Advanced Accounting by Debra Jeter and Paul Chaney Chapter 14: Translation of Financial Statements of Foreign Affiliates Slides Authored by Hannah Wong, Ph.D. Rutgers University 14 - 0 Foreign Subsidiaries A foreign subsidiary is consolidated if the parent company owns a controlling interest in the subsidiary Exceptions: The intent to control is temporary Control does not rest with the parent government restrictions on asset withdrawal exchange restrictions 14 - 1 Translating Financial Statements of Foreign Affiliates Translation: the conversion of financial statements from one currency to another Financial statements in Franc Translation Financial statements in U.S. dollars 14 - 2 Exchange Rates Current exchange rate = the spot rate on the balance sheet date Historical exchange rate = the spot rate on the transaction date 14 - 3 Functional Currency Definition: Functional currency of a foreign affiliate is the currency of the economic environment in which it primarily conducts its operations can be: local the a currency of the affiliate U. S. dollar third currency 14 - 4 Translation Methods Current Rate Method Temporal Method all assets and liabilities monetary assets and are translated using liabilities - current the current exchange exchange rate rate assets and liabilities revenues and carried at historical cost expenses - average - historical exchange rate exchange rate assets and liabilities carried at current value current exchange rate 14 - 5 Functional Currency Indicators cash flows sales prices sales market expenses financing intercompany transactions 14 - 6 Determining Functional Currency Accounts stated in local currency of foreign affiliate Do economic indicators show that functional currency = U.S. $? No Foreign economy highly inflationary? Yes Yes Function currency = U.S. $ Function currency = U.S. $ Remeasurement Remeasurement No Function currency = local currency Translation 14 - 7 Remeasurement VS Translation Remeasurement convert financial statement elements using temporal method translation adjustment included in net income Translation convert financial statement elements using current rate method translation adjustment recorded in stockholders equity 14 - 8 Translation Process Local currency Remeasurement Not necessary Functional currency Local currency Translation U.S. dollar Current rate method Books kept in local currency Temporal method U.S. dollar Not necessary Temporal method A third currency Current rate method Financial statements in U. S. dollars 14 - 9 Translation (Current Rate Method) Assets and liabilities Current exchange rate Paid-in capital: purchase acquisition Historical rate on the date of acquisition Paid-in capital: pooling acquisition Historical rate on the date of capital transaction of subsidiary 14 - 10 Translation (Current Rate Method) Beginning R/E = Ending balance of last year Dividends Historical rate when dividend is declared Revenue and Average exchange rate expenses Cumulative translation adjustment = Balance amount in the balance sheet 14 - 11 Translation (Current Rate Method) Cumulative translation adjustment = Balance amount in the balance sheet Current year translation adjustment “Other comprehensive income” in shareholders equity 14 - 12 Remeasurement (Temporal Method) Monetary assets and liabilities carried at current values Current exchange rate Nonmonetary assets and liabilities carried at current values Current exchange rate Nonmonetary assets and liabilities carried at historical costs Historical rate on the date of transaction 14 - 13 Remeasurement (Temporal Method) Paid-in capital: purchase acquisition Historical rate on the date of acquisition Paid-in capital: pooling acquisition Historical rate on the date of capital transaction of subsidiary 14 - 14 Remeasurement (Temporal Method) Beginning R/E = Ending balance of last year Dividends Historical rate when dividend is declared 14 - 15 Remeasurement (Temporal Method) Revenues and expenses related to assets and liabilities translated at historical rates Historical rate used for the related asset or liability accounts (inventory cost and depreciation) Other revenues and expenses Average exchange rate 14 - 16 Remeasurement (Temporal Method) Current year translation adjustment Net income 14 - 17 Financial Statement Disclosure Aggregate translation gain/loss included in net income disclosed in (notes to) financial statement Exchange rate changes that occur after the balance sheet date and their effect on unsettled foreign currency transactions, if significant 14 - 18 Financial Statement Disclosure Analysis of the cumulative translation adjustment should be presented as part of statement of changes in equity or in a separate statement 14 - 19 Financial Statement Disclosure Analysis of the cumulative translation adjustment includes beginning current and ending amounts period’s aggregate adjustment translation of foreign currency statements gains/losses from hedging activities and intercompany long-term investment transactions income taxes allocated amount transferred to net income 14 - 20 Advanced Accounting by Debra Jeter and Paul Chaney Copyright © 2001 John Wiley & Sons, Inc. 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