Chapter 12

Multinational
Accounting:
Issues in Financial
Reporting and
Translation of Foreign
Entity Statements
McGraw- Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 12-2

Determine the functional

currency and understand the
ramifications of different
functional currency
designations.

12-2
 The Accounting Issues

⬥ Many corporations have

multinational operations
The foreign subsidiaries prepare
P
■

their financial statements in the Parent

currency of their countries.
■ The foreign currency amounts in
these financial statements have to
be converted into their parent’s
S Foreign

currency equivalents before they

can be consolidated with the
parent’s financial statements.
11-3
Presentation Vs Functional Currency

• A company is required to determine its functional

currency
• The company is free, however to determine its
presentation currency
• For group entity:
– The presentation currency of the group is the
presentation currency of the parent company

Tan, Lim & Lee Chapter 8 © 2015 4

Concept of Functional Currency

• Functional currency under IAS 21:

– Currency of the “primary economic environment in which the entity
operates”
– The currency that influences the sale prices of goods and services
– Normally the currency that sales prices are denominated and settled in
– The currency in which the costs are accumulated in

• A firm’s “primary economic environment” is not determined by

national or political boundaries
Example: Neptune Orient Lines is located in SG.: revenue is mainly in form
of freight charges, with significant proportion of operating costs attributable
to fuel oil
– Prices of freight charges and fuel oil: denominated in US dollars (main
currency in shipping and commodities)
– Functional currency: USD; NOT SGD

Tan & Lee Chapter 7 © 2009 5

Factors to Indicate an Entity’s Functional
Currency

1. The currency that mainly influences the sale prices of goods and
services

2. The currency of country whose competitive forces and regulations

determine the sales prices of goods and services

3. The currency that mainly influences the labour, material and other
cost of goods and services

4. The currency in which financing is obtained; or

5. The currency in which receipts from operating activities are
retained

Tan & Lee Chapter 7 © 2009 6

 Functional Currency Indicators

⬥ Functional currency designation in highly

inflationary economies
■ The volatility of hyperinflationary currencies
distorts the financial statements if the local
currency is used as the foreign entity’s
functional currency
■ In such cases, the reporting currency of the
parent should be used as the foreign entity’s
functional currency

12-7
Learning Objective 12-3

Understand and explain the

differences between
translation and
remeasurement.

12-8
Presentation Vs Functional Currency

IAS 21 specific two approaches to translate the financial

statement

Foreign Functional Presentation

Currency Currency Currency

Remeasurement Method Translation Method

Tan, Lim & Lee Chapter 8 © 2015 9

Functional Currency to Presentation
Currency

• Translation method is used to translate financial

statements from functional to the presentation currency

• This method is applicable to:

– Foreign operation (branch, subsidiary or associate)
that records its books in its functional currency but
need to translate its financial statements into parent’s
presentation currency for consolidation

Tan, Lim & Lee Chapter 8 © 2015 10

Foreign Currency to Functional Currency

• Remeasurement method is used to translate financial statements

from functional to the presentation currency

• This method is applicable to:

– A foreign operation that records its books in local currency but its
functional currency is the presentation currency of its parent (assumed
to be the same as the parent’s functional currency)

• Purpose of re-measurement is to achieve the same result as if the

transactions had been originally recorded in the functional currency

Tan, Lim & Lee Chapter 8 © 2015 11

Big Picture: Foreign Currencies

■ Assumptions:
■ Pepper is a U.S.-
based company
■ Salt is based in Italy
and the functional
currency is the Euro.
■ In order to “add them
up,” they need to be
stated in the same
currency.
■ Objective:
■ Convert oranges to
apples. 12-12
 Translation Versus Remeasurement of Foreign
Financial Statements
⬥ Methods used to restate foreign entity
statements to U.S. dollars:
■ The translation of the foreign entity’s functional
currency statements into U.S. dollars
■ The remeasurement of the foreign entity’s
statements into the functional currency of the
entity
● After remeasurement, the statements must then
be translated if the functional currency is not the
U.S. dollar.
● No additional work is needed if the functional
currency is the U.S. dollar
12-13
 Translation Versus Remeasurement

⬥ Remeasurement is the restatement of the

foreign entity’s financial statements from
the local currency that the entity used
into the foreign entity’s functional
currency
■ Required only when the functional currency is
different from the currency used to maintain the
books and records of the foreign entity
■ The method used is called the temporal method

12-14
 Translation Versus Remeasurement
⬥ Example: A U.S. company owns 100% of the stock of
an Argentinian company. The local currency in
Argentina is the peso
■ Scenario 1: The company pays employees, buys
inventory, and conducts most of its operations in
pesos. Thus, its functional currency is the peso.
● Translate the financial statements to U.S. dollars
■ Scenario 2: The company pays buys and sells most
of its inventory in southern Brazil. It also pays
many of its employees in Brazilian reias. Thus, its
functional currency is the Brazilian reias.
● Remeasure the financial statements to reias.
● Then, translate them back to U.S. dollars. 12-15
 Translation Versus Remeasurement

LC = Local Currency
FC = Functional Currency
⬥ Summary for U.S. Parent Companies:
■ If LC = FC 🡺 Translate to U.S. Dollars
■ If LC ≠ FC 🡺 Remeasure to FC
● If FC = U.S. dollars, no further work is needed
(this is the case for subsidiaries in countries
with hyperinflationary currencies)
● If FC ≠ U.S. dollars 🡺 Translate to U.S. Dollars
(this is the case for Scenario 2 of the
Argentinian company in the previous example)
12-16
Translation vs remeasurement
Assumed that parent’s functional and presentation currency is the dollar (US$)
Foreign Foreign operation’s Translation or Remeasurement (Assume that
operation’s functional currency presentation currency is parent’s currency)
financial
statement
The local The local currency Functional currency (LC) is ≠ the group’s
currency (LC) (LC) presentation currency ($).

Translate into $ using the closing rate method

The local The parent’s Functional currency is ≠LC. All transactions

currency (LC) functional currency recorded in LC are deemed foreign currency
($) transactions. Transactions recorded in LC
need to be remeasured from LC to $.
The dollar ($) The dollar ($) No translation or remeasurement; FS
presented in $

The local A third currency Remeasure from LC into the functional

currency (LC) currency; then translate into $
Tan, Lim & Lee Chapter 8 © 2015 17
 Translation

■ The current rate is used to convert local currency

asset and liability accounts into U.S. dollars
■ Historical rates are used to convert equity
accounts into U.S. dollars
■ Revenues and expenses are translated using the
average rate for the reporting period
■ Any translation adjustment that occurs is a
component of comprehensive income
■ This method is called the current rate method

12-18
 Remeasurement

■ Monetary balance sheet items are remeasured

using the current rate
■ Nonmonetary balance sheet items are
remeasured using historical rates
■ Revenues and expenses are remeasured using:
● The average rate for items related to monetary
items (e.g., the gain on the sale of a fixed asset)
● Historical rates for income statement items
related to nonmonetary items (e.g., depreciation)
■ Any imbalance flows through the income
statement as a remeasurement gain or loss.

12-19
Learning Objective 12-4

Make calculations and translate

financial statements of a foreign
subsidiary.

12-20
 Translation

⬥ Generally, accounts are translated as follows:

Note: Retained Earnings is unique (with a mixed rates).

Functional
Currency Rate U.S. $
Use Last
Retained Earnings 1/1 Mixed Year’s #
+ Net Income Average
- Dividends Historical
Retained Earnings 12/31 Mixed

■ Net income is translated using the average exchange rate 12-21

 Translation

⬥ The outcome of the translation process:

■ Because various rates are used, the trial balance
debits and credits after translation generally are
not equal
■ The balancing item to make the translated trial
balance debits equal the credits is called the
translation adjustment
■ It by-passes the income statement and as “other
comprehensive income.”

12-22
 Translation

⬥ Financial statement presentation

■ The translation adjustment is part of the entity’s
comprehensive income for the period
■ Comprehensive income includes net income and “other
comprehensive income” Statement of
Income Statement Comprehensive Income
Sales Net Income
- Cost of Goods sold +/- OCI Items
Gross Profit Comprehensive Income
- Operating Expenses
Income from Continuing Operations
- Extraordinary Items
- Discontinued Operations
Net Income 12-23
 Translation

⬥ Financial statement presentation

■ Major items comprising the other comprehensive income:
● Foreign currency translation adjustments (Ch. 12)
● Revaluation of cash flow hedges (Ch. 11)
● Unrealized gains/losses on available-for-sale securities
● Adjustments in the minimum pension liability item
Sales Net Income
- Cost of Goods sold +/- OCI Items
Gross Profit Comprehensive Income
- Operating Expenses
Income from Continuing Operations
- Extraordinary Items
- Discontinued Operations
Net Income 12-24
 Translation

⬥ Each period’s other comprehensive

income (OCI) is closed to accumulated
other comprehensive income (AOCI)
⬥ An appropriate title, such as
“Accumulated Other Comprehensive
Income,” is used to describe this
stockholders’ equity item

12-25
 Practice question #1
⬥ Simon Company has two foreign subsidiaries. One is located
in France, the other in England. Simon has determined the
U.S. dollar is the functional currency for the French
subsidiary, while the British pound is the functional
currency for the English subsidiary. Both subsidiaries
maintain their books and records in their respective local
currencies. What methods will Simon use to convert each of
the subsidiary's financial statements into U.S. dollars?

12-26
 Practice question #2

⬥ Parisian Co. is a French company located in Paris.

Yankee Corp., located in New York City, acquires
Parisian Co. Parisian has the Euro as its local
currency and the Swiss Franc as its functional
currency. Yankee has the U.S. dollar as its local
currency and the U.S. dollar as its functional
currency.
⬥ Explain which method is appropriate to use to
use at year-end

12-27
 Practice question #3

If the restatement method for a foreign subsidiary

involves remeasuring from the local currency into the
functional currency, then translating from functional
currency to U.S. dollars, the functional currency of the
subsidiary is:
I. U.S. dollar.
II. Local currency unit.
III. A third country's currency.
A. I
B. III
C. II
D. Either I or II
12-28
 Practice question #4

⬥ When the local currency of the foreign subsidiary is

the functional currency, a foreign subsidiary's
inventory carried at cost would be converted to U.S.
dollars by:
A. translation using historical exchange
rates.
B. remeasurement using historical exchange
rates.
C. remeasurement using the current
exchange rate.
D. translation using the current
exchange rate.

12-29
 Practice question #5

When the local currency of the foreign subsidiary is

the functional currency, a foreign subsidiary's income
statement accounts would be converted to U.S. dollars
by:
A. translation using historical exchange rates.
B. remeasurement using current exchange rates at
the time of statement preparation.
C. translation using average exchange rate for the
period.
D. remeasurement using the current exchange rate
at the time of statement preparation.
12-30
 Practice question #6
If the U.S. dollar is the currency in which the foreign affiliate's
books and records are maintained, and the U.S. dollar is also the
functional currency,
A. the translation method should be used for restatement.
B. the remeasurement method should be used for
restatement.
C. either translation or remeasurement could be used for
restatement.
D. no restatement is required.

12-31
Learning Objective 12-5

Prepare consolidated financial

statements including a foreign
subsidiary after translation.

12-32
 Group Exercise 1: Translation

⬥ On 1/2/X7, Padre Corp. (a U.S. based company)

formed a new subsidiary in Honduras, Sucursal
Inc., with an initial investment of 150,000
Honduras Lempiras (HNL).
⬥ Assume Sucursal:
■ Purchases inventory evenly throughout 20X7.
The ending inventory is purchased 11/30/X7.
■ Uses straight-line depreciation on fixed assets.
■ Declares and pays dividends on 11/30/X7.
■ Purchased the fixed assets on 4/1/X7.
■ Uses Lempiras as the functional currency.
REQUIRED 12-33
Group Exercise 1: Translation

12-34
Group Exercise 1: Translation

Note: Beginning Retained

Earnings does not appear in
the trial balance because it is
zero.
12-35
 Group Exercise 1: Translation

The resulting journal entry on Padre’s books:

Other Comprehensive Income 382

Investment in Sucursal 382

12-36
 Practice question #7
⬥ Dover Company owns 90% of the capital stock of a foreign
subsidiary located in Italy. Dover's accountant has just
translated the accounts of the foreign subsidiary and
determined that a debit translation adjustment of $80,000
exists. If Dover uses the fully adjusted equity method for its
investment, what entry should Dover record in order to
recognize the translation adjustment?

12-37
 Practice question #7
⬥ Dover Company owns 90% of the capital stock of a foreign
subsidiary located in Italy. Dover's accountant has just
translated the accounts of the foreign subsidiary and
determined that a debit translation adjustment of $80,000
exists. If Dover uses the fully adjusted equity method for its
investment, what entry should Dover record in order to
recognize the translation adjustment?

12-38
Learning Objective 12-6

Make calculations and

remeasure financial statements
of a foreign subsidiary.

12-39
 Remeasurement

⬥ Remeasurement is similar to translation

in that its goal is to obtain equivalent U.S.
dollar values for the foreign affiliate’s
accounts so they may be combined or
consolidated with the U.S. company’s
statements
⬥ The exchange rates used are different
from those used for translation

12-40
 Remeasurement Rates

Balance sheet accounts:

Monetary accounts Current rate
Non-monetary accounts Historical rate

Income statement accounts:

Most revenues and expenses Weighted-average rate
Items related to non-monetary accounts Historical rate

■ Points to remember:
● PP&E: Use the historical rate on the date the parent
acquires the subsidiary or the actual date an asset is
acquired if after the subsidiary’s acquisition
● Depreciation: Use the same historical rate for
depreciation expense used for each associated asset.
12-41
 Remeasurement Rates
■ Points to remember:
● COGS: Use historical rates for beginning and ending
inventory and the weighted average rate for
purchases.

Functional
Currency Rate U.S. $
Historical
on date
Beginning Inventory purchased
+ Purchases Average
= Goods Available for Sale Mixed
Historical
on date
- Ending Inventory purchased
= Cost of Goods Sold Mixed

12-42
 Remeasurement Rates

■ Points to remember:
● Retained Earnings
Functional
Currency Rate U.S. $
Use Last
Retained Earnings 1/1 Mixed Year’s #
Average and
+ Net Income Historical
- Dividends Historical
Retained Earnings 12/31 Mixed

● Similar to translation except that while most income items

are remeasured using the weighted average rate, items
related to non-monetary balance sheet items are
remeasured using the corresponding historical rates.
12-43
 Remeasurement

⬥ The process produces the same end result

as if the foreign entity’s transactions had
been initially recorded in dollars
● Debits = credits in the local currency trial balance.
● Because of the variety of rates used to remeasure the
accounts, the debits and credits of the remeasured
trial balance will generally not be equal.
● A remeasurement gain or loss balances the
remeasured trial balance.
● The remeasurement gain or loss only exists in the
subsidiary’s remeasured trial balance.
● It appears on the subsidiary’s remeasured income
statement, but it is not recorded via a journal entry.
12-44
 Remeasurement

⬥ Statement presentation
■ Remeasurement gain or loss is included in the
current period income statement, usually under
“Other Income”
■ Upon completion of the remeasurement process,
the foreign entity’s financial statements are
presented as they would have been had the U.S.
dollar been used to record the transactions in
the local currency as they occurred

12-45
Summary of the Translation and
Remeasurement Processes

12-46
Practice Quiz Question #5

Which of the following statements is false?

a. Exchange rates used for remeasurement
differ from those used in translation.
b. The only difference in exchange rates
between remeasurement and translation of
the balance sheet is for the non-monetary
accounts.
c. The rates used to remeasure the income
statement are all the same as those used in
translation.
d. After remeasuring all items, the trial balance
12-47
Practice Quiz Question #5 Solution

Which of the following statements is false?

a. Exchange rates used for remeasurement
differ from those used in translation.
b. The only difference in exchange rates
between remeasurement and translation of
the balance sheet is for the non-monetary
accounts.
c. The rates used to remeasure the income
statement are all the same as those used in
translation.
d. After remeasuring all items, the trial balance
12-48
Learning Objective 12-7

Prepare consolidated financial

statements including a foreign
subsidiary after remeasurement.

12-49
 Group Exercise 2: Remeasurement

⬥ On 1/2/X7, Padre Corp. (a U.S. based company)

formed a new subsidiary in Honduras, Sucursal
Inc., with an initial investment of 150,000
Honduras Lempiras (HNL).
⬥ Assume Sucursal:
■ Purchases inventory evenly throughout 20X7.
The ending inventory is purchased 11/30/X7.
■ Uses straight-line depreciation on fixed assets.
■ Declares and pays dividends on 11/30/X7.
■ Purchased the fixed assets on 4/1/X7.
■ Uses the U.S. dollar as the functional currency.
REQUIRED: 12-50
Group Exercise 2: Remeasurement

12-51
Group Exercise 2: Remeasurement

12-52
Group Exercise 2: Remeasurement

This remeasurement
gain appears in
Sucursal’s income
statement. As a result,
it will flow into
Padre’s investment
and income from
Sucursal accounts
when Padre records
its 100% share of
Sucursal’s income.
12-53
 Group Exercise 2: Remeasurement
• This remeasurement gain appears in Sucursal’s “remeasured”
income statement.
• No entry is required on Sucursal’s books because the gain
only exists on the remeasured trial balance.
Sales 17,985
COGS (8,880)
Depreciation Expense (550)
Other Expenses (4,905)
Remeasurement gain 443
Net Income 4,093
• The effect on Padre’s books would be through the regular
entry to record its share of Sucursal’s remeasured net income.
Investment in Sucursal 4,093
Income from Sucursal 4,093 12-54
Conclusion

The End

12-71