FX Considerations

Background

Under the new lease accounting guidance for US GAAP and IFRS companies are required to record a right of use asset for the leased asset on the balance sheet and a lease liability for the lease payments that will happen over the life of the lease. When the lease is denominated in a currency other than the functional currency of the entity, different FX rates should be applied to the different transactions and balances associated with the foreign currency lease. This paper will walk through the proper accounting of an FX denominated lease.

FX remeasurement method for Balance Sheet accounts

ASC 842-20-55-10 

The right-of-use asset is a nonmonetary asset while the lease liability is a monetary liability. Therefore, in accordance with Subtopic 830-10 on foreign currency matters, when accounting for a lease that is denominated in a foreign currency, if remeasurement into the lessee’s functional currency is required, the lease liability is remeasured using the current exchange rate, while the right-of-use asset is remeasured using the exchange rate as of the commencement date.

The quoted guidance above very clearly states that the right of use asset and its associated accumulated amortization is a nonmonetary asset and therefore should be recorded at the rate on the date the asset was recognized. In the case of a lease, this is on the lease commencement date. This means that the accumulated amortization account should also be remeasured using the historical rate. 

The guidance is also clear that the lease liability should be remeasured using the current spot rate for each reporting date. 

FX treatment for P&L transactions 

830-20-25-1 

At the date a foreign currency transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be recorded in the functional currency of the recording entity.

In most cases, P&L transactions are recorded at a current rate. This could be either a daily spot rate or a monthly average rate. For simplicity, most companies and systems will use a monthly average rate for P&L transactions. Using this method, the amortization of the right of use asset, the recording of the single lease expense (for operating leases), the reduction of the lease liability, and the recognition of interest expense (for financing leases) would be recorded at the monthly average rate.

FX Adjustment for Right of Use Asset Amortization

The recording of the P&L transactions at the monthly average rate creates a problem for the accumulated amortization account because if recorded at the monthly average rate, would not fully amortize the right of use asset by the end of the lease and would cause the net right of use asset not to be properly recorded at the historical rate as required by the guidance above.  

An adjustment to the ROU accumulated amortization account is required. This adjustment should be calculated by taking the difference in FX rates from lease commencement and the average rate used to convert the amortization amount multiplied by amount of ROU amortization. The other side of this adjustment entry should be recorded on the income statement. The guidance below indicates that while most P&L transactions are recorded at current rates, some types of transactions should be recorded at an historical rate. 

830-10-45-18     

All of the following are common nonmonetary balance sheet items and related revenue, expense, gain, and loss accounts that shall be remeasured using historical rates to produce the same result in terms of the functional currency that would have occurred if those items had been initially recorded in the functional currency:

…

d.  Property, plant, and equipment

e.  Accumulated depreciation on property, plant, and equipment

…

m.  Revenues and expenses related to nonmonetary items, for example:

1.   Cost of goods sold

2.   Depreciation of property, plant, and equipment

3.   Amortization of intangible items such as patents, licenses, and so forth

4.  Amortization of deferred charges or credits except policy acquisition costs for life insurance entities.

Summary

The guidance here is not explicit as it relates to depreciation of a right of use asset, however, a right of use asset can be most closely compared to property, plant, and equipment. We believe based on this guidance, that the ROU asset amortization should be recorded at the historical rate rather than a current rate. To get this effect, the adjustment entry described above should have an adjustment to accumulated depreciation with the offset to ROU amortization expense for financing leases. With respect to operating leases and a single lease expense item, the solution is not quite as clear because other aspects of the transaction are reflected in the lease expense account. There may be a difference in how operating and financing lease handle the same issue.  Operating leases may record the FX adjustment entry to an FX gain/loss account so as to leave the lease expense recorded at the current or monthly average rate. However for financing leases, the FX adjustment should go to ROU amortization expense pursuant to the guidance indicated above.