Advanced accounting, 5th edition international student version ch13

Translate the statements of a foreign entity when the functional currency is the local currency.. Slide 13-6 The conversion from another currency into the currency of the parent company

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13-1

Translation of Financial Statements of Foreign Affiliates

Advanced Accounting, Fifth Edition

13

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13-2

1. Distinguish between the current exchange rate and the

historical exchange rate

2. Understand the objectives of financial statement

translation

3. Identify the functional currency of a foreign entity

4. Compare the two methods used to convert the financial

statements of a foreign entity into U.S dollars

5. Distinguish between the circumstances under which

each of the two methods is appropriate under current GAAP

Learning Objectives

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6. Explain the factors involved in translating the

statements of a foreign entity operating in a highly inflationary economy

7. Translate the statements of a foreign entity when the

functional currency is the local currency

8. Translate the statements of a foreign entity when the

functional currency is the U.S dollar

9. Understand the concept of comprehensive income in

the context of foreign currency translation

10. Identify the disclosure requirements for firms with

foreign entities

Learning Objectives

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13-4

A U.S company may be involved in foreign

activities through the operations of a:

branch, subsidiary, or investee company

Translation of Financial Statements

Accounts of foreign activities, maintained in a foreign currency, must be restated into U.S dollars before they are combined or consolidated or the equity

method of accounting applied.

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A foreign subsidiary is consolidated if the parent

company owns, directly or indirectly, a controlling

interest in the voting stock of the subsidiary

Exceptions include:

The intent to control is likely to be temporary.

Control does not actually rest with the parent company.

 Restriction on withdrawal of assets

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13-6

The conversion from another currency into the currency of

the parent company is frequently called “translation.”

Translating Statements of Foreign

Financial Statements in

Euros

Current Exchange Rate Historical Exchange Rate

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LO 1 Current versus historical exchange rates.

The difference between translating some accounts

using the current exchange rate and others using the

historical exchange rate

Current standards require the translation adjustment

(gain or loss) be reported

 currently in income or

 deferred as a component of stockholders’ equity,

depending on the method used to translate the

accounts.

Translation Adjustment or Translation Gain

or Loss

Not a Choic e

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Objective of Translation – FASB ASC section 830-30:

1. Provide information regarding the exposed economic

effects of an exchange rate change on an enterprise’s cash flows and equity [par 4(a)]

2. Reflect in consolidated statements the financial results

measured in their functional currencies in conformity

with U.S GAAP [par 4(b)]

Functional Currency Concept

The Board believes that the operating performance and financial

condition of a foreign entity are best measured by expressing its accounts in

the currency of the economic environment in which it primarily conducts its operations and generates and expends its cash, its functional

currency.

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Translation Methods

LO 4 Two methods of conversion.

Current rate method

All assets and liabilities.

Revenues and expenses

Translation

Current exchange rate.

Exchange rate on the date each

transaction occurred

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Other revenues and expenses.

Translation

Current exchange rate

Historical exchange rates

Current exchange

rate.

Exchange rate on date transaction occurred

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Identifying the Functional Currency

LO 3 Identifying the functional currency.

The Functional Currency may be

1 The local currency of the foreign entity,

2 The U.S dollar, or

3 The currency of a third country.

Economic Indicators of Functional Currency :

Cash flow Sales prices Sales market

Expenses Financing Intercompany transactions

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Indicators that the local currency is also the functional

currency include all of the following except :

a The majority of the cash flows are in the local

currency.

b Sales prices are determined by local market

conditions.

c Financing is generally from the parent or

guaranteed by the parent.

d Production costs and expenses are determined by

local conditions.

Review Question

Identifying the Functional Currency

LO 3 Identifying the functional currency.

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LO 4 Which methods of conversion to use.

Remeasurement is the process of translating the

accounts of a foreign entity into its functional currency

when they are stated in another currency.

Translation Accounts measured in the functional

currency are translated into the reporting currency

using the current rate method.

“Translation” may be used synonymously with the current method, “remeasurement” is used synonymously with the

temporal method

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LO 4 Which methods of conversion to use.

Accounts stated in local currency of foreign

entity

Is the foreign

economy

highlyinflationary?

Determine the functional currency (FC)

pereconomic indicators

Translate toU.S dollars using current rate method

Remeasure to

FC using temporal method

Yes Yes

Functional

currency (FC)

is U.S Dollar.

Is the FC the U.S dollar?

Is the FC the local currency?

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LO 6 Factors in a highly inflationary economy.

It is the Board’s belief that the currency of a country

that has a highly inflationary economy has lost its

utility as a store of value and cannot be a functional

measuring unit

This means the foreign financial statements should be

translated using the temporal method.

Foreign Entity Operates in Highly Inflationary

Economy

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1 Local currency is the functional currency

 Current rate method

 Translation adjustment recorded as a component of stockholders’ equity

2 U.S dollar is the functional currency.

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Books kept in local currency

Local currency

A third currency

Not necessar

y

Not necessar

y

Current rate method

U S dollars

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Other comprehensive income (shareholders’ equity)

Translation – Current Rate Method

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Exercise 13-4: On January 1, 2008, Trenten Systems, a

U.S.-based company, purchased a controlling interest in Grant

Management Consultants located in Zurich, Switzerland

Direct exchange rates for Swiss franc are:

Dollars per Franc

December 31, 2008 5321

Dividend declaration and payment date 5810

Required: Translate the year-end balance sheet and income

statement of the foreign subsidiary using the current rate

method of translation

LO 7 The functional currency is the local currency.

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Exercise 13-4: (Current Rate

Method)

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Exercise 13-4: Prepare a schedule to verify the

translation adjustment.

Adjustment for changes in net asset position:

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Under the current method of currency translation,

which of the following balance sheet accounts is

translated at historical exchange rates?

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Translation – Temporal Method

LO 8 The functional currency is the U.S dollar.

Other revenues and expenses

Translation

Current exchange rate

Current exchange

rate.

Exchange rate on date transaction occurred

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Exercise 13-5: On January 1, 2008, Trenten Systems, a

U.S.-based company, purchased a controlling interest in Grant

Management Consultants located in Zurich, Switzerland

Direct exchange rates for Swiss franc are:

Dollars per Franc

December 31, 2008 5321

Dividend declaration and payment date 5810

Required: Convert (remeasure) the financial statements of

the foreign subsidiary using the temporal method of

translation

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Exercise 13-5: Prepare a schedule to verify the

translation gain or loss.

Adjustment for changes in net monetary position:

Less: Decrease in net asset position:

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Financial Statement Disclosure

Companies are required to disclose certain items, as

follows:

1 The aggregate translation gain or loss included in the

determination of net income for the period

2 An analysis of the cumulative translation adjustment

equity account should be provided in a separate statement or note or as part of a statement of changes in equity

3 Exchange rate changes that occur after the balance

sheet date and their effect on unsettled foreign currency transactions, if significant

LO 10 Required disclosure.

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Date of Acquisition

acquired for 2,000,000 francs an 80% interest in SFr

Company The direct exchange rate for francs on January 2,

2012, was $.15 The entry to record the acquisition is

Investment in SFr Company 300,000

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On January 2, SFr Company reported common stock of

960,000 francs, additional paid-in capital of 300,000 francs, and retained earnings of 480,000 francs for a net asset

balance of 1,740,000 francs The difference between implied and book value in francs and dollars is allocated to land and buildings

Date of Acquisition

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P Company accounts for its investment by the cost method In this case, SFr Company declared and paid a 300,000 franc

dividend on September 1 when the direct exchange rate was

$.16 The book entry to record the dividend receipt is:

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The major differences between the workpapers are as follows:

1 Under the temporal method,

statement and becomes a part of its ending retained earnings balance

consolidated net income in the current period

retained earnings as part of the reciprocity entry.

2 The unamortized portion of the difference assigned to land and

buildings and the amortization for the current period retain their historical dollar values since such nonmonetary assets are

translated using historical rates.

Consolidation Assuming Temporal

Method

Consolidation Assuming Temporal

Method

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FASB ASC section 830–20–20 defines a foreign currency

transaction as one that is denominated in a currency other than the entity’s functional currency

1 At the transaction date, the current exchange rate is

used to measure and record a foreign currency transaction in the functional currency of the recording entity

2 At subsequent balance sheet dates, recorded balances

that are denominated in a currency other than the functional currency are adjusted to the functional currency using the current exchange rate

3 Any transaction gain or loss resulting from this procedure

is recognized currently in income

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Intercompany Receivables and Payables

FASBASC paragraph 830–20–35–1 requires that transaction gains and losses on intercompany receivables and payables

be recognized in the period that the exchange rate

changes

The procedures for doing so are similar to those discussed

in the preceding section

However, a company is required to distinguish between

transactions that are of a long-term investment nature and other transactions

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Elimination of Intercompany Profit

Profits and losses attributable to intercompany sales or

transfers are eliminated on the basis of the exchange rate

at the date of each sale or transfer

The use of averages or reasonable approximations of

specific rates in effect on the due date of each transaction

is permitted

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Liquidation of a Foreign Investment

Upon the sale of part or all of an investment in a foreign entity, a pro-rata share of the amount included in the

accumulated translation adjustment equity account

associated with that foreign investment is removed and reported as part of the gain or loss from the disposition of the investment

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