Foreign Currency Financial Statements

Foreign Currency Financial Statements
Chapter 14 Foreign Currency Financial Statements Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 1

Foreign Currency Financial Statements: Objectives
Identify the factors that should be considered when determining an entity’s functional currency. Understand how functional currency assignment determines the way the foreign entity’s financial statements are converted into its parent’s reporting currency. Understand how a foreign subsidiary’s economy is determined to be highly inflationary and how this affects the conversion of its financial statements to its parent’s reporting currency. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Foreign Currency Financial Statements: Objectives (Cont.)
Understand how the investment in a foreign subsidiary is accounted for at acquisition. Understand which rates are used to translate balance sheet and income statement accounts under the current rate method and the temporal method on a translation/ remeasurement worksheet. Know how the translation gain or loss, or remeasurement gain or loss, is reported under the current rate and temporal methods. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Foreign Currency Financial Statements: Objectives (Cont.)
Know how a parent accounts for its investment in a subsidiary using the equity method depending on the subsidiary’s functional currency determination. Understand consolidation under the temporal and current rate methods. Understand how a hedge of the net investment in a subsidiary is accounted for under the current rate and temporal methods. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Functional Currency Definition: Currency of the primary economic environment in which the entity operates. Primarily, this means the currency received from customers and used to pay liabilities. Other factors include the currency: Used in setting sales prices That is dominant in the sales market Used to pay operating expenses Financing the company Used in intercompany transactions Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

2: Functional currency determines CONVERSION method
Foreign Currency Financial Statements 2: Functional currency determines CONVERSION method Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Restatement Method Selection
If the functional currency is the U.S. dollar, use the Temporal method. If the functional currency is the local currency, use the Current Rate method. Examples: A Mexican subsidiary of a U.S. firm has the peso as its functional currency. A Japanese subsidiary of a U.S. firm has the U.S. dollar as its functional currency. An Australian subsidiary of a U.S. firm, keeping its own records in Australian dollars, determines its functional currency is the euro. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Selecting the Method Local currency Functional currency
Local currency Functional currency Reporting currency Ex 1 Peso U.S.$ Translate (current rate method) from Peso to US$ Ex 2 Yen Remeasure (temporal method) from Yen to US$ Ex 3 Aus$ Euro Remeasure from Aus$ to Euros, then Translate from Euros to U.S.$ Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Exchange Rates Translation (the Current Rate method) will convert financial statements using Current (FYE): assets, liabilities Historical: equity, dividends (retained earnings is not translated) Current (average): revenues, expenses Remeasurement (the Temporal Method) will convert financial statements using Current (FYE): monetary assets, liabilities Historical: other assets, liabilities Historical: equity, dividends (retained earnings is not remeasured) Current (average) and Historical: revenues, expenses Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

3: highly inflationary economies
Foreign Currency Financial Statements 3: highly inflationary economies Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Inflation and Functional Currency
For subsidiaries of U.S. firms in highly inflationary economies, assume that the functional currency is the U.S. dollar. Remeasure the statements using the Temporal method. Highly inflationary = cumulative inflation of 100% or more over 3 years. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Translation at Acquisition
Foreign assets and liabilities are translated using the current rate at the date of acquisition. If functional currency = local currency Translation is appropriate Analysis of fair value/book value differentials is performed in local currency Results are translated at current rates Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Remeasurement at Acquisition
Foreign assets and liabilities are translated using the current rate at the date of acquisition. If functional currency = US$ or reporting currency Remeasurement is appropriate Analysis of fair value/book value differentials is performed in U.S.$ The 'earliest' historical rate generally used in remeasurement is the date of the acquisition. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Noncontrolling Interest
For both, remeasurement and translation, the consolidation process is applied to the financial statements as restated in U.S.$. Measures of noncontrolling interest, noncontrolling interest share, and controlling interest share are computed in U.S.$. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

5: current rate method and temporal method
Foreign Currency Financial Statements 5: current rate method and temporal method Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Liabilities and Equity
Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Revenues and Expenses Note that "current" rate, as used for income statement items, is usually the average rate for the year. Firms with seasonal business fluctuations would use a weighted average rate. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

6: Translation adjustments and remeasurement gain/loss
Foreign Currency Financial Statements 6: Translation adjustments and remeasurement gain/loss Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Current Rate Method: Example
Translate the adjusted trial balance: Assets and Liabilities at the year-end (“current”) rate Equity at the historical rate (from the date of the related transaction) Except Retained Earnings which is a composite rate from each year Revenues and Expenses will be at the average rate for the related period The entry needed to balance the trial balance after the translation is complete will be an entry to Accumulated Other Comprehensive Income, and thus will appear on the balance sheet. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Current Rate Method: Example (cont.)
See calculation, next slide… Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Current Rate Method: Example (cont.)
Because all debit and credit balances are not translated using the same exchange rate, the trial balance will not balance at the end of the translation. In this example, the debits happen to be $28,600 less than the credits. This is the debit to accumulated OCI at the end of the year. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Temporal Method: Example
Remeasure the adjusted trial balance: Monetary Assets and Liabilities at the year-end (“current”) rate Non-monetary Assets and Liabilities at the rate from the date of transaction (“historical”) Equity at the historical rate (from the date of the related transaction) Except Retained Earnings which is a composite rate Revenues and most Expenses will be at the average rate for the related period Cost of Goods Sold, Depreciation and Amortization Expense at the historical rate of the related asset The entry needed to balance the trial balance after the translation is complete will be an Exchange Gain/(Loss), and thus will appear on the income statement. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 14-25

Temporal Method: Example (cont.)
See calculation, next slide… Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Temporal Method: Example (cont.)
Because all debit and credit balances are not translated using the same exchange rate, the trial balance will not balance at the end of the translation. In this example, the debits happen to be $3,300 less than the credits. This is the exchange loss for the year. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Adjustment Summary Remeasurement results in Exchange gains or losses on the income statement Credit to balance = exchange gain Debit to balance = exchange loss Include the gain or loss in calculating net income in U.S. dollars. Translation results in Translation adjustment, part of accumulated other comprehensive income Include as part of stockholders' equity Debit to balance = deduct from equity Credit to balance = add to equity Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

The Difference in Methodology
The ultimate goal is consolidation. Use the Temporal method when the U.S. dollar is the functional currency of the subsidiary, to best reflect the relationship of the subsidiary as an extension of the parent, and thus the remeasurement adjustment is part of the current period income. Use the Current Rate method when the local currency is the functional currency of the subsidiary, to best reflect the subsidiary’s status as a free-standing company in whom the parent is merely invested, thus the translation adjustment is shown in the equity section of the parent’s balance sheet. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Equity Method Investee
A U.S. firm has a foreign investment it accounts for under the equity method. If functional currency is the local currency, then translation is appropriate At acquisition Analyze fair value and book value, compute goodwill – in local/functional currency Annually Translate statements into U.S. dollars Record other comprehensive income for translation adjustment Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Equity Method Entries 12/31/11 Investment in Star 525,000 Cash Acquisition cost 12/1/12 42,600 Dividends received, at current exchange rate 12/31/12 93,200 OCI, translation adjustment 28,600 Income from Star 121,800 Year-end adjustment for income The income is from the translated income statement, with appropriate amortizations for fair value/book value differences. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Amortization of Differentials
On 12/31/11, Pat acquired Star. Star had unrecorded patent of £100,000. The exchange rate was $1.50. The patent is amortized over 10 years. The average and year-end exchange rates are $1.45 and $1.40. 12/31/11 Patent £100,000 $1.50 $150,000 2012 Amortization expense £10,000 $1.45 $14,500 12/31/12 £90,000 $1.40 $126,000 OCI translation adjustment for patent is $9,500. $150,000 – 14,500 – 126,000 = $9,500 The adjustment brings the net value of the patent to its translated year-end amount of $126,000. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Consolidating Foreign Subsidiaries
The parent uses the appropriately translated or remeasured subsidiary financial statements in its consolidation worksheet. Income from the subsidiary and Investment in subsidiary are eliminated. Subsidiary equity accounts are eliminated (including accumulated OCI). Worksheet procedures are similar to that for domestic subsidiaries. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Worksheet – Income Statement
Star's balances come from the translated statements. Current amortization for the patent is recorded. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Worksheet - Assets The Investment in Star and intercompany receivables are eliminated. Differentials from acquisition are recorded – the patent and its current amortization. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Worksheet – Liabilities & Equity
Intercompany payable is eliminated. All of the subsidiary equity is eliminated, including Accumulated OCI. Parent's Accumulated OCI contains impact of translation adjustments. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Hedge a Foreign Investment
Investee's functional currency = local currency Effective hedges qualify for hedge treatment "Gains or losses" are translation adjustments which are included in accumulated OCI Investee's functional currency = reporting currency "Hedging" is treated as speculative Gains or losses are recognized in income for the current financial period Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall

Foreign Currency Financial Statements

Similar presentations

Presentation on theme: "Foreign Currency Financial Statements"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Foreign Currency Financial Statements

Similar presentations

Presentation on theme: "Foreign Currency Financial Statements"— Presentation transcript:

Similar presentations

About project

Feedback