30-1 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translating the financial statements of foreign operations Chapter 30

30-2 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Learning objectives Understand why it is necessary to translate the accounts of foreign subsidiaries to NZ dollars before the consolidation process is performed Understand what rates to use when translating the accounts of a foreign operation Understand that any gain or loss on translation of a foreign operation’s accounts is to go to equity and not be treated as part of the profit or loss of the period (until such time as the foreign operation is sold)

30-3 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Introduction to translating the accounts of foreign operations Consolidation process involves combining the accounts of a parent and its controlled entities If some of the controlled entities are foreign entities with account balances denominated in foreign currencies, there is a need to translate these accounts to a given presentation currency (e.g. New Zealand dollars) before the consolidation process Accounting standard relating to the translation of foreign subsidiaries is NZ IAS 21 ‘Accounting for the Effects of Changes in Foreign Currency Exchange Rates’ (Continues)

30-4 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Introduction to translating the accounts of foreign operations (cont.) Note NZ IAS 21 permits selection of a presentation currency, which need not be New Zealand dollars A single method of translation is to be used to translate the accounts of foreign subsidiaries into a particular presentation currency

30-5 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations Under approach required by NZ IAS 21: All assets and liabilities of a foreign operation are basically translated using the spot rate applicable at reporting date Income and expenses are translated at the exchange rates in place at the dates of the various transactions If expense and revenue transactions are considered to occur uniformly throughout the period, average rates may be used Any resulting translation gains or losses are taken directly to reserves (rather than to profit or loss) Refer to NZ IAS 21, pars 39, 40 and 41 (Continues)

30-6 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Gains or losses on translation If the assets of the foreign operation exceed its liabilities (shareholders’ funds are positive) and if the value of the New Zealand dollar falls relative to the currency of the foreign operation, there will be a credit to the foreign currency translation reserve — otherwise, there will be a debit to the foreign currency translation reserve (Continues)

30-7 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Note that NZ IAS 21 (par. 39) outlines method for translating the assets, liabilities, income and expenses of a foreign entity but is silent on the translation of: – equity at the date of investment, that is pre-acquisition capital and reserves – post-acquisition movements in equity other than retained profits or accumulated losses; and – distributions from retained profits. (Continues)

30-8 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Approach to translating the accounts of a foreign subsidiary is as follows (refer to p.1221): (a)Assets and liabilities are translated at the exchange rate current at reporting date (b)Equity at the date of the investment, including in the case of a corporation, share capital at acquisition and pre-acquisition reserves, is translated at the exchange rate current at that date (c)Post-acquisition movements in equity, other than retained profits (surplus) or accumulated losses (deficiency), are translated at the exchange rates current at the date of those movements, except that where a movement represents a transfer between items within equity the movement is translated at the exchange rate current at the date that the amount transferred or returned was first included in equity (d)Distributions from retained profits (that is, dividends paid or proposed, or their equivalent) are translated at the exchange rates current at the dates when the distributions were first proposed (e)Revenue and expense items are translated at the exchange rates current at the applicable transaction dates (Continues)

30-9 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Summary of the method to be applied for foreign currency translation (Table 30.1, p. 1221) ITEM RATE Income statement items Revenues Average rate for the year Expenses (apart from the Average rate for the year amortisation or depreciation of non-current assets) Depreciation/Amortisation Average rate for the year Income tax expense Average rate for the year Dividends paid/proposed Rate when paid/proposed (Continues)

30-10 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Summary of the method to be applied for foreign currency translation (per table 30.1, p. 1221) ITEM RATE Balance sheet items Assets Rate at reporting date Liabilities Rate at reporting date Share capital and reserves Rate when investment acquired at the date of acquisition Post-acquisition movements Rate at the date they were share capital and reserves recognised in the accounts (excluding retained earnings/ accumulated losses) Post-acquisition retained Amount determined from income earnings statement (Continues)

30-11 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Refer to Worked Example 30.1, 'Translation from a foreign currency into a functional currency', pp. 1222–5 Note foreign currency translation reserve – All assets and liabilities of the foreign subsidiary are translated at the reporting date spot rate – Individual components of owners’ equity translated differently  Share capital translated using the rate in place when the investment was acquired  Retained earnings is the balance provided from the income statement  Translation gain remains part of equity (Continues)

30-12 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Translation of the accounts of foreign operations (cont.) Foreign currency translation reserve (cont.) Net assets at reporting date (current rate) XXXX Less components of net assets at their historical rates: – Share capital (XXXX) – Retained earnings from income statement (XXXX) Translation gain $XXX to foreign currency translation reserve Assuming the exchange rate has moved against the New Zealand $: Assets exceed liabilities — a gain would arise on the assets and a loss would arise on the liabilities As assets exceed liabilities, a net gain is credited to the foreign currency translation reserve

30-13 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Consolidation subsequent to translation After translation of foreign subsidiary’s financial statements, consolidation takes place according to normal principles (refer to Chs 24 to 26) – Cost of investment eliminated against pre-acquisition capital and reserves of controlled entities, with resultant goodwill or discount being recognised – Pre-acquisition capital and reserves are translated at the rates in place when the investment was acquired, i.e. same rates used each year so the goodwill or discount recognised on consolidation does not fluctuate (Continues)

30-14 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Consolidation subsequent to translation (cont.) – Minority interests will be determined following translation of accounts – Foreign currency translation reserve will reside in the subsidiaries’ balance sheets before the consolidation adjustments and the minority interests will be allocated a proportion of this reserve – Inter-entity sales of inventory are eliminated

30-15 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Summary NZ IAS 21 ‘The Effects of Changes in Foreign Exchange Rates’ effects considerable changes to the requirements previously contained in AASB 1012 ‘Foreign Currency Translation’ No longer are foreign operations classified as either self-sustaining (current-rate method adopted for translation) or integrated (temporal method adopted for translation) NZ IAS 21 requires only one approach to be used for translating the accounts of foreign operations — basically equivalent to the current-rate method (Continues)

30-16 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Summary (cont.) All assets and liabilities of a foreign operation are basically translated using the spot rate applicable at reporting date Income and expenses are translated at the exchange rates in place at the dates of the various transactions If expense and revenue transactions are considered to occur uniformly throughout the period, average rates may be used Any resulting translation gains or losses are taken directly to reserves (rather than to profit or loss)