2. 13 - 1 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Foreign Currency Financial Statements Chapter 13

3. 13 - 2 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 1 Understand the functional currency concept.

4. 13 - 3 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Application of the Functional Currency Concept A foreign subsidiary’s foreign currency statements must be in conformity with U.S. GAAP before translation into U.S. dollars. Adjustments are required before translation is performed.

5. 13 - 4 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Application of the Functional Currency Concept All account balances on the balance sheet date denominated in a foreign currency (from the foreign entity’s point of view) are adjusted to reflect current exchange rates.

6. 13 - 5 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Application of the Functional Currency Concept Under the functional currency concept, a foreign entity’s assets, liabilities, and operations must be measured in its functional currency.

7. 13 - 6 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Application of the Functional Currency Concept Subsequently, the foreign entity’s balance sheet and income statement are consolidated (subsidiary) or combined (branch) with those of the reporting enterprise’s currency. $ £¥ €

8. 13 - 7 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 2 Determine a subsidiary’s functional currency.

9. 13 - 8 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation Translation involves expressing functional currency measurements in the reporting currency. Current rate method

10. 13 - 9 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Remeasurement When the foreign entity’s books are not maintained in its functional currency, the foreign currency financial statements must be remeasured into the functional currency. Temporal method

11. 13 - 10 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Remeasurement Monetary assets and liabilities Current exchange rates Nonmonetary items Historical rates

12. 13 - 11 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 3 Produce financial statements using translation or remeasurement, or both.

13. 13 - 12 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation and Remeasurement of Foreign Currency Financial Statements Patriot Corporation, a U.S. company, has a wholly-owned subsidiary, Regal Corporation, that operates in England.

14. 13 - 13 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation and Remeasurement of Foreign Currency Financial Statements Case 1British poundsBritish poundsTranslation Case 2U.S. dollarBritish poundsRemeasurement Case 3EuroBritish poundsRemeasurement and translation Currency of Required Procedures Functional Accountingfor Consolidating CurrencyRecords or Combining

15. 13 - 14 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Intercompany Foreign Currency Transactions These transactions are foreign currency transactions if they produce receivable or payable balances denominated in a currency other than the entity’s (parent’s or subsidiary’s) functional currency.

16. 13 - 15 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Intercompany Foreign Currency Transactions A U.S. parent company borrows $1,600,000 (£1,000,000) from its British subsidiary. Case 1British poundBritish poundNoYes Case 2British poundU.S. dollarYesYes Case 3U.S. dollarBritish poundYesNo Case 4U.S. dollarU.S. dollarNoNo Loan Functional Foreign Currency Denominated Currency ofTransaction of Currency Subsidiary Subsidiary? Parent?

17. 13 - 16 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Foreign Entities Operating in Highly Inflationary Economies The reporting currency (the U.S. dollar) is used to remeasure the financial statements of foreign entities in highly inflationary economies. Price-level-adjusted financial statements are not basic financial statements under GAAP.

18. 13 - 17 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Foreign Entities Operating in Highly Inflationary Economies Statement No. 52 defines a “highly inflationary economy” as one with a cumulative three-year inflation rate of 100% or more.

19. 13 - 18 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Business Combinations The assets and liabilities of a foreign entity are translated into U.S. dollars using the current exchange rate in effect on the date of the business combination. Cost/book value differential Minority interest

20. 13 - 19 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 4 Apply the current rate translation method.

21. 13 - 20 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation Under Statement No. 52 On December 31, 2003, Pat Corporation, a U.S. firm, paid $525,000 cash to acquire all the stock of the British firm, Star Company. The book value of Star’s net assets was $375,000, which was equal to the fair value. The British pound exchange rate was $1.50.

22. 13 - 21 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation Under Statement No. 52 Assets Cash140$1.50210 Accounts receivable 40 1.50 60 Inventories (cost)120 1.50180 Plant assets100 1.50150 Less: Accumulated depr.–20 1.50–30 Total assets380570 British ExchangeU.S. (000) Pounds Rate Dollars

23. 13 - 22 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation Under Statement No. 52 Equities Accounts payable 30$1.50 45 Bonds payable100 1.50150 Capital stock200 1.50300 Retained earnings 50 1.50 75 Total equities380570 British ExchangeU.S. (000) Pounds Rate Dollars

24. 13 - 23 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation Under Statement No. 52 The 2004 year-end exchange rate was $1.40. Average exchange rates for 2004 were $1.45. Star paid £30,000 dividends on December 1, 2004, when the exchange rate was $1.42 per British pound. The only intercompany transaction was an $84,000 (£56,000) non-interest-bearing advance by Star to Pat made on January 4, 2004, when the exchange rate was still $1.50.

25. 13 - 24 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation Under Statement No. 52 What is Star’s adjustment at year end? Advance to Pat£4,000 Exchange Gain£4,000 To adjust receivable denominated in dollars [($84,000 ÷ $1.40) – £56,000 per books]

26. 13 - 25 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Star Company Translation Worksheet for 2004 Cash110$1.40 154.0 Accounts receivable 80 1.40 112.0 Inventories (FIFO)120 1.40 168.0 Plant assets100 1.40 140.0 Advance to Pat 60 1.40 84.0 Cost of sales270 1.45 391.5 Depreciation 10 1.45 14.5 Wages and salaries120 1.45 174.0 Other expenses 60 1.45 87.0 Dividends 30 1.42 42.6 Accumulated income – 28.6 9601,396.2 ₤ TrialTranslation$ Trial Debits (000) Balance RateBalance

27. 13 - 26 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Star Company Translation Worksheet for 2004 Accumulated depreciation 30$1.40 42.0 Accounts payable 36 1.40 50.4 Bonds payable100 1.40 140.0 Capital stock200 1.50 300.0 Retained earnings 50 computed 75.0 Sales540 1.45 783.0 Exchange gain (advance) 4 1.45 5.8 9601,396.2 ₤ TrialTranslation$ Trial Credits (000) Balance RateBalance

28. 13 - 27 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Star Company Income and Retained Earnings Statement for the Year 2004 Sales$783,000 Less costs and expenses Cost of sales$391,500 Depreciation 14,500 Wages and salaries 174,000 Other expenses 87,000 667,000 Operating income$116,000 Exchange gain 5,800 Net income$121,800 Retained earnings January 1, 2004 75,000 $196,800 Less: Dividends 42,600 Retained earnings December 31, 2004$154,200

29. 13 - 28 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Star Company Balance Sheet at December 31, 2004 Assets Cash$154,000 Accounts receivable 112,000 Inventories 168,000 Plant assets 140,000 Less: Accumulated depreciation – 42,000 Advance to Pat 84,000 $616,000 Equities Accounts payable$ 50,400 Bonds payable 140,000 Capital stock 300,000 Retained earnings 154,200 Accumulated other comprehensive income – 28,600 $616,000

30. 13 - 29 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Equity Method of Accounting What is Pat’s entry to record receipt of the £30,000 ($42,600) dividend ? Cash$42,600 Investment in Star$42,600 To record dividend received

31. 13 - 30 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Patent Amortization $525,000 – $375,000 = $150,000 $150,000 ÷ $1.50 = £100,000 £100,000 ÷ 10 years × $1.45 = $14,500 Pat’s Books Income from Star14,500 Other Comprehensive Income: Equity Adjustment from Translation 9,500 Investment in Star24,000

32. 13 - 31 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Equity Adjustment £10,000 amortization × ($1.50 – $1.45) exchange rate decline to midyear$ 500 £90,000 unamortized patent × ($1.50 – $1.40) exchange rate decline for the year 9,000 Equity adjustment$9,500 Alternatively, the $9,500 equity adjustment can be computed as follows:

33. 13 - 32 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Investment in Foreign Subsidiary (Summary) Changes is Pat’s investment in Star account during 2004: Investment cost December 31, 2003$525,000 Less: Dividends received 2004 – 42,600 Add: Equity in Star’s net income 121,800 Less: Unrealized loss on translation – 28,600 Less: Patent amortization – 14,500 Less: Unrealized translation loss on patent – 9,500 Investment balance December 31, 2004$551,600

34. 13 - 33 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidation Working Papers for the Year Ended December 31, 2004 Adjustments/ Consol- Pat Star Eliminations idated Sales Income from Star Cost of sales Depreciation Wages and salaries Other expenses Exchange gain Net income Retained earnings – Pat Retained earnings – Star Dividends Retained earnings 12/31/04 $1,218.3 107.3 (600) (40) (300) (150) $ 235.6 $ 245.5 (100) $ 381.1 $783 (391.5) (14.5) (174) (87) 5.8 $121.8 $ 75 (42.6) $154.2 a 107.3 c 14.5 b 75 a 42.6 $2,001.3 (991.5) (54.5) (474) (251.5) 5.8 $ 235.6 $ 245.5 (100) $ 381.1 Income Statement (000)

35. 13 - 34 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Consolidation Working Papers for the Year Ended December 31, 2004 Cash Accounts receivable Inventories Plant assets Accumulated depreciation Advance to Pat Investment – Star Patent Accounts payable Advance from Star Bonds payable Capital stock retained earnings Other income $ 317.6 150 300 400 (100) 551.6 $1,619.2 $ 142.2 84 250 800 381.1 (38.1) $1,619.2 $154 112 168 140 (42) 84 $616 $ 50.4 140 300 154.2 (28.6) $616 d 84 a 64.7 b 486.9 b 140.5c 14.5 d 84 b 300 b 28.6 $ 471.6 262 468 540 (142) 126 $1,725.6 $ 192.6 390 800 381.1 (38.1) $1,725.6 Balance Sheet (000) Adjustments/ Consol- Pat Star Eliminations idated

36. 13 - 35 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 5 Apply the temporal translation method.

37. 13 - 36 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Remeasurement Under Statement No. 52 RemeasurementTemporal method TranslationCurrent rate method The objective of remeasurement is to produce the same results as if the books had been maintained in the U.S. dollar.

38. 13 - 37 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Remeasurement Under Statement No. 52 Under remeasurement procedures, the $150,000 patent value is not adjusted for subsequent changes in exchange rates. Annual amortization = $15,000

39. 13 - 38 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Remeasurement Under Statement No. 52 The £56,000 ($84,000) advance to Pat is not a foreign currency transaction of either Pat or Star. Star’s monetary items other than the intercompany advance are remeasured at current exchange rates.

40. 13 - 39 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The Equity Method Investment in Star$525,000 Cash$525,000 To record acquisition on December 31, 2003

41. 13 - 40 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn The Equity Method Cash$42,600 Investment in Star$42,600 To record dividends received on December 1, 2004 Investment in Star$87,600 Income from Star$87,600 To record investment income for 2004 equal to Star’s $102,600 net income less $15,000 patent amortization

42. 13 - 41 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Income and Retained Earnings Statements for the Year Ended 12/31/04 Sales$2,001,300$2,001,300 Less:Cost of sales 991,500 1,001,100 Wages and salaries 474,000 474,000 Other expenses 237,000 237,000 Depreciation 54,500 55,000 Patent amortization 14,500 15,000 Operating income$ 229,800$ 219,200 Exchange gain (loss) 5,800 – 3,300 Net income$ 235,600$ 215,900 Retained earnings 01/01/04 245,500 245,500 $ 481,100$ 461,400 Less:Dividends 100,000 100,000 Retained earnings 12/31/04$ 381,100$ 361,400 ConsolidatedTranslation Remeasurement

43. 13 - 42 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Balance Sheets for the Year Ended 12/31/04 Assets Cash $ 471,600$ 471,600 Accounts receivable 262,000 262,000 Inventories 468,000 470,400 Plant assets 540,000 550,000 Less: Accumulated depreciation – 142,000 – 145,000 Patent 126,000 135,000 Total assets$1,725,600$1,744,000 ConsolidatedTranslation Remeasurement

44. 13 - 43 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Balance Sheets for the Year Ended 12/31/04 Liabilities Accounts payable$ 192,600$ 192,600 Bonds payable 390,000 390,000 Total liabilities$ 582,600$ 582,600 Stockholders’ Equity Capital stock$ 800,000$ 800,000 Retained earnings 381,100 361,400 Other income – 38,100– Total stockholders’ equity$1,143,000$1,161,400 Total liabilities and stockholders’ equity$1,725,600$1,744,000 ConsolidatedTranslation Remeasurement

45. 13 - 44 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Translation With Minority Interest On January 1, 2003, Pacific Corporation, a U.S. firm, paid $232,500 cash to acquire a 90% interest in Sea, a foreign company. Sea’s stockholders’ equity consisted of 1,000,000 LCU capital stock and 500,000 LCU retained earnings. The exchange rate was $0.15. Pacific designated Sea’s functional currency to be the subsidiary’s local currency unit.

46. 13 - 45 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Minority Interest Stockholders’ equity January 1 $202,500$22,500$225,000 Net income 21,600 2,400 24,000 Dividends – 14,400 – 1,600 – 16,000 Equity adjustment 27,450 3,050 30,500 Stockholders’ equity December 31$237,150$26,350$263,500 10% to 90% toMinority PacificInterests Total

47. 13 - 46 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn End of Chapter 13