1. Analysis of Multinational Operations Chapter 17 Robinson, Munter and Grant

2. Robinson, Munter & Grant Chapter 172 Learning Objectives Foreign currency transactions and translation Functional and measurement currency Exchange rate Remeasurement of financial statements Hyperinflation

3. Robinson, Munter & Grant Chapter 173 Foreign Currency Transactions US: Transactions whose terms are denominated in a currency other than the entity’s functional currency. International: Transaction which is denominated in, or requires settlement in, a foreign currency.

4. Robinson, Munter & Grant Chapter 174 Currencies Functional: Currency of the primary economic environment in which the entity operates (generates/expends cash). –FASB Statement 52 Measurement: Reflects the economic substance of the underlying events and circumstances relevant to that enterprise. –IAS 21 and 29

5. Robinson, Munter & Grant Chapter 175 Foreign Currency Translations Process of converting financial statements from one currency to another Necessary when a parent has a foreign subsidiary and that subsidiary uses a local currency as its functional currency

6. Robinson, Munter & Grant Chapter 176 Accounting for FC Transactions Transactions are initially measured using the exchange rate between the functional currency and the foreign currency as of the transaction date Subsequent changes in the exchange rates giving rise to a FC gain/loss are included income –Between purchasing an item and paying for it the exchange rate may change.

7. Robinson, Munter & Grant Chapter 177 Analytical Issues Accounting standards require transaction gains and losses be included in income but do not specify where FC gains and losses could appear in a number of places –Sales –Cost of goods sold or S, G & A –A category of “other” income or expense

8. Robinson, Munter & Grant Chapter 178 Analytical Issues Placement of FC gains and losses will affect a variety of ratios and margins including –Gross profit –Operating profit –Return on sales… Net income will not change

9. Robinson, Munter & Grant Chapter 179 Disclosures Companies are required to disclose the amount of the transaction gain or loss included in current income. Possibly under the heading “Foreign Currency Transactions” in the notes to the financial statements

10. Robinson, Munter & Grant Chapter 1710 FC Translation Issues Realized Gains and Losses Have been settled Realizable, has been converted into a monetary item Both are related to FC transactions

11. Robinson, Munter & Grant Chapter 1711 FC Translation Issues Unrealized Gains and Losses Have not been settled Unrealizable, will not be settled in the foreseeable future Both are related to FC translations

12. Robinson, Munter & Grant Chapter 1712 Objectives of FC Translation One business entity might be composed of numerous separate legal entities Results of separate entities must be consolidated and presented as though they were the financial statements of a single enterprise Using a single reporting currency

13. Robinson, Munter & Grant Chapter 1713 Objectives of FC Translation According to the FASB 1.Provide information that is compatible with the expected economic effects of a rate change on an entity’s cash flows and equity. 2.Reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with GAAP.

14. Robinson, Munter & Grant Chapter 1714 Translation of FC Statements Translate subsidiary financial statements from their functional/measurement currency into the reporting currency Not recorded in the income statement –An accounting process not an economic process –A component of other comprehensive income US and international standards are essentially the same

15. Robinson, Munter & Grant Chapter 1715 Translation of FC Statements IAS 21 Assets and liabilities (monetary and non- monetary) should be translated using the closing rate Income and expense items should be translated at exchange rates at the dates of the transactions (unless hyperinflationary) Resulting differences go to equity until disposal of net investment.

16. Robinson, Munter & Grant Chapter 1716 Translation of FC Statements FAS 52 Assets and liabilities – use the rate in place on the balance sheet date –Paid in capital uses historical date/rate Income and expense items – use the rate in place on the transaction date –If numerous transactions, use a weighted average exchange rate (generally the case) Translation adjustments are a component of equity.

17. Robinson, Munter & Grant Chapter 1717 Remeasurement of FC Statements Different form Translation in terms of –Process, and –Treatment of the translation adjustment Subtle difference

18. Robinson, Munter & Grant Chapter 1718 Remeasurement of FC Statements Sometimes called the Monetary and Non- monetary method Monetary items on the balance sheet are translated at the current rate Non-monetary items are translated using the rates in effect when asset was acquired or liability was incurred

19. Robinson, Munter & Grant Chapter 1719 Remeasurement of FC Statements Income Statement Items If derived from monetary items, translate using weighted-average rate –Sales, salary expense If derived from non-monetary items are translated using the historical rate used for the balance sheet items –Cost of goods sold and inventory Translation adjustment is a component of income

20. Robinson, Munter & Grant Chapter 1720 Remeasurement of FC Statements Necessary when an entity’s records are maintained on a basis other than the entity’s functional currency In some cases, both remeasurement and translation are necessary

21. Robinson, Munter & Grant Chapter 1721 Remeasurement of FC Statements Company Location Functional Currency Reporting Currency Translate? Remeasure? AAANeither ABBRemeasure from A to B AABTranslate from A to B ABCRemeasure from A to B, then translate from B to C

22. Robinson, Munter & Grant Chapter 1722 Translation of FC Statements Exchange rate summary TranslationRemeasurement Balance sheetCurrent rate MonetaryCurrent rate Non-MonetaryHistorical rate Income statementWeighted average MonetaryWeighted average Non-MonetaryHistorical rate

23. Robinson, Munter & Grant Chapter 1723 Hyperinflationary Environment Significant inflation leads to currency devaluation GAAP requires the remeasurement of the financial statement of foreign subsidiaries operating in a hyperinflationary environment –Translation adjustment will affect income

24. Robinson, Munter & Grant Chapter 1724 Hyperinflationary Environment GAAP Remeasure as if functional currency were the reporting currency When the cumulative inflation is at least (or approximately) 100 percent over a 3-year period

25. Robinson, Munter & Grant Chapter 1725 Hyperinflationary Environment International Standards Without restatement, purchasing power changes could make financial results misleading Restatement is a mater of managerial judgment International standards provide guidelines only

26. Robinson, Munter & Grant Chapter 1726 Hyperinflationary Environment International Guidelines Population keeps wealth in non-monetary assets Monetary amounts are in terms of a stable foreign currency Prices compensate for expected purchasing power loss Interest, wages and prices are linked to a price index 3-year inflation rate approaches or exceeds 100%

27. Robinson, Munter & Grant Chapter 1727 Hyperinflationary Environment International Standards Make general price-level adjustments –Restate in local currency to reflect the impact of inflation –Gain/loss on net monetary position is a component of net income –Specific steps to follow Then translate

28. Robinson, Munter & Grant Chapter 1728 Hyperinflationary Environment Overview US –Remeasure –Translation adjustment included income International –Restate for inflation in local currency Gain/loss on net monetary position in income –Translate restated amounts

29. Robinson, Munter & Grant Chapter 1729 Analytical Considerations Period-to-period analyses can be affected by exchange rates Some companies report “currency neutral” in addition to translated financial statements Currency neutral is based on local currency Discussion may be part of MD&A

30. Robinson, Munter & Grant Chapter 1730 Summary Foreign currency –International and US standards Transactions Translations Hyperinflation Analytical considerations