A U.S. corporation may have subsidiariesAn entity in which the controlling financial interest is owned by another entity (ie, parent). in foreign countries that have their own currencies. These subsidiaries must report their financial statements in U.S. dollars to be part of the parent company'sA corporation (ie, acquirer) that owns controlling interest in another corporation (ie, acquiree). For GAAP purposes, the parent issues consolidated financial statements that combine the parent's and the subsidiary's financial statements when controlling interest is ≥ 50%. For tax purposes, the controlling interest required to file a consolidated tax return is ≥ 80%. consolidated financial statementsThe financial statements of a consolidated group of entities, including a parent and all its subsidiaries, presented as those of a single economic entity.. In addition, these subsidiaries may conduct transactions in several other currencies. These currencies are categorized as:

• Transactional currencyThe currency used in a specific transaction.—the currency used in a specific transaction
• Functional currencyThe currency that has the greatest economic impact on an entity's financial performance—usually the local currency. The determining factors include cash flows, sales, expenses, product demand, and financing.—the currency with the greatest economic impact on the company (usually the subsidiary's local currency)
• Reporting currencyThe currency in which an entity prepares its financial statements.—the currency used for the financial statements (usually the parent's local currency)

When these currencies differ, it is necessary to convert them for recording and reporting of accounting information. The transactional currency must first be converted to the functional currency (ie, remeasurementConversion of transactional currency to functional currency.). Remeasurement gains and losses are recognized on the income statement.

The functional currency must then be converted to the reporting currency (ie, translationConversion from functional currency to reporting currency.). Translation gains and losses are recognized as other comprehensive income (OCI)Certain changes in the equity of a business from nonowner transactions and events that are not considered net income. Other comprehensive income (OCI) mainly includes gains and losses from changes in fair value of certain assets and liabilities in an accounting period. on the consolidated balance sheet.

Mentor Co.'s $25,000 remeasurement gain would be recognized on the income statement; its $40,000 translation gain would be part of OCI.

(Choice A) Recognition of $0 implies no foreign currency gains are on the income statement.

(Choice C) Recognition of $40,000 incorrectly includes the translation gain while ignoring the remeasurement gain.

(Choice D) Recognition of $65,000 incorrectly includes the translation gain of $40,000.

Things to remember:
Converting transactional currency to functional currency is remeasurement, which is reported on the income statement. Converting functional currency to reporting currency is translation, which is reported as OCI on the balance sheet.