13

13
Translation of Financial
Statements of Foreign Affiliates

Advanced Accounting, Fifth Edition

Slide
13-1
 Learning
Learning Objectives
Objectives

1. Distinguish between the current exchange rate and the

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

Slide
13-2
 Learning
Learning Objectives
Objectives

6. Explain the factors involved in translating the

statements of a foreign entity operating in a highly
inflationary economy.
7. Translate the statements of a foreign entity when the
functional currency is the local currency.
8. Translate the statements of a foreign entity when the
functional currency is the U.S. dollar.
9. Understand the concept of comprehensive income in
the context of foreign currency translation.
10. Identify the disclosure requirements for firms with
foreign entities.
Slide
13-3
 Translation
Translation of
of Financial
Financial Statements
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.

Slide
13-4
 Accounting
Accounting for
for Operations
Operations in
in Foreign
Foreign
Countries
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
Foreign statements that are not in conformity with GAAP in
 Exchange restrictions.
the United States must be adjusted to conform to U.S.
standards before conversion into U.S. dollars.

Slide
13-5
 Translating
Translating Statements
Statements of
of Foreign
Foreign
Affiliates
Affiliates
The conversion from another currency into the currency of
the parent company is frequently called “translation.”

Translation Process

Current
Financial Exchange Rate Financial
Statements in Statements in
Euros Historical U.S. Dollars
Exchange Rate

Slide
13-6
LO 1 Current versus historical exchange rates.
 Translating
Translating Statements
Statements of
of Foreign
Foreign
Affiliates
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 adjustment

(gain or loss) be reported
Not a
 currently in income or Choic
e
 deferred as a component of stockholders’ equity,

depending on the method used to translate the

accounts.
Slide
13-7
LO 1 Current versus historical exchange rates.
 Objectives
Objectives of
of Translation
Translation

Functional Currency Concept

Objective of Translation – FASB ASC section 830-30:

1. Provide information regarding the exposed economic

effects of an exchange rate change on an enterprise’s
cash flows and equity [par. 4(a)].

2. 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.
Slide
13-8
LO 2 Objectives of translation.
 Translation
Translation Methods
Methods

Current rate method Translation

All assets and Current exchange
liabilities. rate.
Revenues and Exchange rate on
expenses. the date each
transaction
occurred.

Slide
13-9
LO 4 Two methods of conversion.
 Translation
Translation Methods
Methods

Temporal Method Translation

Monetary assets and Current exchange
liabilities (cash, a/r, a/p). rate.
Assets and liabilities carried
at historical cost. Historical exchange
Assets and liabilities carried rates.
at current values. Current exchange
rate.
Revenues and expenses
related to assets and
liabilities translated at Historical exchange
historical rates. rates.
Other revenues and
expenses.
Slide
13-10
LO 4 Two methods rate
Exchange of conversion.
on
 Identifying
Identifying the
the Functional
Functional Currency
Currency

The Functional Currency may be

1. The local currency of the foreign entity,
2. The U.S. dollar, or
3. The currency of a third country.

Economic Indicators of Functional Currency:

Cash flow Expenses

Sales prices Financing
Sales market Intercompany
transactions
Slide
13-11
LO 3 Identifying the functional currency.
 Identifying
Identifying the
the Functional
Functional Currency
Currency

Review Question
Indicators that the local currency is also the functional
currency include all of the following except:
a. The majority of the cash flows are in the local
currency.
b. Sales prices are determined by local market
conditions.
c. Financing is generally from the parent or
guaranteed by the parent.
d. Production costs and expenses are determined by
local conditions.
Slide
13-12
LO 3 Identifying the functional currency.
 Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial
Statements
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.

Slide
13-13
LO 4 Which methods of conversion to use.
 Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial
Statements
Statements
Accounts stated in local currency of foreign
entity.

Is the foreign Determine the

economy No functional currency
highly (FC) per
inflationary? economic indicators.
Functional
Is the FC the No Is the FC the
currency (FC)
is U.S. Dollar. U.S. dollar? local Yes
currency?
Yes No
Translate to
Remeasure to Remeasure to U.S. dollars
U.S. dollars FC using using current
using temporal temporal rate method.
Slide
method. method.
13-14
LO 4 Which methods of conversion to use.
 Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial
Statements
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.

Slide
13-15
LO 6 Factors in a highly inflationary economy.
 Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial
Statements
Statements
Foreign Entity in Economy that is Not Highly
Inflationary
Functional currency must be identified. Translation
process:

1. Local currency is the functional currency.

 Current rate method.
 Translation adjustment recorded as a component of
stockholders’ equity.

2. U.S. dollar is the functional currency.

 Temporal method.
 Translation adjustment reported in income
Slide statement.
13-16
 Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial
Statements
Statements
Local Books kept in
currency local currency

Remeasure Not
- Temporal Temporal
necessar
ment method method
y
Function
al Local U.S. A third
currency dollar currency
currency
Translati Current Not Current
on rate necessar rate
method y method

U.S.
dollar U. S. dollars

Slide
13-17
 Translation
Translation –– Current
Current Rate
Rate Method
Method
Current Rate Translation
Method
Assets and liabilities Current exchange rate
Paid-in capital Historical rate
Beginning R/E Equals ending balance of last
year
Dividends
Historical rate when dividend
is declared
Revenue and Expenses
Average exchange rate
Cumulative translation
adjustment Balance amount in the
balance sheet
Current year translation
adjustment Other comprehensive income
Slide (shareholders’ equity)
13-18
LO 7 The functional currency is the local currency.
 Translation
Translation –– Current
Current Rate
Rate Method
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, 2008 $.5987
December 31, 2008 .5321
Average for 2008 .5654
Dividend declaration and payment date .5810
Required: Translate the year-end balance sheet and income
statement of the foreign subsidiary using the current rate
method of translation.
Slide
13-19
LO 7 The functional currency is the local currency.
 Translation
Translation –– Current
Current Rate
Rate Method
Method
Exercise 13-4: (Current Rate
Method) Swiss Translation
Income Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses (30,000) 0.5654 (16,962)
Net income 45,000 25,443
Retained earnings 1/1 10,000 0.5987 5,987
55,000 31,430
Dividends (15,000) 0.5810 (8,715)
Retained earnings 12/31 40,000 22,715

Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment 37,000 0.5321 19,688
Total assets 92,000 48,954

Accounts payable 32,000 0.5321 17,027

Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,715
92,000 51,716
Cumulative translation adjustment (2,762)
Slide Total liab. & equity 92,000 48,954
13-20
 Translation
Translation –– Current
Current Rate
Rate Method
Method

Exercise 13-4: Prepare a schedule to verify the

translation adjustment.
Swiss Translation
Francs Rate $

Exposed net asset position - 1/1 30,000 $.5987 17,961

Adjustment for changes in net asset position:
Net income 45,000 .5654 25,443
Dividends (15,000) .5810 (8,715)
Net asset position translated --- 34,689
Exposed net asset position - 12/31 60,000 .5321 31,926
Cumulative translation adjustment (debit) (2,763)

Slide
13-21
LO 7 The functional currency is the local currency.
 Translation
Translation –– Current
Current Rate
Rate Method
Method

Review Question
Under the current method of currency translation,
which of the following balance sheet accounts is
translated at historical exchange rates?
a. Cash
b. Accounts Receivable
c. Bonds Payable
d. Common Stock

Slide
13-22
LO 7 The functional currency is the local currency.
 Translation
Translation –– Temporal
Temporal Method
Method

Temporal Method Translation

Monetary assets and Current exchange
liabilities (cash, a/r, a/p). rate.
Assets and liabilities carried
at historical cost. Historical exchange
Assets and liabilities carried rates.
at current values. Current exchange
rate.
Revenues and expenses
related to assets and
liabilities translated at Historical exchange
historical rates. rates.
Other revenues and
expenses.
Slide
13-23
LO 8 The functional currency
Exchangeis the U.S.
rate on dollar.
 Translation
Translation –– Temporal
Temporal Method
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, 2008 $.5987
December 31, 2008 .5321
Average for 2008 .5654
Dividend declaration and payment date .5810

Required: Convert (remeasure) the financial statements of

the foreign subsidiary using the temporal method of
translation.
Slide
13-24
LO 7 The functional currency is the local currency.
 Translation
Translation –– Temporal
Temporal Method
Method
Exercise 13-5: (Temporal Method)
Swiss Translation
Income Statement Francs Rate U.S. Dollars
Revenue 75,000 0.5654 42,405
Operating expenses: depreciation (3,000) 0.5987 (1,796)
Operating expenses: other (27,000) 0.5654 (15,266)
Translation loss (198)
Net income 45,000 25,145
Retained earnings 1/1 10,000 0.5987 5,987
55,000 31,132
Dividends (15,000) 0.5810 (8,715)
Retained earnings 12/31 40,000 22,417

Balance Sheet
Cash and receivables 55,000 0.5321 29,266
Net property, plant, equipment 37,000 0.5987 22,152
Total assets 92,000 51,418

Accounts payable 32,000 0.5321 17,027

Common stock 20,000 0.5987 11,974
Retained earnings 40,000 22,417
Slide Total liab. & equity 92,000 51,418
13-25
 Translation
Translation –– Temporal
Temporal Method
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 75,000 .5654 42,405
Less: Decrease in net asset position:
Other operating expenses (27,000) .5654 (15,266)
Dividends (15,000) .5810 (8,715)
Net asset position translated --- 12,437
Net monetary asset position-12/31 23,000 .5321 12,238
Translation gain (loss) (199)
Slide
13-26
LO 7 The functional currency is the local currency.
 Financial
Financial Statement
Statement Disclosure
Disclosure

Companies are required to disclose certain items, as

follows:

1. The aggregate translation gain or loss included in the

determination of net income for the period.

2. 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.

3. Exchange rate changes that occur after the balance

sheet date and their effect on unsettled foreign
Slide
currency transactions, if significant.
13-27
LO 10 Required disclosure.
 Date
Date of
of Acquisition
Acquisition

Illustration: Recall that on January 2, 2012, P Company

acquired for 2,000,000 francs an 80% interest in SFr.
Company. The direct exchange rate for francs on January 2,
2012, was $.15. The entry to record the acquisition is

Investment in SFr Company 300,000

Cash
300,000

Slide
13-28
 Date
Date of
of Acquisition
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.

Slide
13-29
 After
After Acquisition
Acquisition
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)

Slide
13-30
 After
After Acquisition
Acquisition
Workpaper entries assuming current rate method.

Slide
13-31
 Consolidation
Consolidation Assuming
Assuming Temporal
Temporal
Method
Method
The major differences between the workpapers are as follows:
1. 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.
Slide
13-32
 Remeasurement
Remeasurement and
and Translation
Translation of
of
Transactions
Transactions
FASB ASC section 830–20–20 defines a foreign currency
transaction as one that is denominated in a currency other
than the entity’s functional currency.
1. 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.

2. 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.

3. Any transaction gain or loss resulting from this procedure

Slide
13-33
is recognized currently in income.
 Intercompany
Intercompany Receivables
Receivables and
and Payables
Payables

FASBASC paragraph 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.

Slide
13-34
 Elimination
Elimination of
of Intercompany
Intercompany Profit
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.

Slide
13-35
 Liquidation
Liquidation of
of aa Foreign
Foreign Investment
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.

Slide
13-36
 Copyright
Copyright

Copyright © 2012 John Wiley & Sons, Inc. All rights

reserved. Reproduction or translation of this work beyond
that permitted in Section 117 of the 1976 United States
Copyright Act without the express written permission of
the copyright owner is unlawful. Request for further
information should be addressed to the Permissions
Department, John Wiley & Sons, Inc. The purchaser may
make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by
the use of these programs or from the use of the
information contained herein.
Slide
13-37