Chapter 36
Translating the
financial statements of
foreign operations
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-1
Objectives of this lecture
• Understand why it is necessary to translate the financial
statements of foreign subsidiaries to a specific
presentation currency before the consolidation process is
performed
• Be able to translate the financial statements of a foreign
operation into a particular functional currency
• Be able to translate the financial statements of a foreign
operation into a particular presentation currency
• Understand which rates to use when translating the
financial statements of a foreign operation
.
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36-2
Introduction to translating the financial
statements of foreign operations
• The consolidation process involves combining the
financial statements of a parent and its controlled
entities (that is, its subsidiaries)
• If some of the controlled entities are foreign
entities with account balances denominated in
different foreign currencies, there is a need to
translate these accounts to a given presentation
currency (e.g. Australian dollars) before the
consolidation process
• Accounting standard relating to the translation of
foreign subsidiaries is AASB 121 The Effects of
Changes in Foreign Exchange Rates
.
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36-3
Introduction to translating the accounts of
foreign operations (cont.)
• Note AASB 121 permits selection of a presentation currency,
which need not be Australian dollars
• A single method of translation is to be used to translate the
accounts of foreign subsidiaries into a particular presentation
currency
.
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36-4
Different classifications of currencies
Reference can made to three different types of
currencies, these being local currency, functional
currency, and presentation currency. These currencies
can be defined as follows:
• Local currency: the currency used in the country in
which the foreign operation is located
• Functional currency: AASB 121, paragraph 8,
defines functional currency as ‘the currency of the
primary economic environment in which the entity
operates’
• Presentation currency: AASB 121, paragraph 8,
defines the presentation currency as ‘the currency in
which the financial statements are presented’
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-5
Considerations of the functional currency
• In this lecture we will consider two situations
– First, we will consider translating the financial statements of
an entity into a particular functional currency
– Then, we will consider how to translate the financial
statements of an entity from a particular functional currency
into a particular presentation currency (which is required
prior to consolidation)
• If the functional currency is the same as the local currency, then
there will be no need to translate the financial statements of the
foreign operation into the functional currency, as the financial
statements prepared in the local currency will already have
been prepared in the functional currency
• In such circumstances we will only need to translate the foreign
operation’s financial statements into the group’s presentation
currency (a one-step as opposed to a two-step process)
.
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36-6
Translating the accounts into a particular
functional currency
• According to AASB 121, functional currency is ‘the
currency of the primary economic environment in
which the entity operates’
• According to paragraph 12 of AASB 121,
management uses its judgment ‘to determine the
functional currency that most faithfully represents the
economic effects of the underlying transactions,
events and conditions’
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-7
Translating the accounts into a particular functional
currency (cont.)
• If a parent entity has a subsidiary located in another country
then the first task to be undertaken prior to the
consolidation process is to determine the functional
currency of the overseas subsidiary
• For example, if an Australian parent has a subsidiary that is
located in New Zealand then it is likely that the subsidiary
would maintain its accounts in the local currency, which is
New Zealand dollars
• For the functional currency of the subsidiary to be
Australian dollars there would be an expectation that there
is a high degree of dependence between the subsidiary and
the parent entity. Perhaps the entity acquires products
directly from the parent entity and sells the products at
prices based on the Australian dollar
.
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36-8
Translating the accounts into a particular functional
currency (cont.)
• If the functional currency is determined to be Australian
dollars then there will be a need to translate the New
Zealand accounts from New Zealand dollars into
Australian dollars.
• By contrast, if the subsidiary operates quite independently
of the Australian parent—perhaps because it produces
the goods locally, and sells its products at prices based
on New Zealand dollars—then the functional currency
might be New Zealand dollars and there would be no
need to translate the accounts into a different functional
currency
• Once the subsidiary’s accounts have been translated into
the appropriate functional currency then the accounts will
need to be translated to the appropriate presentation
currency prior to consolidation (e.g. for BHP Billiton the
presentation is US$)
.
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36-9
Translating the accounts into a particular functional
currency (cont.)
• Paragraphs 21 and 23 of AASB 121 provide the rules for
translating one currency into another currency. In relation
to items included within the statement of
comprehensive income, paragraph 21 states:
A foreign currency transaction shall be recorded, on initial
recognition in the functional currency, by applying to the
foreign currency amount the spot exchange rate between
the functional currency and the foreign currency at the
date of the transaction
• There is a general requirement that each item of expense
and revenue shall be translated at the spot exchange rate
between the functional currency and the local currency on
the dates the respective transactions took place
.
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36-10
Translating the accounts into a particular functional
currency (cont.)
• However, this would be an extremely time-consuming and
difficult task and, as such, AASB 121 allows average
rates to be used. For example, an average exchange rate
between the local currency and the functional currency for
a month may be used to translate transactions that
occurred within that month. As paragraph 22 of AASB
121 states:
For practical reasons, a rate that approximates the actual
rate at the date of the transaction is often used, for
example, an average rate for a week or a month might be
used for all transactions in each foreign currency
occurring during that period. However, if exchange rates
fluctuate significantly, the use of the average rate for a
period is inappropriate
.
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36-11
Translating the accounts into a particular functional
currency (cont.)
The above requirements relate to accounts contained within the
statement of comprehensive income. In relation to accounts that
would generally be presented within the statement of financial
position, paragraph 23 of AASB 121 states:
At each reporting date:
(a) foreign currency monetary items shall be translated using
the closing rate
(b) non-monetary items that are measured in terms of
historical cost in a foreign currency shall be translated
using the exchange rate at the date of the transaction, and
(c) non-monetary items that are measured at fair value in a
foreign currency shall be translated using the exchange
rates at the date when the fair value was determined
.
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36-12
Translating the accounts into a particular functional
currency (cont.)
• In relation to non-monetary assets, such as plant and
equipment, AASB 116 Property, Plant and Equipment allows
that either cost or fair value be used as the basis of
measurement
• If the cost basis is used, and consistent with paragraph 23, the
rate to be used to translate the local currency to the functional
currency is the spot rate as at the date the asset was originally
recognised by the subsidiary
• If fair values are used by way of undertaking revaluations, then
the exchange rate to be used between the foreign currency and
the functional currency will be the exchange rate in place when
the valuation was made
.
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36-13
Translating the accounts into a particular functional
currency (cont.)
• The rates to be used to translate financial statements into
a given functional currency are summarised in Table 36.1
– see the next slide
• Applying the requirements of AASB 121 as they relate to
translating the accounts from a local currency to a
particular functional currency means that the final
accounts, after translation, will reflect amounts that would
be recorded had the transactions or events been
originally recorded in the functional currency
.
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36-14
Summary of rates used when translating financial statements
into a functional currency
Category
Rate
Assets
Monetary
Translate at the spot exchange rate at reporting rate (that is, at the
closing rate)
Non-monetary—held at
historical cost
Translate at the spot rate at the day the asset was recorded by the
subsidiary
Non-monetary—fair value
Translate at the exchange rate at the date of valuation
Liabilities
Monetary
Translate at the closing rate
Non-monetary
Translate at the exchange rate at the date of valuation
Equity
.
Contributed equity—at
acquisition
Translated at the rate when the investment acquired
Reserves—at acquisition
Translated at the rate when the investment acquired
Reserves—post
acquisition
If the transfer to reserves is the result of a revaluation of property plant
and equipment the rate used is the rate at the date of the revaluation
Retained earnings—at
acquisition
Translated at the rate when the investment acquired
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36-15
Summary of rates used when translating financial
statements into a functional currency (cont.)
Revenues and expenses
Revenues and expenses
Translated at the rate in place at the
date of the transaction. For practical
purposes, a rate that approximates the
actual rate of the transaction can be
used
Non-monetary related expenses, e.g.
depreciation
Translated at the rate used to translate
the related non-monetary item
Distributions
.
Dividends paid
Translated at the current rate at the date
of payment
Dividends declared
Translated at the current rate at the date
the dividends are declared
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-16
Worked Example 36.1—Translation from a foreign
currency into a functional currency
• On 1 July 2011, Kiwi Ltd, a New Zealand company whose
shares are listed on the New Zealand Securities Exchange,
acquired all the equity in Bulldog plc, a company incorporated
in England
• Because of the high level of dependence of Bulldog plc on Kiwi
Ltd, the functional currency is deemed to be the New Zealand
dollar
• The exchange rates for the reporting period ending 30 June
2012 are shown below:
1 July 2011
Average rate for the year
Ending inventory (acquired before year end)
30 June 2012
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs to accompany Deegan, Australian Financial Accounting 6e
UK£1 = NZ$3.00
UK£1 = NZ$3.10
UK£1 = NZ$3.20
UK£1 = NZ$3.30
36-17
Worked Example 36.1—Translation from a foreign currency
into a functional currency (cont.)
Bulldog plc
Statement of comprehensive income and details of closing retained
earnings for the year ended 30 June 2012
UK£000
Sales
2 500
Cost of sales:
Inventory—1 July 2011
(500)
Purchases
(2 000)
Inventory—30 June 2012
450
Administration expenses
(75)
Depreciation expense
(100)
Profit before tax
275
Income tax expense
(125)
Profit for the year
150
Retained earnings—1 July 2011
150
Retained earnings—30 June 2012
300
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-18
Worked Example 36.1—Translation from a foreign currency
into a functional currency (cont.)
Bulldog plc
Statement of financial position as at 30 June 2012
1 July 2011
30 June 2012
UK£000
UK£000
Assets
Property, plant and equipment
1 050
950
Cash and debtors
100
800
Inventory
500
450
Total assets
1 650
2 200
Liabilities
Bank loan
1 000
1 000
Trade creditors
–
400
Total liabilities
1 000
1 400
Net assets
650
800
Equity
Share capital
500
500
Retained earnings
150
300
650
800
REQUIRED
Translate the financial statements of Bulldog plc into the functional currency
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-19
Worked Example 36.1—Solution
Bulldog plc
Statement of comprehensive income for the year ending 30 June 2012
Exchange
UK£000
rate
NZ$000
Sales
2 500
3.10
7 750.0
Cost of sales:
Inventory—1 July 2011
(500)
3.00
(1 500.0)
Purchases
(2 000)
3.10
(6 200.0)
Inventory—30 June 2012
450
3.20
1 440.0
Administration expenses
(75)
3.10
(232.5)
Depreciation expense
(100)
3.00
(300.0)
Foreign exchange loss
---–
(210.0)
Profit before tax
275
747.5
Income tax expense
(125)
3.10
(387.5)
Profit for the year
150
360.0
Retained earnings—1 July 2011
150
3.00
450.0
Retained earnings—30 June 2012
300
810.0
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs to accompany Deegan, Australian Financial Accounting 6e
36-20
Worked Example 36.1—Solution
Bulldog plc
Statement of financial position as at 30 June 2012
Exchange
UK£000
rate
Assets
Property, plant and equipment
950
3.00
Cash and debtors
800
3.30
Inventory
450
3.20
Total assets
2 200
Liabilities
Bank loan
1 000
3.30
Trade creditors
400
3.30
Total liabilities
1 400
Net assets
800
Share capital
500
3.00
Equity
Retained earnings
300
800
.
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PPTs to accompany Deegan, Australian Financial Accounting 6e
NZ$000
2 850
2 640
1 440
6 930
3 300
1 320
4 620
2 310
1 500
810
2 310
36-21
Worked Example 36.1—Solution (cont.)
Reconciliation of foreign exchange loss
UK£000
Net monetary assets at 1/7/2011
Bank loan
(1 000)
Cash and debtors
100
Increases in monetary assets—sales
Decreases in monetary assets resulting from:
Purchases
Cash expenses
Income tax expense
UK£000
Current rate
less
rate applied
NZ$
gain/
(loss)
(900)
2 500
(3.30 – 3.00)
(3.30 – 3.10)
(270)
500
(2 000)
(75)
(125)
(600)
(3.30 – 3.10)
(3.30 – 3.10)
(3.30 – 3.10)
(400)
(15)
(25)
(210)
Reconciled to net monetary items at 30 June 2012 as follows:
Bank loan
(1 000)
Creditors
(400)
Cash and debtors
800
(600)
.
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36-22
Translating the accounts of foreign
operations into the presentation currency
• Before consolidating the financial statements of the parent
entity and its subsidiaries it will be necessary to convert the
financial statements of the various foreign subsidiaries from
their respective functional currencies into the presentation
currency of the parent entity
• Under the approach required by AASB 121 all assets and
liabilities of a foreign operation are to be translated from the
functional currency to the presentation currency using the spot
rate applicable at reporting date
• Income and expenses are translated at the exchange rates in
place at the dates of the various transactions
• If expense and revenue transactions are considered to occur
uniformly throughout the period, average rates may be used
• Any resulting translation gains or losses are taken directly to
reserves (rather than to profit or loss, which was the case when
we translated the financial statements from a local currency to
the functional currency)
.
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36-23
Translating the accounts of foreign operations into the
presentation currency (cont.)
The approach to translating the accounts of a foreign subsidiary
from a particular functional currency to a particular presentation
currency is as follows:
(a) Assets and liabilities are translated at the exchange rate
current at reporting date
(b) Equity at the date of the investment, including in the case
of a corporation, share capital at acquisition and preacquisition reserves, is translated at the exchange rate
current at that date of investment
(c) Post-acquisition movements in equity, other than retained
earnings (surplus) or accumulated losses (deficiency), are
translated at the exchange rates current at the dates of
those movements, except that, where a movement
represents a transfer between items within equity, the
movement is translated at the exchange rate current at the
date that the amount transferred or returned was first
included in equity
.
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36-24
Translating the accounts of foreign operations into
the presentation currency (cont.)
(d) Distributions from retained earnings (i.e. dividends paid or
declared, or their equivalent) are translated at the exchange
rates current at the dates when the distributions were first
declared
(e) Revenue and expense items are translated at the exchange
rates current at the applicable transaction dates
Table 36.2 (next slide) summarises the approach to translating the
accounts of a foreign subsidiary
.
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36-25
Summary of the method to be applied for translating financial
statements from a given functional currency to a specific
presentation currency
Assets
Monetary assets
Translated at closing rate
Non-monetary assets—measured at historical
cost
Translated at closing rate
Non-monetary assets—measured at fair value
Translated at closing rate
Liabilities
Monetary
Translated at closing rate
Non-monetary
Translated at closing rate
Equity
Share capital and reserves at date of acquisition
Translated at spot rate when investment
acquired
Post-acquisition movements in share capital and
reserves (excluding retained
earnings/accumulated losses)
Translated at the spot rate at the date they
were recognised in the accounts
Post-acquisition retained earnings
Amount determined from translating the
statement of comprehensive income
(cont.)
.
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36-26
Summary of the method to be applied for translating financial
statements from a given functional currency to a specific
presentation currency (cont.)
Revenues and expenses
Revenues
Translated at the rate in place as at the time of the
transaction. For practical reasons, however, it is
acceptable to use a rate that approximates the
rate in place when the transactions took place
(e.g. to use an average rate for the year)
Expenses (apart from the amortisation or
depreciation of non-current assets)
Translated at the rate in place as at the time of the
transaction. For practical reasons, however, it is
acceptable to use a rate that approximates the
rate in place when the transactions took place
(e.g. to use an average rate for the year)
Depreciation/Amortisation
Translated at the average rate for the year
Income tax expense
Translated at the average rate for the year
Distributions
Dividends paid/declared
.
Translated at the spot rate when paid/declared
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs to accompany Deegan, Australian Financial Accounting 6e
36-27
Worked Example 36.2—Translation of a foreign operation’s
financial statements from a functional currency into a
presentation currency
On 1 July 2011 Bruce Ltd, an Australian company, acquires all the
issued shares in Nigel plc, a company incorporated in England.
Exchange rates for the year ending 30 June 2012 are as follows:
01 July 2011
Average rate for year
Ending inventory acquired (before year end)
30 June 2012
£1.00 = A$2.00
£1.00 = A$2.10
£1.00 = A$2.20
£1.00 = A$2.30
The statement of comprehensive income and statement of
financial position of Nigel plc are shown on the next slides. The
accounts are stated in UK£, which is Nigel plc’s functional currency
.
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PPTs to accompany Deegan, Australian Financial Accounting 6e
36-28
Worked Example 36.2—Translation of a foreign operation’s
financial statements from a functional currency into a
presentation currency (cont.)
Abbreviated statement of comprehensive income for Nigel plc
for the year ending 30 June 2012 and details of closing retained
earnings
UK£
Sales
2 500
Cost of sales
Inventory—01 July 2011
(500 )
Purchases
(2 000 )
Inventory—30 June 2012
450
Administration expense
(75 )
Depreciation expense
(100 )
Profit
275
Income tax expense
(125 )
Profit after tax
150
Retained earnings—01 July 2011
150
Retained earnings—30 June 2012
300
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-29
Worked Example 36.2—Translation of a foreign operation’s
financial statements from a functional currency into a
presentation currency (cont.)
Statement of financial position for Nigel plc as at 30 June 2012
01 July 2011
30 June 2012
(UK£)
(UK£)
Assets
Plant and equipment
1 050
950
Cash and debtors
100
800
Inventory
500
450
Total assets
1 650
2 200
Liabilities
Bank loan
1 000
1 000
Trade creditors
–
400
Total liabilities
1 000
1 400
Net assets
650
800
Represented by:
Shareholders’ funds
Share capital
500
500
Retained earnings
150
300
650
800
REQUIRED
Translate the financial statements of the foreign operation from the functional currency of the
subsidiary into the presentation currency of the group
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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36-30
Worked Example 36.2—Solution
Statement of comprehensive income and reconciliation of retained
earnings, for Nigel plc for the year ending 30 June 2012
Sales
Cost of sales
Inventory—01 July 2011
Purchases
Inventory—30 June 2012
Administration expense
Depreciation expense
Profit
Income tax expense
Profit after tax
Retained earnings—01 July 2011
Retained earnings—30 June 2012
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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(UK£)
2 500
(Rate)
2.10
(A$)
5 250
(500 )
(2 000 )
450
(75 )
(100 )
275
(125 )
150
150
300
2.00
2.10
2.20
2.10
2.10
(1 000 )
(4 200 )
990
(157.5 )
(210 )
672.5
(262.5 )
410
300
710
2.10
2.00
36-31
Worked Example 36.2—Solution (cont.)
Statement of financial position for Nigel plc as at 30 June 2012
01 July 2011
30 June 2012
(UK£)
(UK£)
Assets
Plant and equipment
1 050
950
Cash and debtors
100
800
Inventory
500
450
1 650
2 200
Liabilities
Bank loan
1 000
1 000
Trade creditors
–
400
1 000
1 400
Net assets
650
800
Represented by:
Shareholders’ funds
Share capital
500
500
Foreign currency translation reserve
Retained earnings
150
300
650
800
*See calculation provided overleaf
**See statement of comprehensive income
.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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(Rate)
(A$)
2.30
2.30
2.30
2 185
1 840
1 035
5 060
2.30
2.30
2 300
920
3 220
1 840
2.00
1 000
130 *
710 **
1 840
36-32
Worked Example 36.2—Solution (cont.)
Foreign currency translation reserve
All assets and liabilities of the foreign subsidiary are translated at the reporting
date spot rate. Because we know that assets less liabilities equals owners’
equity, it follows that in effect the total of owners’ equity is translated at the
reporting date spot rate
However, the individual components of owners’ equity will be translated
differently. The share capital will be translated using the rate in place when the
investment was acquired
Retained earnings will be the balance provided from the statement of
comprehensive income (which might use a variety of rates). The translation gain,
which does not go to the statement of comprehensive income but remains part of
equity, is in effect the balancing item
When the foreign operation is ultimately disposed of, the amount accumulated in
equity as the foreign currency translation reserve will be treated as part of profits
The transfer to the foreign currency translation reserve is determined as follows:
Net assets at 30 June 2012 at closing rate (800 × $2.30)
$1 840
less Components of net assets at their historical rates
– Share capital 500 × $2.00
($1 000 )
– Retained earnings from statement of comprehensive income ($710 )
Translation gain—to foreign currency translation reserve
$130
.
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36-33
Consolidation subsequent
to translation
• After translation of foreign subsidiary’s financial statements,
consolidation takes place according to normal principles (refer
to Chapters 28 to 32)
– Cost of investment eliminated against pre-acquisition
capital and reserves of controlled entities, with resultant
goodwill or discount being recognised
– Pre-acquisition capital and reserves are translated at the
rates in place when the investment was acquired, i.e. same
rates used each year so the goodwill or discount
recognised on consolidation does not fluctuate
.
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36-34
Consolidation subsequent
to translation (cont.)
– Non-controlling interests will be determined following
translation of accounts
– foreign currency translation reserve will reside in the
subsidiaries’ statement of financial position before the
consolidation adjustments and the non-controlling
interests will be allocated a proportion of this reserve
.
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36-35