Slide
10-1
Chapter Ten
Translation of
Foreign
Currency
Financial
Statements
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-2
International Acquisitions
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-3
Translation of Financial
Statements
If we control our
subsidiaries, why
don’t they all use
the U.S. $ as their
currency?
McGraw-Hill/Irwin
Our subsidiaries in other
countries are required by
local regulations to use
the local currency where
they are located. Their
statements must be
translated to US $.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-4
Translation of Financial
Statements
In addition, many countries have
different accounting rules that we
must consider before translating
the sub’s financial statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-5
Exchange Rates Used in
Translation
To translate a foreign
subsidiary’s financial
statements into U.S. $, we
must use both:
 Historical Exchange
Rates, and
Current Exchange Rates.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-6
Translation Adjustments

The use of different
exchange rates during
translation means the
resulting financial
statements will not
balance!
 To force the statements
to balance, an account
called “Translation
Adjustment” is debited
or credited.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-7
Balance Sheet Exposure
Balance sheet items translated
at current exchange rates
change in $ value from one
balance sheet to the next are
exposed to translation
adjustments.
Balance sheet items translated
at historical exchange rates do
not change in $ value from one
balance sheet to the next and
are NOT subject to balance
sheet exposure.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-8
Balance Sheet Exposure
Net Asset Balance Sheet
Exposure
When assets translated at
current rates > liabilities
translated at current rates.
Net Liability Balance Sheet
Exposure
When liabilities translated at
current rates > assets
translated at current rates.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-9
Translation Methods
Current Rate Method

Parent
Subsidiary
McGraw-Hill/Irwin
Use current exchange rates
to translate all assets and
liabilities.
 Use historical* (or average
exchange rates) to translate
equity accounts.
 Use historical* (or average
exchange rates) to translate
income statement accounts.
* Historical is the rate applicable at
the time that the transaction
occurred.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-10
Translation Methods
Temporal Method

Use historical exchange rates to translate
assets and liabilities carried at historical cost.
 Use current exchange rates to translate assets
and liabilities carried at current cost or future
value. (most liabilities are carried at current or future
value)

Use historical* (or average) exchange rates to
translate equity, revenue, and expense
accounts.
* Certain expenses are related to assets carried at historical
costs which in turn are translated at historical rates. These
expenses MUST therefore be translated at historical rates
e.g. cost of goods sold, depreciation & amortization.
© The McGraw-Hill Companies, Inc., 2004
McGraw-Hill/Irwin
Slide
10-11
Translation of Retained Earnings
Since R/E is a composite of many previous
transactions, translating R/E requires special attention.
At the end of the first year of operations:
Net Income
from the translated
Net Income
=
in FC
income statement
in US $
Dividends in
historical exchange
Dividends in
x
=
- FC
rate when declared
US $
Ending R/E
Ending R/E
in FC
in US $
Ending R/E from year 1, becomes Beginning
R/E in Year 2.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-12
Calculation of Cost of Goods Sold
Current Rate Method - translate using the weighted
average rate for the current period = simple!
Temporal Method - decompose COGS into its
component parts and translate each part using the
appropriate rate
+
=
Beginning Inventory
Purchases
Ending Inventory
COGS
×
×
×
Historical Rate
Average Rate
Historical Rate
Apply Lower-of-Cost-or-Market using the foreign
exchanges rates.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-13
Fixed Assets and Accumulated
Depreciation
Current Rate Method - translate fixed
assets and accumulated
depreciation using the spot rate as of
the balance sheet date.
Temporal Method - fixed assets
acquired at different times will be
translated using their respective historical
translation rates. Accumulated
depreciation uses the same historical
rates as the related asset.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-14
Depreciation Expense
Current Rate Method - translate
depreciation expense using the
weighted-average rate for the current
period
Temporal Method - translate
depreciation expense using the
various historical rates related to the
underlying assets.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-15
Gain or Loss on the Sale of an
Asset
Current Rate Method - translate the gain/loss using
the historical rate in effect on the date of sale
Temporal Method - the gain must be computed
indirectly, using different rates.
Cash
Received
×
-
Asset NBV ×
=
Gain
(Loss)
McGraw-Hill/Irwin
Current
Rate
Historical
Rate
=
=
US $ Cash
US $ Asset
NBV
Difference is
the Gain or
(Loss)
© The McGraw-Hill Companies, Inc., 2004
Slide
10-16
Disposition of Translation Adjustment
– 4 possible combinations

Current Method
 Translation Adjustment is reported on the
Balance Sheet via “Other Comprehensive
Income”
 Adjustment is reported on the Income
Statement as a Translation Gain or (Loss)

Temporal Method
 Translation Adjustment is reported on the
Balance Sheet via “Other Comprehensive
Income”
 Adjustment is reported on the Income
Statement as a Translation Gain or (Loss)
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-17
Translation
U.S. Accounting Rules
SFAS No. 1 (1974) – Disclosure of Foreign
Currency Translation Information
 SFAS No. 8 (1975) - Accounting for
Translation of Foreign Currency
Transactions and Foreign Currency
Financial Statements – temporal method
with gain/loss in income
 SFAS No. 52 (1981) - Foreign Currency
Translation. – gave additional treatment:
current method with gain/loss in equity
 SFAS No. 130 (1998)

McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-18
SFAS No. 52
Recognized two
types of subs:
 Subs that do
most of their
transactions
in U.S. $
 Subs that
operate
relatively
independently
of their U.S.
parents.
McGraw-Hill/Irwin
Temporal method still
applies.
Applies the “local
currency perspective”.
Use current rate
method.
Translation
adjustment appears in
the equity section.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-19
Functional Currency
To determine whether a subsidiary is integrated
with the parent or operates independently,
SFAS 52 introduced the concept of
functional currency.
A company’s functional
currency is the primary
currency of the foreign
entity’s operating
environment.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-20
Functional Currency
To determine whether a subsidiary is integrated
with the parent or operates independently,
SFAS 52 introduced the concept of
functional currency.
McGraw-Hill/Irwin
U.S.
Dollar
Local
Currenc
y
Use the Temporal
Method for
translation.
Use the Current
Rate Method for
translation.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-21
Determining a Subsidiary’s
Functional Currency
Indicator
Cash Flow
Sales Price
Sales Market
Expenses
Financing
Intercompany
Transactions
McGraw-Hill/Irwin
Exh.
10-2
Indication that the Functional Currency is the
Foreign Currency
Parent's Currency
Primarily in FC and do not affect parent's Directly impact parent's cash flows on a
cash flows.
current basis.
Not attected on short-term basis by
Affected on short-term basis by changes in
changes in exchange rate
exchange rate.
Active local sales market.
Sales market mostly in parent's country or
sales denominated in parent's currency.
Primarily local costs
Primarily costs for components obtained
from parent's country.
Primarily denominated in foreign currency Primarily from parent or denominated in
and FC cash flows adequate to service
parent currency or FC cash flows not
obligations.
adequate to service adequate to service
obligations.
Low volume of intercompany transactions, High volume of intercompany transactions
not extensive interrelationship with
and extensive interrelationship with parent's
parent's operations.
operations.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-22
Highly Inflationary Economies
In highly inflationary
economies, SFAS 52 mandates
the use of the Temporal Method
for translation.
Disappearing Plant Problem
If the Current Method were
used, the US $ equivalent
would be VERY small due to
the rapidly increasing
exchange rate.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-23
Current Rate Method Example


McGraw-Hill/Irwin
News Co., is a wholly owned
foreign sub of ATG
Corporation. News Co.’s
transactions and financial
statements are denominated
in the local (functional)
currency, the Pater (PT).
Using the following
information, translate their
statements into US $.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-24
Current Rate Method Example
News Co.’s common stock was
issued in 1992 when the exchange
rate was $1.00 = 1.20 PT.
 Fixed assets were acquired in
1993 when the exchange rate was
$1.00 = 1.10 PT.
 As of Jan. 1, 2007, the R/E balance
was translated at $350,000.
 Inventory was acquired evenly
throughout the year.

McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-25
Current Rate Method Example

The Dec. 31, 2007 translation adjustment had
a debit balance of $69,841.
 Dividends were declared on March 15, 2007,
and equipment was sold on October 1, 2007.
 The following exchange rates were in effect
during the year:
Jan 1, 2007
Mar 15, 2007
Oct 1, 2007
Dec 31, 2007
Weighted Avg. Rate
McGraw-Hill/Irwin
$1.00
$1.00
$1.00
$1.00
$1.00
=
=
=
=
=
.90 PT
.86 PT
.80 PT
.98 PT
.85 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-26
Current Rate Method Example
News Co.
Income Statement
For the Year Ended 12/31/07
Sales
Cost of Goods
Sold
Gross Profit
Operating
Expenses
Gain on Sale
of Equip.
Net Income
McGraw-Hill/Irwin
690,000 PT
(430,000)
÷
÷
260,000 PT
(190,000)
÷
20,000
÷
Determine the
appropriate
$
exchange
rates
to use for each
account.
90,000 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-27
Current Rate Method Example
News Co.
Income Statement
For the Year Ended 12/31/07
Weighted average
Sales
690,000 PT
Cost
of Goods
rates
are generally
Sold
(430,000)
used for Sales, COGS,
Gross Profit
260,000 PT
and other recurring
Operating
Expenses
expenses. (190,000)
Gain on Sale
of Equip.
20,000
Net Income
90,000 PT
McGraw-Hill/Irwin
÷
0.85
÷
0.85
$
÷
-
0.85
÷
© The McGraw-Hill Companies, Inc., 2004
Slide
10-28
Current Rate Method Example
News Co.
Income Statement
For the Year Ended 12/31/07
Sales
690,000 PT
The actual historical
Cost of Goods
rate is used when
we
Sold
(430,000)
can identify260,000
it
Gross Profit
PT
Operating
efficiently.
Expenses
(190,000)
Gain on Sale
of Equip.
20,000
Net Income
McGraw-Hill/Irwin
÷
0.85
÷
0.85
$ 811,765
(505,882)
$ 305,882
÷
0.85
÷
0.80
(223,529)
90,000 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-29
Current Rate Method Example
News Co.
Income Statement
For the Year Ended 12/31/07
Sales
Cost of Goods
Sold
Gross Profit
Operating
Expenses
Gain on Sale
of Equip.
Net Income
McGraw-Hill/Irwin
690,000 PT
(430,000)
÷
0.85
÷
0.85
260,000 PT
$ 811,765
(505,882)
$ 305,882
(190,000)
÷
0.85
(223,529)
20,000
÷
0.80
25,000
90,000 PT
$ 107,353
© The McGraw-Hill Companies, Inc., 2004
Slide
10-30
Current Rate Method Example
News Co.
Statement of Retained Earnings
For the Year Ending December 31, 2007
Retained Earnings,
1/1/07
Net Income
Dividends
Retained Earnings,
12/31/07
McGraw-Hill/Irwin
216,000 PT
90,000
(40,000)
266,000 PT
÷
Determine the
appropriate
exchange rates
to use for each
account.
© The McGraw-Hill Companies, Inc., 2004
Slide
10-31
Current Rate Method Example
News Co.
Statement of Retained Earnings
For the Year Ending December 31, 2007
Retained Earnings,
1/1/07
Net Income
Dividends
Retained Earnings,
12/31/07
216,000 PT
350,000
90,000
(40,000)
The beginning
R/E is
carried over266,000
from PT
the
prior year.
McGraw-Hill/Irwin
$
÷
© The McGraw-Hill Companies, Inc., 2004
Slide
10-32
Current Rate Method Example
News Co.
Statement of Retained Earnings
For the Year Ending December 31, 2007
Retained Earnings,
1/1/07
Net Income
Dividends
Retained Earnings,
12/31/07
216,000 PT
90,000
$
350,000
107,353
(40,000)
The net income
is taken ÷
from the 266,000
incomePT
statement.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-33
Current Rate Method Example
News Co.
Statement of Retained Earnings
For the Year Ending December 31, 2007
Retained Earnings,
1/1/07
Net Income
Dividends
Retained Earnings,
12/31/07
216,000 PT
$
90,000
(40,000)
350,000
107,353
÷
0.86
Dividends are translated
266,000 PT
at the historical rate on
the date of declaration.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-34
Current Rate Method Example
News Co.
Statement of Retained Earnings
For the Year Ending December 31, 2007
Retained Earnings,
1/1/07
Net Income
Dividends
Retained Earnings,
12/31/07
McGraw-Hill/Irwin
216,000 PT
$
90,000
(40,000)
266,000 PT
350,000
107,353
÷
0.86 $
(46,512)
410,841
© The McGraw-Hill Companies, Inc., 2004
Slide
10-35
Current Rate Method Example
News Co.
Balance Sheet
At December 31, 2007
Assets
35,000 PT
125,000
78,000
368,000
606,000 PT
Cash
Receivables
Inventory
Fixed Assets (net)
Total Assets
÷
÷
÷
÷
-
Liabilities and Equities
190,000 PT
÷
150,000
÷
266,000
Liabilties
Common Stock
R/E, 12/31/07
Translation Adj.
Total Liabs. & Equities
McGraw-Hill/Irwin
606,000 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-36
Current Rate Method Example
News Co.
Balance Sheet
At December 31, 2007
Cash
Receivables
Inventory
Fixed Assets (net)
Total Assets
Assets
35,000 PT
125,000
78,000
368,000
606,000 PT
÷
All assets and
÷
liabilities are
÷
÷
translated at
the current rate
Liabilities and Equities
at the balance 190,000 PT ÷
Liabilties
Common
Stock date.
150,000
÷
sheet
R/E, 12/31/07
Translation Adj.
Total Liabs. & Equities
McGraw-Hill/Irwin
0.98
0.98
0.98
0.98
-
0.98
266,000
606,000 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-37
Current Rate Method Example
News Co.
Balance Sheet
At December 31, 2007
Cash
Receivables
Inventory
Fixed Assets (net)
Total Assets
Assets
35,000 PT
125,000
78,000
368,000
606,000 PT
÷
÷
÷
÷
Common Stock is
translated at the
historical rate at
the time the Liabilities
stock and Equities
Liabilties
190,000 PT
÷
was
issued.
Common Stock
150,000
÷
R/E, 12/31/07
Translation Adj.
Total Liabs. & Equities
McGraw-Hill/Irwin
0.98
0.98
0.98
0.98
-
0.98
1.20
266,000
606,000 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-38
Current Rate Method Example
News Co.
Balance Sheet
At December 31, 2007
Cash
Receivables
Inventory
Fixed Assets (net)
TotalThe
Assets
Ending
Assets
35,000 PT
125,000
78,000
368,000
606,000 PT
comes
÷
÷
÷
÷
R/E
from the statement
of
Liabilities and Equities
retained earnings.
Liabilties
190,000 PT
÷
Common Stock
R/E, 12/31/07
Translation Adj.
Total Liabs. & Equities
McGraw-Hill/Irwin
150,000
266,000
÷
0.98
0.98
0.98
0.98
$
$
0.98
1.20
$
35,714
127,551
79,592
375,510
618,367
193,878
125,000
410,841
606,000 PT
© The McGraw-Hill Companies, Inc., 2004
Slide
10-39
Current Rate Method Example
News Co.
Balance Sheet
At December 31, 2007
The translation adjustment is:
Assets
The difference between
Cash
35,000 Net
PT
÷
Receivables
125,000
Assets at current rates
and Net÷
Inventory
78,000
÷
Assets at historical
rates ÷
Fixed Assets (net)
368,000
Total added
Assets to the translation
606,000 PT
adjustment balance at the
Liabilities and Equities
beginning of the190,000
year:PT ÷
Liabilties
Common Stock
150,000
÷
$41,511
$111,352
R/E,
12/31/07 + $69,841 =266,000
Translation Adj.
Total Liabs. & Equities
606,000 PT
McGraw-Hill/Irwin
0.98
0.98
0.98
0.98
$
$
0.98
1.20
$
35,714
127,551
79,592
375,510
618,367
193,878
125,000
410,841
(111,352)
© The McGraw-Hill Companies, Inc., 2004
Slide
10-40
Current Rate Method Example
News Co.
Balance Sheet
At December 31, 2007
Assets
35,000 PT
125,000
78,000
368,000
606,000 PT
Cash
Receivables
Inventory
Fixed Assets (net)
Total Assets
÷
÷
÷
÷
Liabilities and Equities
190,000 PT
÷
150,000
÷
266,000
Liabilties
Common Stock
R/E, 12/31/07
Translation Adj.
Total Liabs. & Equities
McGraw-Hill/Irwin
606,000 PT
0.98
0.98
0.98
0.98
$
$
0.98
1.20
$
$
35,714
127,551
79,592
375,510
618,367
193,878
125,000
410,841
(111,352)
618,367
© The McGraw-Hill Companies, Inc., 2004
Slide
10-41
Remeasurement of Financial
Statements
If the sub’s functional
currency is the U.S. $, then
any balances denominated
in the local currency, must
be remeasured.
 Remeasurement requires
the application of the
temporal method.
 The remeasurement
gain/loss appears on the
income statement.

McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2004
Slide
10-42
Disclosures Related to Translation

An analysis of the change in
the cumulative translation
adjustment.
 can be on the Statement of
Retained Earnings or in the
Notes

McGraw-Hill/Irwin
Many companies also include
a description of the
translation procedures in
Note 1.
© The McGraw-Hill Companies, Inc., 2004