12-1
Baker / Lembke / King
Multinational
Accounting:
Translation of
Foreign Entity
Statements
12
Electronic Presentation by
Douglas Cloud
Pepperdine University
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Differences in Accounting Principles
Four major models of accounting
The U.S. model, which
focuses on the
information needs of the
common stockholder
through the application of
generally accepted
accounting principles.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-2
Differences in Accounting Principles
Four major models of accounting
The British model, which
focuses on the
information needs of
bondholders, creditors,
and preferred
stockholders.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-3
Differences in Accounting Principles
Four major models of accounting
The French-ItalianSpanish model, which
is based on the
information needs of
the taxing authorities.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-4
Differences in Accounting Principles
Four major models of accounting
The German and
Scandinavian
countries model, which
is extremely
conservative and uses
large number of
reserves to reduce
income to its lowest
level possible.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-5
Determining the Functional Currency
FASB 52 provides
specific guidelines
for translating
foreign currency
financial statements.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-6
Determining the Functional Currency
Normally,
FASB 52that
defines
is theitcurrency
as the
of currency
the environment
of the primary
in which
aneconomic
entity primarily
environment
generates
in
which
andthe
expends
entity operates.
cash.
McGraw-Hill/ Irwin
What is
functional
currency?
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-7
Functional Currency Indicators
Indicator
Cash flows
McGraw-Hill/ Irwin
Factors indicating
Foreign Currency
(Local Currency) is
the Functional
Currency
Primarily in
foreign
currency and do
not affect
parent’s cash
flows
12-8
Factors indicating
U.S. Dollar
(Parent’s Currency)
is the Functional
Currency
Directly impact
the parent’s
current cash
flows and are
readily
available to the
parent company
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-9
Functional Currency Indicators
Indicator
Sales prices
McGraw-Hill/ Irwin
Factors indicating
Foreign Currency
(Local Currency) is
the Functional
Currency
Factors indicating
U.S. Dollar
(Parent’s Currency)
is the Functional
Currency
Primarily
determined by
local competition
or local
government
regulations
Responsive to
short-term
changes in
exchange rate
and worldwide
competition
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Functional Currency Indicators
Indicator
Sales
markets
McGraw-Hill/ Irwin
12-10
Factors indicating
Foreign Currency
(Local Currency) is
the Functional
Currency
Factors indicating
U.S. Dollar
(Parent’s Currency)
is the Functional
Currency
Active local sales
markets for
company’s
products; might be
significant amount
of exports
Sales market
mostly in parent’s
country, or sales
contracts are
denominated by
parent’s currency
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Functional Currency Indicators
Indicator
Expenses
McGraw-Hill/ Irwin
12-11
Factors indicating
Foreign Currency
(Local Currency) is
the Functional
Currency
Factors indicating
U.S. Dollar
(Parent’s Currency)
is the Functional
Currency
Labor, materials,
and other costs are
primarily local
costs
Production
components
generally obtained
from the parent
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Functional Currency Indicators
Indicator
Financing
McGraw-Hill/ Irwin
Factors indicating
Foreign Currency
(Local Currency) is
the Functional
Currency
Primarily obtained
from and
denominated in local
current units, entity’s
operations generate
funds sufficient to
service financing
needs.
12-12
Factors indicating
U.S. Dollar
(Parent’s Currency)
is the Functional
Currency
Primarily from
the parent, or
other dollar
denominated
financing
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Functional Currency Indicators
Indicator
Intercompany
transactions
and
arrangement
McGraw-Hill/ Irwin
Factors indicating
Foreign Currency
(Local Currency) is
the Functional
Currency
Few intercompany
transactions with
parent
12-13
Factors indicating
U.S. Dollar
(Parent’s Currency)
is the Functional
Currency
Frequent intercompany
transactions with
parents or foreign
entity is an investment
or financing arm for
the parent
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Translation Versus Remeasurement
12-14
Translation is the most
common method used and is
applied when the local
currency is the foreign
Remeasurement is the
entity’s functional restatement
currency. of the foreign
entity’s financial statements
from the local currency used
by the entity into the foreign
entity’s functional currency.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Translating Foreign Entity’s Trial Balance
12-15
Income statement accounts:
- Revenue and expenses Generally, weighted average
exchange rate for the period
covered by the statement
Balance sheet accounts:
Current exchange rate on
- Assets and liabilities
balance sheet date
Historical exchange rate
- Stockholders’ equity
Cumulative translation
adjustment
McGraw-Hill/ Irwin
To Accumulated Other
Comprehensive Income
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Translation and Consolidation
12-16
On January 1, 20X1, Peerless Products (U.S.)
purchases 80 percent of the outstanding capital stock
of German Company (Germany) for $54,000.
The local currency for German Corporation is euro( ),
which is also the functional currency.
On October 1, 20X1, the subsidiary declared and paid
dividends of 6,250.
The subsidiary received $4,200 in sales transactions with a
U.S. company when the exchange rate was $1.20 = 1.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-17
Translation and Consolidation
Relevant direct spots exchange rates ($/ 1) are:
Date
Rate
January 1, 20X1
October 1, 20X1
December 31, 20X1
20X1 average
$1.20
1.36
1.40
1.30
Jan. 1, 20X1
Investment in Germany Company Stock
Cash
Purchase of Germany Company stock.
McGraw-Hill/ Irwin
54,000
54,000
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-18
Translation and Consolidation
1/1/X1 80%
P
G
Investment cost
Book value of investment:
Common stock
$48,000
Retained earnings
12,000
Total
$60,000
Percent of German Company’s
stock acquired by Peerless
Company
x .80
Differential attributed to goodwill
McGraw-Hill/ Irwin
$54,000
(48,000)
$ 6,000
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
January 1, 20X1 Workpaper
Item
Investment in
German Co.
Stock
Differential
Common Stock
Retained
Earnings
Noncontrolling
Interest
McGraw-Hill/ Irwin
Peerless
Products
German
Company
Eliminations
Debits
Credits
12-19
Consolidated
54,000
500,000
48,000
300,000
12,000
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-20
January 1, 20X1 Workpaper
Item
Investment in
German Co.
Stock
Differential
Common Stock
Retained
Earnings
Noncontrolling
Interest
Peerless
Products
German
Company
Eliminations
Debits
Credits
54,000
Consolidated
54,000
6,000
500,000
48,000
48,000
500,000
300,000
12,000
12,000
300,000
12,000
12,000
Noncontrolling Interest = ($48,000 +
$12,000) x .20 = $12,000
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-21
January 1, 20X1 Workpaper
Item
Investment in
German Co.
Stock
Differential
Patent
Common Stock
Retained
Earnings
Noncontrolling
Interest
Peerless
Products
German
Company
Eliminations
Debits
Credits
54,000
500,000
48,000
6,000
6,000
48,000
300,000
12,000
12,000
Consolidated
54,000
6,000
6,000
500,000
300,000
12,000
12,000
Assign differential
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Dec. 31, 2001--Translation Trial Balance
Balance
Item
Cash
10,750
Foreign Currency Units Current3,000
exchange
Receivables
rate10,500
on balance
Inventory
5,000
sheet
date
Plant and Equipment
50,000
Cost of Goods Sold
22,500
WeightedOperating Expenses
14,500
average
Foreign Currency
exchange
rate
Historical
Transaction Loss
500
exchange rate on
Dividends Paid
6,250
date of
Total Debits
123,000
declaration
McGraw-Hill/ Irwin
Exchange
Rate
12-22
Balance,
$
1.40
1.40
1.40
1.40
1.40
1.30
1.30
15,050
4,200
14,700
7,000
70,000
29,250
18,850
1.30
1.36
650
8,500
168,200
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Dec. 31, 2001--Translation Trial Balance
Balance
Item
Exchange
Rate
Accumulated Depreciation
7,500
Current
exchange
rate3,000
on balance
Accounts Payable
Historical
sheet
date
Bonds Payable
12,500
exchange
rate on
From the
Common Stock
date40,000
of acquiring
beginning
of year
Retained Earnings (1/1) 10,000
subsidiary
Weighted
translation
Sales
50,000
average
workpaper
exchange
Total
128,000 rate
Accumulated Other
Comprehensive Income-Translation Adjustment
Total Credits
1.40
1.40
1.40
1.20
*
1.30
12-23
Balance,
$
10,500
4,200
17,500
48,000
12,000
65,000
157,200
11,000
168,200
*From the January 1, 20X1, translation workpaper.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-24
Proof of Translation Adjustment
Peerless Products and Subsidiary
Translation
Rate
Net assets at beginning of year
50,000 1.20
Adjustment for changes in net assets
position during year:
Net income for year
12,500 1.30
Dividends paid
( 6,250) 1.36
Net assets translated at:
Rates during year
Rates at end of year
56,250 1.40
Change in other comprehensive income-translation adjustment during year (net increase)
Accumulated other comprehensive income-translation adjustment, 1/1
Accumulated other comprehensive income-translation adjustment, 12/31 (credit)
McGraw-Hill/ Irwin
$
60,000
16,250
(8,500)
67,750
78,750
11,000
-011,000
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Translated Balance Sheet--12/31/X1
12-25
Translated Balance Sheet, 12/31/X1
Net assets
McGraw-Hill/ Irwin
$78,750 Common stock
60,000
Retained earnings
7,750
(net income less
dividends)
Accumulated other
comprehensive
income--translation
adjustment
11,000
$78,750
$78,750
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Entries on Parent Company’s Books
12-26
On October 1, 20X1, Peerless Products
received a dividend of DM 10,000 and
immediately converted it to U.S. dollars.
October 1, 20X1
Cash
6,800
Investment in German Company Stock
Dividend received from foreign
subsidiary.
6,800
6,250 x .80 x
$1.36 exchange rate
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Entries on Parent Company’s Books
12-27
Equity in the net income of foreign subsidiary
is recorded on December 31, 20X1.
December 31, 20X1
Investment in German Company Stock
Income from Subsidiary
Equity in net income of foreign
subsidiary.
McGraw-Hill/ Irwin
13,000
13,000
12,500 x .80 x
$1.30 average
exchange rate
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Entries on Parent Company’s Books
12-28
Amortization of the parent’s portion of the
differential assigned to the patent is recorded
on December 31, 20X1:
December 31, 20X1
Income from Subsidiary
Investment in German Company Stock
Amortize differential.
650
650
500 x $1.30
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Entries on Parent Company’s Books
12-29
An entry is needed to record the portion of the
translation adjustment on the increase in the
differential on the investment in foreign subsidiary.
December 31, 20X1
Investment in German Company Stock
Other Comprehensive Income-Translation Adjustment
Recognize translation adjustment on
increase in differential.
McGraw-Hill/ Irwin
950
950
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Entries on Parent Company’s Books
12-30
Peerless Products’ share of the translation
adjustment is recorded on December 31, 20X1.
December 31, 20X1
Investment in German Company Stock
Other Comprehensive Income-Translation Adjustment
Parent’s share of change in translation
adjustment from translation of
subsidiary’s accounts.
McGraw-Hill/ Irwin
8,800
8,800
$11,000 x .80
ownership
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Situations Requiring Remeasurement
12-31
1. A foreign sales branch or subsidiary of a U.S. manufacturer
which primarily takes orders from foreign customers for
The major
reason
forfrom
U.S.-manufactured goods, which
bills and
collects
foreign customers.
remeasurement is Item 5.
2. A foreign division, branch, or subsidiary which primarily
manufactures a subassembly that is shipped to a U.S. plant.
3. A foreign shipping subsidiary which primarily transports ore
from a U.S. Company’s foreign mines to the United States
for processing.
4. A foreign subsidiary which is primarily a conduit for
Eurodollar borrowing to finance operations in the United
States
5. The foreign entity is located in a hyperinflationary economic
environment.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
12-32
The major reason for
remeasurement is Item 5.
5. The foreign entity is located in a hyperinflationary economic
environment.
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Remeasuring a Foreign Entity’s Trial Balance
12-33
Income statement accounts:
Revenue--
Weighted-average exchange rate, except
revenue from nonmonetary items
(historical exchange rate)
Expenses--
Weighted-average exchange rate,
except costs related to nonmonetary
items (historical exchange rate)
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Remeasuring a Foreign Entity’s Trial Balance
12-34
Balance sheet accounts:
-Monetary accounts
-Nonmonetary accounts
-Equity capital accounts
-Retained earnings
Remeasurement gain
or loss
McGraw-Hill/ Irwin
Current exchange rate
Historical exchange rate
Historical exchange rate
Prior period’s balance plus
income less dividends
Included in net income
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12-35
Chapter Twelve
The
End
McGraw-Hill/ Irwin
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.