Translation of Foreign Currency in Financial Statements An.docx

Translation of Foreign Currency in Financial Statements
And
Preparation of Journal Entries
This week’s focus is on the translation of foreign currency
financial statements for the purpose of
preparing consolidated financials and also posting journal
entries.
When preparing consolidated financial statements on a
worldwide basis, the foreign currency financial
statements prepared by foreign operations must be translated
into the parent company’s reporting
currency.
Issues related to this translation:

1. Which method should be used, and
2. Where should the resulting translation adjustment be reported
in the consolidated financial
statements.
Translation methods differ on the basis of which accounts are
translated at the current exchange rate
and which are translated at historical rates. Accounts translated
at the current exchange rate are
exposed to translation adjustment (balance sheet exposure).
Different translation methods give rise to different concepts of
balance sheet exposure and translation
adjustments of differing sign and magnitude.
There are four major methods of translating foreign currency
financial statements:
1. current/noncurrent method
2. monetary/non-monetary method
3. temporal method

4. current rate
We will be focusing on the temporal and current rate methods.
CURRENT RATE METHOD
All assets and liabilities are translated at the current exchange
rate giving rise to a balance sheet
exposure equal to the foreign subsidiary’s net assets.
Stockholders’ equity accounts are translated at
historical exchange rates. Income statement items are translated
at the average exchange rate for the
current period.
Appreciation of the foreign currency results in a positive
translation adjustment
Depreciation of the foreign currency results in a negative
translation adjustment
Translating all assets and liabilities at the current exchange rate
maintains the relationships that exist in
the foreign currency financial statements.

Translating assets carried at historical cost at the current
exchange rate results in amounts being
reported on the parent’s consolidated balance sheet that have no
economic meaning.
TEMPORAL METHOD
A method of foreign currency translation that uses exchange
rates based on the time assets and
liabilities are acquired or incurred. The exchange rate used also
depends on the method of valuation
that is used. Assets and liabilities valued at current costs use the
current exchange rate and those that
use historical exchange rates are valued at historical costs.
Source: INVESTOPEDIA
With the temporal method assets are carried at current or future
value (cash, marketable securities,
receivables) and liabilities are re-measured at the current
exchange rate.

Assets carried at historical cost and stockholders’ equity
accounts are re-measured at historical
exchange rates.
Expenses related to assets re-measured at historical exchange
rates are re-measured using the same
rates.
Other income statements items are re-measured using the
average exchange rate for the period.
When liabilities are greater than the sum of cash, marketable
securities, and receivables, a net liability
balance sheet exposure exists.
Appreciation of the foreign currency results in a re-
measurement loss.
Depreciation of the foreign currency results in a re-
measurement gain.
Re-measuring assets carried at historical cost at historical
exchange rates maintains the underlying
valuation method used by the foreign operation in preparing its
financial statements.
Re-measuring some assets at historical exchange rates and other
assets at the current exchange rate

distorts the relationships that exist among account balances in
the foreign currency financial
statements.
All of the above is determined by identifying the functional
currency of a foreign operation.
The financial statements of a foreign operation whose
functional currency is different from the parent’s
reporting currency are translated using the current rate method,
with the resulting translation
adjustment deferred in stockholders’ equity until the foreign
entity is disposed of. Upon disposal of the
foreign operation, the accumulated translation adjustment is
recognized as a gain or loss in net income.
The financial statements of foreign operations whose functional
currency is the same as the parent’s
reporting currency are re-measured using the temporal method
with the resulting re-measurement gain

or loss reported immediately in net income.
FASB RULES
Statement #52 Summary
Foreign Currency Translation (Issued 12/81)
Summary Application of this Statement will affect financial
reporting of most companies operating in
foreign countries. The differing operating and economic
characteristics of varied types of foreign
operations will be distinguished in accounting for them.
Adjustments for currency exchange rate
changes are excluded from net income for those fluctuations
that do not impact cash flows and are
included for those that do. The requirements reflect these
general conclusions:
The economic effects of an exchange rate change on an
operation that is relatively self-contained and
integrated within a foreign country relate to the net investment
in that operation. Translation

adjustments that arise from consolidating that foreign operation
do not impact cash flows and are not
included in net income.
The economic effects of an exchange rate change on a foreign
operation that is an extension of the
parent's domestic operations relate to individual assets and
liabilities and impact the parent's cash flows
directly. Accordingly, the exchange gains and losses in such an
operation are included in net income.
Contracts, transactions, or balances that are, in fact, effective
hedges of foreign exchange risk will be
accounted for as hedges without regard to their form.
More specifically, this Statement replaces FASB Statement No.
8, Accounting for the Translation of
Foreign Currency Transactions and Foreign Currency Financial
Statements, and revises the existing
accounting and reporting requirements for translation of foreign
currency transactions and foreign
currency financial statements. It presents standards for foreign
currency translation that are designed to
(1) provide information that is generally compatible with the
expected economic effects of a rate change
on an enterprise's cash flows and equity and (2) reflect in
consolidated statements the financial results

and relationships as measured in the primary currency in which
each entity conducts its business
(referred to as its "functional currency").
An entity's functional currency is the currency of the primary
economic environment in which that entity
operates. The functional currency can be the dollar or a foreign
currency depending on the facts.
Normally, it will be the currency of the economic environment
in which cash is generated and expended
by the entity. An entity can be any form of operation, including
a subsidiary, division, branch, or joint
venture. The Statement provides guidance for this key
determination in which management's judgment
is essential in assessing the facts.
A currency in a highly inflationary environment (3-year
inflation rate of approximately 100 percent or
more) is not considered stable enough to serve as a functional
currency and the more stable currency of
the reporting parent is to be used instead.
The functional currency translation approach adopted in this
Statement encompasses:

Identifying the functional currency of the entity's economic
environment
Measuring all elements of the financial statements in the
functional currency
Using the current exchange rate for translation from the
functional currency to the reporting currency, if
they are different
Distinguishing the economic impact of changes in exchange
rates on a net investment from the impact
of such changes on individual assets and liabilities that are
receivable or payable in currencies other
than the functional currency
Translation adjustments are an inherent result of the process of
translating a foreign entity's financial
statements from the functional currency to U.S. dollars.
Translation adjustments are not included in
determining net income for the period but are disclosed and
accumulated in a separate component of
consolidated equity until sale or until complete or substantially
complete liquidation of the net
investment in the foreign entity takes place.
Transaction gains and losses are a result of the effect of
exchange rate changes on transactions

denominated in currencies other than the functional currency
(for example, a U.S. company may borrow
Swiss francs or a French subsidiary may have a receivable
denominated in kroner from a Danish
customer). Gains and losses on those foreign currency
transactions are generally included in
determining net income for the period in which exchange rates
change unless the transaction hedges a
foreign currency commitment or a net investment in a foreign
entity. Intercompany transactions of a
long-term investment nature are considered part of a parent's
net investment and hence do not give
rise to gains or losses.
SOURCE: fasb.org
IFRS RULES
IAS 21
An entity may carry on foreign activities in two ways. It may
have transactions in foreign currencies or it

may have foreign operations. In addition, an entity may present
its financial statements in a foreign
currency. The objective of this Standard is to prescribe how to
include foreign currency transactions
and foreign operations in the financial statements of an entity
and how to translate financial statements
into a presentation currency. The principal issues are which
exchange rate(s) to use and how to report
the effects of changes in exchange rates in the financial
statements.
This Standard does not apply to hedge accounting for foreign
currency items, including the hedging of a
net investment in a foreign operation. IAS 39 applies to hedge
accounting.
This Standard does not apply to the presentation in a statement
of cash flows of the cash flows arising
from transactions in a foreign currency, or to the translation of
cash flows of a foreign operation (see IAS
7 Statement of Cash Flows).
Functional currency

Functional currency is the currency of the primary economic
environment in which the entity operates.
The primary economic environment in which an entity operates
is normally the one in which it primarily
generates and expends cash. An entity considers the following
factors in determining its functional
currency:
(a) the currency:
(i) that mainly influences sales prices for goods and services
(this will often be the currency in which
sales prices for its goods and services are denominated and
settled); and
(ii) of the country whose competitive forces and regulations
mainly determine the sales prices of its
goods and services.
(b) the currency that mainly influences labor, material and other
costs of providing goods or services
(this will often be the currency in which such costs are
denominated and settled).
Reporting foreign currency transactions in the functional
currency

Foreign currency is a currency other than the functional
currency of the entity.
Spot exchange rate is the exchange rate for immediate delivery.
Exchange difference is the difference resulting from translating
a given number of units of one currency
into another currency at different exchange rates.
Net investment in a foreign operation is the amount of the
reporting entity’s interest in the net assets of
that operation.
A foreign currency transaction shall be recorded, on initial
recognition in the functional currency, by
applying to the foreign currency amount the spot exchange rate
between the functional currency and
the foreign currency at the date of the transaction.
At the end of each reporting period:

foreign currency monetary items shall be translated using the
closing rate;
non-monetary items that are measured in terms of historical cost
in a foreign currency shall be
translated using the exchange rate at the date of the transaction;
and
non-monetary items that are measured at fair value in a foreign
currency shall be translated using the
exchange rates at the date when the fair value was measured.
Exchange differences arising on the settlement of monetary
items or on translating monetary items at
rates different from those at which they were translated on
initial recognition during the period or in
previous financial statements shall be recognized in profit or
loss in the period in which they arise.
However, exchange differences arising on a monetary item that
forms part of a reporting entity’s net
investment in a foreign operation shall be recognized in profit
or loss in the separate financial
statements of the reporting entity or the individual financial
statements of the foreign operation, as

appropriate. In the financial statements that include the foreign
operation and the reporting entity (e.g.
consolidated financial statements when the foreign operation is
a subsidiary), such exchange differences
shall be recognized initially in other comprehensive income and
reclassified from equity to profit or loss
on disposal of the net investment.
Furthermore, when a gain or loss on a non-monetary item is
recognized in other comprehensive income,
any exchange component of that gain or loss shall be recognized
in other comprehensive income.
Conversely, when a gain or loss on a non-monetary item is
recognized in profit or loss, any exchange
component of that gain or loss shall be recognized in profit or
loss
Translation to the presentation currency/Translation of a foreign
operation
The Standard permits an entity to present its financial

statements in any currency (or currencies). For
this purpose, an entity could be a stand-alone entity, a parent
preparing consolidated financial
statements or a parent, an investor or a venturer preparing
separate financial statements in accordance
with IAS 27 Consolidated and Separate Financial Statements. If
the presentation currency differs from
the entity’s functional currency, it translates its results and
financial position into the presentation
currency.
For example, when a group contains individual entities with
different functional currencies, the results
and financial position of each entity are expressed in a common
currency so that consolidated financial
statements may be presented.
An entity is required to translate its results and financial
position from its functional currency into a
presentation currency (or currencies) using the method required
for translating a foreign operation for
inclusion in the reporting entity’s financial statements.

The results and financial position of an entity whose functional
currency is not the currency of a
hyperinflationary economy shall be translated into a different
presentation currency using the following
procedures:
(a) assets and liabilities for each statement of financial position
presented (i.e. including comparatives)
shall be translated at the closing rate at the date of that
statement of financial position;
(b) income and expenses for each statement of comprehensive
income or separate income statement
presented (i.e. including comparatives) shall be translated at
exchange rates at the dates of the transactions; and
(c) all resulting exchange differences shall be recognized in
other comprehensive income.
Any goodwill arising on the acquisition of a foreign operation
and any fair value adjustments to the
carrying amounts of assets and liabilities arising on the
acquisition of that foreign operation shall be
treated as assets and liabilities of the foreign operation. Foreign
operation is an entity that is a

subsidiary, associate, joint venture or branch of a reporting
entity, the activities of which are based or
conducted in a country or currency other than
those of the reporting entity.
On the disposal of a foreign operation, the cumulative amount
of the exchange differences relating to
that foreign operation, recognized in other comprehensive
income and accumulated in the separate
component of equity, shall be reclassified from equity to profit
or loss (as a reclassification adjustment)
when the gain or loss on disposal is recognized (see IAS 1
Presentation of Financial Statements (as
revised in 2007)).
On the partial disposal of a subsidiary that includes a foreign
operation, the entity shall re-attribute the
proportionate share of the cumulative amount of the exchange
differences recognized in other
comprehensive income to the non-controlling interests in that
foreign operation. In any other partial
disposal of a foreign operation the entity shall reclassify to

profit or loss only the proportionate share of
the cumulative amount of the exchange differences recognized
in other comprehensive income.
SOURCE: ifrs.org
IFRS/GAAP MAJOR DIFFERENCES
FUNCTIONAL CURRENCY DETERMINATION
SOURCE: www.grantthornton.com April 2012 IFRS vs. US
GAAP Reporting Webinar

PLEASE USE THE LINK BELOW FOR DETAILS
REGARDING POSTING JOURNAL ENTRIES.
Preparation of Journal Entries
AIS documentation:
http://docs.oracle.com/cd/E16582_01/doc.91/e15123/enterforeig
ncurrencyje.htm
This link will serve as your reference (textbook) for this topic.
There are five sections included in this
Chapter 11 Entering and Processing Foreign Currency Journal
Entries.
Homework Assignment
This week we are discussing functional currency….what is the
definition?
http://docs.oracle.com/cd/E16582_01/doc.91/e15123/enterforeig
ncurrencyje.htm

Functional currency is the currency of the subsidiary’s primary
economic environment. It is usually
identified as the currency in which the company generates and
expends cash.
Your assignment is to report on the functional currency of your
MNC. When researching your answer
keep in mind the following:
Both U.S. GAAP and IFRS recommend the following factors:
the location of primary sales markets,
sources of materials and labor,
the source of financing, and
the amount of intercompany transactions should be evaluated in
identifying an entity’s functional
currency.
U.S. GAAP does not provide any guidance as to how these
factors are to be weighted (equally or
otherwise) when identifying an entity’s functional currency.

Unlike U.S. GAAP, IAS 21 provides a
hierarchy of factors to consider (reference the exhibit on the
next page for details).
Your homework is to be posted in the chapter conference.
IAS FUNCTIONAL CURRENCY INDICATORS*
Factors Considered in Determining the Functional Currency
In accordance with IAS 21, The Effects of Changes in Foreign
Exchange Rates, the following factors
should be considered first in determining an entity’s functional
currency:
The currency (a) that mainly influences sales prices for goods
and services and (b) of the country whose
competitive forces and regulations mainly determine the sales
prices of its goods and services.
The currency that mainly influences labor, material, and other
costs of providing goods and services.

If the primary factors listed above are mixed and the functional
currency is not obviously, the following
secondary factors must be considered:
The currency is which funds from financing activities are
generated.
The currency in which receipts from operating activities are
usually retained.
Whether the activities of the foreign operation are an extension
of the parent’s or are carried out with a
significant amount of autonomy.
Whether transaction with the parent are a large or a small
proportion of the foreign entity’s activities.
Whether cash flows generated by the foreign operation directly
affect the cash flow of the parent and
are available to be remitted to the parent.
Whether operating cash flows generated by the foreign
operation are sufficient to service existing and
normally expected debt or whether the foreign entity will need
funds from the parent to service its
debt.

*International Accounting, Doupnik and Perera, 3rd edition,
page 419 Exhibit 8.3

Translation of Foreign Currency in Financial Statements An.docx

Recomendados

Recomendados

Más contenido relacionado

Similar a Translation of Foreign Currency in Financial Statements An.docx

Similar a Translation of Foreign Currency in Financial Statements An.docx (20)

Más de turveycharlyn

Más de turveycharlyn (20)

Último

Último (20)

Translation of Foreign Currency in Financial Statements An.docx