Z15030000120164011 CH 13

Advanced
Accounting
Jeter Chaney
Translation of
Financial
Statements of Foreign
Affiliates
1
Prepared by Sheila Ammons, Austin Community College
Learning Objectives
Distinguish between the current exchange rate and the
historical exchange rate.
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.
Distinguish between the circumstances under which each
of the two methods is appropriate under current GAAP.
2
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.
3
Translation of Financial
Statements
A U.S. company may be involved in foreign activities
through the operations of a:
branch,
subsidiary, or
investee company.
If the foreign entity maintains its books in a foreign
currency,
Its accounts must be restated into U.S. dollars before
they are combined or consolidated or the equity method
of accounting applied.
4
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.
5
Translating
Statements
of
Foreign
Accounting for Operations in Foreign
Affiliates
Countries
The conversion from another currency into the currency
of the parent company is frequently called translation.
Translation Process
Financial
Statements in
Euros
Current Exchange
Rate
Historical Exchange
Rate
Financial
Statements in
U.S. Dollars
6
LO 1 Current versus historical exchange rates.
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
Not a
Choice
currently in income or
deferred as a component of stockholders equity,
depending on the method used to translate the accounts.
7
LO 1 Current versus historical exchange rates.
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 enterprises
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.
8
LO 2 The objectives of translation.
Translation Methods
To accomplish
the objectives of translation, two

translation methods are used depending on the
functional currency of the foreign entity.
1. Current rate method
2. 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.
9
LO 4 Two methods of conversion.
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 4 Two methods of conversion.
Identifying the Functional

Currency
The Functional Currency may be
1. The local currency of the foreign entity,
2. The U.S. dollar, or
3. The currency of a third country.
Economic Indicators of Functional Currency:
Cash flow
Expenses
Sales prices
Financing
Sales market
Intercompany transactions
11
LO 3 Identifying the functional currency.
Identifying the Functional

Currency
Review Question
Indicators that the local currency is also the functional
currency include all of the following except:
a) The majority of the cash flows are in the local currency.
b) Sales prices are determined by local market conditions.
c) Financing is generally from the parent or guaranteed by
the parent.
d) Production costs and expenses are determined by local
conditions.
12
LO 3 Identifying the functional currency.
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 4 Which methods of conversion to13use.


Accounts stated in local currency of foreign entity.
Is the foreign
economy highly
inflationary?
Determine the functional

currency (FC) per
economic indicators.
No
Yes
Functional
currency (FC) is
U.S. Dollar.
Is the FC the
U.S. dollar?
Yes
Remeasure to U.S.
dollars using
temporal method.
No
Is the FC the local

currency?
No
Remeasure to
FC using temporal
method.
Yes
Translate to
U.S. dollars using
current rate method.
LO 4 Which methods of conversion to14use.


Foreign Entity Operates in Highly Inflationary
Economy
It is the Boards 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 6 Foreign entity operating in a highly inflationary economy.

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
Translation of Foreign Currency Financial

Statements
Books kept in
local currency
Local
currency
Remeasurement
Not
necessary
Temporal
method
Temporal
method
Functional
currency
Local
currency
U.S.
dollar
A third
currency
Translation
Current rate
method
Not
necessary
Current rate
method
U.S. dollar
U. S. dollars
17
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 7 The functional currency is the local currency.

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:
January 1, 2014
December 31, 2014
Average for 2014
Dividend declaration and payment date
Dollars per Franc

$.5987
.5321
.5654
.5810
Required: Translate the year-end balance sheet and income statement of the
foreign subsidiary using the current rate method of translation.
19
Translation Current Rate Method

Exercise 13-4: (Current Rate Method)
20

Method
Exercise 13-4: Prepare a schedule to verify the translation
Swiss
Translation
adjustment.
Francs
Exposed net asset position - 1/1
Rate
30,000
$.5987
17,961
45,000
.5654
25,443
Adjustment for changes in net asset position:

Net income
Dividends
(15,000)
Net asset position translated

Exposed net asset position - 12/31
.5810
--60,000
Cumulative translation adjustment (debit)
(8,715)
34,689
.5321
31,926
(2,763)
21

Method
Review Question
Under the current method of currency translation, which
of the following balance sheet accounts is translated at
historical exchange rates?
a) Cash
b) Accounts Receivable
c) Bonds Payable
d) Common Stock
22
Translation Temporal Method

Temporal Method
Monetary assets and
liabilities (cash, a/r, a/p).
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.
Other revenues and expenses.
Translation
Current exchange rate.
Historical exchange rates.
Current exchange rate.
Historical exchange rates.
Exchange rate on date
transaction occurred.
23
LO 8 The functional currency is the U.S. dollar.

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:
January 1, 2014
December 31, 2014
Average for 2014
Dividend declaration and payment date
Dollars per Franc

$.5987
.5321
.5654
.5810
Required: Convert (remeasure) the financial statements of the foreign

subsidiary using the temporal method of translation.
24

Exercise 13-5: (Temporal Method)
25

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
--23,000
Translation gain (loss)
12,437
.5321
12,238
(199)
26
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.

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Prepared by Sheila Ammons, Austin Community College

Accounting for Operations in Foreign

Translating Statements of Foreign

the objectives of translation, two

Identifying the Functional

Economic Indicators of Functional Currency:

Identifying the Functional

Translation of Foreign Currency

LO 4 Which methods of conversion to13use.

Translation of Foreign Currency

Determine the functional

Is the FC the local

LO 4 Which methods of conversion to14use.

Translation of Foreign Currency

Translation of Foreign Currency

Translation of Foreign Currency Financial

Translation Current Rate

Translation Current Rate

Dollars per Franc

Translation Current Rate Method

Translation Current Rate

Exposed net asset position - 1/1

Adjustment for changes in net asset position:

Net asset position translated

Cumulative translation adjustment (debit)

Translation Current Rate

Translation Temporal Method

Translation Temporal Method

Dollars per Franc

Required: Convert (remeasure) the financial statements of the foreign

Translation Temporal Method

Translation Temporal Method

Adjustment for changes in net monetary position:

Less: Decrease in net asset position:

Net asset position translated

Translation gain (loss)

Financial Statement Disclosure

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