Professional Documents
Culture Documents
McGraw-Hill/Irwin
Scope of Chapter
Translation of the amounts in the financial statements of the foreign entities from its functional currency to the reporting currency. Remeasurement of financial records to functional currency from the local currency.
Functional Currency
The FASB defined functional currency of a foreign
entity as follows:
An entitys functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment in which an entity primarily generates and expends cash.
Notes:
1.
2.
For an entity with operations that are relatively self contained and integrated within a particular country, the functional currency would be the currency of that country. A foreign entitys functional currency might not be the currency of the country in which it is located.
Foreign Currency: Cash Flows related to the foreign entitys individual assets and liabilities are primarily in the foreign currency and do not directly impact the parent companys cash flows. Parents Currency: Cash Flows related to the foreign entitys individual assets and liabilities directly impact the parents cash flows on a current basis and are readily available for remittance to the parent company.
Foreign Currency: Sales prices for the foreign entitys products are not primarily responsive on a short-term basis to changes in exchange rates but are determined more by local competition or local government regulation. Parents Currency:Sales prices for the foreign entitys products are primarily responsive on a short-term basis to changes in exchange rates; for example,sales prices are determined more by worldwide competition or by international prices.
Foreign Currency: There is an active local sales market for the foreign entitys products, although there also might be significant amounts of exports. Parents Currency: The sales market is mostly in the parents country or sales contracts are denominated in the parent;s currency.
Expense indicators
Foreign Currency: Labor, materials, and other costs for the foreign entitys product or services are primarily local costs, even though there also might be imports from some other countries. Parents Currency: Labor, materials, and other costs for the foreign entitys product or services, on a continuing basis, are primarily costs for components obtained from the country in which the parent company is located.
Financing Indicators
Foreign Currency: Financing is primarily denominated in foreign currency, and funds generated by the foreign entitys operations are sufficient to service existing and normally expected debt obligations. Parents Currency:
Financing is primarily from the parent or other dollar denominated obligations, or funds generated by the foreign entitys operations are not sufficient to service existing and normally expected debt obligations without infusion of additional funds from the parent company. Infusion of additional funds from the parent company for expansion is not a factor, provided funds generated by the foreign entitys expanded operations are expected to be sufficient to service that additional financing.
Foreign Currency:
1.
2.
There is a low volume of intercompany transactions and there is not an extensive interrelationship between the operations of the foreign entity and the parent company. However, the foreign entitys operations my rely on the parents or affiliates competitive advantages, such as patents and trademarks. There is a high volume of intercompany transactions and there is an extensive interrelationship between the operations of the foreign entity and the parent company. The parents currency generally would be the functional currency if the foreign entity is a device or shell corporation for holding investments, obligations, intangible assets, etc., that could readily be carried on the parents or an affiliates books.
Parents Currency:
1.
2.
10
11
12
Current/Noncurrent Method
Rates used for translation:
Current Rate: Current Assets and current liabilities. Historical Rate: All other assets, liabilities and owners equity in the balance sheet and depreciation and amortization expense applicable to related assets in the income statement. Average Rate: All other revenues and expenses.
Note: Today this method is objectionable with respect to inventories since inventories are translated at current rate, it represents a departure from historical cost.
13
Monetary/Nonmonetary Method
Rates used for translation: Current Rate: Monetary assets and liabilities . Historical Rate: All other assets, liabilities and owners equity in the balance sheet and cost of goods sold and depreciation and amortization expense applicable to related assets and in the income statement. Average Rate: All other revenues and expenses.
Notes:
1. 2.
Monetary assets and liabilities are those representing claims or obligations expressed in a fixed monetary amount. This method focuses on the characteristics of assets and liabilities of the foreign entity, rather than on their balance sheet classifications and misstates the actual financial position and operating results of the foreign entity.
14
Current Rate: All balance sheet amount other than owners equity and in income statement, all revenue and expenses, if practical. Historical Rate: Owners equity. Average Rate: All other revenues and expenses.
15
16
FASB Statement No. 52 has adopted the current rate method for translating a foreign entitys financial statements from the entitys functional currency to the reporting currency of the parent company. If the foreign entitys accounting records are maintained in a currency other than its functional currency, account balances must be remeasured to the functional currency before their translation. Remeasurement is accomplished by the monetaty/nonmonetary method of translation. If a foreign entitys functional currency is the U.S. dollar, remeasurement eliminates the need for translation (as remeasurement must precede translation).
2.
3.
Historical exchange rates between the functional currency and another currency for certain accounts. Current rate for all others. Recognize currently in income, all gains and losses from remeasurement of monetary assets and liabilities that are not denominated in the functional currency.
17
Nonmonetary Balance Sheet Items and Related Revenu/Expense Items Remeasured Using Historical Rates
Inventories carried at cost. Short-term prepayments such as insurance, advertising, and rent. Plant assets and their accumulated depreciation. Patents, trademarks, licenses, formulas, goodwill, other intangible assets and their accumulated amortization. Deferred charges and credits.
18
Nonmonetary Balance Sheet Items and Related Revenu/Expense Items Remeasured Using Historical Rates
Deferred revenue. Common stock. Preferred stock carried at issuance price. Examples of revenue and expenses related to nonmonetary items:
1.
19
Cost of goods sold. 2. Depreciation of plant assets. 3. Amortization of intangible assets. 4. Amortization of deferred charges or credits. Note: The appropriate historical or current exchange rate generally is the rate applicable to conversion of foreign currency for dividend remittances.
2.
Foreign currency transactions that are designated as, and are effective as, economic hedges of a net investment in a foreign entity, commencing as of the designation date. Intercompany foreign currency transactions that are of a longterm investment nature (that is, settlement is not planned or anticipated in the foreseeable future), when the entities to the transaction are consolidated, combined, or accounted for by the equity method.
21
The FASB requires that the functional currency of a foreign entity in a highly inflationary economy be identified as the reporting currency (the U.S. dollar for a U.S. multinational enterprise). The FASB defined a highly inflationary economy as on having cumulative inflation of 100% or more over a three-year period. Thus, financial statements of a foreign entity in a country experiencing severe inflation are remeasured in U.S. dollars, regardless of the criteria for determination of the functional currency.
22
23
24
25