Combo with "F2: Foreign Currency Transactions" and 8 others

"Translation" adjustments are not included in determining net income for the period but are disclosed and accumulated as a component of other comprehensive income in consolidated equity until sale or until liquidation of the investment takes place.

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As services are provided on the contract over the two years, deferred revenue will be debited and sales revenue will be credited.

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Under IFRS, goodwill impairment is analyzed at the cash-generating unit level.

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One approach for converting from cash-basis to accrual-basis is as follows:

1. Add increases in current assets. For example, when AR increases is not considered to be income under the cash basis because the cash has not been collected, but the increase is income under the accrual basis.

The exchange rate may be expressed as

1. Direct method 2. Indirect method

Foreign Currency Measurement (dysfunctional) is the restatement of foreign financial statements from the foreign currency to the entity's functional currency in the following situation:

1. The reporting currency is the functional currency. 2. The financial statements must be restated in the entity's functional currency prior to translating the financial statements from the functional currency to the reporting currency.

Impact of cash flows The standards for foreign currency accounting are designed to: 1. Provide information regarding the effects of exchange rate changes on an enterprise's cash flow and equity.

2. Recognize in income from continuing operations the effects (gain or loss) of adjustments for currency exchange rate changes that impact cash flows and exclude from net income those adjustments that do not impact cash flows.

One approach for converting from cash-basis to accrual-basis is as follows:

2. Subtract decreases in current asset. Conversely, when AR decreases, then cash-basis counted it as revenue when the cash was collected, but under then accrual basis, the income was recognized in a prior period and should not be recognized again in the current period.

One approach for converting from cash-basis to accrual-basis is as follows:

3. Add decreases in current liabilities. For example, when AP decreases, this represents a cash outflow that is recorded as an expense under the cash basis. However, under the accrual basis the paid expenses were recorded in a prior period and should not be recorded again in the current period.

One approach for converting from cash-basis to accrual-basis is as follows:

4. Subtract increases in current liabilities. Conversely, when AP increases, this represents expenses incurred under the accrual basis method that have not been recorded under the cash basis method because they have not been paid.

Non-monetary items

=historical rate=fluctuate

Parent company: Reporting currency= Functional currency

> Foreign subsidiary: Foreign currency (dysfunctional)

Under IFRS, research costs related to an internally developed intangible asset must be expensed but an intangible asset arising from development is recognized if the entity can demonstrate all of the following: (capitalized)

>> The intangible asset will generate future economic benefits >> Adequate resources are available to complete the development and sell or use the asset. The entity can reliably measure the expenditure attributable to the development of the intangible asset.

Parent company: Reporting currency

>Foreign subsidiary: Foreign currency= functional currency

Expenses are necessarily incurred to generate revenues.

All expenses incurred to generate a particular revenue should be recorded in the same period in which the revenue is recorded.

When translating foreign currency financial statements into the reporting currency, which of the following items would not be translated using current (year-end) rates?

Common stock.

Conversion adjustments associated with translation of financial statements are displayed in accumulated other comprehensive income.

Conversion adjustments associated with remeasurement of financial statements is displayed in income.

Which of the following should be reported in a stockholders' equity contra account?

Cumulative foreign exchange translation loss.

Research and development expense is calculated as follows:

Depreciation of equipment for current & future projects + Equipment for current projects only + R&D salaries + Material and labor costs for prototype = Total R&D expense.

Foreign Currency Translation (Functional)

Foreign currency translation is the conversion of financial statements of a foreign entity into financial statements expressed in the domestic currency (the dollar).

Foreign currency transaction gains and losses are included in operating income, not as an adjustment to the asset purchased.

Foreign exchange translation gains and losses are generally included as a component of other comprehensive income in stockholders' equity, but foreign exchange transactions (like this one) are not.

Rule: The functional currency of an entity generally depends upon the environment in which the entity generates and expends cash (unless there is a requirement by law to use another currency), which may be any of the above three.

However, the functional currency cannot be the local currency if the foreign entity operates in a highly inflationary environment (i.e., approximately 100% over three year).

Net income is overstated because Hayworth should not report the entire $20,000 as sales revenue during the current year.Under the revenue recognition rule, revenue cannot be recognized until services have been performed.

Of the $20,000 received by Hayworth, $18,000 is for the equipment and $2,000 is for the two-year service contract. When the $20,000 was received, it should have been recorded with the following journal entry: Dr: Cash Cr: Sales Revenue Cr: Deferred Revenue

Remeasurement Gain or Loss

Plug "Currency Gain/Loss" to get net income to the required amount needed to adjust retained earnings in order to make the balance sheet balance.

Personnel costs and design/testing/construction both fall under

R&D expenses.

Remember that organizational expenses are not capitalized as an intangible asset.

Rather, they are expensed immediately.

A balance arising from the translation or remeasurement of a subsidiary's foreign currency financial statements is reported in the consolidated income statement when the subsidiary's function currency is the:

Reporting Currency.

Foreign exchange gains and losses are recorded at year end on uncompleted contracts.

The gain for year 2 is the exchange rate change from 12/31/Y1 to 2/1/Y2.

Gains and losses resulting from foreign exchange transactions that are an "extension" of the parent's domestic operations are included as a component of "income from continuing operations " in the period in which they occur.

They are not extraordinary items.

Research and development does not include the amount paid for the equipment purchased for current and future projects because the equipment has alternative future uses.

This equipment will be capitalized, but the related depreciation expense will be allocated to R&D. The legal fees to obtain the patent are capitalized as an intangible asset.

Under U.S. GAAP, an entity's local currency qualifies as the functional currency if it is the currency of the primary economic environment in which the company operates, and all of the following conditions exist:

a. The foreign operations are relatively self-constraint and integrated within the country. b. The day-to-day operations do not depend on the patent's or investor's functional currency. c. The local economy of the foreign entity is Not highly inflationary, which is defined as cumulative inflation of 100% over three years.

When the translation method is used,

all assets and liabilities are translated to the reporting currency using the current (year-end) exchange rate, while common stock and additional paid-in capital are translated using historical exchange rates.

During Year 2, Classic will record amortization on the patent of $40,000 ($200,000 revalued patent/5 years).The carrying value of the patent on December 31, Year 2 will be $160,000 ($200,000 fair value on revaluation date - $40,000 amortization)

and a revaluation gain of $15,000 will be recorded in Year 2 income to adjust the patent to its December 31, Year 2 fair value of $175,000. This represents a revaluation gain that partially offsets a previously recorded revaluation loss, so this is an income statement item.

The best available spot rate is not used to measure

assets, liabilities, or operations for either the subsidiary or the parent company.

Monetary items

current/year-end rate= fixed

Translation Method (Functional/Normal) If the financial statements of the foreign subsidiary are in the subsidiary's functional currency,

financial statements are translated to the reporting currency starting with the income statement.

Remeasurement method (temporal method)>(dysfunctional)

if the financial statements of the foreign subsidiary are not in the subsidiary's functional currency, the financial statements are remeasured to the functional currency starting with the balance sheet.

Functional Currency

is the currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency.

Reporting Currency (=U.S. $)

is the currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency.

Direct method

is the domestic price of one unit of another currency

Forward Exchange Rate (Bet)

is the exchange existing now for exchanging two currencies at a specific future date.

The matching principle:

matches expenses against revenues in the same accounting period.

Under IFRS, the entity should recognize a patent asset of

purchase price of the patent + the VAT taxes + Legal costs to register the patent.

Value in use=

recoverable amount

Cash-Generating Unit=

recoverable amount because it exceeds the fair value less costs to sell.

Translated retained earnings is equal to

the beginning translated retained earnings plus translated net income for the current period less translated dividends declared for the current period.

The rate to be used to translate all assets and all liabilities from the functional currency to the reporting currency (U.S. dollar) is

the current rate, that is, the exchange rate in effect at the balance sheet date.

If a foreign subsidiary's local currency is the functional currency and the economy of the foreign entity is not highly inflationary, then the translation (current) method is used to convert the financial statements of the foreign subsidiary from

the local/functional currency to the reporting currency.Under he translation (current) method, all income statement items, including salaries expense and sales to external customers, are translated using the weighted-average exchange rate for the current year.

Forward Exchange Contract (used for income statement)

is an agreement to exchange at a future specified date and rate a fixed amount of currencies of different countries.

Under U.S. GAAP, subsequent reversal of intangible asset impairment losses

is prohibited unless the intangible asset is held for sale.

Current exchange rate (year end/sport rate)

is the exchange rate at the current rate, or for immediate delivery of currency, often referred to as the spot rate.

Indirect Method

is the foreign price of one unit of the domestic currency.

Exchange rate

is the price of one unit of a currency expressed in units of another currency; the rate at which two currencies will be exchanged at equal value.

Historical Exchange Rate (used for equity)

is the rate in effect at the date of issuance of stock or acquisition of assets.

When the fair value exceeds the carrying value we need to test for an impairment loss and use the fair value as the carrying value for the following year.

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The total Year 2 revaluation gain is $15,000 ($90,000 fair value on 12/31/Y2 -$75,000 fair value on 12/31/Y1). $10,000 of the revaluation gain will be recognized on the income statement to reverse the revaluation loss of $10,000

($75,000 fair value - $85,000 carrying value) reported on the income statement in Year 2. The remaining $5,000 will be recognized as a revaluation surplus in Year 2 other comprehensive income.

Under IFRS, research costs related to an internally developed intangible asset must be expensed but an intangible asset arising from development is recognized if the entity can demonstrate all of the following: (capitalized)

>> technological feasibility has been established. >> The entity intends to complete the intangible asset. >> The entity has the ability to use or sell the intangible asset.

Cumulative foreign exchange translation loss should be reported as a component of accumulated other comprehensive income.

A cumulative foreign exchange translation loss would be a debit to accumulated other comprehensive income; therefore, contra to shareholders' equity.

Changes in Exchange Rate

A foreign exchange transaction gain or loss will result if the exchange rate changes between the time a purchase or sale in foreign currency is contracted for and the time actual payment is made.

Under IFRS, an impairment loss is recorded for the excess of the carrying value of an intangible asset over its recoverable amount.

The recoverable amount is the greater of the asset's fair value less costs to sell and the asset's value in use.

If the subsidiary's functional currency is not the same as its local currency (the functional currency may be the reporting currency or another currency), the subsidiary's financial statements must be "remeasured" into the functional currency.

The resulting gain or loss on remeasurement is reported in the consolidated income statement.

The entity has a revaluation loss of $20,000 ($150,000 revalued amount from Year 5 - $130,000 fair value on 12/31/Y6).

The revaluation loss will be recorded in Year 6 other comprehensive income and will offset the $30,000 revaluation surplus in accumulated other comprehensive income (AOCI), for a net revaluation surplus of $10,000 reported in AOCI on December 31, Year 6.

A foreign subsidiary of a U.S. parent company should measure its assets, liabilities, and operations using:

The subsidiary's functional currency.

The exchange rate specifically associated with FIFO inventory would be used to remeasure inventory on the balance sheet and cost of goods sold on the income statement if the temporal method was used

The temporal method should be used when the subsidiary operates in a highly inflationary economy or the local currency of the subsidiary is not the functional currency. Neither of these situations is indicated in the facts.

The transaction would first be journalized when title transfers to the buyer on December 15. At fiscal year-end, the exchange rate has increased from one dollar to 20 francs on 12/15 to one dollar 21 francs on 12/31, so a foreign exchange gain would be recognized.

The transaction would first be journalized when title transfers to the buyer. At fiscal year-end, the exchange rate has increased so a foreign exchange gain would be recognized.

Intangible Assets should be amortized over the lesser of the useful life or the legal life.

The useful economic life is 25 years and the legal life is 30 years, so the copyright will be amortized over 25 years.

During the year, prepaid expenses increased $5,000 from $10,000 to $15,000. Prepaid expenses represent assets where no benefit has received yet. In accrual accounting, they are not officially expenses until there is associated benefit.

Therefore, the $5,000 needs to be subtracted from $150,000. Also during the year, accrued liabilities increased from $5,000 to $25,000. This represents benefit received but no cash paid out yet.

The franchise fee will not be earned until Year 2 when the services for the initial fee will be performed.

Therefore, the total (discounted) amount of the fee must be reported as unearned franchise fees: Unearned franchise fees = $40,000 cash payment + $48,000 PV of future payments= $88,000

>> The $16,000 increase in accounts payable represents expenses incurred but not yet paid. Under the cash basis, no expense would be recorded for the $16,000 increase because cash has not been paid.

Under the accrual basis, expense totaling $16,000 are recorded when the payables are recorded. As a result, cash basis income is $16,000 higher than accrual basis income.

Cash basis pre-tax income would be $36,000 higher than accrual basis income because: >> The $20,000 decrease in accounts receivable represents cash paid in the current period on accounts receivable from prior periods.

Under the cash basis, this $20,000 would be recorded as current period income but under the accrual basis the revenue would have been recorded in the prior periods. Therefore cash basis income in the current period is $20,000 higher than accrual basis income.

Absent any information to the contrary, the functional currency of the British subsidiary must be the British pound. To convert from the British pound to the U.S. dollar (the reporting currency), the translation (current) method is used and all income statement items are translated using the average exchange rate.

Under the translation (current) method, the assets and liabilities on the balance sheet are translated using the current exchange rate and the income statement is translated using the average exchange rate.

Accrual-based revenue will count all sales applicable to Year 2, regardless of when they are collected.

Year 2 sales include the cash receipts in Year 2 ($200,000) plus the Year 3 cash receipts applicable to Year 2 ($75,000).

Since the spot rate at year end is different from the spot rate at September 22,

a foreign currency transaction gain or loss must be recognized.

At a reporting unit level, when the fair value is less than the carrying amount, a loss on impairment is booked on the income statement (a debit)

and a reduction in goodwill (credit) is booked to the balance sheet.

Under U.S. GAAP, goodwill impairment exists because the $3,310,000 fair value of the reporting unit is less than its $3,450,000(including goodwill) carrying value of the reporting unit. After allocating $3,170,000 of the fair value of the reporting unit to its assets

and liabilities other than goodwill, the $140,000 ($3,310,000 - $3,170,000) unallocated fair value is the implied fair value of the goodwill and the goodwill impairment loss is: Goodwill implied fair value(140,000) -Goodwill book value(225,000).

Foreign currency translation gains and losses

are reported in other comprehensive income and recognized as a separate component of stockholders' equity.

Foreign Currency Transactions

are transactions with a foreign entity [e.g., buying from and selling to] denominated in [to be settled in] a foreign currency.

All relevant costs incurred before technological feasibility is established should be expensed as research and development expenditures.

After technological feasibility is established, all relevant costs are capitalized until the product is released for sale. At that point all relevant costs are included in "Inventory" (normal product costs) and charged to "Cost of Goods Sold" when sold.

Because the trademark is expected to be renewed indefinitely, there will be no amortization expense on the books.

Amortization is only recorded for intangible assets with a definite life.

Under IFRS, the goodwill impairment test is a one-step test in which the carrying value of a cash-generating unit (CGU) is compared to the CGU's recoverable amount, which is the greater of the CGU's fair value less costs to sell and its value in use (PV of future cash flows expected from the CGU).

For this CGU, the fair value less costs to sell of $955,000 is the recoverable amount because it exceeds the value in use of $940,000. The Impairment loss is: Impairment loss = Recoverable amount - Carrying value.

If the transaction is denominated in U.S. dollars, however, there is no foreign exchange gain or loss.

Foreign exchange transactions gains or losses are generally included in determining net income for the period in which exchange rates change.

The expense of $20,000 (representing the increase) should be booked now (which creates the liability), and when cash payment is made, the liability will be removed.

Given the starting point of $150,000, subtracting $5,000 and adding $20,000 will bring accrued expenses to $165,000.

A company's foreign subsidiary operation maintains its financial statements in the local currency. The foreign operation's capital accounts would be translated to the functional currency of the reporting entity using which of the following rates?

Historical exchange rate.

"Translation adjustments" are not included in determining net income for the period but are disclosed and accumulated as a component of other comprehensive income in consolidated equity until dispose of.

However, gains or losses from remeasuring the foreign subsidiary's financial statements from the local currency to the functional currency should be included in "income from continuing operations" of the parent company.

Under U.S. GAAP, impairment analysis begins with a test for recoverability in which the net carrying value of the asset is compared to the undiscounted cash flows expected from the asset.

If the net carrying value exceeds the undiscounted cash flows, then an impairment loss is recorded equal to the difference between the carrying value and fair value of the asset.

A subsidiary's financial statements are usually maintained in its local currency.

If the subsidiary's functional currency is its local currency, the subsidiary's financial statements are simply "translated" to the reporting currency.The resulting adjustment is reported as other comprehensive income.

In this problem, the value in use of $475,000 exceeds the fair value less costs to sell of $465,000 ($480,000-$15,000) and an impairment loss of $25,000 must be reported on the income statement:

Impairment loss = $475,000 recoverable amount - $500,000 carrying amount = $(25,000)

Balance sheet accounts are generally included at the current exchange rate, except for 1. A self contained subsidiary with a 3 year inflation rate of 100% or more (hyperinflationary economy). 2. A foreign entity which does not maintain its accounts in a foreign functional currency.

In these circumstances, the remeasurement method is used and the historical rates should be used only for those balance sheet accounts carried at "cost"- (most non-monetary items). Otherwise follow the general rule and use the "current" rate.

When remeasuring foreign currency financial statements into the functional currency, which of the following items would. be remeasured using historical exchange rates?

Inventories carried at cost.

Translation Gain or Loss (other comprehensive income =PUFER)>(cumulative translation adjustment)

Plug "translation adjustment" to other comprehensive income. The translation adjustment is equal to the difference between the debits and credits in the translated trial balance.

Legal costs associated with obtaining a patent on a new product are capitalized.

Research and development costs related to developing a new product, including prototype testing, design modification and engineering salaries, must be expensed.

VAT taxes (value added taxes) are similar to sale taxes.

Research expenditures must be expensed under IFRS (and U.S. GAAP). Staff training and administrative salaries must also be expensed.

Valuation of Assets and Liabilities= historical rate

The assets or liabilities resulting from foreign currency transactions should be recorded in the U.S. company's books using the exchange rate in effect at the date of the transaction.

In the case that a patent has been permanently impaired and a loss equal to its carrying amount should be recorded.

The charge against income is >> Patent Cost - Pre-Year 4 amortization x 3= Total, 1-1-Year 4 (amortization expense) >> The 63,000 would be amortized for another year (year 4) or $9,000 expense and the balance of $54,000 written off. The total charge to income is $63,000 in year 4.

The weighted average rate is used for all income statement items.

The current exchange rate at the balance sheet date is used to translate assets and liabilities.

Transaction not Settled at Balance Date (mark to market) >> A foreign exchange transaction gain or loss that is recognized in current net income must be computed at each balance sheet date on all recorded transactions denominated in foreign currencies that have not been settled.

The difference between the exchange rate used in recording the transaction in dollars and the exchange rate at the balance sheet date (current exchange rate) is an unrealized gain or loss on the foreign currency transaction.

Royalty revenue for the year = $1,800,000 x 0.05= $90,000. Since the initial $100,000 payment can be applied against future royalty payments, it should be recorded as "Deferred Revenue" (a liability).

The fact that it is is non-refundable does not change the accounting.

Capital accounts are translated into the functional currency using the historical exchange rates.

The foreign currency is normally referred to as the functional currency. The functional exchange rate is not the rate used to translate capital accounts, which would include common stock and APIC accounts.

The functional currency is the currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency.

The foreign subsidiary itself should measure its assets, liabilities, and operations using the currency of its primary economic environment.

The foreign subsidiary's functional currency is the currency of the environment in which the subsidiary primarily generates and expends cash

The functional currency of a company may be: 1. A foreign entity's local currency, which is typically the one in which the entity keeps its books; 2. The currency in which the financial statement will be presented, which is the currency of the patent company; or 3. A foreign currency other than the one in which the foreign entity maintains its books.