BY
rm:\'cri::,
INJlrlN,{
CCNTENTS
I.
II.
Introcmc tien
,:,urvey of Literatere
A.
B.
III.
FASB
A.
B.
DI.
B.
1/8
•
A.
p
....,.
•
2
•
#P
•
•
• •
•
•
,->
:;
c'
:;;
7
7
7
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•
•
l(,
11
11
11
II
14
15
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•
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15
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16
IE.
17
17
17
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le
18
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19
•
Gt:rrE·nt 2L:..tus of FASE liP:
other Closing Remarks • •
o
• •
•
•
:::urrent Rate ;!eU:cd •
•
•
1. No r~stcrtion of Relationships
2. t'-a Xisrr:atch1.r.g Eevent:.e and Expense
3. 1-.. 'liard of Caution.
Immediate Hecognition with Disclosure
1. Disclosure of the Types of Exchcmge
Gains and Losses
Disclosure ir:c;ta temer. ts
J. Disclosure in Footrctes
•
2
•
•
The Eequirements of :3tate!7lent No. 8
• •
The Lesponse to F.I';SB No. P • •
•
1. \'ore Disclosure of ~xcrlarge Gair./Loss
c.. Realized ~.~a ins and Losses
t. Unrealized Gains and Lesses •
c. Translation Gains and Losses
2. ~-:cre Disclosu!'e of Yxchange Gain/Loss
Before and Aft.er Tax!?s
.3. Hore Disclosure of Gross VarGin Distorticn
Bibliography
1
•
8
The F'u!'pose of Statement No.
Ccnclusion
• •
• •
I'ram-'lat ion ~'~E,U,ods •
•
•
1. Current-t·:orcnrrent ~'~e thod
•
,::. ~Jone tary-Honmone tary ;rethcd. • • • • • •
•
3. Temporal r~ethod •
•• •
•••
L. Curren"'::, Rate :~ethod •
5. ';:'ransl3.ti.cn Yethocis CO!Ti:Jared and Contrasted
Exchange Gair: and Loss Treatment
••
1. Immediate Reeogni tion
2. Defer Gain--Recq;nize Loss
3. Defer Gain and Less •
1.. Hodge-Podge I-'ethods
•
The :~o':;'t:. tien to FASE
A.
v.
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•
• •
•
•
•
• • •
19
19
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• • •
•
22
ILLUSTRATIONS
Exhibit
1.
1979 Income Statement
• • • • • • • • • • • • • • • • • • • •
12
2.
1979 Balance Sheet, 1978 Balance Sheet • • • • • • • • • • • •
13
3.
Computation of Translation Gain
• • • • • • • • • • • • • ••
14
Comprehensive Review • • • • • • • • • • • • • • • • • • • • • • ••
20
TABLES
1.
Summary of Translation Methods • • • • • • • • • • • • • • • • •
6
2.
Rates Used to Translate Assets
and Liabilities • • • • • • • •
9
•
• • • • • • • • • • • • • •
Intr0.:iuc:ti C!!
if
th~
AmericCiD :::ulVrat,iond::' ('irmc; ... ul~:"d ccnVert their
from the i'creign cUlTencJ tc TTni ted St""tes
r
enE: currency ,;n it f0r c.nc :,Jl,: r, the
forei;:;!] entities.
TLis is
·~h;:!jr
had teen
;1'''1:::
~,ract'
7'Ht
e'lEn state:l,er:ts are transJd.ted.
as thollgrl
.!'
do11a~":-;.
'IJ"u1c 1
th~
~;nd
phy:::ica~1;)'
liabilj ti.es
c):chanprG
the exac t, J1e t "ort.h of the i r
cal, so at the erect
The p;rpose of
r~ea,:ur,"d
~:n(:w
3y
aSSE,'t:::
:::>~'
clc:.ch pd'icd the ':or-
translaticn is to ch'=.nge the
and recorcir;c: in dollars l1nder' fiClerican cencI'dlly
acce;: t.ea acccl:nting :JI'inc iple;:;.
individual currenc',-ps
dollar.
liMited.
(-lb.S
"-:;':presse~i
:en
tfr~s
of gold and "PE€:becJ'f to a convertible
Foreign curr:::nc'es could crl;- ::hct\:3.te ty 1% up or down u[ainst the dol-
In the early 1970's U:e sy3tem of fixed exchanp, rate,' Was ren13,c;n.d Ly
tt,€; :1oating rate systerr,.
wi th m ,m·ifor""ity.
l'~C'W
the vuricus transL" tien ",etLcds char:,,::e consideraLly
For In:3tance, under de7a1uat:ir,n, t.he c;.;.rrcnt-rcncerrent o.r;d
the current ra t.e :'lc":,t;ods cf translati('n prodece exch;mgc,
103::,(:,5 \.. h~ 1,:0
the :r.onet:lry-
fessicn ar~ues that these losses a~d [a~ns are produced 1::J co~vc~t'~n~l lr~ns1~tio~
"':ethcQs
econcm~c
th,~t
stress
rT'lct~ca1
::1eas'.;re:':'12nt and dL;clcsl:re practice.: ;nstead of
real~ty.
1
2
Are thE accol,.;.ntine practices reflecting or distorting the economic
substance underlying the financial results of foreign operations?
The conven-
tional translation methods are accused of creating an accounting reality which
induces American r.1ultinat:'onal firms to overmanage the risks of foreign currency
translation.
Firms are tempted to reduce exposure to translation adjustments by
increasing the:ir cash borrowings.
The costs incurred to avoid the exposure are
more detrimental to the firms' profits than the exposure, itself.
Under the fixed exchange rate system, there was no need to be concerned
with the management of the exposure to translatjon since it had little impact cn
reporting the results of foreign operations.
The floating exchange rate system
allows the translation exposure to have a significant impact on reported earnings.
Today's shifting economy, created by floating rates, calls for a re-evaluation of
the various translation methods to determine their ability to resolve the problems
of increased international business activity, extensive currency adjustments, and
new accounting procedures.
The intent of this paper is to provide insight to the
different techniques and to select a translation method that will best reflect
today's changing environment.
Survey of Literature
Translation Hethods
Current-Noncl.:.rrent Method
The current-noncurrent method waS acknowledged as the first proper
practice for translating foreign financial statements with the issuance of ARB
No. ~3.
The translation of current assets and current liabilities at the exchange
rate in effect at the balance sheet date was established by Chapter 12 of this
bulletin.
All other assets, liabilities, and equities were to be translated at
the historical rates prevailing when they were incurred.
3
The practice of translating noncurrent items at historical rates served
several purposes. The dollar value of property, plant, and equipment was
not felt U, be diminished by the devaluation as long as operations continued because the devaluation usually reflected severe inflationary conditions locally. Use of historical rates for long-term liabilities held
to the principle of conservatism. Any gain resulting from the rate change
was deferred in this manner until the liquidation of a liability.l
The current-noncurrent mettod treated property, plant, and equipment as having
intrinsic value which did not change witb devaluation.
The accounting profession
felt the failure to treat inventory in this same manner represented a departure
from the historical cost concept; therefore, the monetary-nonmonetary method
evolved.
Monetary-Nonmonetary Method
In
196~),
APB Opin ion No. 6 was issued to provide a me thod to translate
assets and liabilities upon their characteristics, rather than upon their balance sheet classification.
Those assets and liabilities representing claims or
obligations expressed in a fixed monetary amount are translated at the current
exchange rate.
All other assets, liabilities, and owners' equity accounts are
translated at t.he appropriate historical rates.
Under this method, inventory is
translated at ;:1istorical rates since it is a nonmonetary asset.
occurred with noncurrent payables and receivables.
The other change
vJithout specifying the cir-
cumstances, Paragraph 18 of APB Opinion No.6 found translati(n of these accounts
at current rates is appropriate in many instances.
The monetary-nonmonetary method retains the historical concept in foreign
financial statements, which makes accounting standards applied in consolidated or
combined statements more consistent.
Under
~his
method, changes in resources,
obligations, and operating rt:'sults of a foreign subsidiary are stated as though
they occurred in the parent co:npany's currency.
Alth::)Ugh thjs method corrected
IRuth .:<:. Pleak, !IAn Analysis of the FASB' s Treatment of Foreign Currcn::y
Translaticns," Hanagemen '.:, A.ccounting, Vol. 59, September 1977, p. 31.
problems of thp current-noncurrent method, it created a nev,
determination of the
do~inant
prC':~lem
characteristic of some assets and
in the
lia~ilities.
The temr:,oral method evolved to answer the (iuestion.
Temporal Vt,thod
In 1972, Ah3 No. 12 recommended a new methcd of translation which would
be more cor1patible with the tistorical cost framework of accepted accounting
principles.
mettod.
Ttis method is a sligh"
!Tlod~ficaticn
of' the monetary-nonmonetary
It calls for the translation of assets ano liabilities accC'unted for at
present or futt:re prices at the cu{'rent exchange rate, while those assets and
liabilitie:3 carried at past prices are translated at
appl~_c2ble
hLtorical rates.
Euch of the confusion created by the 1"lonetctry-nonrnonetary syster.; was
eliminated.
Trle ncticeatle change" occur in inventory and investm.ents.
The
inventory and inv8st'nent accounts that arE! carried at cost are translated at
historical ratE!s.
The inventcrJ and investment accounts recorded at market
value are tranC31ated at current rates.
Curren t Ita te Ye thod
This method has not teeT' generally accepted by the United States.
The
FASB rejectt::d :Lt in the Proposed Statement of' Fir:ancia1 Accounting Standards on
Foreign Currency TrCinslation in 1974.
from foreign er'.tities.
East of the suprcrt of this method comes
Today, i t is gaining more sUpDort, especially from the
critics of thE othEr translation metr.ods.
The current rate methed, unlike the
ether techniqla:s, emphCisizes the local cUYTenc;;r aspects of forei[:n subsjdjaries.
It best reflects the actu",l financial po;:)i tion
0:
foreigr cperations.
All ac;;,ets and lialil:ties are translated at the current o:change rate.
Owners 1 ec,ui ty accounts are translo.ted at appropriate hi storical ratAS.
,\
r.
s
minority of accountants beli8ves that the
tra~slation
of owners' equity should
also be at the current rate.
Translation Hethods Compared and Contras ted
In the income statement, depreciation and amortization are translated at
historical rates under the current-noncurrent, monetary-nonmonetary, and temporal
methods.
Cost of goods sold is translated at the appropriate rate used to trans-
late the inventory; this may be either current or historical rates.
Historical
rates are used to translate the remainder of the revenue and expense accounts.
Average rates may be used since it is often difficult and costly to keep record of
these transactinns.
transl~ted
Under the current rate method, all expenses and revenues are
at current rates.
The income statement is treated similarly with respect to all methods.
The methods differ primarily in translatbn of the balance sheet accounts.
Table
1 summarizes the differences of the four methods.
Exchange Gain and Loss Treatment
Under each dU'ferent method, items in the financial sta tements are translated at several rates--current, average, and historical.
The use of these
different rates produces an imbalance of debits and credits.
A balancing figure
labeled as an exchange gain (loss) is produced to reconcile the difference.
This
gain (loss) has been treated in several different manners.
Immediate Recognition
This technique is the simplest.
There is no record keeping of deferrals
of the exchangE! gains or losses since they are entirely recognized in the immediate period.
With the full recognition of the exchange gains and losses, a greater
fluctuation from period to period in ne t income will result.
6
TABLE 1
SUMMARY OF' TRANSLATICN METHODS
}1onetaryNonmonetary
Temporal
C-H
C
C
C
C
C
C
C
• • • •
C
H**
H
C
• • • •
C
H
C
C
·• • • • •·
Market •
·• ···• • •
Fixed Assets
·• • ··• •
Other Assets • • •
·•·•
H
H
H
C
H
H
C
C
H
H
H
C
H
H
H
C
• • • • •
C
C
C
C
····
• • · ·
··• ·
H
C
C
C
H
H
H
H
*
*
*
*
CurrentNoncurrent
Cash
• • • • • • • • • • •
Accounts Receivable • • • •
Current
Rate
Inventory:
·• •• • •
Market
··• ·•
Cost
,
Investments:
Cost • • •
Accounts Payable
Long-term Debt
Common Stock
Retained
• •
• • •
Earni~r.gs
•
*Residual Bala.nce
i:-il-Current Rate (C), Historical Rate (H)
7
Defer Gain--Recognize Loss
This technique is the most compatible with the concept of conservatism.
Therefore, gains are not recorded until they are realized.
Technically, no gain
is realized under translation; it is realized under conversion.
A gain may be
recognized to the extent that it offsets other exchange losses; then the remainder is deferred.
Exchange losses, or the remainder exceeding the gains, are
recognized immediately.
Defer Gain and Loss
Under t.his technique, both gains and losses are deferred.
then amortized over some smooth long-run average basis.
The net is
Fluctuations in net in-
come would dev€!lop primarily from adjustments to the amortization rates, not
from varying currency exchange rates.
This technique is more judgmental than the
others since each entity would determine an amortization rate to be used for the
deferral.
Hodge-Podge Methods
These methods evolved from the combination of the prior techniques.
A
method recommended by Chapter 12 of ARB No. L3 called for the recognition of
exchange losses and realized exchange gains immediately in net income while unrealized exchange gains wo\;ld be deferred to the extent that they offset the
losses.
In 19'71, the APB proposed another method in the exposure draft entitled,
"Translating Foreign Operations".
This technique was compatible with the monetary-
nonmonetary system and required an entity to " •• • defer exchange gains and losses
to the extent t.hat they did not exceed those attributable to long-term debt.
Amounts deferred were to be accounted for in a similar to debt di.scount.,,2
2"Translating Foreign Operati.ons," exposure draft, December 20, 1971,
quoted in "Sta'~ement of Financial Accounting Stan::iards No. B--Accounting for the
Translation of Foreign Currency Transactions and Foreign Currency Financial Statements," The Journal of Accountancy, December 1975, p. A7.
8
FASE #8
The different f1'Ietho:l.s used fo;:" translation of foreign financ:.al statements led to confusion as mere companies became 'nultinationals.
consistency among
state~ents;
there was no basis for
com~arison.
There ,,,as no
In order to
correct this mE,tter, FASE No. £1, "Accounting for the Translation of Forejgn
Currency Transa.cticns and Foreign Currency Financial Statements", was released
in October 197;;.
The Purpose of Statement No.8
Statement No.
P
established standards of financial accounting and report-
ing for foreign currency transactions plus foreign currency financial statements
that 'rlere
comb:~ned
enterprise.
or consolidated with the statement:') of an American reporting
For the purpose of preparing combined or consolidated financial
statements, F'A~>B #8 selected a translation method with the objective of measurf.ng
and expressing .the assets, liabilities, revenue, or expenses, which were !neasured
or denominated in foreign currency, in dollars and in conformity '.>lith U. S.
generally accepted account:ing proced'lres.
The purpose of this statement was to
select a translation metbod that reMeasllred the foreign currency accounts in
dollars wi thOll t altering the measurement bases required by other accounting
principles.
~.
The Requirements of Statement No.
Statement No.
'llodified tempo::-al
e re{juires
m~thod
for
the America.n multinational firms !~o adotJt a
transl~,tion
of foreign financial statements.
2 summarizes the rates to be used in translating the balance sheet items.
Table
The
exchange gains or losses resulting from translation are to be recognized entirely
in the immediate period; there are
:J()
deferrals.
9
TABLE 2
RATES USED TO TRANSLATE ASSETS AND LIABILITIES
Translation Rates
Current
Cash on hand and demand and time deposits
Marketable equity securities
Carried at cost
Carried at current market price
Accounts and notes receivable and related
unearned discount
Allowance for doubtful accounts and notes
receivable
Inventories:
Carried at cost
Carried at current replacement price or
current selling price
Carried at net realizable value
Carried at contract price (produced under
fixed price contracts)
Prepared insurance, advertising, and rent
Refundable deposits
Advances to unconsolidated subsidiaries
Property, plant., and equipment
Accumulated depreciation of property, plant,
and equ ipment
Cash surrender value of life insurance
Patents, trademarks, licenses, and formulas
Goodwill
Other intangible assets
Historical
x
x
x
x
x
x
x
X
X
x
X
X
X
X
X
X
X
X
Liabilities
Accounts and notes payable and overdrafts
Accrued expenses payable
Accrued losses on firm purchase commitments
Refundable deposits
Deferred income
Bonds payable or other long-term debt
Unamortized premium or discount on bonds or
notes payable
Convertible bonds payable
Accrued pension obligations
Obligations under warranties
X
X
X
X
X
X
X
X
X
X
SOURCE: "Statement of Financial Accounting Standards No. 8--Accounting for
the Translation of Foreign Currency Transactions and Foreign Currency Financial
Statements, II The Journal of Accountancy, December 1975, p. 84.
10
The Response to FASB No.8
Overwhelming criticism emerged when this statement was issued.
At first,
the criticism focused on the methods selected to transl"l.te foreign statements
and to report the foreign currency adjustments.
Prior to the statement, only
one out of three American firms used the temroral method.
cent of the
Am~rican
Approximately 70 per-
firms used some form of deferral to prevent erratic
fluct~a-
tions to the income statement caused by translation adjustments.
Today, criticism focuses on
re~uired
disclosure of the statement.
John
K. Shank and Ga.ry S. Shamis expressEd the following opinion in their article on
foreign currency translation.
GAAP requires that disclosures be adequate to ensure a full and fair presentat~on of the financial situation.
A question can be raised as to
whether the required disclosures under statement no. 8 measure up to this
standard. This is a particularly crucial question in an area such as
foreign currency accounting where extensive disagreement on basic objectives
and wo:."ld'dide diversity in accounting practices make full disclosure even
more important than is normally the case. Full disclosure of the impact of
foreign exchange rate swings on the consolidated financial statements enables
the reader to rr:ake whatever adjustllents are deemed necessary in terms Cof the
conceptual framework selected by the user. ,,3
Critics are demanding more disclosure.
that reflect economic reality.
it creating a new reality?
They want disclosure of statements
Does FASB No.8 reflect economic reality or is
The goal of proper accoun"Cing is to reflect actual
results of the business entities.
The profession questions whether this state-
ment reflects reality when it translates foreign operations from a partnt
pany's point of view.
COM-
Translated results and relationships, under this modified
temporal method, differ significantly from these reflected in the foreign
currency statements.
The accounting profession is focusing its attention to
these criticisms.
3John L Shank and Gary S. Shamis, "Reporting Foreign Currer:cy Adjustments:
A Disclosure Perspective," The Journal ef Accountancy, Vol. 147, April 1979, p. 59.
11
Hore Disclosure of Exchange Gain/Loss
Statement No. 8 requires that all foreit;n exchange gains and losses be
reported in the inccme statement imEediately--only the aggregate amount needs to
be disclosed.
This does net seem to present full disclosure.
Jotn K. Shank
notes that there exists three different types of exchange gains and losses having
significantly different implications.
Realized Gains and Losses.
These are gains and losses resulting from a
closed exchange in which a transaction is settled at a rate different from the
rate used to record the carrying value of items.
The transactions are completed.
There is no question as to whether the gain or loss is "real" and should be
recognized.
Unrealized Gains and Lcsses.
These gains and losses result frem an
open exchange ...,hich is a transaction invclving two currencies that has not been
settled at the end of the period.
is completed, :_s unknown.
ized.
The exchange rate, at the time the transaction
Under this open exchange, the gain or loss is not real-
By the time the transaction is closed it may have reversed or increased.
FASE No.8 still requires the immediate recognition of the unrealized gain or loss.
Translation Gains and Losses.
This third type of exchange gain or loss
arises when the conversion rates used to translate successive balance sheets of
a foreign entity are different.
The debi ts and credits will net be equal when the
successive balcLnce sheets are translated into equivalent dollars at the different
exchange rates.
A balancing figure is created to account for the difference.
"This figure car. always be rationalized or explained as the product. of the parent's net 'exposure' position to fluctuations in the subsidiarJ's currency multiplied by the percentage change in the exchange rate.,,4
4Ibid. J p. 60.
-
Exami.nation of £Xhjbits 1,
12
EXHIBIT 1
1979 Income Statement
Foreign
Currency
DollarsFASB #8
FC 2000
$1800
600
540
Fe 2600
$2340
Cost of Goods
Sold (FIFO)
800
880
Depreciation
500
600
Depreciation on plant acquired when the exchange
rate was Fe 1 : 1.2.
Selling &
Administration
300
200
Accrued ratably over the year.
Other Expenses
400
360
600
$ 230
300
270
300
$(40)
Sales
Interest Income
Total Revenue
Profit Before 1'axes
Fe
Income Tax
Net Income
Fe
Assumptions
Revenues accrued ratably
over the year - no seasonal
effect.
Represents inventory purchased in equal amounts each
month during 1978.
II
II
II
II
II
Paid monthly.
Exchange Rates
January 1, 197B
January 1, 1979
January 1, 1980
Fe 1
FC 1
FCI
1.2
1.0
.8
Average Rate 1978
Average Rate 1979
FC 1
Fe 1
1.1
.9
2, and 3 shoul(i clarify the definition of translation gains and losses.
In Exhibit 3, a translation gain of $750 was computed, but what is its
significance?
If this foreign subSidiary and the parent company continually
make regular transactions exchanging the foreign currency for dollar3, then the
gain is real.
If the foreign subsidiary conducts all of its transactions locally,
13
EXHIBIT 2
1979 Balance Sheet
Foreign
Currencl
DollarsFASB #8 a
Cash
Accts. Rec.
Inventory (FIFO)
Plant & Equipment
Land
Total Assets
FC
700
1100
1200
6000
2000
FC lJpOO
$
Acets. Pay.
Notes Pay.
Bonds Pay.
Mortgage Pay.
Common Stock
Add. Paid-ln C~p.
Retained Earnin.gs
Total Liab. & Capital
FC
880
960
1680
1360
4200
600
1990
$ 11/670
FC
1100
1200
2100
1700
3500
500
900
l~OOO
$
560
P80
1080b
c
67S0
2400d
u,670
$
1978 Balance Sheet
Cash
Accts. Rec.
Inventory (FIFO)
Plant & Equipment
Land
Total Assets
FC
Accts. Pay.
Notes Pay.
Bonds Pay.
Mortgage Pay.
Common Stock
Add. Paid-In Cap.
Retained Earnings
Total Liab. & Capital
FC
600
1000
800
5000
2000
600
1000
880
6000
2400
$ 10,880
800
1000
2000
1000
3500
600
1000
2000
1000
4200
600
1280
$ 10,880
FC 9 ,1~oo
500
600
FC 9,460'
$
$
aRefer to rates used in Exhibit 1.
blnventory was purchased each month during year.
cPlant & Equipment:
$ 4500
Purchased when rate was FC 1 : 1.2
1500
Purchased equal amounts in each
$ 6000
month when rate was FC 1 : .9
d
Land was purchased when exchange rate was FC 1 : 1.2
EXHIBIT 3
Computation of Translation Gain
Exposurec~
6100
CA 1800
4300
CL
1979 Net Liability Exposure
1978 Net Liability Exposure
Change in Exposure in 1979
41300
1600
3200
4300
3200
ITOo
Translation Gain**
Exposure throughout the year times
full year's devaluation
(3200 x 20%)
640
Change in exposure during year times
one-half year's devaluation
(llOO x 10%)
110
Total Translation Gain
750
OR
1979 Translated Retained Earnings
1978 Translated. Retained Earnings
1979 Net Income (Loss)
1990
1280
710
(40)
--go
Total Translation Gain
*Exposure to t.ranslation gain or loss equals the net of the accounts
tra.."lslateci at current rates.
**Translation gain or loss equals exposure times the percentage of devaluation.
then this gain is meaningless.
It makes no difference how many dollars resulted
from the translation if there is no intercurrency exchanges in the foreseeable
future.
This gain would be unrealized.
More Disclosure of Exchange Gain/Loss
Before and After Taxes
FASB Nc. 8 does net require any disclosure of the effect taxes have on
15
exchange gains and losses.
This iMpact is not always clear according to Shank
and Shamis, who uncovered the following eX<1mples.
In 1975, Tenneco reported an
exchange gain of $2 million before taxes and reported an exchange loss of ;;J1
million after t.axes.
On the other hand, International Paper had an exchange loss
of $1,100,000 tefore taxes and an exchange gain of $200,000 after taxes in 1976.
It seems that more disclosure of the income tax impact on exchange gains and
losses would be necessary.
More Disclosure of Gross Margin Distortion
By trar:.slating inventories at historical rates, there is a mismatch of
revenue and expense.
Cost of goods sold contains an element of the realized
gain or loss on foreign inventories sold during the period.
by referring back to Exhibits 1 and 2.
exchange rate was Fe 1 : 1.1.
FC 1 : .9.
Und~r
This can be seen
Inventory was bought for :$800 when the
It was sold in 1979 for $2000 when the rate was
this method, there is a gross margin of $920; yet, part of this
margin resulted from a realized gain of $160 from holding the goods when they
devalued from $1:80 to $720.
There is no disclosure to distinguish results of
operations and results of translation.
The Solution to FASB #8
liThe public expects of financial statements that any loss or gain reported in net i:r1come is identifiable
~vi th
a discernable
economic worth of the company's resources .,,5
correspondi~g
In the past the arguments centered
on shallow explanations used to defend the modified teMporal method.
is accused of using prior labels without studying their full
It is hoped that this proposed,
alt~rnate
change in
imp~ct
FASB #8
on translation.
method can better report the actual
5Marvin Deupree, "Is FASB #8 the Best Approach?," Financial Executive,
Vol. 46, Januar:r 1978, p. 26.
16
operations of foreign entities and clarify those areas where confusion exists.
Current Rate Nethod
Statement No.
e was
Accounting Standards Board.
adopted by six affir!!lative votes of the Financial
Hr. r-1ays, the seventh member, dissented.
He
dissented because he felt the te:tlporal method was inappropriate for translation.
YlI'. Mays suppo:;'ted the current rate !!lethod because he felt it met two requirements
deemed essential:
• • • (1) that the translation process should preserve the essence of the
foreign currency statements in ter!!lS of financial position and results of
operations and (2) that it shOl..;ld produce results that are genera::'ly consistent with the economic effects of exchange rate changes.
By translating financial statements from an ongoing foreign currency perspective,
the current rate maintains the characteristics of the foreign operations.
The tem-
pora::' method misstates actual results by translating assets, liabilities, revenue,
and expenses as though they had individually been transacted and recorded in
dollars.
~1r.
\1ays felt that all assets are equally at risk in the foreign exchange
market, not injividual assnts acquired by the foreign subsidiary.
No Distortion of Relationships
The greatest weakness of the
tem~oral
method and the greatest strength
of the current rate method lies in the relationship of the items in the financial
statements.
By referring back to Exhibi ts 1 and 2, i t is possible to see the
distortion of financial ratios after translation by the temporal method.
ratio of sales to fixed assets before translation is
.25,
while it is .20 after
.15; it is (.02) after
translation.
Net income to net sales before transl8.tion is
translation.
The current rate method maint.ains these ratios.
6"Accounting Standards No.8," p.
83.
The
17
No Mi:3r1atching Revenue and
~pense
CO~lt of goods sold retained a portion of realized gain ($160) by trans-
lating inventory at historical cost.
The Pli,)r1atching arises from translating
inventorie:3 and fixed assets at historical rates while translati.ne: the short- and
long-term debt, used to finance them, at current rates.
It was generally
ac('e~teri
that the temprral method waS superior because it waS the most compatible with the
historical cost. concept.
r~r.
~1ays
stated in his dissenting opin:lon that
It • • •
assets acq'.1irecl for local currency by a foreign subsidiary have no historical
dollar cost; their historical cost exists only in local currency, and translation
at the current rate does not change that baSis."?
By adopting the current rate
method, characteristics of items are maintained without mismatching revenue and
expense.
A tJord of Cau t:~on
There are discrepancies under the current rate mnthod.
The vast majority
of the accounting professic'n translate all items in the balance sheet, except
m·mers' equity, at the current rate.
rates.
Owners' ec;uity is translated at historical
Under this variety of the current rate method, some ratios .... ill rema-Ln
distorted.
A minority of accountants ad'pt the position that owners' equity should
also be translated at the current rate.
only existed
~::1
the local currency.
It was stated before that
h~storical
cost
Therefore, it WQuld seem logical to translate
owners' e;uity at the current rate.
Immediate RecognUion with Disclosure
There is a significant argullent against immediate
ga ins and 10ss9s.
r8cogn:~tion
of exchange
Under the concept of conservatism, all gains and losses '..rould
be recognized, except unrealized gains.
7Ibid., p. fl3.
These w(}uld be
deferred.~tatements
be-
come more judE!r.ental by using deferrals.
If the crange in ratE;s is permanent,
then tte company is delaying the inev:ltable.
By recognizing the entire exchange
gain or loss and then dis(;losing the different aspects of it, the reader is able
to determine the significance of the gain or loss.
rlsclosure of the Types of Exchc.nge
Gains and Losses
It was discussed earlier that tpIee types cf exchange gains and losses
exist--realized, unrealized, and translation.
By using the definition of the
current-r.oncurrent concept, the !'ealized and unrea] ized portions can be detE;rmined.
Since current asset and liability transactions are
one year, t.he
devaluat~on
nor~ally
closed withir
or revaluation of these items is realized.
cr revalnation of the remaining items would be unrealized.
DevaluaUcn
There is no translation
gain or loss wr:.en the current rate is used to translate all items, including owners' equity, ir the financial statements.
Disclosure in :::tatements
The unrealized and reA.ljzed portions of the exchange ga:in or loss should
be disclosed ir:. the body of the inccme statement.
These porticns should be dis-
closed before and after taxes, since income tax can greatly influence the results.
Disclosure in Footnotes
The significance the currency has, with regard to exchange gains and
losses, was not. previously llentioneo before.
These gains and losses can l::;e inter-
preted differertly depending on the currency that generated them.
By gatl:ering
information about the foreign currency, it i3 possiblE to estimate whether unrealized gains and losses will increase or reverse.
Estimation of realized gains and
losses can be obtained with the disclosure of the major currencies.
This di8-
closure reflects ;mother irr:portant economical aspect of exchG.nge gains and losses.
19
To
avo~d
confusion in the bc·dy of the inco:ne stateMent, it is proposed that the
djsclosurE:: of i'oreigr. currency be in footnotes follm.;ing the stateMents.
Conclusion
Curren t Status of Fil.SB
#8
Tht::: Financial Accounting Standards Board is currentl;{ revie·w:inG this
statement.
ThEY are
reco:nmend~.ng
the use of the cUI-r,mt rate method.
exists some diE,crepancy on the treat-r.ent of the exchange gain or loss.
There
There is
the recornmendat.ion that unrealized gains and losses tecome a ncnoperating item
or be a direct charge or credit to retilined earnint:s.
A direct charge or credit
to retained earnings is a departure from the all -:nclusive accourting jn('ome
concept which
E:
ta tes tha tall reverme, expenses, gains, and losses are included
in income, except those resultir.g from c&pital transactirns.
Another recommen-
dation is to defer the unrealized gains and losses and then amortize them (lVer
the carryin£ value of the relatec item.
continl~al=-y be~ng
itell is disposed.
Other Clos ing
Under this app:'cach, if the currency is
devalued over the periods, deferro.l ocellrs until the related
This "'1ethod leads to
post~,oninG
the inevitatle.
l~emarks
No translation method is suitable in all situations.
the current rate
rr.et~od
It is felt that
is superior because it best reflects economic reslity.
It shows the f:.nancial stater:ents from a loea:!. viewpoint, not a p&rent company's
viewpoint.
Diflclosure of the different aspects of the exch,mEe gajns and losses
is strongly recommended uncier any translation mettod selected for use by the ?1-.SB.
The
followi~C
comprehensive review covers points "'1entioned in the paoer.
20
1979 BALANCE SHEET
FOREIGN
CURRENCY
U.S. DOLLAR
CURRENT RATE
Cash
Acets. Ree.
Inventory (FIFO)
Plant & Equipment
Land
Total Assets
FC
700
1100
1200
6000
2000
$
FC llpOO
$
Acets. Pay.
Notes Pay.
Bonds Pay.
Mortgage Pay.
Common Stock
Add. Paid-In Cap.
Retained Earnings
Total Liab. & Owner's Equity
FC
$
1100
1200
2100
1700
3500
500
900
FC lJpOO
"$
U.S. DOLLAR
FASB #8 *
560
880
960
4800
1600
8,800
$
880
960
1680
1360
2800
400
720
8,800
$
600
1000
800
5000
2000
9400
I
$
800
1000
2000
1000
3500
500
600
9,400
$
$
$
560
880
108e
6750
2400
11P70
880
960
1680
1360
4200
600
1990
11,670
1978 BALAN CE SHEET
Cash
Accts. Ree.
Inventory (FIFO)
Plant & EGuipm,ant
Land
Total Assets
F'C
Accts. Pay.
Notes Pay.
Bonds Pay.
Mortgage Pay.
Common Stock
Add. Paid-In Cap.
Retained Earnings
Total Liab. & Owner's Equity
FC
Exchan~e
600
1000
800
5000
2000
9,400
$
800
1000
2000
1000
3500
500
600
FC 9,400
$
FC
$
$
$
:$
600
1000
880
6000
2400
10}380
800
1000
2000
1000
4200
600
1280
1q880
Rates.
January 1, 197'8
January 1, 1979
January 1, 1960
FC 1
FC 1
FC 1
1.2
1.0
.8
Average Rate 1978
Average Rate 1979
FC 1
FC 1
*Refer to Exh1.bits 1,2, and 3 for assumptions used under this method of
translation.
1.1
.9
21
1979 INCOME STATEMENT
FOREIGN
CURRENCY
U.S. DOLLAR
CURRENT RATE
Sales
Interest IncomE:
Total Revenue
FC
2000
600
2600
$
COGS (FIFO)
Depreciation
Selling &
Administration
Other Expenses
FC
BOO
500
$
Profi t Before Taxes
Fe
FC
$
Income Tax
FC
300
$
640
400
$
480
$
1800
540
2340
$
880
600
270
360
230
$
240
300
Net Income (Loss)
1600
480
2080
240
320
300
400
600
U.S. DOLLAR
FASB # 8
240
$
270
(40)
$
FOOTNOTE DISCLOSURE
FASB #B
CURRENCY
REALIZED
UNREALIZED
Spanish Peso
French Franc
$
40
70
$
80
150
$
320
430
Total
$
110
$
230
$
750
Spanish Peso
French Franc
$
120
(20)
$
(150)
(230)
100
$
(Jeo)
CURRENT RATE
Total
TRANSLATION
22
BIBLICGRAPHY
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e
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~illiam
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23
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A
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F:na!l·::ldl
1~~~-llj!3~J
t1f'*)u.rnal,
,'(-1.
~: 0.
C.
,
!I
:'~3.na;::l~"11ent. l\~countjnb'
\T::~,.