1. Translation of Foreign Currency Financial Statements
Chapter Ten
Translation of Foreign Currency Financial Statements
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2. Worldwide Consolidated Financial Statements
To prepare worldwide consolidated financial statements a U. S. parent must:
(1) convert the foreign GAAP financial statements of its foreign operations into U.S. GAAP and
(2) translate the financial statements from the foreign currency into U.S. dollars.
To prepare worldwide consolidated financial statements a U. S. parent must:
(1) convert the foreign GAAP financial statements of its foreign operations into U.S. GAAP and
(2) translate the financial statements from the foreign currency into U.S. dollars.

3. Learning Objective 10-1
Explain the theoretical underpinnings and the limitations of the current rate and temporal methods.
Explain the theoretical underpinnings and the limitations of the current rate and temporal methods.

4. Translation Methods: Temporal and Current Rate
Two major translation methods are currently used:
the current rate (or closing rate) method and
the temporal method.
Each method is presented from the perspective of a
U.S.–based multinational company translating foreign currency financial statements into U.S. dollars.
Two major translation methods are currently used: (1) the current rate (or closing rate)
method and (2) the temporal method. We discuss each method from the perspective of a
U.S.–based multinational company translating foreign currency financial statements into
U.S. dollars.

5. Comparison of the Two Translation Methods
Marketable debt securities classified as held to maturity are carried at amortized cost and translated at the historical exchange rate under the temporal method.

6. Learning Objective 10-2
Describe guidelines as to when foreign currency financial statements are to be translated using the current rate method and when they are to be translated using the temporal method.
Describe guidelines as to when foreign currency financial statements are to be translated using the current rate method and when they are to be translated using the temporal method.

7. Two Translation Combinations
Some subs are so closely tied to their U.S. parents. They use a U.S. dollar perspective to translation, so most of their transactions are recorded in U.S. dollars using the temporal method.
Other subs use the local currency perspective; they operate relatively independent of their U.S. parents and use the current rate method for translation.
Translation adjustment appears in the equity section.
FASB does not express preference for either of the two theoretical views
Two Translation Combinations
Some subs are tied closely to their U.S. parents so they use a U.S. dollar perspective to translation, so most of their transactions are recorded in U.S. dollars using the temporal method.
Other subs use the local currency perspective; they operate relatively independent of their U.S. parents and use the current rate method for translation.
Translation adjustment appears in the equity section.
Interestingly enough, the FASB chose not to express preference for either of these theoretical
Views.

8. Determining Subsidiary’s Functional Currency
In addition to introducing the concept of the functional currency, the FASB introduced
some new terminology. The reporting currency is the currency in which the entity
prepares its financial statements. For U.S.–based corporations, this is the U.S. dollar. If a
foreign operation’s functional currency is the U.S. dollar, foreign currency balances must
be remeasured into U.S. dollars using the temporal method with translation adjustments
reported as remeasurement gains and losses in net income. When a foreign currency is
the functional currency, foreign currency balances are translated using the current rate
method and a translation adjustment is reported on the balance sheet.
The functional currency is essentially a matter of fact. However, in some cases the
facts will not clearly indicate a single functional currency. Management’s judgment is
essential in assessing the facts to determine the functional currency. Indicators to guide
parent company management in its determination of a foreign entity’s functional currency
are presented in Exhibit Current authoritative literature provides no guidance
as to how to weight these indicators in determining the functional currency. Leaving
the decision about identifying the functional currency up to management allows some
leeway in this process. Research has shown that the weighting schemes used by U.S. multinationals to determine the functional currency might be biased toward selection of the foreign currency as
the functional currency. This would be rational behavior for multinationals because, when the foreign currency is the functional currency, the translation adjustment is reported in stockholders’ equity and does not affect net income.

9. Learning Objective 10-3
Translate a foreign subsidiary’s financial statements into its parent’s reporting currency
using the current rate method and calculate the related translation adjustment.
Translate a foreign subsidiary’s financial statements into its parent’s reporting currency using the current rate method
and calculate the related translation adjustment.

10. Current Rate Method
The first step in translating foreign currency financial statements is to determine the functional currency.
Under the current rate method, all revenues and expenses are translated at the exchange rate in effect at the date of accounting recognition.
The weighted average exchange rate is used when revenues and expenses have been recognized evenly throughout the year.
The first step in translating foreign currency financial statements is to determine the functional currency.
Under the current rate method, all revenues and expenses are translated at the exchange rate in effect at the date of accounting recognition.
The weighted average exchange rate is used when revenues and expenses have been recognized evenly throughout the year.

11. Current Rate Method
However, when an income account, such as a gain or loss, occurs at a specific point in time, the exchange rate as of that date is applied.
Depreciation and amortization expenses also are translated at the average rate for the year. These expenses accrue evenly throughout the year even though the journal entry could be delayed until year- end for convenience.
The weighted average exchange rate is used when revenues and expenses have been recognized evenly throughout the year.
However, when an income account, such as a gain or loss, occurs at a specific point in time, the exchange rate as of that date is applied.
Depreciation and amortization expenses also are translated at the average rate for the year. These expenses accrue evenly throughout the year even though the journal entry could be delayed until year-end for convenience.

12. Learning Objective 10-4
Remeasure a foreign subsidiary’s financial statements using the temporal method and
calculate the associated remeasurement
gain or loss.
Remeasure a foreign subsidiary’s financial statements using the temporal method and calculate the associated remeasurement gain or loss.

13. Temporal Method
If the sub’s functional currency is the US dollar, then any balances denominated in the local currency, must be remeasured. Remeasurement requires the application of the temporal method. The remeasurement gain or loss appears on the income statement.
Temporal Method
If the sub’s functional currency is the US dollar, then any balances denominated in the local currency, must be remeasured.
Remeasurement requires the application of the temporal method.
The remeasurement gain or loss appears on the income statement.

14. Temporal Method
The temporal method remeasures cash, receivables, and liabilities into U.S. dollars using the current exchange rate. Inventory, property and equipment, patents, and contributed capital accounts are remeasured at historical rates resulting in differences in total assets and liabilities plus equity which must be reconciled resulting in a remeasurement gain or loss.
The temporal method remeasures cash, receivables, and liabilities into U.S. dollars using the current exchange rate.
Inventory, property and equipment, patents, and contributed capital accounts are remeasured at historical rates resulting in differences in total assets and liabilities plus equity which must be reconciled resulting in a remeasurement gain or loss.

15. Learning Objective 10-5
Understand the rationale for hedging a net investment in a foreign operation and describe
the treatment of gains and losses on hedges used for this purpose.
Understand the rationale for hedging a net investment in a foreign operation and describe the treatment of gains and
losses on hedges used for this purpose.

16. Hedging Balance Sheet Exposure
When the U.S. dollar is the functional currency or when a foreign operation is located in a highly inflationary economy, remeasurement gains and losses are reported in the consolidated income statement.
Translation adjustments and remeasurement gains or losses are functions of two factors:
changes in the exchange rate and
balance sheet exposure.
When the U.S. dollar is the functional currency or when a foreign operation is located in
a highly inflationary economy, remeasurement gains and losses are reported in the consolidated
income statement.
Translation adjustments and remeasurement gains or losses are functions of two
factors: (1) changes in the exchange rate and (2) balance sheet exposure.

17. Learning Objective 10-6
Prepare a consolidation worksheet for a parent and its foreign subsidiary.
Understand the rationale for hedging a net investment in a foreign operation and describe the treatment of gains and
losses on hedges used for this purpose.

18. Consolidation of a Foreign Subsidiary
Translation of Foreign Subsidiary Trial Balance
Translation of Foreign Subsidiary Trial Balance
The initial step in consolidating the foreign subsidiary is to translate its trial balance
from British pounds into U.S. dollars. Because the British pound has been determined to
be the functional currency, this translation uses the current rate method. The historical
exchange rate for translating Bradford’s common stock and January 1, 2014, retained
earnings is the exchange rate that existed at the acquisition date—$1.51.

19. Investment in Foreign Subsidiary Account
The carrying value of the investment account in U.S. dollar terms at December 31,
2015, is determined as shown. In addition to Altman’s $44,783,000 investment in Bradford, it has equity income on its December 31, 2015, trial balance in the amount of $6,122,500.
The carrying value of the investment account in U.S. dollar terms at December 31, 2015, is $44,783,000. In addition, Altman reports equity income on its December 31, 2015, trial balance in the amount of $6,122,500.

20. Consolidation Worksheet with Foreign Subsidiary

21. IFRS and Translations
IAS 21 indicates that the primary factors to be considered in determining the functional currency of a foreign subsidiary are: 1. The currency that mainly influences sales price. 2. The currency of the country whose competitive forces and regulations mainly determine sales price. 3. The currency that mainly influences labor, material, and other costs of providing goods and services.
IAS 21 indicates that the primary factors to be considered in determining the functional
currency of a foreign subsidiary are:
1. The currency that mainly influences sales price.
2. The currency of the country whose competitive forces and regulations mainly determine
sales price.
3. The currency that mainly influences labor, material, and other costs of providing
goods and services.