foreign entity's functional currency statements to the reporting currency, and the effect goes to OCI.
Where do foreign currency translation adjustments go?
To other comprehensive income, accumulated in equity as the cumulative translation adjustment. They are removed from equity and included in the gain or loss when the foreign entity is sold or substantially liquidated.
Which exchange rate applies to the income statement?
The rates in effect when the items were recognized. An appropriately weighted average rate for the period may be used.
What is a highly inflationary economy under ASC 830?
One with cumulative inflation of approximately 100 percent or more over a three-year period. Foreign operations there are remeasured using the parent's reporting currency as the functional currency.
Can an entity change its functional currency?
Only when the underlying facts and circumstances change, and the guidance on the effect depends on the reason for the change.
Sources
- FASB, Accounting Standards Codification Topic 830, Foreign Currency Matters, including Subtopics 830-10, 830-20, 830-30, 830-230 and 830-740: asc.fasb.org
- KPMG, Handbook: Statement of cash flows (2026), chapter 21, Foreign currency matters
- KPMG, Handbook: Equity method of accounting (2025), sections on foreign investees
- KPMG, Handbook: Income taxes (2025), chapter 7, Foreign operations
- KPMG, Handbook: Impairment of nonfinancial assets (2025), on the CTA and impairment (ASC 830-30-45-13 and 45-14)
Related
- ASC 740 income taxes for private companies
- Statement of cash flows, indirect method
- Equity method investment
- Consolidated vs combined financial statements
- Long-lived asset impairment
- Goodwill impairment testing
- Audit procedures by account
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