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