Advanced Accounting, Fourth Edition 13 Translation of Financial Statements of Foreign Affiliates Advanced Accounting, Fourth Edition

Translation of Financial Statements A U.S. company may be involved in foreign activities through the operations of a: branch, subsidiary, or investee company. Accounts of foreign activities, maintained in a foreign currency, must be restated into U.S. dollars before they are combined or consolidated or the equity method of accounting applied.

Accounting for Operations in Foreign Countries A foreign subsidiary is consolidated if the parent company owns, directly or indirectly, a controlling interest in the voting stock of the subsidiary. Exceptions include: The intent to control is likely to be temporary. Control does not actually rest with the parent company. Restriction on withdrawal of assets Exchange restrictions. Foreign statements that are not in conformity with GAAP in the United States must be adjusted to conform to U.S. standards before conversion into U.S. dollars.

Translating Statements of Foreign Affiliates The conversion from another currency into the currency of the parent company is frequently called “translation.” Translation Process Current Exchange Rate Financial Statements in Euros Financial Statements in U.S. Dollars Historical Exchange Rate LO 1 Current versus historical exchange rates.

Translating Statements of Foreign Affiliates Translation Adjustment or Translation Gain or Loss The difference between translating some accounts using the current exchange rate and others using the historical exchange rate. Current standards require the translation gain or loss be reported currently in income or as a component of stockholders’ equity, depending on the method used to translate the accounts. Not a Choice LO 1 Current versus historical exchange rates.

Objectives of Translation-SFAS No. 52 Functional Currency Concept Objective of Translation - SFAS No. 52 [ASC 830-30]: Provide information regarding the exposed economic effects of an exchange rate change on an enterprise’s cash flows and equity [par. 4(a)]. Reflect in consolidated statements the financial results measured in their functional currencies in conformity with U.S. GAAP [par. 4(b)]. The Board believes that the operating performance and financial condition of a foreign entity are best measured by expressing its accounts in the currency of the economic environment in which it primarily conducts its operations and generates and expends its cash, its functional currency. LO 2 Objectives of translation.

Translation Methods Current rate method All assets and liabilities. Revenues and expenses. Translation Current exchange rate. Exchange rate on the date each transaction occurred. LO 4 Two methods of conversion.

Translation Methods Temporal Method Translation Monetary assets and liabilities (cash, a/r, a/p). Assets and liabilities carried at historical cost. Assets and liabilities carried at current values. Revenues and expenses related to assets and liabilities translated at historical rates. Other revenues and expenses. Translation Current exchange rate. Historical exchange rates. Exchange rate on date transaction occurred. LO 4 Two methods of conversion.

Identifying the Functional Currency The Functional Currency may be The local currency of the foreign entity, The U.S. dollar, or The currency of a third country. Economic Indicators of Functional Currency: Cash flow Sales prices Sales market Expenses Financing Intercompany transactions LO 3 Identifying the functional currency.

Identifying the Functional Currency Review Question Indicators that the local currency is also the functional currency include all of the following except: The majority of the cash flows are in the local currency. Sales prices are determined by local market conditions. Financing is generally from the parent or guaranteed by the parent. Production costs and expenses are determined by local conditions. LO 3 Identifying the functional currency.

Translation of Foreign Currency Financial Statements Remeasurement is the process of translating the accounts of a foreign entity into its functional currency when they are stated in another currency. Translation. Accounts measured in the functional currency are translated into the reporting currency using the current rate method. “Translation” may be used synonymously with the current method, “remeasurement” is used synonymously with the temporal method. LO 4 Which methods of conversion to use.

Translation of Foreign Currency Financial Statements Foreign Entity Operates in Highly Inflationary Economy It is the Board’s belief that the currency of a country that has a highly inflationary economy has lost its utility as a store of value and cannot be a functional measuring unit. This means the foreign financial statements should be translated using the temporal method. LO 6 Factors in a highly inflationary economy.

Translation of Foreign Currency Financial Statements Foreign Entity in Economy that is Not Highly Inflationary Functional currency must be identified. Translation process: Local currency is the functional currency. Current rate method. Translation adjustment recorded as a component of stockholders’ equity. U.S. dollar is the functional currency. Temporal method. Translation adjustment reported in income statement.

Translation of Foreign Currency Financial Statements Books kept in local currency Local currency Remeasure- ment Not necessary Temporal method Temporal method Local currency U.S. dollar A third currency Functional currency Current rate method Not necessary Current rate method Translation U. S. dollars U.S. dollar

Translation – Current Rate Method Assets and liabilities Paid-in capital Beginning R/E Dividends Revenue and Expenses Cumulative translation adjustment Current year translation adjustment Current exchange rate Historical rate Ending balance of last year Historical rate when dividend is declared Average exchange rate Balance amount in the balance sheet Other comprehensive income (shareholders’ equity) LO 7 The functional currency is the local currency.

Translation – Current Rate Method Exercise 13-4: On January 1, 2008, Trenten Systems, a U.S.-based company, purchased a controlling interest in Grant Management Consultants located in Zurich, Switzerland. Direct exchange rates for Swiss franc are: Dollars per Franc January 1, 2008 $.5987 December 31, 2008 .5321 Average for 2008 .5654 Dividend declaration and payment date .5810 Required: Translate the year-end balance sheet and income statement of the foreign subsidiary using the current rate method of translation. LO 7 The functional currency is the local currency.

Translation – Current Rate Method Exercise 13-4: (Current Rate Method)

Translation – Current Rate Method Review Question Under the current method of currency translation, which of the following balance sheet accounts is translated at historical exchange rates? Cash Accounts Receivable Bonds Payable Common Stock LO 7 The functional currency is the local currency.

Translation – Temporal Method Monetary assets and liabilities (cash, a/r, a/p). Assets and liabilities carried at historical cost. Assets and liabilities carried at current values. Revenues and expenses related to assets and liabilities translated at historical rates. Other revenues and expenses. Translation Current exchange rate. Historical exchange rates. Exchange rate on date transaction occurred. LO 8 The functional currency is the U.S. dollar.

Translation – Temporal Method Exercise 13-5: On January 1, 2008, Trenten Systems, a U.S.-based company, purchased a controlling interest in Grant Management Consultants located in Zurich, Switzerland. Direct exchange rates for Swiss franc are: Dollars per Franc January 1, 2008 $.5987 December 31, 2008 .5321 Average for 2008 .5654 Dividend declaration and payment date .5810 Required: Convert (remeasure) the financial statements of the foreign subsidiary using the temporal method of translation. LO 7 The functional currency is the local currency.

Translation – Temporal Method Exercise 13-5: (Temporal Method)

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