1. Translation of Foreign Currency Financial Statements
PERTEMUAN #7
EBA 604
AKUNTANSI INTERNASIONAL
PROGRAM STUDI AKUNTANSI
FAKULTAS EKONOMI DAN BISNIS
UNIVERSITAS ESA UNGGUL

2. Translation of Foreign Currency Financial Statements
Chapter Topics
Conceptual issues of foreign currency financial statements translation.
Balance sheet vs. transaction exposure.
Methods of financial statement translation.
Temporal and current rate methods illustrated.
U.S. GAAP, IFRSs, and other standards related to translation.
Hedging balance sheet exposure.

3. Translation of Foreign Currency Financial Statements
Learning Objectives
1. Describe the conceptual issues involved in translating foreign currency financial statements.
2. Explain balance sheet exposure and how it differs from transaction exposure.
3. Describe the concepts underlying the current rate and temporal rate methods of translation.
4. Apply the current rate and temporal methods of translation and compare the results of the two methods.

4. Translation of Foreign Currency Financial Statements
Learning Objectives
5. Describe the requirements of applicable International Financial Reporting Standards (IFRSs) and U.S. generally accepted accounting principles (GAAP).
6. Discuss hedging of balance sheet exposure.
7. Highlight translation procedures used internationally.

5. Translating Foreign Currency Financial Statements -- Conceptual Issues
Foreign country operations usually prepare financial statements using local currency as the monetary unit.
These financial statements must be translated into home country currency.
These operations also typically use local GAAP.
Financial statements must be translated into home country GAAP.
Learning Objective 1

6. Translating Foreign Currency Financial Statements -- Conceptual Issues
Primary conceptual issues
Each financial statement item must be translated using the appropriate exchange rate.
Choices include the current exchange rate, average exchange rate, and the historical exchange rate.
Current exchange rate is as of the balance sheet date, historical exchange rate is as of date of transaction.
The resulting translation adjustment can be recognized in current income or included in an equity account on the balance sheet.
Learning Objective 1

7. Balance Sheet Exposure
Assets and liabilities translated at the current exchange rate are exposed to risk of a translation adjustment.
When foreign currency appreciates, a net asset exposure results in a positive translation adjustment.
When foreign currency appreciates, a net liability exposure results in a negative translation adjustment.
Assets and liabilities translated at the historical exchange rate are not exposed to a translation adjustment.
Learning Objective 2

8. Translation Methods Current/Noncurrent Method
Current assets and liabilities are translated at the current exchange rate.
Noncurrent assets and liabilities and stockholders’ equity accounts are translated at historical exchange rates.
There is no theoretical basis for this method.
Method is seldom used in any countries and is not allowed by U.S. GAAP or IFRSs.
Learning Objective 3

9. Translation Methods Monetary/Nonmonetary Method
Monetary assets and liabilities are translated at the current exchange rate.
Nonmonetary assets and liabilities and stockholders’ equity accounts are translated at historical exchange rates.
The translation adjustment measures the net foreign exchange gain or loss on current assets and liabilities as if these items were carried on the parent’s books.
Learning Objective 3

10. Translation Methods Temporal Method
Objective is to translate financial statements as if the subsidiary had been using the parent’s currency.
Items carried on subsidiary’s books at historical cost, including all stockholders’ equity items are translated at historical exchange rates.
Items carried on subsidiary’s books at current value are translated at current exchange rates.
Income statement items are translated at the exchange rate in effect at the time of the transaction.
Learning Objective 3

11. Translation Methods Current Rate Method
Objective is to reflect that the parent’s entire investment in a foreign subsidiary is expose to exchange risk.
All assets and liabilities are translated at the current exchange rate.
Stockholders’ equity accounts are translated at historical exchange rates.
Income statement items are translated at the exchange rate in effect at the time of the transaction.
Learning Objective 3

12. Temporal and Current Rate Methods
Translation methods illustrated
U.S. Inc. owns Juarez, SA, a subsidiary in Mexico which was established January 1, 2005.
Juarez’s balance sheet items as of 12/31/05, in pesos.
Cash 1,000 Accounts payable 2,000
Accounts rec. 2,000 Long-term debt 6,000
Inventory 2,500 Capital stock 3,000
Fixed assets 8,000 Retained earnings 1,500
Accum. depr. 1,000
Learning Objective 4

13. Temporal and Current Rate Methods
Translation methods illustrated
Juarez’s income statement items for 2005, in pesos.
Sales 20,000 Depr. exp ,000
COGS 14,000 Interest exp
S,G,&A exp ,500 Income tax exp
Learning Objective 4

14. Temporal and Current Rate Methods
Translation methods illustrated
There was no beginning inventory.
Inventory, which is carried at cost, was acquired evenly during the last quarter of 2005.
Purchases were made evenly throughout year.
Fixed assets were acquired on January 1, 2005.
Capital stock was sold on January 1, 2005.
Learning Objective 4

15. Temporal and Current Rate Methods
Translation methods illustrated
Relevant exchange rates (U.S. dollar per Mexican peso)
January 1, $0.10
Average for $0.095
Average for 4th quarter 2005 $0.09
December 31, $0.08
Learning Objective 4

16. Temporal and Current Rate Methods
Current Rate Method – Income Statement
Income Statement – 2005
Sales ,900
COGS ,330
Gross profit
S,G,&A
Depreciation expense
Interest expense
Income tax expense
Net income
Learning Objective 4

17. Temporal and Current Rate Methods
Current Rate Method – Balance Sheet
Balance Sheet – December 31, 2005
Cash Accounts payable
Accounts Rec Long-term debt
Inventory Capital stock
Fixed Assets, net Retained earnings 142
Total assets Cumulative
translation adj. (97) Total liab. & S.E
Learning Objective 4

18. Temporal and Current Rate Methods
Temporal Method – Balance Sheet
Balance Sheet – December 31, 2005
Cash Accounts payable
Accounts Rec Long-term debt
Inventory Capital stock
Fixed Assets, net Retained earnings 225
Total assets 1, Total liab. & S.E. 1,165
Learning Objective 4

19. Temporal and Current Rate Methods
Temporal Method – Balance Sheet
Income Statement – 2005
Sales ,900
COGS ,343
Gross profit
S,G,&A
Depreciation expense
Interest expense
Income tax expense
Remeasurement gain
Net income
Learning Objective 4

20. Temporal and Current Rate Methods
Translation methods illustrated – Summary
Current Rate Method
All assets and liabilities translated at current rate.
This results in net asset exposure.
Net asset exposure and devaluing foreign currency results in translation loss.
Translation adjustment included in equity.
Learning Objective 4

21. Temporal and Current Rate Methods
Translation methods illustrated – Summary
Temporal Method
Primarily monetary assets and liabilities translated at current rate.
This results in net liability asset exposure.
Net liability exposure and devaluing foreign currency results in translation gain.
Translation gain included in current income.
Learning Objective 4

22. U.S. GAAP and IFRS Requirements
SFAS 52, Foreign Currency Translation is the relevant accounting standard.
Requires identification of functional currency.
Functional currency is the primary currency of the foreign subsidiary’s operating environment.
The standard includes a list of indicators as guidance for the foreign currency decision.
When functional currency is U.S. Dollar, temporal method is required.
When functional currency is foreign currency, current rate method is required.
Learning Objective 5

23. U.S. GAAP and IFRS Requirements
IAS 21, The Effects of Changes in Foreign Exchange Rates is the relevant accounting standard.
Uses the functional currency approach developed by the FASB.
The standard includes a list, similar to the FASB list, of indicators as guidance for the foreign currency decision.
The standard’s requirements pertaining to hyperinflationary economies are substantially different from SFAS 52.
Learning Objective 5

24. U.S. GAAP and IFRS Requirements
Highly Inflationary Economies – U.S. GAAP
SFAS 52 provides guidance on highly inflationary economies.
SFAS 52 defines such economies as those with 100% inflation over a period of three years.
SFAS 52 requires the use of the temporal method in these cases of significant inflation.
Learning Objective 5

25. U.S. GAAP and IFRS Requirements
Hyperinflationary Economies -- IFRSs
IAS 21 and 29 use the term hyperinflationary economies.
IAS 21 is not a specific in defining hyperinflationary economies as is SFAS 52.
IAS 21 requires restatement of the foreign financial statements for inflation per IAS 29, Financial Reporting in Hyperinflationary Economies.
IAS 21 then requires the use of the current rate method of translation on the restated financial statements.
IAS approach is substantially different from SFAS 52.
Learning Objective 5

26. Hedging Balance Sheet Exposure
Companies that have foreign subsidiaries with highly integrated operations use the temporal method.
The temporal method requires translation gains and losses to be recognized in income.
Losses negatively affect earnings, and both gains and losses increase earnings volatility.
Learning Objective 6

27. Hedging Balance Sheet Exposure
These gains and losses result from the combination of balance sheet exposure and exchange rate fluctuations.
Companies can also hedge to offset the effects of the translation adjustment to equity under the current rate method.
Companies can hedge against gains and losses by using foreign currency forward contracts, options, and borrowings.
Learning Objective 6

28. Translation Procedures Internationally
Canada – very similar to U.S., however under the temporal method, some translations adjustments can be deferred and amortized.
Mexico – standards are silent, but SFAS 52 is commonly followed. In cases where it is not, practice varies widely.
Brazil – current rate method is used with gains and losses included in income.
Japan – significantly different from U.S. GAAP and IFRSs, with cumulative translation adjustment reported as an asset or liability.
Korea – only the current rate method is used.
Learning Objective 7

29. SEKIAN DAN TERIMA KASIH
EBA 604 Akuntansi Internasional