Ch. 10 Translation of Foreign Currency F/S
Multiple exchange rates
-In some countries there is more than one rate at which the local currency can be converted into foreign currency. -There can be an "official rate" available from the Central Bank, and a "parallel rate" available in the open (sometimes illegal) market. -In some countries there is one rate for certain types of transactions and another rate for other transactions. -The existence of multiple exchange rates raises the question of which exchange rate to use in the financial statement translation process.
What is the translation adjustment if the functional currency is US dollar?
gain (loss) in net income
(Temporal) Assets and liabilities carried on the foreign operation's balance sheet at historical cost are translated at
historical exchange rates to yield an equivalent historical cost in U.S. dollars.
remeasurement
if a foreign operation's functional currency is the U.S. dollar, the currency balances are remeasured into U. S. dollars using the temporal method resulting in remeasurement gains and losses
The current rate method is used ______ than the temporal rate method
more predominately
What is the translation adjustment if the functional currency is foreign currency?
separate component of OCI (Stockholders' Equity)
What is the appropriate exchange rate when the temporal method is used?
the applicable rate at which a transaction could be settled, which is a matter for management judgment.
For current rate method, foreign exchange gain/loss should be remeasured using
the average rate
(Temporal) Assets and liabilities carried at a current or future value are translated at
the current exchange rate to yield an equivalent current value in U.S. dollars (monetary assets and liabilities).
What is the appropriate exchange rate when the current rate method is used?
the exchange rate applicable for converting dividend remittances into U.S. dollars should be used to translate financial statements. Generally, this will be the official exchange rate established by the Central Bank or other governmental authority.
The current rate method translates the gain on sale of land at:
the exchange rate in effect at the date of sale.
Use the Current Method when...
the majority of the subsidiaries transactions are carried out using their local currency, as opposed to the U.S. dollar.
Purchases in FC translation
use average ER (for this year)
Beginning inv in FC translation
use historical ER (4th Q last year)
Functional currency
-We look at this to determine whether a subsidiary is integrated with the parent or operates independently -the primary currency of the foreign entity's operating environment
Current Rate Method Translation
First, determine the functional currency. The amount of the cumulative translation adjustment can be determined indirectly as the amount needed to keep the translated balance sheet in balance. Translate the income statement, then the statement of retained earnings, and then the balance sheet to facilitate the translation adjustment reported in the balance sheet.
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.
Current rate positive translation adjustment
Increases stockholder's equity (AOCI) The positive translation adjustment is not realized in terms of dollar cash flow.
Intangible assets
R: historical CR: current
How to calculate remeasurement loss
Remeasure the changes in net monetary assets using the exchange rates for the temporal method (historical rates) Remeasure the changes using the current rate Take the difference
Current rate method - stockholders equity translation
Stockholders' equity items are translated at historical rates. Retained earnings is an accumulation of all of the net income less dividends declared by a company since its inception. Translation adjustment is reported as a component of Accumulated Other Comprehensive Income
Amortization of intangibles
T: historical CR: average
Each method is presented from the perspective of a ______ translating foreign currency financial statements into U.S. dollars.
U.S.-based multinational company
The basic objective underlying the temporal method is to produce a set of U.S. dollar-translated financial statements as if the foreign subsidiary had actually used _______ in conducting its operations.
US dollars
Current liabilities
both current
LT debt
both current
cash and receivables
both current
inventory at net realizable value
both current
marketable securities
both current
Additional PIC
both historical
Capital stock
both historical
dividends
both historical
(Temporal) Calculation of COGS
no single exchange rate can be used to directly translate COGS in FC into COGS in dollars. COGS must be decomposed into: -beginning inventory -purchases -ending inventory, and each component must then be translated at its appropriate historical rate. When purchases can be assumed to have been made evenly throughout 2017, the average 2017 exchange rate is used to translate purchases
Nonlocal Currency Balances
If any accounts of the foreign subsidiary are denominated in a currency other than the local currency, they would first have to be restated into the local currency. Both the foreign currency balance and any related foreign exchange gain or loss would then be translated (or remeasured) into U.S. dollars.
(Temporal) Property, Plant, and Equipment, Depreciation, and Accumulated Depreciation
The temporal method requires translating property, plant, and equipment acquired at different times at different (historical) exchange rates. The same is true for depreciation of property, plant, and equipment and accumulated depreciation related to property, plant, and equipment.
CR method balance sheet translation steps
1.Translate the net asset balance of the subsidiary at the beginning of the year at the exchange rate in effect that date. 2.Translate individual increases and decreases in the net asset balance during the year at the rates in effect when those increases and decreases occurred. Events such as net income, dividends, stock issuance, and acquisition of treasury stock change net assets; purchase of equipment or payment of a liability does 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 during the year. 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 (c) with the ending translated value of the individual changes (d). The difference is the result of exchange rate changes during the period. -If (c) is higher than (d), a negative (debit) translation adjustment exists. -If (d) is higher than (c), a positive (credit) translation adjustment results.
Two major related theoretical issues are:
1.Which translation method should be used. 2.Where the resulting translation adjustment should be reported in the consolidated financial statements.
Use the Temporal Method when...
1.The majority of their transactions are recorded in U.S. dollars as if the foreign subsidiary had actually used the dollar in carrying out its activities. Translation gains and losses are reported in net income. 2.In highly inflationary economies (i.e. when its cumulative three year inflation exceeds 100 percent.
What is the translation method if the functional currency is foreign currency?
Current rate method
inventory at cost
T: historical (price when it was acquired) CR: current
COGS
T: historical (use rate when the inventory was purchased) CR: average
What is the translation method if the functional currency is US dollar?
Temporal method
Overall
Temporal: - Current: cash, inventory at NRV, current liabilities, LT-debt -Historical: inventory at cost, prepaid expenses, PPE, Intangibles, deferred income, SE, COGS, Depreciation, Amortization -Average: revenues and most expenses Current Rate: -Current: All assets and liabilities -Historical: SE -Average: Income statement items
Remeasurement: Balance Sheet— Temporal Method
remeasures cash, receivables, and liabilities (other than deferred revenue) into U.S. dollars using the current exchange rate. Inventory, property and equipment, patents, and contributed capital accounts are remeasured at historical rates, resulting in differences in total assets and liabilities plus equity which must be reconciled, resulting in a remeasurement gain or loss.
Current Rate Method Translation of Income Statement
All revenues and expenses are translated at the exchange rate in effect at the date of accounting recognition. Use the weighted average exchange rate if each revenue and expense is recognized evenly throughout the year. When an income account, such as a gain or loss, occurs at a specific point in time, the exchange rate as of that date is applied. Depreciation and amortization expenses are translated at the average rate for the year. These expenses accrue evenly throughout the year even though the journal entry to recognize them might not have been made until year-end for convenience. The translated amount of net income for the year is taken from the income statement and entered on the statement of retained earnings. Dividends are translated at the exchange rate on the date of declaration.
CR Method - Translating the balance sheet
Assets - translated using the current rate Liabilities - translated using the current rate Stockholders Equity - Historic Rate - with the balancing amount recorded as an adjustment to Accumulated Other Comprehensive Income
Current rate method - how to measure the net investment's exposure to foreign exchange risk?
all assets and all liabilities of the foreign operation are translated at the current exchange rate.
Reporting currency
currency in which an entity prepares its financial statements. U.S.-based companies use the U.S. dollar
Revenues
both average
most expenses
both average
Retained earnings
both composite
(Temporal) gain/loss on the sale of an asset
cannot translate the gain on the sale of land directly. The cash received and the cost of the land sold must be translated into U.S. dollars separately, the difference is the U.S. dollar value of the gain. The temporal method translates the Cash account at the exchange rate on the date of sale, and the Land account is translated at the historical rate.
Current rate method - balance sheet exposure
equal to the foreign operation's net asset (total assets minus total liabilities) position If the foreign currency increases in value, an increase in the U.S. dollar value of the net asset occurs and will be reflected through a positive (credit balance) translation adjustment.
To prepare worldwide consolidated financial statements, a U.S. parent company must
1.Convert the foreign GAAP financial statements of its foreign operations into U.S. GAAP. 2.Translate the financial statements from the foreign currency into U.S. dollars.
Two major translation methods are currently used:
1.The current rate (or closing rate) method. 2.The temporal method.
Ending inv in FC translation
Use historical ER (4th Q this year) -- use the rates for each inventory at the time they were purchased
Current rate translation adjustment steps
1. Translate the net asset balance of the subsidiary at the beginning of the year at the exchange rate in effect on that date (a). The beginning balance is SE + RE 2. Translate individual increases and decreases in the net asset balance during the year at the rates in effect when those increases and decreases occurred (b). Only a few events, such as net income, dividends, stock issuance, and the acquisition of treasury stock, actually change net assets. Transactions such as the acquisition of equipment or the payment of a liability have no effect on total net assets. 3. Combine the translated beginning net asset balance (a) and the translated value of the individual changes (b) to arrive at the relative value of the net assets being held prior to the impact of any exchange rate fluctuations during the year (c). 4. Translate the ending net asset balance at the current exchange rate to determine the reported value after all exchange rate changes have occurred (d). This is going to be the same value that we get when we add a + b before exchange rate 5. Compare the translated value of the net assets prior to any rate changes (c) with the ending translated value (d). The difference is the result of exchange rate changes during the period. If (c) is higher than (d), a negative (debit) translation adjustment arises. If (d) is higher than (c), a positive (credit) translation adjustment results.
Depreciation of PPE
T: historical CR: average
PP&E
T: historical CR: current
deferred income
T: historical CR: current
prepaid expenses
T: historical CR: current
Remeasurement Gain or Loss— Temporal Method
GOES INTO RETAINED EARNINGS To ensure remeasurement gain or loss is reported in income, it is easiest to remeasure the balance sheet first A remeasurement gain/loss is computed by translating the beginning net monetary asset position and subsequent changes in monetary items at appropriate exchange rates. Compare that amount with the dollar value of net monetary liabilities at year-end based on the current exchange rate. -Find Total assets in US$ -Add total liabilities and SE in US$ -Find the difference (this is the remeasurement gain/loss in RE) -If assets are less, than its a loss