Translation of foreign financial statements
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Translation of Foreign Financial Statements. Foreign currency translation. The process of expressing amounts denominated or measured in foreign currencies into amounts measured in the reporting currencies of the domestic entity. FASB’s Statement No. 52. Adopted a functional currency approach

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Translation of foreign financial statements

Translation of

Foreign

Financial Statements


Foreign currency translation
Foreign currency translation

  • The process of expressing amounts denominated or measured in foreign currencies into amounts measured in the reporting currencies of the domestic entity

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Fasb s statement no 52
FASB’s Statement No. 52

  • Adopted a functional currency approach

  • The previous standard (SFAS No. 8) employed the temporal method

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Functional currency
Functional currency

  • The currency of the primary economic environment in which the entity generates and expends cash

  • A number of factors must be evaluated in order to properly identify the functional currency

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Objectives of the translation process
Objectives of the translation process

  • Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise’s cash flows and equity

  • Reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with U.S. GAAP

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Expected economic effects of a rate change
Expected economic effects of a rate change

The foreign entity is a conduit:

  • Cash inflows/outflows are affected

  • Translation gains/losses should be included in net income

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Expected economic effects of a rate change con t
Expected economic effects of a rate change (con’t)

The foreign entity is not a conduit:

  • Cash inflows/outflows are not affected

  • No translation gains/losses should be included in net income (include as a component of other comprehensive income)

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Reflect financial results and relationships in conformity with u s gaap
Reflect financial results and relationships in conformity with U.S. GAAP

  • If not affected by rate changes, the relationship between accounts (e.g., current ratio, debt / equity ratio) should be the same after translation as they were before

  • If affected by rate changes, relationships between accounts are different than they were prior to translation, therefore, reflecting the economic effect of rate changes

  • Foreign financial statements should be restated into U.S. GAAP before translation begins

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The translation process
The translation process with U.S. GAAP

Identify the “Books of Record” (BR) currency and the “Functional Currency” (FC)

Convert foreign financial statements to GAAP

Start

Is FC the inflationary

currency?

Use functional method to get FC into $’s

No

Is BR = FC?

Yes

Yes

End

apply the remeasurement

process (shown later)

No

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The translation of financial statement accounts con t
The translation of financial statement accounts with U.S. GAAP(con’t)

  • Monetary items: rights to receive or pay an amount of money which is:

    • (a) fixed or

    • (b) determinable without reference to future prices of specific goods/services; that is, its value does not change according to changes in price levels.

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Accounting for the translation adjustment
Accounting for the translation adjustment with U.S. GAAP

  • The adjustment is NOT included in net income

  • The adjustment is shown as a separate component of other comprehensive income (OCI)

  • The adjustment may be recognized as a component of net income when there is a partial or complete sale/liquidation of the investment in the foreign entity

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Reconciliation of the annual translation adjustment
Reconciliation of the annual translation adjustment with U.S. GAAP

  • Net assets at the beginning of the period multiplied by the change in exchange rates during the period

  • [100,000 FC  ($1.05 - $1.00)] = $5,000

  • Increase in net assets (excluding capital transactions) multiplied by the difference between the current rate and the average rate used to translate income

  • [50,000 FC  ($1.05 - $1.03)] = $1,000

continued . . .

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Reconciliation of the annual translation adjustment con t
Reconciliation of the annual translation adjustment (con’t)

  • Increase in net assets due to capital transactions (including investments by the domestic investor) multiplied by the difference between the current rate and the rate at the time of the capital transaction

    [60,000 FC  ($1.05 - $1.00)] = 3,000

    Translation adjustment (credit) = $9,000

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Special issues related to consolidating the foreign subsidiary
Special issues related to consolidating the foreign subsidiary

  • The translation adjustment is allocated between the controlling and noncontrolling interests

  • Any excess of cost over book value is translated at the end of the period exchange rate

  • Any amortization of excess is translated at the average exchange rate for the period

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Special issues related to consolidating the foreign subsidiary con t
Special issues related to consolidating the foreign subsidiary (con’t)

  • Unrealized intercompany profits must be eliminated using the rate of exchange which existed at the date of the intercompany transaction

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Special issues related to the sophisticated equity method
Special issues related to the sophisticated equity method subsidiary

The investment account includes:

  • The investor’s share of the investee’s translated net income

  • Amortization of any excess of cost over book value

  • The investor’s share of the cumulative translation adjustment

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Remeasured financial statements
Remeasured financial statements subsidiary

  • The remeasurement process is intended to produce financial statements that are the same as if the entity’s transactions had been originally recorded in the functional currency

  • Remeasurement is based on the temporalmethod

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Remeasurement is necessary when

The foreign entity’s financial statements are prepared in a currency that is not the functional currency. The functional currency may be

another foreign currency

the U.S.dollar

The foreign entity’s functional currency is that of a highly inflationary economy

Remeasurement is necessary when

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The remeasurement process
The remeasurement process a currency that is not the functional currency. The functional currency may be

Identify the “Books of Record” (BR) currency and the “Functional Currency” (FC)

Convert foreign financial statements to GAAP

Start

A

No

Is FC = inflationary currency?

Is FC = $?

Is BR = FC?

Use Temporal method

Yes

Yes

No

No

Yes

Use Temporal method to get into functional currency

End

Use Temporal method

A

A

End

apply the translation process shown earlier

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Remeasurement of financial statement accounts
Remeasurement of financial statement accounts a currency that is not the functional currency. The functional currency may be

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Special remeasurement issues
Special remeasurement issues a currency that is not the functional currency. The functional currency may be

  • Application of lower of cost or market for inventory

  • Historical exchange rates for purchase accounting

  • Remeasured financial statements may still need to be translated

  • Equity method of accounting for an investment should include the appropriate share of remeasurement gains or losses

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Disclosure requirements
Disclosure requirements a currency that is not the functional currency. The functional currency may be

An analysis of the cumulative translation adjustment including:

  • Beginning and ending amount of cumulative translation adjustments

  • The aggregate adjustment for the period resulting from translation adjustments and gains and losses from certain hedges and intercompany balances

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Disclosure requirements con t
Disclosure requirements a currency that is not the functional currency. The functional currency may be(con’t)

  • The amount of income taxes for the period allocated to translation adjustments

  • The amounts transferred from cumulative translation adjustments in OCI and included in determining net income for the period as a result of the sale or complete or substantially complete liquidation of an investment in a foreign entity

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