translation of foreign financial statements. c112 foreign currency translation uthe process of...
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Translation of
ForeignFinancial
Statements
C11 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
C11 3
FASB’s Statement No. 52
Adopted a functional currency approach The previous standard (SFAS No. 8)
employed the temporal method
C11 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
C11 5
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
C11 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
C11 7
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)
C11 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
C11 9
The translation process
Start
End
Convert foreign financial statements to GAAP
Identify the “Books of Record” (BR) currency and the
“Functional Currency” (FC)
Is FC the inflationarycurrency? Yes
No
Is BR = FC?
Use functional method to get FC into
$’s
Yes
Noapply the remeasurement process (shown later)
C11 10
The translation of financial statement accounts
Account Functional Method
Assets & Liabilities:At current values or monetary items(defined next slide)
Current
Not as current values of nonmonetaryitems (defined next slide)
Current
Revenues and Expenses:
Representing amoritzation of historicalamounts
Weighted Average
Not representing amoritzation ofhistorical amounts
Weighted Average
Equity accounts (excluding RE) Historical
Retained EarningsBeginning balance plus
translated net income lesstranslated dividends
Translation adjustment recorded as acomponent of
Other Comprehensive Income
C11 11
The translation of financial statement accounts (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.
C11 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
C11 13
Reconciliation of the annual translation adjustmentNet 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)] = $1,000continued . . .
C11 14
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
Reconciliation of the annual translation adjustment (con’t)
C11 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
C11 16
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
C11 17
Special issues related to the sophisticated equity method
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
The investment account includes:
C11 18
Remeasured financial statements 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 temporal method
C11 19
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
C11 20
The remeasurement process
Start
A
Convert foreign financial statements to
GAAP
Identify the “Books of Record” (BR) currency
and the “Functional Currency” (FC)
Is BR =
FC?
Is FC = inflationar
y currency?
Use Temporal method
Is FC = $?
A
Use Temporal method
End
Use Temporal method to get into
functional currency
End
Yes
No
Yes No
Yes
A apply the translation process shown earlier
No
C11 21
Remeasurement of financial statement accounts
Account Temporal Method
Assets & Liabilities:At current values or monetary items CurrentNot as current values or nonmonetaryitems
Historical
Revenues and Expenses:
Representing amoritzation of historicalamounts
Historical
Not representing amoritzation ofhistorical amounts
Weighted Average
Equity accounts (excluding RE) Historical
Retained EarningsBeginning balance plus
remeasured net income lessremeasured dividends
Translation adjustment recorded as acomponent of
Net Income
C11 22
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
C11 23
Disclosure requirements
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
An analysis of the cumulative translation adjustment including:
C11 24
Disclosure requirements (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