2. Advanced Accounting, Fourth Edition13
Translation of Financial
Statements of Foreign Affiliates
Advanced Accounting, Fourth Edition

3. Learning Objectives
Distinguish between the current exchange rate and the historical exchange rate.
Understand the objectives of financial statement translation.
Identify the functional currency of a foreign entity.
Compare the two methods used to convert the financial statements of a foreign entity into U.S. dollars.
Distinguish between the circumstances under which each of the two methods is appropriate under current GAAP.

4. Learning Objectives
Explain the factors involved in translating the statements of a foreign entity operating in a highly inflationary economy.
Translate the statements of a foreign entity when the functional currency is the local currency.
Translate the statements of a foreign entity when the functional currency is the U.S. dollar.
Understand the concept of comprehensive income in the context of foreign currency translation.
Identify the disclosure requirements for firms with foreign entities.

5. Translation of Financial Statements
A U.S. company may be involved in foreign activities through the operations of a:
branch,
subsidiary, or
investee company.
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.

6. Accounting for Operations in Foreign Countries
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.

7. Translating Statements of Foreign Affiliates
The conversion from another currency into the currency of the parent company is frequently called “translation.”
Translation Process
Current Exchange Rate
Financial Statements in Euros
Financial Statements in U.S. Dollars
Historical Exchange Rate
LO 1 Current versus historical exchange rates.

8. Translating Statements of Foreign Affiliates
Translation Adjustment or Translation Gain or Loss
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.
Not a Choice
LO 1 Current versus historical exchange rates.

9. Objectives of Translation-SFAS No. 52
Functional Currency Concept
Objective of Translation - SFAS No. 52 [ASC ]:
Provide information regarding the exposed economic effects of an exchange rate change on an enterprise’s cash flows and equity [par. 4(a)].
Reflect in consolidated statements the financial results measured in their functional currencies in conformity with U.S. GAAP [par. 4(b)].
The Board believes that the operating performance and financial
condition of a foreign entity are best measured by expressing its accounts in
the currency of the economic environment in which it primarily conducts its operations and generates and expends its cash, its functional currency.
LO 2 Objectives of translation.

10. Translation Methods Current rate method All assets and liabilities.
Revenues and expenses.
Translation
Current exchange rate.
Exchange rate on the date each transaction occurred.
LO 4 Two methods of conversion.

11. Translation Methods Temporal Method Translation
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.
Exchange rate on date transaction occurred.
LO 4 Two methods of conversion.

12. Identifying the Functional Currency
The Functional Currency may be
The local currency of the foreign entity,
The U.S. dollar, or
The currency of a third country.
Economic Indicators of Functional Currency:
Cash flow
Sales prices
Sales market
Expenses
Financing
Intercompany transactions
LO 3 Identifying the functional currency.

13. Identifying the Functional Currency
Review Question
Indicators that the local currency is also the functional currency include all of the following except:
The majority of the cash flows are in the local currency.
Sales prices are determined by local market conditions.
Financing is generally from the parent or guaranteed by the parent.
Production costs and expenses are determined by local conditions.
LO 3 Identifying the functional currency.

14. Translation of Foreign Currency Financial Statements
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.
LO 4 Which methods of conversion to use.

15. Translation of Foreign Currency Financial Statements
Accounts stated in local currency of foreign entity.
Is the foreign economy highly
inflationary?
Determine the functional currency (FC) per
economic indicators. No No
Functional currency (FC) is U.S. Dollar.
Is the FC the U.S. dollar?
Is the FC the local currency?
Yes
Yes No
Translate to
U.S. dollars using current rate method.
Remeasure to U.S. dollars using temporal method.
Remeasure to
FC using temporal method.
LO 4 Which methods of conversion to use.

16. Translation of Foreign Currency Financial Statements
Foreign Entity Operates in 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.
LO 6 Factors in a highly inflationary economy.

17. Translation of Foreign Currency Financial Statements
Foreign Entity in Economy that is Not Highly Inflationary
Functional currency must be identified. Translation process:
Local currency is the functional currency.
Current rate method.
Translation adjustment recorded as a component of stockholders’ equity.
U.S. dollar is the functional currency.
Temporal method.
Translation adjustment reported in income statement.

18. Translation of Foreign Currency Financial Statements
Books kept in
local currency
Local currency
Remeasure-
ment
Not necessary
Temporal
method
Temporal
method
Local
currency
U.S.
dollar
A third
currency
Functional
currency
Current rate method
Not necessary
Current rate method
Translation
U. S. dollars
U.S. dollar

19. Translation – Current Rate Method
Assets and liabilities
Paid-in capital
Beginning R/E
Dividends
Revenue and Expenses
Cumulative translation adjustment
Current year translation adjustment
Current exchange rate
Historical rate
Ending balance of last year
Historical rate when dividend is declared
Average exchange rate
Balance amount in the balance sheet
Other comprehensive income (shareholders’ equity)
LO 7 The functional currency is the local currency.

20. Translation – 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, $.5987
December 31,
Average for
Dividend declaration and payment date
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.

21. Translation – Current Rate Method
Exercise 13-4: (Current Rate Method)

22. Translation – Current Rate Method
Exercise 13-4: Prepare a schedule to verify the translation adjustment.
Swiss Translation
Francs Rate $   
Exposed net asset position - 1/1 30,000 $ ,961 Adjustment for changes in net asset position:
Net income 45, ,443 Dividends (15,000) (8,715) Net asset position translated ,689 Exposed net asset position - 12/31 60, , Cumulative translation adjustment (debit) (2,763)
LO 7 The functional currency is the local currency.

23. Translation – Current Rate Method
Review Question
Under the current method of currency translation, which of the following balance sheet accounts is translated at historical exchange rates?
Cash
Accounts Receivable
Bonds Payable
Common Stock
LO 7 The functional currency is the local currency.

24. Translation – 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.
Exchange rate on date transaction occurred.
LO 8 The functional currency is the U.S. dollar.

25. Translation – 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, $.5987
December 31,
Average for
Dividend declaration and payment date
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.

26. Translation – Temporal Method
Exercise 13-5: (Temporal Method)

27. Translation – Temporal Method
Exercise 13-5: Prepare a schedule to verify the translation gain or loss.
Swiss Translation
Francs Rate $   
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, ,405 Less: Decrease in net asset position:
Other operating expenses (27,000) (15,266) Dividends (15,000) (8,715) Net asset position translated ,437 Net monetary asset position-12/ , ,238 Translation gain (loss)    (199)
LO 7 The functional currency is the local currency.

28. Financial Statement Disclosure
Companies are required to disclose certain items, as follows:
The aggregate translation gain or loss included in the determination of net income for the period.
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.
Exchange rate changes that occur after the balance sheet date and their effect on unsettled foreign currency transactions, if significant.
LO 10 Required disclosure.

29. Date 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

30. Date of Acquisition
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.

31. After Acquisition Cash 38,400 Dividend income 38,400
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:
Cash 38,400
Dividend income 38,400
(300,000 francs x $.16 = $48,000 x .80 = $38,400)

32. After Acquisition
Workpaper entries assuming current rate method.

33. Consolidation Assuming Temporal Method
The major differences between the workpapers are as follows:
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.

34. Remeasurement and Translation of 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.
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.
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.
Any transaction gain or loss resulting from this procedure is recognized currently in income.

35. 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.

36. Elimination 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.

37. Liquidation 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.

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