Translation
of
Foreign
Financial
Statements
Foreign currency translation
 The process of expressing amounts
denominated or measured in foreign
currencies into amounts measured in the
reporting currencies of the domestic entity
C11
2
FASB’s Statement No. 52
 Adopted a functional currency approach
 The previous standard (SFAS No. 8)
employed the temporal method
C11
3
Functional currency
 The currency of the primary economic
environment in which the entity generates
and expends cash
 A number of factors must be evaluated in
order to properly identify the functional
currency
C11
4
Objectives of the translation process
 Provide information that is generally
compatible with the expected economic
effects of a rate change on an enterprise’s
cash flows and equity
 Reflect in consolidated statements the
financial results and relationships of the
individual consolidated entities as measured
in their functional currencies in conformity
with U.S. GAAP
C11
5
Expected economic effects of a rate
change
The foreign entity is a conduit:
 Cash inflows/outflows are affected
 Translation gains/losses should be included in net
income
C11
6
Expected economic effects of a rate
change (con’t)
The foreign entity is not a conduit:
 Cash inflows/outflows are not affected
 No translation gains/losses should be included in net
income (include as a component of other
comprehensive income)
C11
7
Reflect financial results and relationships
in conformity with U.S. GAAP
 If not affected by rate changes, the relationship
between accounts (e.g., current ratio, debt / equity
ratio) should be the same after translation as they
were before
 If affected by rate changes, relationships between
accounts are different than they were prior to
translation, therefore, reflecting the economic effect
of rate changes
 Foreign financial statements should be restated into
U.S. GAAP before translation begins
C11
8
The translation process
Convert foreign financial
statements to GAAP
Start
Use
functional
method to No
get FC into
$’s
Is FC the
inflationary
currency?
Identify the “Books
of Record” (BR)
currency and the
“Functional
Currency” (FC)
Yes
Is BR =
FC?
Yes
End
C11
apply the remeasurement
process (shown later)
No
9
The translation of financial
statement accounts
Account
Assets & Liabilities:
At current values or monetary items
(defined next slide)
Not as current values of nonmonetary
items (defined next slide)
Revenues and Expenses:
Representing amoritzation of historical
amounts
Not representing amoritzation of
historical amounts
Equity accounts (excluding RE)
Retained Earnings
Translation adjustment recorded as a
component of
C11
Functional Method
Current
Current
Weighted Average
Weighted Average
Historical
Beginning balance plus
translated net income less
translated dividends
Other Comprehensive Income
10
The translation of financial statement
accounts (con’t)
Monetary items: rights to receive or pay an
amount of money which is:
(a) fixed or
(b) determinable without reference to future
prices of specific goods/services; that is, its
value does not change according to
changes in price levels.
C11
11
Accounting for the translation
adjustment
 The adjustment is NOT included in net
income
 The adjustment is shown as a separate
component of other comprehensive income
(OCI)
 The adjustment may be recognized as a
component of net income when there is a
partial or complete sale/liquidation of the
investment in the foreign entity
C11
12
Reconciliation of the annual
translation adjustment
 Net assets at the beginning of the period
multiplied by the change in exchange rates during
the period
[100,000 FC  ($1.05 - $1.00)] = $5,000
 Increase in net assets (excluding capital
transactions) multiplied by the difference
between the current rate and the average rate used
to translate income
[50,000 FC  ($1.05 - $1.03)] = $1,000
continued . . .
C11
13
Reconciliation of the annual
translation adjustment (con’t)
 Increase in net assets due to capital transactions
(including investments by the domestic investor)
multiplied by the difference between the current
rate and the rate at the time of the capital
transaction
[60,000 FC  ($1.05 - $1.00)] = 3,000
Translation adjustment (credit) = $9,000
C11
14
Special issues related to consolidating
the foreign subsidiary
 The translation adjustment is allocated between
the controlling and noncontrolling interests
 Any excess of cost over book value is
translated at the end of the period exchange rate
 Any amortization of excess is translated at the
average exchange rate for the period
C11
15
Special issues related to consolidating
the foreign subsidiary (con’t)
 Unrealized intercompany profits must be
eliminated using the rate of exchange which
existed at the date of the intercompany
transaction
C11
16
Special issues related to the
sophisticated equity method
The investment account includes:
 The investor’s share of the investee’s
translated net income
 Amortization of any excess of cost over book
value
 The investor’s share of the cumulative
translation adjustment
C11
17
Remeasured financial statements
 The remeasurement process is intended to
produce financial statements that are the same
as if the entity’s transactions had been
originally recorded in the functional currency
 Remeasurement is based on the temporal
method
C11
18
Remeasurement is necessary when
 The foreign entity’s financial statements are
prepared in a currency that is not the
functional currency. The functional currency
may be
– another foreign currency
– the U.S.dollar
 The foreign entity’s functional currency is
that of a highly inflationary economy
C11
19
The remeasurement process
Start
Identify the “Books of
Record” (BR) currency
and the “Functional
Currency” (FC)
Convert foreign
financial statements to
GAAP
Use
Temporal
method
Yes
Is FC
= $?
No
Is BR
=
FC?
No
End
A
C11
Use Temporal method
to get into functional
currency
Yes
A
No
Is FC =
inflationar
y
currency?
Yes
A
Use Temporal
method
apply the translation process shown earlier
End
20
Remeasurement of financial statement
accounts
Account
Assets & Liabilities:
At current values or monetary items
Not as current values or nonmonetary
items
Revenues and Expenses:
Representing amoritzation of historical
amounts
Not representing amoritzation of
historical amounts
Equity accounts (excluding RE)
Retained Earnings
Translation adjustment recorded as a
component of
C11
Temporal Method
Current
Historical
Historical
Weighted Average
Historical
Beginning balance plus
remeasured net income less
remeasured dividends
Net Income
21
Special remeasurement issues
 Application of lower of cost or market for
inventory
 Historical exchange rates for purchase
accounting
 Remeasured financial statements may still
need to be translated
 Equity method of accounting for an
investment should include the appropriate
share of remeasurement gains or losses
C11
22
Disclosure requirements
An analysis of the cumulative translation
adjustment including:
 Beginning and ending amount of cumulative
translation adjustments
 The aggregate adjustment for the period
resulting from translation adjustments and
gains and losses from certain hedges and
intercompany balances
C11
23
Disclosure requirements (con’t)
 The amount of income taxes for the period
allocated to translation adjustments
 The amounts transferred from cumulative
translation adjustments in OCI and included
in determining net income for the period as a
result of the sale or complete or substantially
complete liquidation of an investment in a
foreign entity
C11
24