Implications of recent events in Venezuela At a glance

No. 2014-07
April 14, 2014
What’s inside:
Background ..................... 1
Key provisions .................2
Implications of recent events in Venezuela
Multiple legal exchange rates exist as of March 31, 2014
At a glance
Consideration of
deconsolidation ................... 4
Impairment of assets .............. 4
Presentation of bolivar
cash balances....................... 4
Disclosures .............................. 5
At March 31, 2014, there were three legal exchange mechanisms administered by the
Venezuelan government, each with a different exchange rate: the fixed official
CENCOEX rate, the variable auction-like SICAD1 rate, and the variable transactionbased SICAD2 rate.
What’s next ...................... 5
The recent introduction of the variable SICAD1 and SICAD2 mechanisms requires
reporting entities to exercise considerable judgment to determine which rate to utilize
to remeasure their bolivar denominated monetary assets and liabilities, and to record
associated revenues and expenses. There will likely be significant diversity among
reporting entities in the March 31, 2014 financial reporting cycle.
It remains imperative that reporting entities provide robust footnote disclosure
regarding their operations in Venezuela.
Background
.1 In January 2003, the Venezuelan government suspended the free exchange of
bolivars for foreign currency. The following month, the Venezuelan government
implemented certain foreign currency exchange controls that served to centralize the
purchase and sale of foreign currency within the country. Under these regulations, the
purchase and sale of foreign currency must be made at the "official rate" of exchange, as
determined by the Venezuelan government.
.2 The official rate has been devalued significantly from the 1.6 BsF/US$ set in January
2003 to today’s 6.3 BsF/US$. The Venezuelan government has, at times, facilitated
secondary foreign exchange markets, including the “parallel market” (eliminated in May
2010) and the “SITME” market (eliminated on February 8, 2013).
.3 Venezuela has been considered a highly inflationary economy since 2010.
Accordingly, the Venezuelan operations of most US companies now have a
US$ functional currency, which in turn, requires bolivar denominated monetary assets
and liabilities, and associated revenues and expenses, to be remeasured into US$ using
an exchange rate at which such balances could be settled as of the balance sheet date.
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
Dataline
1
.4 On March 18, 2013, the Venezuelan government announced the creation of a new
foreign exchange mechanism called the “Complimentary System of Foreign Currency
Acquirement” (or SICAD1), which operates similar to an auction system and allows
invited entities in specific sectors to bid for US$ to be used for specified import
transactions. In December 2013, the regulation that created the SICAD1 mechanism was
amended to require the Central Bank of Venezuela to disclose on its website the weekly
average exchange rate implied by transactions settled via the SICAD1 auction mechanism.
SICAD1 did not eliminate or change the official rate of 6.3 BsF/US$.
.5 On January 23, 2014, the Venezuelan government issued Exchange Agreement No.
25 (“EA25”), which stated that the rate of exchange established in the most recent
SICAD1 auction will be used for payments related to “international investments”,
royalties, and the use and exploitation of patents, trademarks, licenses franchises and
technology.
.6 In mid-February 2014, the Venezuelan government announced plans to launch a
third foreign exchange mechanism, known as SICAD2, which became operational on
March 24, 2014. SICAD2 relies on US$ cash and US$ denominated bonds offered by the
Venezuelan Central Bank, PDVSA (the national oil and gas company) and private
companies. The Venezuelan government has indicated that all industry sectors will be
able to access SICAD2 and its use will not be restricted as to purpose. The average
exchange rate transacted in SICAD2 is expected to be published by the Venezuelan
Central Bank each day. SICAD2 does not eliminate or change the official rate of 6.3
BsF/US$.
.7 The March 31, 2014 exchange rates inferred by the three legal mechanisms
administered by the Venezuelan government were:

CENCOEX (the successor to CADIVI): 6.3 BsF /US$ (fixed)

SICAD1: 10.7 BsF/ US$ (variable)

SICAD2: 50.85 BsF/ US$ (variable)
Key provisions
.8 As described in Dataline 2014-01, Implications of recent events in Venezuela
(published January 24, 2014), reporting entities could not use the SICAD1 published rate
to remeasure net monetary assets or liabilities denominated in bolivars as of December
31, 2013 primarily because EA25 was enacted after December 31, 2013. Further, when
Dataline 2014-01 was published, it was believed that the SICAD1 mechanism would only
be available for prospective transactions and would not be applicable to dividends.
.9 EA25 indicated that the exchange rate established in the most recent SICAD1 auction
will be used for payments related to “international investments” and certain intangibles.
Subsequent to the January 24, 2014 effective date of EA25, many legal professionals in
Venezuela concluded that the term “international investment” included the payment of
dividends. This is significant because many reporting entities have Venezuelan
operations with net monetary asset positions in bolivars comprised largely of cash
balances representing years of undistributed profits. Given the current uncertain
financial situation in Venezuela, many reporting entities believe that the only applicable
method to “settle” these bolivar cash deposits would be through a dividend. Since legal
professionals now believe that SICAD1 can legally be used to pay dividends, many
reporting entities are now considering using the SICAD1 rate for remeasurement
purposes.
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
Dataline
2
PwC observation:
We believe that companies should consult their legal counsel before making the
determination that SICAD1 is the rate applicable to dividend remittances. In
addition, companies should consider whether or not they have asserted that
undistributed earnings in Venezuela are indefinitely reinvested for income tax
accounting purposes. A decision to remeasure with the SICAD1 rate solely on the fact
that it could be used for dividend remittances would be inconsistent with an assertion
that all undistributed earnings are permanently reinvested.
In addition, we believe that reporting entities should disclose that dividend payments
require the approval of the Venezuelan government, and that in the recent past, such
approvals have been rare at any exchange rate.
.10 On March 24, 2014, the SICAD2 mechanism became operative. Although the average
rate transacted is being published daily by the Central Bank, there is very little known
about the volumes being transacted. The Venezuelan government has indicated that they
will intervene in the market as deemed necessary, but it is unclear to what extent they
have done so. It has been reported that companies transacting in the SICAD2 mechanism
are generally only receiving a portion of the US$ they are requesting and that the
settlement of the transaction can take time, causing most to believe that there is some
government allocation of US$ occurring.
PwC observation:
Although the SICAD2 mechanism is not intended to be restricted to certain industry
sectors or transaction types, there is very little history with this mechanism.
.11 With the existence of the three legal exchange mechanisms, reporting entities should
carefully consider which rate to use to remeasure their net monetary bolivar assets or
liabilities, and associated revenues and expenses. The decision should be based on the
reporting entity’s unique facts and circumstances, and should be contemporaneously
documented. As a reporting entity’s facts and circumstances change, or as the legal
exchange mechanisms within Venezuela change, a reporting entity should reevaluate the
rate used for remeasurement purposes.
PwC observation:
In determining which foreign exchange mechanism best fits a reporting entity’s facts
and circumstances, we believe that a reporting entity should consider seeking legal
counsel to determine which of the legal mechanisms are available to them. They
should also consider their intent to use a particular mechanism, as well as their
recent history with respect to transacting in the various mechanisms. However, we do
not believe that a reporting entity needs to have actually transacted in a particular
mechanism to use the exchange rate inferred by that mechanism. We also believe that
in certain fact patterns, it is possible that a reporting entity may conclude that the use
of multiple rates for remeasurement is appropriate.
All three exchange rate mechanisms suffer from lack of exchangeability and unclear
participation requirements. ASC 830, Foreign Currency Matters, does not
contemplate the situation found currently in Venezuela, thus preparers are required
to exercise judgment to determine the rate to use for remeasurement. Regardless of
which rate is used, reporting entities should disclose the rate used for
remeasurement, and provide information on the risks and limitations associated with
the chosen rate. In addition, reporting entities should disclose the earnings sensitivity
associated with utilization of alternative rates.
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
Dataline
3
Consideration of deconsolidation
.12 ASC 810-10-15-10 indicates that consolidation might not be appropriate when “the
subsidiary operates under foreign exchange restrictions, controls, or other
governmentally imposed uncertainties so severe that they cast significant doubt on the
parent’s ability to control the subsidiary.” Further, ASC 830-30-45-9 says “If the lack of
exchangeability is other than temporary, the propriety of consolidating, combining or
accounting by the equity method in the financial statements of the reporting entity
should be carefully considered.” Given the current form of currency restrictions,
combined with a recently enacted law limiting pricing and profit margins, all reporting
entities should be evaluating, documenting, and potentially disclosing its conclusions
regarding the continued consolidation of a Venezuelan operation.
PwC observation:
Some believe “exchangeability” as originally envisioned in FAS 52, Foreign Currency
Translation, has not existed in Venezuela for an extended period of time. While we
are not aware of a reporting entity that has deconsolidated its Venezuelan operation
based solely on the currency restrictions, we are increasingly fielding questions
concerning how the guidance in ASC 810 and ASC 830 should be interpreted in
regard to the facts and circumstances that exist currently in Venezuela. Some have
argued that if the deconsolidation guidance is not applicable in Venezuela, then such
guidance will likely never be applicable.
While the continued consolidation of a Venezuelan operation produces financial
reporting results that do not necessarily reflect economic reality, the only likely
alternative would be to revert to a cost method investment model, which would
effectively put a Venezuelan operation on the cash basis of accounting with an
inherent valuation issue. This model could be viewed just as problematic as the
consolidation model.
While we do not believe that a registrant is required to pre-clear a decision to
deconsolidate its Venezuelan operation, given the very unusual situation that has
existed in Venezuela for an extended period of time, we believe that a reporting entity
contemplating deconsolidation would be well served by a pre-clearance consultation
with the SEC.
Impairment of assets
.13 An official devaluation or a determination by a reporting entity that a less
advantageous exchange rate mechanism should be used to record its bolivar
denominated sales represents a triggering event indicating that assets, such as inventory,
long-lived assets and goodwill, should be tested for recoverability. Such impairment
testing should be performed in the functional currency of the Venezuelan operation,
which, since the commencement of highly inflationary accounting, is usually the US$.
Presentation of bolivar cash balances
.14 SEC Regulation S-X Rule 5-02 indicates that in certain circumstances, cash items
which are restricted as to withdrawal or usage should not be classified as “cash and cash
equivalents.” Although there are significant restrictions on a reporting entity’s ability to
remove bolivar cash from Venezuela or to convert bolivar cash into US$, bolivar cash is
not restricted as to withdrawal or use within Venezuela. As a result, bolivar cash held in
Venezuela should not be classified as restricted cash solely due to the Venezuelan
government’s exchange control laws.
National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com
Dataline
4
Disclosures
.15 At the 2009 AICPA National Conference on Current SEC and PCAOB Developments,
the SEC staff expressed concern over the lack of disclosure included in the filings of
registrants with Venezuelan operations. The SEC continues to request robust disclosure
regarding registrants’ operations in Venezuela. We believe that it is prudent for preparers
to consider disclosing the following:

A description of the Company’s business in Venezuela (including the types and
amounts of materials imported, plant and equipment in country and the impact of
regulations such as price controls on their business)

A general description of the economic environment in Venezuela, including a
general description of each of the legal exchange mechanisms that exist

Summarized financial information of the Venezuelan entity (including balance
sheet, statement of cash flows, and income statement)

Net monetary assets and liabilities by currency

The exchange rates used for remeasurement purposes. If multiple exchange rates
are being used, provide an explanation of the criteria used to make the distinction
and provide information on the relative significance of the various exchange rates.

The amount of any gain or loss that resulted from changing exchange rates

The profit and loss impact had the Company recorded or remeasured at one of the
other legally available exchange rates

The amount of BsF pending government approval at each of the exchange rates, as
well as the length of time the requests have been pending

Business practices that have or are expected to change as a result of recent events

MD&A disclosures should enable a reader to understand the risk and accounting
impact of an exchange rate change on future operations, financial position, and cash
flows
What’s next
.16 Venezuela’s currency laws and its high inflation rate are likely to persist. The
development of SICAD1 and SICAD2 combined with the current state of bolivar
exchangeability makes the application of ACS 830, Foreign Currency Matters, very
difficult. Reporting entities should continue to monitor political and economic
developments in Venezuela with the expectation that future changes to the currency laws
will likely occur.
Questions?
Authored by:
PwC clients who have questions about
this Dataline should contact their
engagement partner. Engagement teams
who have questions should contact the
Financial Instruments team in the
National Professional Services Group
(1-973-236-7803).
Kenneth O. Miller Jr.
Partner
Phone: 1-973-236-7336
Email: [email protected]
John F. Horan
Director
Phone: 1-973-236-5790
Email: [email protected]
© 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the
PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should
not be used as a substitute for consultation with professional advisors. To access additional content on financial reporting issues, visit www.cfodirect.pwc.com, PwC’s online
resource for financial executives.