FA: Multinational Operations

Under IFRS, highly inflationary economy procedure for translating financial statements

- First, restate for local inflation - Then, the restated financials are translated into the parent's presentation currency using the current exchange rate.

Some companies may choose not to disclose either the location or the amount of their foreign currency transaction gains and losses, presumably because the amounts involved are immaterial. Some reasons are:

- foreign currency transactions are few and relatively small - exchange rates are relatively stable - gains are naturally offset by losses, such that the net is minimal - the company engages in hedging activities which offset foreign currency gain/loss

While IFRS and US GAAP require foreign currency g/l to be reported on the income statement, neither...

- indicate where to place it. - Two most likely places: operating or non-operating income/expense. - Affects operating profit margin ratio.

Foreign currency transaction occurs when a company

1) makes an import purchase or an export sale that is denominated in a foreign currency, or 2) borrows or lends funds where the amount to be repaid or received is denominated in a foreign currency.

Procedures for Temporal Method (Balance Sheet)

1. a.Monetary assets and liabilities are translated at the current exchange rate. b.Non-monetary assets and liabilities measured at historical cost are translated at historical exchange rates. c.Non-monetary assets and liabilities measured at current value are translated at the exchange rate at the date when the current value was determined. 2.Stockholders' equity accounts are translated at historical exchange rates.

Procedures for the Current Rate Method

1.All assets and liabilities are translated at the current exchange rate at the balance sheet date. 2.Stockholders' equity accounts are translated at historical exchange rates. 3.Revenues and expenses are translated at the exchange rate that existed when the transactions took place. For practical reasons, a rate that approximates the exchange rates at the dates of the transactions, such as an average exchange rate, may be used. - the cum. translation adjustment is reported in S.E.

In accordance with IFRS, the following factors should be considered in determining an entity's functional currency: Although not identical, US GAAP provide similar indicators for determining a foreign entity's functional currency.

1.The currency that mainly influences sales prices for goods and services. 2.The currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services. 3.The currency that mainly influences labour, material, and other costs of providing goods and services. 4.The currency in which funds from financing activities are generated. 5.The currency in which receipts from operating activities are usually retained.

Both IFRS and US GAAP require two types of disclosures related to foreign currency translation:

1.the amount of exchange differences recognized in net income, and 2.the amount of cumulative translation adjustment classified in a separate component of equity, along with a reconciliation of the amount of cumulative translation adjustment at the beginning and end of the period. - US GAAP also specifically require disclosure of the amount of translation adjustment transferred from stockholders' equity and included in current net income as a result of the disposal of a foreign entity.

2. Foreign Currency Transactions

2.1 Foreign Currency Transaction Exposure to foreign exchange risk 2.2 analytical issues 2.3 Disclosures related to foreign currency transactions gains and losses

Procedures for Temporal Method (Income Statement)

3. a.Revenues and expenses, other than those expenses related to non-monetary assets (as explained in 3.b. below), are translated at the exchange rate that existed when the transactions took place (for practical reasons, average rates may be used). b.Expenses related to non-monetary assets, such as cost of goods sold (inventory), depreciation (fixed assets), and amortization (intangible assets), are translated at the exchange rates used to translate the related assets.

Additional factors to consider in determining whether the foreign entity's functional currency is the same as the parent's functional currency are

6.Whether the activities of the foreign operation are an extension of the parent's or are carried out with a significant amount of autonomy. 7.Whether transactions with the parent are a large or a small proportion of the foreign entity's activities. 8.Whether cash flows generated by the foreign operation directly affect the cash flow of the parent and are available to be remitted to the parent. 9.Whether operating cash flows generated by the foreign operation are sufficient to service existing and normally expected debt or whether the foreign entity will need funds from the parent to service its debt.

How to realize the unrealized translation adjustment

A translation: - loss is realized when the asset is sold. - gain is realized if the subsidiary or parent pays as much of the subsidiary's liabilities as possible

Transfer prices, the prices that related companies charge on intercompany transactions, affect the allocation of profit between the companies. Countries have established various laws and practices to prevent aggressive transfer pricing practices.

An entity with operations in multiple countries with different tax rates could aim to set transfer prices such that a higher portion of its profit is allocated to lower tax rate jurisdictions.

What rates are applied on the Balance Sheet under the Current Rate Method ?

Balance Sheet - All assets and liabilities are translated at the current exchange rate (the spot exchange rate on the balance sheet date). - Common stock is translated at the historical rate.

Under hyper-inflation, IFRS requires restatement and translation at current rate. The following procedures are taken on the balance sheet. the procedures are similar to the temporal method.

Balance Sheet - monetary assets/liabilities are not restated (cash, receivables, and payables) - non-monetary assets/liabilities are restated for changes in purchasing power. PPE is restated from its revaluation date. - all components of S.E are restated Income Statement - all items restated, net gain/loss resulting from purchasing power is included in net income.

Under hyperinflation, the shortcoming of using the current rate method.

Because this method accounts for adjustments in exchange rates but does not account for likely changes in the local currency values of assets, it does a poor job of accurately reflecting the economic reality of situations. Restating for inflation and using the CR method is the most accurate in representing economic reality.

When Presentation <> Functional, Functional = Local, use what method?

Current Rate Method.

Under the temporal method, monetary assets (and non-monetary assets measured at current value) and monetary liabilities (and non-monetary liabilities measured at current value) are translated at the current exchange rate.

Expenses related to non-monetary assets are translated at the exchange rates used for the related assets.

Items Translated at Current Exchange Rate

Exposed assets > Exposed liabilities → Net asset balance sheet exposure Exposed assets < Exposed liabilities → Net liability balance sheet exposure

Normally, the _______currency is the currency in which an entity primarily generates and expends cash.

Functional currency.

How come net income between the CR and Temporal methods are different?

IFRS and US GAAP require the resulting translation gain/loss to be included in net income when the temporal method is used, not so with the CR method.

Disclosures Related to Foreign Currency Transaction Gains and Losses Disclosures related to foreign currency are commonly found both in the Management Discussion & Analysis (MD&A) and the Notes to Financial Statements sections of an annual report.

IFRS require disclosure of "the amount of exchange differences recognized in profit or loss," and US GAAP require disclosure of "the aggregate transaction gain or loss included in determining net income for the period," but neither standard specifically requires disclosure of the line item in which these gains and losses are located.

Explain what the 'disappearing plant problem' is in regards to using the temporal vs. current rate method under hyper inflation.

In a highly inflationary economy, as the local currency loses purchasing power within the country, it also tends to weaken in value in relation to other currencies drawing down the exchange rate. Therefore, using the depressed current rates to value assets appeared to diminish PP&E. That's why US firms prefer the temporal method.

The country currency in which the company operates

Local currency.

Monetary assets consist of...

Monetary items are cash and receivables (payables) that are to be received (paid) in a fixed number of currency units.

Under the current rate method, the translation adjustment is...

NOT included in the calculation of income, but is included under the temporal method.

Non-monetary assets/liabilities consist of...

Non-monetary assets include inventory, fixed assets, and intangibles, and non-monetary liabilities include deferred revenue.

Under the Temporal Rate Method (Historical), what rates are applied on the Balance Sheet?

Only monetary assets and liabilities are translated at the current exchange rate; non-monetary assets and liabilities are translated at historical exchange rates

How is the realized gain/loss recorded after the unrealized gain/loss is captured on the Balance Sheet on intervening dates?

Subsequent foreign currency transaction gains and losses are recognized from the balance sheet date through the date the transaction is settled. Producing an amount equal to the actual realized gain or loss on the transaction.

When Presentation = Functional, Functional <> Local, use what method? i.e. German parent company has a subsidiary in Switzerland, which also uses the euro in its daily operations, but its transactions are recorded in Swiss francs

Temporal Method. The company would need to translate its financial statements as if originally recorded using the euro. US GAAP calls this 'remeasurement'. IFRS calls it 'reporting foreign currency transactions in functional currency'

Under US GAAP, what method is used under a highly inflationary economy and how is it determined?

Temporal method. - a highly inflationary economy as one in which the cumulative three-year inflation rate exceeds 100% (~26% per year)

A conceptual issue regarding translation adjustments is whether

The unrealized net translation should be consolidated in net income or held in stockholder's equity until realized through sale.

Clean surplus accounting

all non-owner changes in stockholders' equity, such as translation adjustments, should be included in the determination of net income, in which some income items are reported as part of stockholders' equity rather than as gains and losses on the income statement.

By definition, a foreign currency and foreign currency transactions is

anything denominated in a currency other than the company's functional currency.

what, if anything, should be done if a balance sheet date falls between the initial transaction date and the settlement date? ** one of few situations in which companies include an unrealized gain in income.

both IFRS and US GAAP require adjustments to reflect intervening changes in currency exchange rates. Foreign currency transaction gains and losses are reported on the income statement before it has been realized.

under the temporal method, historical exchange rates will differ for inventory depending on the matching method

ending inventory reported on the balance sheet is translated at the exchange rate that existed when the inventory's acquisition is assumed to occurred. i.e. FIFO recent Ex-rates, LIFO older ex-rates. - Similar treatment is given to COGS

Under the temporal method, a net liability balance sheet exposure is most likely because... which method typically results in greater equity?

most liabilities are monetary liabilities, while only cash and receivables are monetary assets. - as a result, the CR method tends to have greater equity due to a positive translation adjustment, on a net asset with appreciating currency exchange.

Under both international and US accounting standards, when the temporal method is used, the translation adjustment needed to keep the translated balance sheet in balance is reported as a gain or loss in __________.

net income.

Under IFRS and US GAAP, a foreign currency gain/loss is reported ...

on the income statement.

A 'translation adjustment' is included where on the balance sheet?

stockholder's equity. It represents the 'net' foreign currency translation gain/loss. First translate, then determine the 'net' adjustment amount to include on balance sheet.

If a firm purchases an asset for 100 pesos, but differs payment for 45 days, and the value of the peso rises, what is recorded on the balance sheet? (2.1.1 - Example 1)

the balance sheet records the purchase price of 100 pesos at the spot rate that day. Then records a foreign exchange loss for the additional (excess) payment due to the increased value in peso. (increase inventory for purchase, decrease cash and retained earnings for payment on B/S)

A transaction exposure arises in an Export sale when

the exporter agrees to be paid in a foreign currency.

A transaction exposure arises in an import purchase when

the importer defers payment in a foreign currency, incurring the change in exchange rates

Under both IFRS and US GAAP, the functional currency of a foreign operation determines

the method to be used in translating its foreign currency financial statements into the parent's presentation currency and whether the resulting translation adjustment is recognized in income or as a separate component of equity.

The currency in which financial statement amounts are presented is...

the presentation currency, which usually matches the country where the company is located.

the only ratio that is not different when using either the CR or Temporal method is

the receivables turnover ratio. All other ratios translate items in the numerator and denominator under different rates