Foreign Currency Financial Statements

13 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Foreign CurrencyFinancial Statements

Chapter 13


Learning Objective 1

Understand the functional

currency concept.


Application of the FunctionalCurrency Concept

A foreign subsidiary’s foreign currencystatements must be in conformity with U.S.GAAP before translation into U.S. dollars.

Adjustments are required beforetranslation is performed.



All account balances on the balance sheetdate denominated in a foreign currency

(from the foreign entity’s point of view) areadjusted to reflect current exchange rates.



Under the functional currency concept,a foreign entity’s assets, liabilities,and operations must be measured

in its functional currency.



Subsequently, the foreign entity’s balancesheet and income statement are consolidated(subsidiary) or combined (branch) with those

of the reporting enterprise’s currency.

$£ ¥

€



Determine a subsidiary’s

functional currency.


Translation

Translation involves expressingfunctional currency measurements

in the reporting currency.

Current ratemethod


Remeasurement

When the foreign entity’s books are notmaintained in its functional currency, the

foreign currency financial statements mustbe remeasured into the functional currency.

Temporalmethod


Remeasurement

Monetary assetsand liabilities

Current exchangerates

Nonmonetaryitems

Historicalrates



Produce financial statements

using translation or

remeasurement, or both.


Translation and Remeasurement ofForeign Currency Financial

Statements

Patriot Corporation, a U.S. company,has a wholly-owned subsidiary, RegalCorporation, that operates in England.


Translation and Remeasurement ofForeign Currency Financial

Statements

Case 1 British pounds British pounds TranslationCase 2 U.S. dollar British pounds RemeasurementCase 3 Euro British pounds Remeasurement

and translation

Currency of Required Procedures Functional Accounting for Consolidating

Currency Records or Combining


Intercompany ForeignCurrency Transactions

These transactions are foreign currencytransactions if they produce receivableor payable balances denominated in a

currency other than the entity’s (parent’sor subsidiary’s) functional currency.


Intercompany ForeignCurrency Transactions

A U.S. parent company borrows $1,600,000(£1,000,000) from its British subsidiary.

Case 1 British pound British pound No YesCase 2 British pound U.S. dollar Yes YesCase 3 U.S. dollar British pound Yes NoCase 4 U.S. dollar U.S. dollar No No

Loan Functional Foreign Currency Denominated Currency of Transaction of Currency Subsidiary Subsidiary? Parent?


Foreign Entities Operating inHighly Inflationary Economies

The reporting currency (the U.S. dollar) is usedto remeasure the financial statements of

foreign entities in highly inflationary economies.

Price-level-adjusted financial statements arenot basic financial statements under GAAP.


Foreign Entities Operating inHighly Inflationary Economies

Statement No. 52 defines a“highly inflationary economy”

as one with a cumulativethree-year inflation rate

of 100% or more.


Business Combinations

The assets and liabilities of a foreign entityare translated into U.S. dollars using the

current exchange rate in effect on thedate of the business combination.

Cost/book valuedifferential Minority interest



Apply the current rate

translation method.


Translation Under Statement No. 52

On December 31, 2003, Pat Corporation, aU.S. firm, paid $525,000 cash to acquire allthe stock of the British firm, Star Company.

The book value of Star’s net assets was$375,000, which was equal to the fair value.

The British pound exchange rate was $1.50.



AssetsCash 140 $1.50 210Accounts receivable 40 1.50 60Inventories (cost) 120 1.50 180Plant assets 100 1.50 150Less: Accumulated depr. –20 1.50 –30Total assets 380 570

British Exchange U.S.(000) Pounds Rate Dollars



EquitiesAccounts payable 30 $1.50 45Bonds payable 100 1.50 150Capital stock 200 1.50 300Retained earnings 50 1.50 75Total equities 380 570

British Exchange U.S.(000) Pounds Rate Dollars



The 2004 year-end exchange rate was $1.40.

Average exchange rates for 2004 were $1.45.

Star paid £30,000 dividends on December 1, 2004,when the exchange rate was $1.42 per British pound.

The only intercompany transaction was an$84,000 (£56,000) non-interest-bearing advance by

Star to Pat made on January 4, 2004, when theexchange rate was still $1.50.



What is Star’s adjustment at year end?

Advance to Pat £4,000Exchange Gain £4,000

To adjust receivable denominated in dollars[($84,000 ÷ $1.40) – £56,000 per books]


Star Company TranslationWorksheet for 2004

Cash 110 $1.40 154.0Accounts receivable 80 1.40 112.0Inventories (FIFO) 120 1.40 168.0Plant assets 100 1.40 140.0Advance to Pat 60 1.40 84.0Cost of sales 270 1.45 391.5Depreciation 10 1.45 14.5Wages and salaries 120 1.45 174.0Other expenses 60 1.45 87.0Dividends 30 1.42 42.6Accumulated income – 28.6

960 1,396.2

₤ Trial Translation $ TrialDebits (000) Balance Rate Balance


Star Company TranslationWorksheet for 2004

Accumulated depreciation 30 $1.40 42.0Accounts payable 36 1.40 50.4Bonds payable 100 1.40 140.0Capital stock 200 1.50 300.0Retained earnings 50 computed 75.0Sales 540 1.45 783.0Exchange gain (advance) 4 1.45 5.8

960 1,396.2

₤ Trial Translation $ TrialCredits (000) Balance Rate Balance


Star Company Income and Retained

Earnings Statement for the Year 2004Sales $783,000

Less costs and expensesCost of sales $391,500Depreciation 14,500Wages and salaries 174,000Other expenses 87,000 667,000

Operating income $116,000Exchange gain 5,800Net income $121,800Retained earnings January 1, 2004 75,000

$196,800Less: Dividends 42,600Retained earnings December 31, 2004 $154,200


Star Company Balance Sheetat December 31, 2004

AssetsCash $154,000Accounts receivable 112,000Inventories 168,000Plant assets 140,000Less: Accumulated depreciation – 42,000Advance to Pat 84,000

$616,000EquitiesAccounts payable $ 50,400Bonds payable 140,000Capital stock 300,000Retained earnings 154,200Accumulated other comprehensive income – 28,600

$616,000


Equity Method of Accounting

What is Pat’s entry to record receiptof the £30,000 ($42,600) dividend ?

Cash $42,600Investment in Star $42,600

To record dividend received


Patent Amortization

$525,000 – $375,000 = $150,000$150,000 ÷ $1.50 = £100,000

£100,000 ÷ 10 years × $1.45 = $14,500

Pat’s BooksIncome from Star 14,500Other Comprehensive Income:Equity Adjustment from Translation 9,500

Investment in Star 24,000


Equity Adjustment

£10,000 amortization × ($1.50 – $1.45) exchange rate decline to midyear $ 500£90,000 unamortized patent × ($1.50 – $1.40) exchange rate decline for the year 9,000Equity adjustment $9,500

Alternatively, the $9,500 equityadjustment can be computed as follows:


Investment in Foreign Subsidiary(Summary)

Changes is Pat’s investment in Star account during 2004:

Investment cost December 31, 2003 $525,000Less: Dividends received 2004 – 42,600Add: Equity in Star’s net income 121,800Less: Unrealized loss on translation – 28,600Less: Patent amortization – 14,500Less: Unrealized translation loss on patent – 9,500Investment balance December 31, 2004 $551,600


Consolidation Working Papers for the

Year Ended December 31, 2004 Adjustments/ Consol- Pat Star Eliminations idated

SalesIncome from StarCost of salesDepreciationWages and salariesOther expensesExchange gainNet incomeRetained earnings – PatRetained earnings – StarDividends

Retained earnings 12/31/04

$1,218.3 107.3 (600) (40) (300) (150)

$ 235.6$ 245.5

(100)

$ 381.1

$783

(391.5) (14.5) (174) (87) 5.8$121.8

$ 75 (42.6)

$154.2

a 107.3

c 14.5

b 75a 42.6

$2,001.3

(991.5) (54.5) (474) (251.5) 5.8$ 235.6$ 245.5

(100)

$ 381.1

Income Statement (000)


Consolidation Working Papers for the

Year Ended December 31, 2004CashAccounts receivableInventoriesPlant assetsAccumulated depreciationAdvance to PatInvestment – Star

Patent

Accounts payableAdvance from StarBonds payableCapital stockretained earningsOther income

$ 317.6 150 300 400 (100)

551.6

$1,619.2$ 142.2 84 250 800 381.1 (38.1)$1,619.2

$154 112 168 140 (42) 84

$616$ 50.4

140 300 154.2 (28.6)$616

d 84a 64.7b 486.9

b 140.5 c 14.5

d 84

b 300

b 28.6

$ 471.6 262 468 540 (142)

126$1,725.6$ 192.6

390 800 381.1 (38.1)$1,725.6

Balance Sheet (000) Adjustments/ Consol-

Pat Star Eliminations idated



Apply the temporal

translation method.


Remeasurement UnderStatement No. 52

Remeasurement Temporal method

Translation Current rate method

The objective of remeasurement is to producethe same results as if the books had been

maintained in the U.S. dollar.



Under remeasurement procedures, the $150,000patent value is not adjusted for subsequent

changes in exchange rates.

Annual amortization= $15,000



The £56,000 ($84,000) advance to Patis not a foreign currency transaction

of either Pat or Star.

Star’s monetary items other than theintercompany advance are remeasured

at current exchange rates.


The Equity Method

Investment in Star $525,000Cash $525,000

To record acquisition on December 31, 2003


The Equity Method

Cash $42,600Investment in Star $42,600

To record dividends received on December 1, 2004

Investment in Star $87,600Income from Star $87,600

To record investment income for 2004 equal to Star’s$102,600 net income less $15,000 patent amortization


Income and Retained EarningsStatements for the Year Ended

12/31/04Sales $2,001,300 $2,001,300Less: Cost of sales 991,500 1,001,100

Wages and salaries 474,000 474,000Other expenses 237,000 237,000Depreciation 54,500 55,000Patent amortization 14,500 15,000

Operating income $ 229,800 $ 219,200Exchange gain (loss) 5,800 – 3,300Net income $ 235,600 $ 215,900Retained earnings 01/01/04 245,500 245,500

$ 481,100 $ 461,400Less: Dividends 100,000 100,000Retained earnings 12/31/04 $ 381,100 $ 361,400

Consolidated Translation Remeasurement


Balance Sheetsfor the Year Ended 12/31/04

AssetsCash $ 471,600 $ 471,600Accounts receivable 262,000 262,000Inventories 468,000 470,400Plant assets 540,000 550,000Less: Accumulated depreciation – 142,000 – 145,000Patent 126,000 135,000Total assets $1,725,600 $1,744,000



Balance Sheetsfor the Year Ended 12/31/04

LiabilitiesAccounts payable $ 192,600 $ 192,600Bonds payable 390,000 390,000Total liabilities $ 582,600 $ 582,600Stockholders’ EquityCapital stock $ 800,000 $ 800,000Retained earnings 381,100 361,400Other income – 38,100 –Total stockholders’ equity $1,143,000 $1,161,400Total liabilities and stockholders’ equity $1,725,600 $1,744,000



Translation With Minority Interest

On January 1, 2003, Pacific Corporation,a U.S. firm, paid $232,500 cash to acquirea 90% interest in Sea, a foreign company.

Sea’s stockholders’ equity consistedof 1,000,000 LCU capital stock and

500,000 LCU retained earnings.

The exchange rate was $0.15.

Pacific designated Sea’s functional currencyto be the subsidiary’s local currency unit.


Minority Interest

Stockholders’ equity January 1 $202,500 $22,500 $225,000Net income 21,600 2,400 24,000Dividends – 14,400 – 1,600 – 16,000Equity adjustment 27,450 3,050 30,500Stockholders’ equity December 31 $237,150 $26,350 $263,500

10% to 90% to Minority Pacific Interests Total


End of Chapter 13

Documents

Foreign Currency Financial Statements