Advanced Accounting Jeter ● Chaney Translation of Financial Statements of Foreign Affiliates Prepared by Sheila Ammons, Austin Community College Learning Objectives • • • • Distinguish between the current exchange rate and the historical exchange rate • Distinguish between the circumstances under which each of the two methods is appropriate under current GAAP Understand the objectives of financial statement translation Identify the functional currency of a foreign entity Compare the two methods used to convert the financial statements of a foreign entity into U.S dollars Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives • • • • • Explain the factors involved in translating the statements of a foreign entity operating in a highly inflationary economy Translate the statements of a foreign entity when the functional currency is the local currency Translate the statements of a foreign entity when the functional currency is the U.S dollar Understand the concept of comprehensive income in the context of foreign currency translation Identify the disclosure requirements for firms with foreign entities Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation of Financial Statements • A U.S company may be involved in foreign activities through the operations of a: • If the foreign entity maintains its books in a foreign currency, – branch, – subsidiary, or – investee company – Its accounts must be restated into U.S dollars before they are combined or consolidated or the equity method of accounting applied Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 • Government imposed: – Restriction on withdrawal of assets – Exchange restrictions Foreign statements that are not in conformity with U.S GAAP must be adjusted to conform to U.S standards before conversion into U.S dollars Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translating Statements of Foreign Accounting for Operations in Foreign CountriesAffiliates • The conversion from another currency into the currency of the parent company is frequently called “translation.” Translation Process Current Exchange Rate Financial Statements in U.S Financial Statements in Euros Dollars Historical Exchange Rate LO Current versus historical exchange6 rates Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 accounting standards require the translation adjustment (gain or loss) be reported – currently in income or – deferred as a component of stockholders’ equity, – depending on the method used to translate the accounts Not a Choice LO Current versus historical exchange7 rates Copyright © 2015 John Wiley & Sons, Inc All rights reserved Objectives of Translation Functional Currency Concept • • Objectives of translation – FASB ASC section 830-30: Provide information regarding the exposed economic effects of an exchange rate change on an enterprise’s cash flows and equity • Reflect in consolidated statements the financial results and relationships measured in their functional currencies in conformity with U.S GAAP 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 The objectives of translation Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation Methods • To accomplish the objectives of translation, two translation methods are used depending on the functional currency of the foreign entity • Current rate method Temporal method Current rate method – – All assets and liabilities are translated at current exchange rate Revenues and expenses are translated at the exchange rate on the date which each transaction occurred • An appropriate average rate can be used LO Two methods of conversion Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation Methods • Temporal Method – – – – – Monetary assets and liabilities (cash, a/r, a/p) • Translated at current exchange rate Assets and liabilities carried at historical cost • Translated at historical exchange rates Assets and liabilities carried at current values • Translated at current exchange rate Revenues and expenses related to assets and liabilities translated at historical rates • Translated at historical exchange rates Other revenues and expenses • Translated at exchange rate on date transaction occurred 10 LO Two methods of conversion Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Which methods of conversion13to use Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation of Foreign Currency Financial Statements Accounts stated in local currency of foreign entity Is the foreign economy highly Determine the functional currency (FC) per No inflationary? economic indicators Yes Functional currency (FC) is Is the FC the U.S dollar? U.S Dollar No Is the FC the local currency? Yes Yes No Translate to Remeasure to U.S dollars using Remeasure to U.S dollars using current rate temporal method FC using temporal method method LO Which methods of conversion14to use Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 15 LO Foreign entity operating in a highly inflationary economy Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation of Foreign Currency Financial Statements Foreign Entity Operates 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 separate component of stockholders’ equity – U.S dollar is the functional currency • Temporal method; Translation adjustment reported in income statement – Functional currency is the currency of a third country • Remeasure using temporal method, remeasured functional amounts are translated; Translation gain or loss (temporal)is reported in income and adjustment (current rate) is recorded as a separate component of stockholders’ equity 16 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation of Foreign Currency Financial Statements Books kept in Local currency Remeasurement local currency Not necessary Temporal Temporal method method Functional Local U.S A third currency currency dollar currency Translation Current rate method Not necessary Current rate method U.S dollar U S dollars 17 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Current Rate Method • Current Rate Method  Assets and liabilities  Paid-in capital  Beginning R/E •  Dividends  Revenue and Expenses  Cumulative translation adjustment  Current year translation adjustment Translation  Current exchange rate  Historical rate  Equals 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) 18 LO The functional currency is the local currency Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Current Rate Method Exercise 13-4: On January 1, 2014, 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, 2014 $.5987 December 31, 2014 5321 Average for 2014 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 19 LO The functional currency is the local currency Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Current Rate Method Exercise 13-4: (Current Rate Method) 20 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Current Rate Method Exercise 13-4: Prepare a schedule to verify the translation adjustment Swiss Translation Francs Exposed net asset position - 1/1 Rate 30,000 $ $.5987 17,961 5654 25,443 Adjustment for changes in net asset position: Net Dividends income 45,000 (15,000) 5810 Net asset position translated (8,715) - Exposed net asset position - 12/31 60,000 Cumulative translation adjustment (debit) 34,689 5321 31,926 (2,763) 21 LO The functional currency is the local currency Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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? a) b) c) d) Cash Accounts Receivable Bonds Payable Common Stock 22 LO The functional currency is the local currency Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Temporal Method • Temporal Method – – – – Monetary assets and liabilities (cash, a/r, a/p) – Other revenues and expenses 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 • Translation – – – – – Current exchange rate Historical exchange rates Current exchange rate Historical exchange rates Exchange rate on date transaction occurred LO The functional currency is the U.S.23dollar Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Temporal Method Exercise 13-5: On January 1, 2014, 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, 2014 $.5987 December 31, 2014 5321 Average for 2014 5654 Dividend declaration and payment date 5810 Required: Convert (remeasure) the financial statements of the foreign subsidiary using the temporal method of translation 24 LO The functional currency is the local currency Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Temporal Method Exercise 13-5: (Temporal Method) 25 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Temporal Method Exercise 13-5: Prepare a schedule to verify the translation gain or loss Swiss Translation Francs Net monetary liability position - 1/1 Rate (10,000) $ $.5987(5,987) Adjustment for changes in net monetary position: Increase in cash and receivables from sales 75,000 5654 42,405 Less: Decrease in net asset position: Other operating expenses (27,000) 5654 (15,266) Dividends (15,000) 5810 (8,715) Net asset position translated - Net monetary asset position-12/31 12,437 23,000 Translation gain (loss) 5321 12,238 (199) 26 LO The functional currency is the local currency Copyright © 2015 John Wiley & Sons, Inc All rights reserved Financial Statement Disclosure • Companies are required to disclose certain items, as follows: – The aggregate translation gain or loss included in the determination of net income for the period – An analysis of the cumulative translation adjustment equity account should be provided in a separate statement or note or as part of a statement of changes in equity – Exchange rate changes that occur after the balance sheet date and their effect on unsettled foreign currency transactions, if significant 27 LO 10 Required disclosure Copyright © 2015 John Wiley & Sons, Inc All rights reserved ... 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 12 LO... they are combined or consolidated or the equity method of accounting applied Copyright © 2015 John Wiley & Sons, Inc All rights reserved Accounting for Operations in Foreign Countries • A foreign... Current Rate Method Exercise 13- 4: (Current Rate Method) 20 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Translation – Current Rate Method Exercise 13- 4: Prepare a schedule to