Foreign Currency
Financial Statements
Chapter 13
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 1
Learning Objective 1
Understand the functional
currency concept.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 2
Application of the Functional
Currency Concept
A foreign subsidiary’s foreign currency
statements must be in conformity with U.S.
GAAP before translation into U.S. dollars.
Adjustments are required before
translation is performed.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 3
Application of the Functional
Currency Concept
All account balances on the balance sheet
date denominated in a foreign currency
(from the foreign entity’s point of view) are
adjusted to reflect current exchange rates.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 4
Application of the Functional
Currency Concept
Under the functional currency concept,
a foreign entity’s assets, liabilities,
and operations must be measured
in its functional currency.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 5
Application of the Functional
Currency Concept
Subsequently, the foreign entity’s balance
sheet and income statement are consolidated
(subsidiary) or combined (branch) with those
of the reporting enterprise’s currency.
£
$
¥
€
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 6
Learning Objective 2
Determine a subsidiary’s
functional currency.
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13 - 7
Translation
Translation involves expressing
functional currency measurements
in the reporting currency.
Current rate
method
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 8
Remeasurement
When the foreign entity’s books are not
maintained in its functional currency, the
foreign currency financial statements must
be remeasured into the functional currency.
Temporal
method
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
13 - 9
Remeasurement
Monetary assets
and liabilities
Current exchange
rates
Nonmonetary
items
Historical
rates
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 10
Learning Objective 3
Produce financial statements
using translation or
remeasurement, or both.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 11
Translation and Remeasurement of
Foreign Currency Financial Statements
Patriot Corporation, a U.S. company,
has a wholly-owned subsidiary, Regal
Corporation, that operates in England.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 12
Translation and Remeasurement of
Foreign Currency Financial Statements
Functional
Currency
Case 1
Case 2
Case 3
Currency of
Accounting
Records
Required Procedures
for Consolidating
or Combining
British pounds British pounds Translation
U.S. dollar
British pounds Remeasurement
Euro
British pounds Remeasurement
and translation
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 13
Intercompany Foreign
Currency Transactions
These transactions are foreign currency
transactions if they produce receivable
or payable balances denominated in a
currency other than the entity’s (parent’s
or subsidiary’s) functional currency.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 14
Intercompany Foreign
Currency Transactions
A U.S. parent company borrows $1,600,000
(£1,000,000) from its British subsidiary.
Case 1
Case 2
Case 3
Case 4
Loan
Denominated
Currency
Functional
Currency of
Subsidiary
British pound
British pound
U.S. dollar
U.S. dollar
British pound
U.S. dollar
British pound
U.S. dollar
Foreign Currency
Transaction of
Subsidiary? Parent?
No
Yes
Yes
No
Yes
Yes
No
No
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 15
Foreign Entities Operating in
Highly Inflationary Economies
Price-level-adjusted financial statements are
not basic financial statements under GAAP.
The reporting currency (the U.S. dollar) is used
to remeasure the financial statements of
foreign entities in highly inflationary economies.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 16
Foreign Entities Operating in
Highly Inflationary Economies
Statement No. 52 defines a
“highly inflationary economy”
as one with a cumulative
three-year inflation rate
of 100% or more.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 17
Business Combinations
The assets and liabilities of a foreign entity
are translated into U.S. dollars using the
current exchange rate in effect on the
date of the business combination.
Cost/book value
differential
Minority interest
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 18
Learning Objective 4
Apply the current rate
translation method.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 19
Translation Under Statement No. 52
On December 31, 2003, Pat Corporation, a
U.S. firm, paid $525,000 cash to acquire all
the stock of the British firm, Star Company.
The book value of Star’s net assets was
$375,000, which was equal to the fair value.
The British pound exchange rate was $1.50.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 20
Translation Under Statement No. 52
(000)
Assets
Cash
Accounts receivable
Inventories (cost)
Plant assets
Less: Accumulated depr.
Total assets
British
Pounds
140
40
120
100
–20
380
Exchange
Rate
$1.50
1.50
1.50
1.50
1.50
U.S.
Dollars
210
60
180
150
–30
570
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 21
Translation Under Statement No. 52
(000)
Equities
Accounts payable
Bonds payable
Capital stock
Retained earnings
Total equities
British
Pounds
Exchange
Rate
U.S.
Dollars
30
100
200
50
380
$1.50
1.50
1.50
1.50
45
150
300
75
570
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 22
Translation Under Statement No. 52
The 2004 year-end exchange rate was $1.40.
Average exchange rates for 2004 were $1.45.
Star paid £30,000 dividends on December 1, 2004,
when the exchange rate was $1.42 per British pound.
The only intercompany transaction was an
$84,000 (£56,000) non-interest-bearing advance by
Star to Pat made on January 4, 2004, when the
exchange rate was still $1.50.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 23
Translation Under Statement No. 52
What is Star’s adjustment at year end?
Advance to Pat
£4,000
Exchange Gain
£4,000
To adjust receivable denominated in dollars
[($84,000 ÷ $1.40) – £56,000 per books]
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 24
Star Company Translation
Worksheet for 2004
Debits (000)
Cash
Accounts receivable
Inventories (FIFO)
Plant assets
Advance to Pat
Cost of sales
Depreciation
Wages and salaries
Other expenses
Dividends
Accumulated income
₤ Trial
Balance
110
80
120
100
60
270
10
120
60
30
–
960
Translation
Rate
$1.40
1.40
1.40
1.40
1.40
1.45
1.45
1.45
1.45
1.42
$ Trial
Balance
154.0
112.0
168.0
140.0
84.0
391.5
14.5
174.0
87.0
42.6
28.6
1,396.2
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 25
Star Company Translation
Worksheet for 2004
₤ Trial
Balance
Credits (000)
Accumulated
depreciation
30
Accounts payable
36
Bonds payable
100
Capital stock
200
Retained earnings
50
Sales
540
Exchange gain (advance)
4
960
Translation
Rate
$ Trial
Balance
$1.40
1.40
1.40
1.50
computed
1.45
1.45
42.0
50.4
140.0
300.0
75.0
783.0
5.8
1,396.2
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 26
Star Company Income and Retained
Earnings Statement for the Year 2004
Sales
Less costs and expenses
Cost of sales
Depreciation
Wages and salaries
Other expenses
Operating income
Exchange gain
Net income
Retained earnings January 1, 2004
Less: Dividends
Retained earnings December 31, 2004
$783,000
$391,500
14,500
174,000
87,000
667,000
$116,000
5,800
$121,800
75,000
$196,800
42,600
$154,200
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 27
Star Company Balance Sheet
at December 31, 2004
Assets
Cash
Accounts receivable
Inventories
Plant assets
Less: Accumulated depreciation
Advance to Pat
Equities
Accounts payable
Bonds payable
Capital stock
Retained earnings
Accumulated other comprehensive income
$154,000
112,000
168,000
140,000
– 42,000
84,000
$616,000
$ 50,400
140,000
300,000
154,200
– 28,600
$616,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 28
Equity Method of Accounting
What is Pat’s entry to record receipt
of the £30,000 ($42,600) dividend ?
Cash
$42,600
Investment in Star
To record dividend received
$42,600
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 29
Patent Amortization
$525,000 – $375,000 = $150,000
$150,000 ÷ $1.50 = £100,000
£100,000 ÷ 10 years × $1.45 = $14,500
Pat’s Books
Income from Star
Other Comprehensive Income:
Equity Adjustment from Translation
Investment in Star
14,500
9,500
24,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 30
Equity Adjustment
Alternatively, the $9,500 equity
adjustment can be computed as follows:
£10,000 amortization × ($1.50 – $1.45)
exchange rate decline to midyear
£90,000 unamortized patent × ($1.50 – $1.40)
exchange rate decline for the year
Equity adjustment
$ 500
9,000
$9,500
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 31
Investment in Foreign Subsidiary
(Summary)
Changes is Pat’s investment in Star account during 2004:
Investment cost December 31, 2003
Less: Dividends received 2004
Add: Equity in Star’s net income
Less: Unrealized loss on translation
Less: Patent amortization
Less: Unrealized translation loss on patent
Investment balance December 31, 2004
$525,000
– 42,600
121,800
– 28,600
– 14,500
– 9,500
$551,600
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 32
Consolidation Working Papers for the
Year Ended December 31, 2004
Income Statement (000)
Pat
Sales
Income from Star
Cost of sales
Depreciation
Wages and salaries
Other expenses
Exchange gain
Net income
Retained earnings – Pat
Retained earnings – Star
Dividends
$1,218.3
107.3
(600)
(40)
(300)
(150)
Retained earnings 12/31/04
$ 381.1
$ 235.6
$ 245.5
(100)
Star
Adjustments/
Eliminations
$783
Consolidated
$2,001.3
a 107.3
(391.5)
(14.5)
(174)
(87)
5.8
$121.8
$ 75
(42.6)
$154.2
(991.5)
(54.5)
(474)
(251.5)
5.8
$ 235.6
$ 245.5
c 14.5
b 75
a 42.6
(100)
$ 381.1
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 33
Consolidation Working Papers for the
Year Ended DecemberAdjustments/
31, 2004ConsolBalance Sheet (000)
Cash
Accounts receivable
Inventories
Plant assets
Accumulated depreciation
Advance to Pat
Investment – Star
Pat
$ 317.6
150
300
400
(100)
Star
$154
112
168
140
(42)
84
b 140.5
$1,619.2 $616
$ 142.2 $ 50.4
84
250
140
800
300
381.1
154.2
(38.1)
(28.6)
$1,619.2 $616
idated
$ 471.6
262
468
540
(142)
551.6
Patent
Accounts payable
Advance from Star
Bonds payable
Capital stock
retained earnings
Other income
Eliminations
d 84
a 64.7
b 486.9
c 14.5
126
$1,725.6
$ 192.6
d 84
b 300
390
800
381.1
b 28.6
(38.1)
$1,725.6
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 34
Learning Objective 5
Apply the temporal
translation method.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 35
Remeasurement Under
Statement No. 52
The objective of remeasurement is to produce
the same results as if the books had been
maintained in the U.S. dollar.
Remeasurement
Temporal method
Translation
Current rate method
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 36
Remeasurement Under
Statement No. 52
Under remeasurement procedures, the $150,000
patent value is not adjusted for subsequent
changes in exchange rates.
Annual amortization
= $15,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 37
Remeasurement Under
Statement No. 52
The £56,000 ($84,000) advance to Pat
is not a foreign currency transaction
of either Pat or Star.
Star’s monetary items other than the
intercompany advance are remeasured
at current exchange rates.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 38
The Equity Method
Investment in Star
$525,000
Cash
$525,000
To record acquisition on December 31, 2003
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 39
The Equity Method
Cash
$42,600
Investment in Star
$42,600
To record dividends received on December 1, 2004
Investment in Star
$87,600
Income from Star
$87,600
To record investment income for 2004 equal to Star’s
$102,600 net income less $15,000 patent amortization
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 40
Income and Retained Earnings
Statements for the Year Ended 12/31/04
Consolidated
Sales
Less: Cost of sales
Wages and salaries
Other expenses
Depreciation
Patent amortization
Operating income
Exchange gain (loss)
Net income
Retained earnings 01/01/04
Less: Dividends
Retained earnings 12/31/04
Translation
$2,001,300
991,500
474,000
237,000
54,500
14,500
$ 229,800
5,800
$ 235,600
245,500
$ 481,100
100,000
$ 381,100
Remeasurement
$2,001,300
1,001,100
474,000
237,000
55,000
15,000
$ 219,200
– 3,300
$ 215,900
245,500
$ 461,400
100,000
$ 361,400
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 41
Balance Sheets
for the Year Ended 12/31/04
Consolidated
Assets
Cash
Accounts receivable
Inventories
Plant assets
Less:
Accumulated depreciation
Patent
Total assets
Translation
Remeasurement
$ 471,600
262,000
468,000
540,000
$ 471,600
262,000
470,400
550,000
– 142,000
126,000
$1,725,600
– 145,000
135,000
$1,744,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 42
Balance Sheets
for the Year Ended 12/31/04
Consolidated
Liabilities
Accounts payable
Bonds payable
Total liabilities
Stockholders’ Equity
Capital stock
Retained earnings
Other income
Total stockholders’ equity
Total liabilities
and stockholders’ equity
Translation
Remeasurement
$ 192,600
390,000
$ 582,600
$ 192,600
390,000
$ 582,600
$ 800,000
381,100
– 38,100
$1,143,000
$ 800,000
361,400
–
$1,161,400
$1,725,600
$1,744,000
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 43
Translation With Minority Interest
On January 1, 2003, Pacific Corporation,
a U.S. firm, paid $232,500 cash to acquire
a 90% interest in Sea, a foreign company.
Sea’s stockholders’ equity consisted
of 1,000,000 LCU capital stock and
500,000 LCU retained earnings.
The exchange rate was $0.15.
Pacific designated Sea’s functional currency
to be the subsidiary’s local currency unit.
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 44
Minority Interest
Stockholders’ equity
January 1
Net income
Dividends
Equity adjustment
Stockholders’ equity
December 31
90% to
Pacific
10% to
Minority
Interests
Total
$202,500
21,600
– 14,400
27,450
$22,500
2,400
– 1,600
3,050
$225,000
24,000
– 16,000
30,500
$237,150
$26,350
$263,500
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 45
End of Chapter 13
©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 13 - 46