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It’s Time for the FASB to Revisit FAS 52

  • By Robert Baer
  • Published: 2/5/2016

Euro1The Financial Accounting Standards Board (FASB) is due to release new hedge accounting rules that will make it easier for U.S. companies to account for currency hedges. But will the proposed changes truly affect the core currency risk facing U.S. multinationals? The answer is no.

The impact of currency risk on global companies cannot be underestimated. According to a January report by FiREapps, the effects of FX volatility on the revenues of U.S. and European companies totaled $24 billion—three times as much as the quarter before. The reason for the earnings hits among U.S. corporations was translation risk; as the U.S. dollar rises in value, corporate revenues denominated in foreign currencies are worth less dollars. Since the start of 2016, the dollar has gotten even stronger. Under hedge accounting rules, companies cannot hedge FX earnings. While there are ways companies attempt to hedge that risk, most are costly or inefficient.

Needed: A single unit of measurement

Changing hedge accounting rules would solve that problem, but the solution to allow hedging of portfolio risk is complex and not an issue the FASB has the appetite to address. And in all fairness, ASC 815 is not the reason for these big swings in earnings; they are the outcome of a much older FASB pronouncement, FAS 52 (functional currency) which became effective in 1983. The functional currency approach was controversial when it was implemented and is not consistent with how companies operate in today’s global economy. It was approved by a slim 4-3 margin. And in the 30-plus years since, technology and treasury management have evolved to where most multinational corporations run central treasury groups and manage foreign currency risk globally.  

In light of these changes, there’s a case to be made for the FASB to reopen FAS 52, which requires legal entities to declare a “functional” currency based on a set of parameters, and replace it with a single reporting currency. U.S. investors don’t care about results in foreign currency. They care about results in USD as that is the currency dividends will be paid.

Under FAS 52, “If a foreign entity’s functional currency is the reporting currency, re-measurement into the reporting currency obviates translation.” A change to a single unit of measure would eliminate the process of translating foreign subsidiary financial statements, and then all probable forecasted currency exposures (transactions not denominated in the reporting currency) could qualify for hedge accounting.  Eliminating the functional currency concept of FAS 52 would be a significant change, but as the global economy and centralized treasury management trends continue to evolve, it is worth considering. And it would eliminate many of the unusual accounting results that certain FASB board members raised prior to issuing that statement.  

Five reasons to eliminate translation

  1. The functional currency approach attempts to measure results in the primary economic environment in which an entity operates. Many multinational corporations manage their business on a global basis through a central treasury operation. As the FAS 52 dissenters suggested, there is no persuasive reason to support the belief that external users want or need to know the amount of gains or losses as measured from the perspective of the manager of the foreign operation.
  2. For investors and creditors, a single unit of measure will better assist in assessing future cash flows.  
  3. Individual assets and liabilities are subject to exchange rate risk rather than the parent’s net investment. When exchange rates change between the reporting currency and a foreign currency, the value of any holdings of that currency changes and from a reporting currency perspective the resulting gain or loss is real. Functional currency accounting can result in a division of the gain or loss into one component that is considered in measuring net income and the other that is considered as an equity, translation adjustment. 
  4. Real foreign currency gains and losses from translation can be deferred indefinitely. 
  5. Comparative financial results would improve with a single unit of measure.

Robert Baer is market specialist, derivatives and hedge accounting, at Bloomberg.

A longer version of this article will appear in an upcoming edition of AFP Exchange.

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