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Slide 13-1
Slide 13-2
Translation of FinancialTranslation of FinancialStatements of Foreign AffiliatesStatements of Foreign Affiliates
Advanced Accounting, Fourth Edition
13131313
Slide 13-3
1. Distinguish between the current exchange rate and the
historical exchange rate.
2. Understand the objectives of financial statement
translation.
3. Identify the functional currency of a foreign entity.
4. Compare the two methods used to convert the financial
statements of a foreign entity into U.S. dollars.
5. Distinguish between the circumstances under which
each of the two methods is appropriate under current
GAAP.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
Slide 13-4
6. Explain the factors involved in translating the
statements of a foreign entity operating in a highly
inflationary economy.
7. Translate the statements of a foreign entity when the
functional currency is the local currency.
8. Translate the statements of a foreign entity when the
functional currency is the U.S. dollar.
9. Understand the concept of comprehensive income in
the context of foreign currency translation.
10. Identify the disclosure requirements for firms with
foreign entities.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
Slide 13-5
A U.S. company may be involved in foreign activities through the operations of a:
branch,
subsidiary, or
investee company.
Translation of Financial StatementsTranslation of Financial StatementsTranslation of Financial StatementsTranslation of Financial Statements
Accounts of foreign activities, maintained in a foreign currency, must be restated into U.S. dollars before they are combined or consolidated or the equity method of accounting applied.
Slide 13-6
Accounting for Operations in Foreign Accounting for Operations in Foreign CountriesCountriesAccounting for Operations in Foreign Accounting for Operations in Foreign CountriesCountries
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.
Restriction on withdrawal of assets
Exchange restrictions.Foreign statements that are not in conformity with GAAP in the United States must be adjusted to conform to U.S. standards before conversion into U.S. dollars.
Slide 13-7
The conversion from another currency into the currency of the parent company is frequently called “translation.”
Translating Statements of Foreign Translating Statements of Foreign AffiliatesAffiliatesTranslating Statements of Foreign Translating Statements of Foreign AffiliatesAffiliates
LO 1 Current versus historical exchange rates.LO 1 Current versus historical exchange rates.
Translation Process
Financial Statements in U.S. Dollars
Financial Statements in
Euros
Current Exchange Rate
Historical Exchange Rate
Slide 13-8
Translating Statements of Foreign Translating Statements of Foreign AffiliatesAffiliatesTranslating Statements of Foreign Translating Statements of Foreign AffiliatesAffiliates
LO 1 Current versus historical exchange rates.LO 1 Current versus historical exchange rates.
The difference between translating some accounts using the current exchange rate and others using the historical exchange rate.
Current standards require the translation gain or loss be reported
currently in income or
as a component of stockholders’ equity,
depending on the method used to translate the accounts.
Translation Adjustment or Translation Gain or Loss
Not a Choic
e
Slide 13-9
Objectives of Translation-SFAS No. 52Objectives of Translation-SFAS No. 52Objectives of Translation-SFAS No. 52Objectives of Translation-SFAS No. 52
LO 2 Objectives of translation.LO 2 Objectives of translation.
Objective of Translation - SFAS No. 52 [ASC 830-30]:
1. Provide information regarding the exposed economic
effects of an exchange rate change on an enterprise’s
cash flows and equity [par. 4(a)].
2. Reflect in consolidated statements the financial results
measured in their functional currencies in conformity
with U.S. GAAP [par. 4(b)].
Functional Currency Concept
The Board believes that the operating performance and financialcondition of a foreign entity are best measured by expressing its accounts inthe currency of the economic environment in which it primarily conducts its operations and generates and expends its cash, its functional currency.
Slide 13-10
Translation MethodsTranslation MethodsTranslation MethodsTranslation Methods
LO 4 Two methods of conversion.LO 4 Two methods of conversion.
Current rate method
All assets and liabilities.
Revenues and expenses.
Translation
Current exchange rate.
Exchange rate on the date each transaction occurred.
Slide 13-11
Translation MethodsTranslation MethodsTranslation MethodsTranslation Methods
LO 4 Two methods of conversion.LO 4 Two methods of conversion.
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.
Slide 13-12
Identifying the Functional CurrencyIdentifying the Functional CurrencyIdentifying the Functional CurrencyIdentifying the Functional Currency
LO 3 Identifying the functional currency.LO 3 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
Sales prices
Sales market
Expenses
Financing
Intercompany transactions
Slide 13-13
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.
Review QuestionReview Question
Identifying the Functional CurrencyIdentifying the Functional CurrencyIdentifying the Functional CurrencyIdentifying the Functional Currency
LO 3 Identifying the functional currency.LO 3 Identifying the functional currency.
Slide 13-14
Translation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatementsTranslation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatements
LO 4 Which methods of conversion to use.LO 4 Which methods of conversion to use.
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.
Slide 13-15
Translation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatementsTranslation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatements
LO 4 Which methods of conversion to use.LO 4 Which methods of conversion to use.
Accounts stated in local currency of foreign entity.
Is the foreign economy highly
inflationary?
Determine the functional currency (FC) per
economic indicators.
Translate toU.S. dollars
using current rate method.
Remeasure toFC using
temporal method.
Remeasure to U.S. dollars using temporal method.
No
No
No
Yes
Yes
Functional currency (FC) is U.S. Dollar.
Is the FC the U.S. dollar?
Is the FC the local currency?
Slide 13-16
Translation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatementsTranslation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatements
LO 6 Factors in a highly inflationary economy.LO 6 Factors in a 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.
Foreign Entity Operates in Highly Inflationary Economy
Slide 13-17
Translation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatementsTranslation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatements
Functional currency must be identified. Translation process:
1. Local currency is the functional currency.
Current rate method.
Translation adjustment recorded as a component of stockholders’ equity.
2. U.S. dollar is the functional currency.
Temporal method.
Translation adjustment reported in income statement.
Foreign Entity in Economy that is Not Highly Inflationary
Slide 13-18
Books kept in local currency
Local currency
A third currency
U.S.dollar
Local currency
U.S. dollar
Functional
currency
Remeasure-
ment
Translation
Translation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatementsTranslation of Foreign Currency Financial Translation of Foreign Currency Financial StatementsStatements
Temporal method
Temporal method
Not necessar
y
Not necessar
y
Current rate
method
Current rate
method
U. S. dollars
Slide 13-19
Assets and liabilitiesAssets and liabilities
Paid-in capitalPaid-in capital
Beginning R/EBeginning R/E
DividendsDividends
Revenue and ExpensesRevenue and Expenses
Cumulative translation Cumulative translation
adjustmentadjustment
Current year translation Current year translation
adjustmentadjustment
Current exchange rate Current exchange rate
Historical rateHistorical rate
Ending balance of last yearEnding balance of last year
Historical rate when dividend Historical rate when dividend
is declaredis declared
Average exchange rateAverage exchange rate
Balance amount in the Balance amount in the
balance sheetbalance sheet
Other comprehensive income Other comprehensive income
(shareholders’ equity)(shareholders’ equity)
Translation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate Method
Current Rate Method
Translation
LO 7 The functional currency is the local currency.LO 7 The functional currency is the local currency.
Slide 13-20
Translation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate Method
Exercise 13-4: On January 1, 2008, 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, 2008 $.5987
December 31, 2008 .5321
Average for 2008 .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.
LO 7 The functional currency is the local currency.LO 7 The functional currency is the local currency.
Slide 13-21
Swiss TranslationIncome Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses (30,000) 0.5654 (16,962)
Net income 45,000 25,443
Retained earnings 1/1 10,000 0.5987 5,987
55,000 31,430
Dividends (15,000) 0.5810 (8,715) Retained earnings 12/31 40,000 22,715
Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment 37,000 0.5321 19,688 Total assets 92,000 48,954
Accounts payable 32,000 0.5321 17,027
Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,715
92,000 51,716
Cumulative translation adjustment (2,762) Total liab. & equity 92,000 48,954
Translation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate Method
Exercise 13-4: (Current Rate Method)
Slide 13-22
Translation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate Method
Exercise 13-4: Prepare a schedule to verify the translation adjustment.
Exposed net asset position - 1/1 30,000 $.5987 17,961
Adjustment for changes in net asset position:
Net income 45,000 .5654 25,443
Dividends (15,000) .5810 (8,715)
Net asset position translated --- 34,689
Exposed net asset position - 12/31 60,000 .5321 31,926
Cumulative translation adjustment (debit) (2,763)
Swiss Translation Francs Rate $
LO 7 The functional currency is the local currency.LO 7 The functional currency is the local currency.
Slide 13-23
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
Review QuestionReview Question
Translation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate MethodTranslation – Current Rate Method
LO 7 The functional currency is the local currency.LO 7 The functional currency is the local currency.
Slide 13-24
Translation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal Method
LO 8 The functional currency is the U.S. dollar.LO 8 The functional currency is the U.S. dollar.
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.
Slide 13-25
Translation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal Method
Exercise 13-5: On January 1, 2008, 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, 2008 $.5987
December 31, 2008 .5321
Average for 2008 .5654
Dividend declaration and payment date .5810
Required: Convert (remeasure) the financial statements of the foreign subsidiary using the temporal method of translation.
LO 7 The functional currency is the local currency.LO 7 The functional currency is the local currency.
Slide 13-26
Swiss Translation
Income Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses: depreciation (3,000) 0.5987 (1,796)
Operating expenses: other (27,000) 0.5654 (15,266)
Translation loss (198)
Net income 45,000 25,145
Retained earnings 1/1 10,000 0.5987 5,987
55,000 31,132
Dividends (15,000) 0.5810 (8,715)
Retained earnings 12/31 40,000 22,417
Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment 37,000 0.5987 22,152
Total assets 92,000 51,418
Accounts payable 32,000 0.5321 17,027
Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,417
Total liab. & equity 92,000 51,418
Translation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal Method
Exercise 13-5: (Temporal Method)
Slide 13-27
Exercise 13-5: Prepare a schedule to verify the translation gain or loss.
Net monetary liability position - 1/1 (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 --- 12,437
Net monetary asset position-12/31 23,000 .5321 12,238
Translation gain (loss) (199)
Swiss Translation Francs Rate $
LO 7 The functional currency is the local currency.LO 7 The functional currency is the local currency.
Translation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal MethodTranslation – Temporal Method
Slide 13-28
Financial Statement DisclosureFinancial Statement DisclosureFinancial Statement DisclosureFinancial Statement Disclosure
Companies are required to disclose certain items, as follows:
1. The aggregate translation gain or loss included in the
determination of net income for the period.
2. 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.
3. Exchange rate changes that occur after the balance sheet
date and their effect on unsettled foreign currency
transactions, if significant.
LO 10 Required disclosure.LO 10 Required disclosure.
Slide 13-29
Date of AcquisitionDate of AcquisitionDate of AcquisitionDate of Acquisition
Illustration: Recall that on January 2, 2009, P Company acquired for 2,000,000 francs an 80% interest in SFr. Company. The direct exchange rate for francs on January 2, 2009, was $.15. The entry to record the acquisition is
Investment in SFr Company 300,000
Cash 300,000
Slide 13-30
On January 2, SFr Company reported common stock of 960,000 francs, additional paid-in capital of 300,000 francs, and retained earnings of 480,000 francs for a net asset balance of 1,740,000 francs. The difference between implied and book value in francs and dollars is allocated to land and buildings.
Date of AcquisitionDate of AcquisitionDate of AcquisitionDate of Acquisition
Slide 13-31
P Company accounts for its investment by the cost method. In this case, SFr Company declared and paid a 300,000 franc dividend on September 1 when the direct exchange rate was $.16. The book entry to record the dividend receipt is:
After Acquisition After Acquisition After Acquisition After Acquisition
Cash 38,400
Dividend income38,400
(300,000 francs x $.16 = $48,000 x .80 = $38,400)
Slide 13-32
Workpaper entries assuming current rate method.
After Acquisition After Acquisition After Acquisition After Acquisition
Slide 13-33
The major differences between the workpapers are as follows:
1. Under the temporal method,
the translation gain or loss is included in the subsidiary’s income
statement and becomes a part of its ending retained earnings
balance.
The controlling interest in the gain or loss is recognized as part of
consolidated net income in the current period.
In subsequent periods the gain or loss is included in consolidated
retained earnings as part of the reciprocity entry.
2. The unamortized portion of the difference assigned to land and
buildings and the amortization for the current period retain their
historical dollar values since such nonmonetary assets are
translated using historical rates.
Consolidation Assuming Temporal Consolidation Assuming Temporal Method Method Consolidation Assuming Temporal Consolidation Assuming Temporal Method Method
Slide 13-34
Remeasurement and Translation of Remeasurement and Translation of Transactions Transactions Remeasurement and Translation of Remeasurement and Translation of Transactions Transactions
SFAS No. 52 [ASC 830–20–20] defines a foreign currency transaction as one that is denominated in a currency other than the entity’s functional currency.
1. At the transaction date, the current exchange rate is used to measure and record a foreign currency transaction in the functional currency of the recording entity.
2. At subsequent balance sheet dates, recorded balances that are denominated in a currency other than the functional currency are adjusted to the functional currency using the current exchange rate.
3. Any transaction gain or loss resulting from this procedure is recognized currently in income.
Slide 13-35
Intercompany Receivables and Payables Intercompany Receivables and Payables Intercompany Receivables and Payables Intercompany Receivables and Payables
SFAS No. 52 [ASC 830–20–35–1] requires that transaction gains and losses on intercompany receivables and payables be recognized in the period that the exchange rate changes.
The procedures for doing so are similar to those discussed in the preceding section.
However, a company is required to distinguish between transactions that are of a long-term investment nature and other transactions.
Slide 13-36
Elimination of Intercompany ProfitElimination of Intercompany ProfitElimination of Intercompany ProfitElimination of Intercompany Profit
Profits and losses attributable to intercompany sales or transfers are eliminated on the basis of the exchange rate at the date of each sale or transfer.
The use of averages or reasonable approximations of specific rates in effect on the due date of each transaction is permitted.
Slide 13-37
Liquidation of a Foreign InvestmentLiquidation of a Foreign InvestmentLiquidation of a Foreign InvestmentLiquidation of a Foreign Investment
Upon the sale of part or all of an investment in a foreign entity, a pro-rata share of the amount included in the accumulated translation adjustment equity account associated with that foreign investment is removed and reported as part of the gain or loss from the disposition of the investment.
Slide 13-38
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