Chapter 10
A country has a highly inflationary economy when its
cumulative three year inflation exceeds 100% - approx. 26% per year for three years in a row
Reporting currency
currency in which a company prepare's its financial statements
Official rate
from a central bank
IAS 21 functinal currency
same functional currency approach as GAAP
Functional currency
the primary currency of the foreign entity's operating environment
In highly inflationary economies
the temporal method is required with re-measurement gains or losses in NI
Calculating COGs under temporal method
Beginning Inventory x Historical rate (4th quarter 2016) Purchases can be multiplied by average rate if assumed to have been made evenly Ending inventory x Historical rate (4th quarter 2017)
Translation adjustments and remeasurement gains/losses are functions of two factors
changes in the exchange rate balance sheet exposure
To prepare worldwide consolidate statements, a U.S. company must.....
1. Convert foreign GAAP to US GAAP 2. Translate the financial statements from the foreign currency into U.S. dollars
Other factors concerning IFRS and translations
1. Currency used when generating funds from financing activities 2. Currency in which receipts from operating activities are retained 3. Whether the foreign operation carries out its activities as an extension of the parent or with a significant degree of autonomy 4. Volume of transactions with the parent 5. Whether cash flows generated by the foreign operation directly affect the cash flows of the parent 6. Whether cash flows generated by the foreign operation are sufficient to service its debt
Order when using temporal method
Balance sheet first, then income statement
Temporal Method
Basic objective is to produce a set of U.S. dollar statements as if the foreign subsidiary has actually used U.S. dollars - Assets and liabilities carried on the foreign operation's balance sheet at historical cost are translated at historical exchange rates - Assets and liabilities carried at a current or future value are translated at the current exchange rate - translation adjustment is not necessarily realized through inflows or outflows of cash - U.S. dollar translation adjustment is realized ONLY if: 1. the parent sends U.S. dollars to the foreign subsidiary to pay all of its liabilities 2. The subsidiary converts its receivables and marketable securities into cash and then sends this amount plus the amount in its cash account to the U.S. parent, which converts it to U.S. dollars
Two types of exchange rates used
Historical exchange rate - exchange rate existed when a transaction occurred Current exchange rate - the exchange rate that exists at the balance sheet date
Weights to indicators
IFRS --> focus on primary GAAP --> no weights
Order for translating under current rate method
Income statement, then statement of RE, then balance sheet
Multiple Exchange rates
Official vs. parallel rates one rate for certain types of transactions and another rate for other types
Temporal I/S and S of CF
US dollar value for net income is taken from remeasured I/S for S of CF depr. and amort. are remeasured at the rates used in I/S and the remeasurement loss is added back to net income increases in AR and AP are remeasured at the average rate increase in inventory is determined by the remeasurement of COGS
IFRS financial instruments
a gain or loss on the hedging instrument is recognized in AOCI along with the translation adjustment being hedged Under both IFRS and GAAP, cumulative translation adjustment and cumulative net gain/loss on net investment hedge are transferred from AOCI to NI when the subsidiary is sold or otherwise disposed of
Re-measurement
if a foreign operation's functional currency is the U.S. dollar, the currency balances are re-measured into US dollars using the temporal method resulting in remeasurement gains and losses
Assets kept at historical cost (temporal)
inventory, prepaid expenses, property, plant and equipment, and intangible assets
temporal method remeasures what at historical rates
inventory, property and equipment, patents, and contributed capital accounts
If translated value of net assets prior to rate changes < translated
positive (credit) adjustment
Two major translation methods used
1. The current rate (or closing rate) method 2. The temporal method
Primary factors concerning IFRS and translations
1. the currency that mainly influences sales price 2. the currency of the country whose competitive forces and regulations mainly determine sales price 3. the currency that mainly influences labor, material, and other costs of providing goods and services
IAS 29 indication of hyperinflation
1. the general population prefers to keep its wealth in a relatively stable foreign currency 2. Interest rates, wages, and other prices are linked to a price index 3. The cumulative rate of inflation over three years is approaching, or exceeds, 100%
Current rate balance sheet
1. translate the net asset balance of the subsidiary at the beginning of the year at the exchange rate in effect at that date 2. Translate individual increases and decreases in net asset balance during the year at the rates in effect when those increases and decreases occurred - NI, dividends, stock issuance, and acquisition of t-stock change net assets. Purchase of equipment or payment of liability do not 3. Combine translated beginning net asset balance value and the translated value of the individual changes to arrive at the relative value of the net assets being held prior to the impact of any exchange rate fluctuations 4. Translate the ending net asset balance at the current exchange rate to determine the reported value after all exchange rate changes have occurred 5. Compare the translated value of the net assets prior to any rate changes (3) with the ending translated value of the individual changes (4). Difference is the result of exchange rate changes during the period
How to translate Foreign currency retained earnings
Beginning R/E is carried forward from last year's translation Net income added is translated in the same method used for income statement items Dividends subtracted are translated with the historical exchange rate when declared
6 indicators for functional currency (U.S.)
Cash flow Sales price Sales market Expenses Financing Intra-entity transactions
Gain/Loss on sale of asset
Current rate translates the gain at the exchange rate in effect at sale date temporal method can't translate directly - cash received and cost of land sold must be translated into dollars first, and then the difference is the gain - cash is translated at date of sale and land is translated at historical rate
Current rate method income statement
all revenues and expenses are translated at the exchange rate in effect of the date of accounting recognition use weighted average rate if each revenue and expense is recognized evenly when an income account (gain/loss) occurs at a specific time, exchange rate as of that date is applied depreciation and amort. are translated at average rate/year translated net income is brought to RE Dividends are translated at exchange rate on declaration date
Appropriate Exchange Rate (when multiple) --> temporal method
appropriate rate to use is the applicable rate at which a transaction could be settled, which is a matter of management judgment
parallel rate
available in the open (sometimes illegal) market
Current Rate Method
basic assumption - a company's net investment in a foreign operation is exposed to foreign exchange risk - if the foreign currency decreases against U.S. dollar, a negative (debit) translation adjustment occurs - if the foreign currency increases against the U.S. dollar, a positive (credit) translation adjustment occurs - All assets and all liabilities of the foreign operation are translated at the current exchange rate - Stockholder equity items are translated at historical rates - Balance sheet exposure = foreign operation's net assets (total assets - total liabilities)
temporal method remeasures cash, receivables, and liabilities into dollars using..
current exchange rate
inventory Translation
current rate method requires ending inventory to be translated at current rate whether carried at cost or NRV Temporal method requires inventory's cost to be translated into dollars at the historical rate and NRV to be translated at the current rate
Appropriate Exchange Rate (when multiple) --> current rate method
exchange rate applicable for converting dividend remittances into US dollars should be used
Translation adjustment
if a foreign currency is the foreign operation's functional currency, the currency balances are translated using the current rate method and a translation adjustment is reported on the balance sheet
If translated value of net assets prior to rate changes > translated
negative (debit) adjustment
Disclosures related to translation
required to present an analysis of the change in the cumulative translation adjustment account in the financial statements or notes - directly in statement f OCI or separate disclosure in notes
How to compute re-measurement gain/loss
translate beginning net monetary asset position and subsequent changes in monetary items compare that amount with dollar value of net monetary liabilities
Translating statements in a hyperinflationary economy (IFRS)
two step process - neither temporal or current rate 1. financial statements are restated for local inflation in accordance with IAS 29 2. Each financial statement line item, which has been restated for inflation, is translated using the current exchange rate no translation adjustment
Subs that are closely tied to US parents
use a US dollar perspective record transactions in US dollars using temporal method translation gains and losses reported in net income
Subs that operate relatively independent of their parents
use a local currency perspective and the current rate method translation adjustments reported as a separate component in AOCI on B/S
If Foreign currency is functional currency
use current rate method translation adjustment is separate component of OCI (equity)
Is US dollar is functional currency..
use temporal method. Translation gain/loss in net income
Calculating COGs under current rate method
use the average-for-the-period exchange rate
When does a net monetary liability position arise
when the foreign currency appreciation coupled with an increase in net monetary liabilities generates a remeasurement LOSS
When does a net monetary asset position arise
when the foreign currency depreciation coupled with a increase in net monetary assets generates a remeasurement GAIN