Remeasurement

What Is Remeasurement?

Remeasurement, in the context of financial accounting, refers to the process of converting financial statement items from a foreign entity's local currency into its determined functional currency when the local currency is not the functional currency. This process is crucial for entities, particularly multinational corporations, that engage in transactions or maintain operations in currencies other than their primary operating currency. The goal of remeasurement is to present the financial results as if the entity's books and records had originally been maintained in its functional currency, ensuring that the financial statements accurately reflect the economic reality in that primary currency.

History and Origin

The concept of remeasurement is deeply rooted in the evolution of accounting standards for foreign currency transactions and operations. In the United States, the Financial Accounting Standards Board (FASB) established comprehensive guidance with the issuance of Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation" (now codified primarily under ASC 830). Adopted in 1981, SFAS 52 aimed to provide information generally compatible with the expected economic effects of exchange rates on an enterprise's cash flows and equity, and to reflect financial results as measured in the primary currency of each entity's business operations⁴. This standard replaced earlier, more volatile methods and introduced the critical distinction between the functional currency and the reporting currency, dictating when remeasurement (the temporal method) or translation (the current rate method) should be applied.

Similarly, internationally, the International Accounting Standards Board (IASB) addresses these principles in IAS 21, "The Effects of Changes in Foreign Exchange Rates." Initially issued by the International Accounting Standards Committee in 1983 and revised by the IASB in 2003, IAS 21 provides global guidelines on how to account for foreign currency transactions and operations in financial statements³. Both U.S. GAAP and IFRS require entities to determine a functional currency for each of their operations, with remeasurement being the prescribed method when the local currency differs from this determined functional currency.

Key Takeaways

Remeasurement is the process of converting financial data into an entity's functional currency when its books are kept in a different currency.
It applies different exchange rates to different balance sheet and income statement items to reflect the functional currency perspective.
Gains or losses arising from remeasurement are generally recognized in the current period's net income.
Remeasurement is particularly relevant for entities operating in highly inflationary economies, where the reporting currency often becomes the functional currency.
The primary goal of remeasurement is to simulate what the financial statements would have looked like if they had always been maintained in the functional currency.

Interpreting the Remeasurement

Interpreting the results of remeasurement involves understanding its impact on an entity's financial statements, particularly the income statement. When remeasurement is performed, exchange rate gains or losses on monetary items (like cash, receivables, and payables) are recognized directly in profit or loss. This direct impact on net income distinguishes remeasurement from foreign currency translation, where translation adjustments typically bypass net income and are recorded in equity as part of other comprehensive income.

The outcome of remeasurement should be viewed as providing a financial picture of the foreign operation as if it were a direct extension of the parent company's domestic operations, with all transactions and balances initially recorded in the functional currency. This means that exposure to foreign currency fluctuations on specific assets and liabilities, particularly monetary ones, directly affects the reported profitability. Therefore, significant gains or losses from remeasurement can introduce volatility into reported earnings, necessitating careful analysis by stakeholders to differentiate between operating performance and currency effects.

Hypothetical Example

Consider a U.S. parent company (reporting in USD, its functional currency) with a subsidiary in a non-highly inflationary foreign country where the local currency is the Euro (EUR). However, due to the nature of its operations (e.g., heavily reliant on U.S. dollar-denominated inputs and financing), the subsidiary's functional currency is determined to be the U.S. Dollar. The subsidiary keeps its local books in EUR. At the end of a reporting period, the subsidiary needs to perform remeasurement.

Let's look at a simple scenario for the subsidiary's balance sheet items:

Cash: €10,000 (Monetary item)
Accounts Receivable: €5,000 (Monetary item)
Inventory: €8,000 (Non-monetary item, carried at historical cost)
Accounts Payable: €7,000 (Monetary item)

Assume the following exchange rates:

Historical rate when inventory was acquired: €1 = $1.10
Current exchange rate at period end: €1 = $1.20

Remeasurement Process:

Monetary Items (Cash, Accounts Receivable, Accounts Payable): Remeasured using the current exchange rate at the balance sheet date.
- Cash: €10,000 x $1.20/€ = $12,000
- Accounts Receivable: €5,000 x $1.20/€ = $6,000
- Accounts Payable: €7,000 x $1.20/€ = $8,400
Non-Monetary Items (Inventory): Remeasured using the historical exchange rate.
- Inventory: €8,000 x $1.10/€ = $8,800

Any difference arising from these remeasurements (e.g., if the Euro value of a monetary asset changed relative to its USD equivalent from the last period) would result in a foreign currency remeasurement gain or loss, which is then recorded directly in the subsidiary's net income for the period.

Practical Applications

Remeasurement is a critical accounting procedure for any entity conducting business in multiple currencies, particularly when a foreign operation's local currency differs from its functional currency. It is commonly applied in scenarios such as:

Multinational Corporations: Companies with subsidiaries or branches that operate in a local currency but are determined to have the parent company's currency as their functional currency. This often occurs when the foreign operation is an extension of the parent's business, with its cash flows directly impacting the parent's currency.
Highly Inflationary Economies: When a foreign operation is situated in a highly inflationary economy (typically defined by cumulative inflation of 100% or more over a three-year period), its local currency is considered unstable. In such cases, the reporting currency of the parent entity is mandated as the functional currency, requiring remeasurement of all local currency financial statements into the stable reporting currency.
Foreign Currency Tra²nsactions: Individual transactions denominated in a currency other than the entity's functional currency also require remeasurement. For example, a U.S. company with USD as its functional currency that purchases raw materials using Japanese Yen would remeasure its Yen-denominated payable at each balance sheet date until settled.
Financial Instrument Valuation: Certain financial instruments, particularly those denominated in a foreign currency and carried at something other than fair value, may require remeasurement to reflect the impact of currency fluctuations.

Limitations and Criticisms

While remeasurement aims to provide a clear picture of an entity's financial position in its functional currency, it has certain limitations and has drawn criticism. A primary concern is the potential for increased earnings volatility. Because remeasurement gains and losses on monetary items are recognized directly in the income statement, fluctuations in exchange rates can lead to significant swings in reported net income, even if the underlying operational performance remains stable. This can make it challenging for investors and analysts to discern the true operational profitability of the entity.

Another point of contenti¹on revolves around the determination of the functional currency. While accounting standards provide guidelines, the decision often requires significant judgment, which can lead to inconsistencies or debates over the most appropriate functional currency for a given operation. An incorrect determination can misrepresent the financial results and lead to the application of remeasurement when translation might be more appropriate, or vice-versa. Additionally, the distinction between monetary items (remeasured at the current exchange rate) and non-monetary items (remeasured at historical cost) can add complexity and may not always align with the economic exposures perceived by management or investors.

Remeasurement vs. Revaluation

Remeasurement and revaluation are distinct accounting concepts, though both involve updating asset or liability values. The key difference lies in their purpose and the underlying drivers of the value change.

Remeasurement (as discussed) specifically addresses the process of converting financial data from a local currency into a determined functional currency. It applies to foreign currency transactions and operations where the functional currency is different from the currency in which the books are maintained. The changes (gains or losses) from remeasurement are due to fluctuations in exchange rates and are typically recognized in the current period's net income. Its aim is to simulate what the financial statements would look like if they were always recorded in the functional currency.

Revaluation, on the other hand, is the process of adjusting the carrying amount of an asset (most commonly property, plant, and equipment or intangible assets) to its fair value at a specific point in time. This is generally permitted under IFRS (e.g., IAS 16 for Property, Plant and Equipment) but is largely prohibited under U.S. GAAP (which prefers the historical cost model, with impairment testing). Revaluation adjustments typically bypass the income statement and are recognized in other comprehensive income as part of equity, unless they reverse a previous revaluation decrement. The change in value stems from market conditions or changes in the asset's assessed value, not primarily from currency fluctuations.

In essence, remeasurement is about currency conversion for reporting consistency, while revaluation is about updating asset values to market-based amounts.

FAQs

What is the primary purpose of remeasurement in accounting?

The primary purpose of remeasurement is to restate the financial results of a foreign operation or transaction in its determined functional currency when the local currency used for record-keeping is different. This ensures that the financial statements reflect the economic reality of the entity's primary operating environment.

How do remeasurement gains and losses impact financial statements?

Remeasurement gains and losses are recognized directly in the current period's net income on the income statement. This can lead to volatility in reported earnings, as fluctuations in exchange rates directly affect profitability.

Which items are remeasured at historical exchange rates versus current exchange rates?

Under the remeasurement method, non-monetary items (such as inventory, property, plant, and equipment) are typically remeasured at the historical cost or the exchange rate that existed when the transaction occurred. Conversely, monetary items (like cash, accounts receivable, and accounts payable) are remeasured using the current exchange rate at the balance sheet date.

Is remeasurement the same as foreign currency translation?

No, remeasurement and foreign currency translation are different. Remeasurement applies when the local currency is not the functional currency, and its adjustments hit net income. Translation applies when the local currency is the functional currency but different from the reporting currency (e.g., the parent company's currency), and its adjustments typically bypass net income, going directly to a separate component of equity (Other Comprehensive Income).