Advanced Accounting by Debra Jeter and Paul Chaney Chapter 14: Translation of Financial Statements of Foreign Affiliates Slides Authored by Hannah Wong, Ph.D. Rutgers University

Foreign Subsidiaries A foreign subsidiary is consolidated if the parent company owns a controlling interest in the subsidiary Exceptions: The intent to control is temporary Control does not rest with the parent government restrictions on asset withdrawal exchange restrictions

Translating Financial Statements of Foreign Affiliates Translation: the conversion of financial statements from one currency to another Financial statements in U.S. dollars Financial statements in Franc Translation

Exchange Rates Current exchange rate = the spot rate on the balance sheet date Historical exchange rate = the spot rate on the transaction date

Functional Currency Definition: can be: Functional currency of a foreign affiliate is the currency of the economic environment in which it primarily conducts its operations can be: local currency of the affiliate the U. S. dollar a third currency

Translation Methods Current Rate Method all assets and liabilities are translated using the current exchange rate revenues and expenses - average exchange rate Temporal Method monetary assets and liabilities - current exchange rate assets and liabilities carried at historical cost - historical exchange rate assets and liabilities carried at current value - current exchange rate

Functional Currency Indicators cash flows sales prices sales market expenses financing intercompany transactions

Determining Functional Currency Accounts stated in local currency of foreign affiliate Do economic indicators show that functional currency = U.S. $? No Foreign economy highly inflationary? No Yes Yes Function currency = local currency Function currency = U.S. $ Function currency = U.S. $ Remeasurement Remeasurement Translation

Remeasurement VS Translation convert financial statement elements using temporal method translation adjustment included in net income Translation convert financial statement elements using current rate method translation adjustment recorded in stockholders equity

Translation Process Books kept in local currency Local currency Remeasure- ment Not necessary Temporal method Temporal method A third currency Local currency U.S. dollar Functional currency Not necessary Translation Current rate method Current rate method Financial statements in U. S. dollars U.S. dollar

Translation (Current Rate Method) Assets and liabilities Paid-in capital: purchase acquisition pooling Current exchange rate Historical rate on the date of acquisition Historical rate on the date of capital transaction of subsidiary

Translation (Current Rate Method) Beginning R/E Dividends Revenue and expenses Cumulative translation adjustment = Ending balance of last year Historical rate when dividend is declared Average exchange rate = Balance amount in the balance sheet

Translation (Current Rate Method) = Balance amount in the balance sheet “Other comprehensive income” in shareholders equity Cumulative translation adjustment Current year

Remeasurement (Temporal Method) Monetary assets and liabilities carried at current values Nonmonetary assets and liabilities carried at current values at historical costs Current exchange rate Historical rate on the date of transaction

Remeasurement (Temporal Method) Paid-in capital: purchase acquisition pooling Historical rate on the date of acquisition Historical rate on the date of capital transaction of subsidiary

Remeasurement (Temporal Method) Beginning R/E Dividends = Ending balance of last year Historical rate when dividend is declared

Remeasurement (Temporal Method) Revenues and expenses related to assets and liabilities translated at historical rates (inventory cost and depreciation) Other revenues and expenses Historical rate used for the related asset or liability accounts Average exchange rate

Remeasurement (Temporal Method) Net income Current year translation adjustment

Financial Statement Disclosure Aggregate translation gain/loss included in net income disclosed in (notes to) financial statement Exchange rate changes that occur after the balance sheet date and their effect on unsettled foreign currency transactions, if significant

Financial Statement Disclosure Analysis of the cumulative translation adjustment should be presented as part of statement of changes in equity or in a separate statement

Financial Statement Disclosure Analysis of the cumulative translation adjustment includes beginning and ending amounts current period’s aggregate adjustment translation of foreign currency statements gains/losses from hedging activities and intercompany long-term investment transactions income taxes allocated amount transferred to net income

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