Translation of

1

• Translation of
• Foreign
• Financial Statements

2
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

3
FASBs Statement No. 52

• Adopted a functional currency approach
• The previous standard (SFAS No. 8) employed the
  temporal method

4
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

5
Objectives of the translation process

• Provide information that is generally compatible
  with the expected economic effects of a rate
  change on an enterprises 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

6
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

7
Expected economic effects of a rate change (cont)

• 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)

8
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

9
The translation process
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
10
The translation of financial statement accounts
11
The translation of financial statement accounts
(cont)
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.
12
Accounting for the translation adjustment

• 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

13
Reconciliation of the annual translation
adjustment

• 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 . . .
14
Reconciliation of the annual translation
adjustment (cont)

• 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

15
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

16
Special issues related to consolidating the
foreign subsidiary (cont)

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

17
Special issues related to the sophisticated
equity method
The investment account includes

• The investors share of the investees translated
  net income
• Amortization of any excess of cost over book
  value
• The investors share of the cumulative
  translation adjustment

18
Remeasured financial statements

• The remeasurement process is intended to produce
  financial statements that are the same as if the
  entitys transactions had been originally
  recorded in the functional currency
• Remeasurement is based on the temporal method

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Remeasurement is necessary when

• The foreign entitys 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 entitys functional currency is that
  of a highly inflationary economy

20
The remeasurement process
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 BR FC?
Is 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
21
Remeasurement of financial statement accounts
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Special remeasurement issues

• 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

23
Disclosure requirements
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

24
Disclosure requirements (cont)

• 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