1. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-1 Chapter 34 Translating the financial statements of foreign operations

2. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-2 Objectives of this lecture Understand why it is necessary to translate the financial statements of foreign subsidiaries to a specific presentation currency before the consolidation process is performed Be able to translate the financial statements of a foreign operation into a particular functional currency Be able to translate the financial statements of a foreign operation into a particular presentation currency Understand which rates to use when translating the financial statements of a foreign operation

3. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-3 Introduction to translating the financial statements of foreign operations The consolidation process involves combining the financial statements of a parent and its controlled entities AASB 121 The Effects of Changes in Foreign Exchange Rates When controlled entities are foreign entities with account balances denominated in different foreign currencies, there is a need to translate these accounts to a given presentation currency before the consolidation process A single method of translation is to be used to translate the accounts of foreign subsidiaries into a particular presentation currency

4. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-4 Different classifications of currencies Reference can be made to three different types of currencies, these being local currency, functional currency, and presentation currency. These currencies can be defined as follows: Local currency: the currency used in the country in which the foreign operation is located Functional currency: AASB 121, paragraph 8, defines functional currency as ‘the currency of the primary economic environment in which the entity operates’ Presentation currency: AASB 121, paragraph 8, defines the presentation currency as ‘the currency in which the financial statements are presented’

5. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-5 Considerations of the functional currency In this lecture we will consider two situations: –First, we will consider translating the financial statements of an entity into a particular functional currency –Then we will consider how to translate the financial statements of an entity from a particular functional currency into a particular presentation currency (which is required prior to consolidation)

6. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-6 Considerations of the functional currency (cont.) If the functional currency is the same as the local currency, then there will be no need to translate the financial statements of the foreign operation into the functional currency, as the financial statements prepared in the local currency will already have been prepared in the functional currency In such circumstances we will only need to translate the foreign operation’s financial statements into the group’s presentation currency (a one-step as opposed to a two- step process)

7. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-7 Translating the accounts into a particular functional currency If a parent entity has a subsidiary located in another country then the first task to be undertaken prior to the consolidation process is to determine the functional currency of the overseas subsidiary Once the subsidiary’s accounts have been translated into the appropriate functional currency then the accounts will need to be translated to the appropriate presentation currency prior to consolidation Paragraphs 21 and 23 of AASB 121 provide the rules for translating one currency into another currency AASB 121 allows average rates to be used

8. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-8 Translating the accounts into a particular functional currency (cont.) There is a general requirement that each item of expense and revenue shall be translated at the spot exchange rate between the functional currency and the local currency on the dates the respective transactions took place In relation to non-monetary assets, such as plant and equipment, AASB 116 Property, Plant and Equipment allows that either cost or fair value be used as the basis of measurement If the cost basis is used, and consistent with paragraph 23, the rate to be used to translate the local currency to the functional currency is the spot rate as at the date the asset was originally recognised by the subsidiary

9. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-9 Translating the accounts into a particular functional currency (cont.) If fair values are used by way of undertaking revaluations, then the exchange rate to be used between the foreign currency and the functional currency will be the exchange rate in place when the valuation was made The rates to be used to translate financial statements into a given functional currency are summarised in Table 34.1 —(on slides 2-10 to 2-11)

10. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-10 Table 34.1: Summary of rates used when translating financial statements into a functional currency CategoryRate Assets Monetary Translate at the spot exchange rate at reporting rate (that is, at the closing rate) Non-monetary—held at historical cost Translate at the spot rate at the day the asset was recorded by the subsidiary Non-monetary—fair value Translate at the exchange rate at the date of valuation Liabilities MonetaryTranslate at the closing rate Non-monetaryTranslate at the exchange rate at the date of valuation Equity Share capital—at acquisition Translated at the rate when the investment acquired Reserves—at acquisitionTranslated at the rate when the investment acquired Reserves—post acquisition If the transfer to reserves is the result of a revaluation of property, plant and equipment the rate used is the rate at the date of the revaluation Retained earnings—at acquisition Translated at the rate when the investment acquired

11. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-11 Table 34.1: Summary of rates used when translating financial statements into a functional currency (cont.) Revenues and expenses Translated at the rate in place at the date of the transaction. For practical purposes, a rate that approximates the actual rate of the transaction can be used Non-monetary related expenses, e.g. depreciation Translated at the rate used to translate the related non-monetary item Distributions Dividends paidTranslated at the current rate at the date of payment Dividends declaredTranslated at the current rate at the date the dividends are declared

12. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-12 Translating the accounts into a particular functional currency (cont.) Applying the requirements of AASB 121 as they relate to translating the accounts from a local currency to a particular functional currency means that the final accounts, after translation, will reflect amounts that would be recorded had the transactions or events been originally recorded in the functional currency. Table 34.1 summarises the rates used when translating financial statements into the functional currency Refer to Worked Example 34.1 (page 1173) —Translation from a foreign currency into a functional currency

13. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-13 Translating the accounts of foreign operations into the presentation currency Before consolidating the financial statements of the parent entity and its subsidiaries it will be necessary to convert the financial statements of the various foreign subsidiaries from their respective functional currencies into the presentation currency of the parent entity Under the approach required by AASB 121 all assets and liabilities of a foreign operation are to be translated from the functional currency to the presentation currency 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

14. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-14 Translating the accounts of foreign operations into the presentation currency (cont.) 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, which was the case when we translated the financial statements from a local currency to the functional currency) The approach to translating the accounts of a foreign subsidiary from a particular functional currency to a particular presentation currency is shown Table 34.2

15. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-15 Translating the accounts of foreign operations into the presentation currency (cont.) Table 34.2 (slide 2-16) summarises the approach to translating the accounts of a foreign subsidiary Refer to Worked Example 34.2 (page 1178)—Translation of a foreign operation’s financial statements from a functional currency into a presentation currency

16. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-16 Table 34.2: Summary of the method to be applied for translating financial statements from a given functional currency to a specific presentation currency Assets Monetary assetsTranslated at closing rate Non-monetary assets—measured at historical cost Translated at closing rate Non-monetary assets—measured at fair valueTranslated at closing rate Liabilities MonetaryTranslated at closing rate Non-monetaryTranslated at closing rate Equity Share capital and reserves at date of acquisitionTranslated at spot rate when investment acquired Post-acquisition movements in share capital and reserves (excluding retained earnings/accumulated losses) Translated at the spot rate at the date they were recognised in the accounts Post-acquisition retained earningsAmount determined from translating the statement of comprehensive income (cont.)

17. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-17 Table 34.2: Summary of the method to be applied for translating financial statements from a given functional currency to a specific presentation currency (cont.) Revenues and expenses RevenuesTranslated at the rate in place as at the time of the transaction. For practical reasons, however, it is acceptable to use a rate that approximates the rate in place when the transactions took place (e.g. to use an average rate for the year) Expenses (apart from the amortisation or depreciation of non-current assets) Translated at the rate in place as at the time of the transaction. For practical reasons, however, it is acceptable to use a rate that approximates the rate in place when the transactions took place (e.g. to use an average rate for the year) Depreciation/Amortisation Translated at the average rate for the year Income tax expenseTranslated at the average rate for the year Distributions Dividends paid/declaredTranslated at the spot rate when paid/declared

18. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-18 Consolidation subsequent to translation After translation of a foreign subsidiary’s financial statements, consolidation takes place according to normal principles (refer to Chapters 27 to 31) –Cost of investment eliminated against pre-acquisition capital and reserves of controlled entities, with resultant goodwill or gain on bargain purchase 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

19. Copyright © 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 7e 2-19 Consolidation subsequent to translation (cont.) –Non-controlling interests will be determined following translation of accounts –Foreign currency translation reserve will reside in the subsidiaries’ statement of financial position before the consolidation adjustments and the non- controlling interests will be allocated a proportion of this reserve