Chapter 10
Translation Of Foreign Currency
Financial Statements
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Basic Issues

Selecting the appropriate method of
translation
For transactions: the temporal method
 For statements: temporal or current rate

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Basic Issues

Treatment of exchange gains and losses
For transactions: Immediately to Net Income
 For statements: To Net or Comprehensive
Income

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Accounting Principles

Use of foreign principles reflects
conditions in the foreign economic and
legal environment

Use of Canadian principles maintains
consistency of application
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Accounting Principles

CICA conclusion:
Statements must be
adjusted to reflect
Canadian GAAP

Will not be an issue
after changeover to
IFRSs
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Classification - CICA

Integrated Foreign Operation:
A foreign operation that is financially or operationally
interdependent with the reporting enterprise such that
the exposure to exchange rate changes is similar to the
exposure that would exist had the transactions and
activities of the foreign operation been undertaken by the
reporting enterprise.
A foreign subsidiary that raises its capital
in Canadian markets, purchases its
merchandise or other goods in Canadian
markets, and/or sells its goods in
Canadian markets.
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Classification - CICA

Self-Sustaining Foreign Operation:
Self-sustaining foreign operation — A foreign operation
that is financially and operationally independent of the
reporting enterprise such that the exposure to exchange
rate changes is limited to the reporting enterprise's net
investment in the foreign operation.
A foreign subsidiary that raises its capital
in the foreign market, purchases its
merchandise or other goods in the foreign
market, and/or sells its goods in the
foreign market.
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Factors To Consider In
Classification – 1651.10

(a) whether there are any factors which would indicate
that the cash flows of the reporting enterprise are
insulated from or are directly affected by the day-to-day
activities of the foreign operation;

(b) whether sales prices for the foreign operation’s
products or services are determined more by local
competition and local government regulations or more by
world-wide competition and international prices and
whether such sales prices are primarily responsive on a
short-term basis to changes in exchange rates or are
immune to such changes;
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Factors To Consider In
Classification – 1651.10

(c) whether the sales market for the foreign operation’s
products and services is primarily outside the reporting
enterprise’s country or within it;

(d) whether labour, materials and other costs of the
foreign operation’s products or services are primarily
local costs or whether the foreign operation depends on
products and services obtained primarily from the
country of the reporting enterprise;
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Factors To Consider In
Classification – 1651.10


(e) whether the day-to-day activities of the foreign
operation are financed primarily from its own operations
and local borrowings or primarily by the reporting
enterprise or borrowings from the country of the
reporting enterprise;
(f) whether there is very little interrelationship between
the day-to-day activities of the foreign operation and
those of the reporting enterprise or whether
intercompany transactions with the reporting enterprise
form a dominant part of the foreign operation’s activities.
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Classification – IAS No. 21

Functional Currency is the
currency of the primary economic
environment in which the entity
operates.
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Classification – IAS No. 21

Paragraph 9 The primary economic environment in
which an entity operates is normally the one in which it
primarily generates and expends cash. An entity
considers the following factors in determining its
functional currency:

(a) the currency:



(i) that mainly influences sales prices for goods and services (this
will often be the currency in which sales prices for its goods and
services are denominated and settled); and
(ii) of the country whose competitive forces and regulations mainly
determine the sales prices of its goods and services.
(b) the currency that mainly influences labour, material and
other costs of providing goods or services (this will often be the
currency in which such costs are denominated and settled).
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Classification - IAS No. 21

functional
currency is the reporting currency (e.g., a
Foreign operations for which the
company that reports in Canadian dollars and has a
foreign subsidiary for which the functional currency is the
Canadian dollar).
A foreign subsidiary that raises its capital
in Canadian markets, purchases its
merchandise or other goods in Canadian
markets, and/or sells its goods in
Canadian markets.
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Classification - IAS No. 21

the functional
currency is different from the reporting
currency (e.g., a company which reports in Canadian
Foreign operations for which
dollars and has a German subsidiary for which the
functional currency is the euro).
A foreign subsidiary that raises its capital
in the foreign market, purchases its
merchandise or other goods in the foreign
market, and/or sells its goods in the
foreign market.
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Classification – The Future

The integrated/selfsustaining approach is a
conceptually flawed
solution

It will disappear with the
changeover
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Translation Method
Integrated Foreign Operations

Paragraph 1651.07
For integrated foreign operations, the reporting
enterprise's exposure to exchange rate changes is
similar to the exposure that would exist had the
transactions and activities of the foreign operation been
undertaken by the reporting enterprise.
Therefore, the financial statements of the foreign
operation are expressed in a manner that is consistent
with the measurement of domestic transactions and
operations. The translation method that best achieves
this objective is the temporal method, because it uses
the Canadian dollar as the unit of measure.
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Application of the Temporal Method

Expenses and Revenues

Generally at average rates

Assumes the item occurred
uniformly over the period

Assumes the rate changed
uniformly over the period
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Application of the Temporal Method

Amortization Expense

A write-off of items
carried at historical cost

at historic rates
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Application of the Temporal Method

Cost Of Sales

Opening inventory at historic

Purchases at average

Closing inventory at historic
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Application of the Temporal Method

Sales of Capital Assets
Proceeds at current rate on transaction date
 Cost at historical rate from acquisition date

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Translation Method
Self-Sustaining Foreign Operation

Paragraph 1651.08
For self-sustaining foreign operations,
the reporting enterprise's exposure to exchange rate changes is
limited to its net investment in the foreign operation. Therefore,
measuring such operations as if they had carried out their activities
in Canadian dollars is considered to be less relevant than measuring
the overall effect of changes in the exchange rate on the net
investment in such operations.
The financial statements of the foreign operation are expressed in
Canadian dollars in a manner that does not change the financial
results and relationships of the foreign operation. The translation
method that best achieves this objective is the current rate
method, because it uses the currency of the foreign operation as
the unit of measure.
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Current Rate Method

The current rate method is a method of
translation that translates assets, liabilities,
revenues and expenses in a manner that
retains their bases of measurement in terms
of the foreign currency (i.e., it uses the foreign
currency as the unit of measure). In particular:


assets and liabilities are translated at the exchange
rate in effect at the balance sheet date;
revenue and expense items (including depreciation
and amortization) are translated at the exchange
rate in effect on the dates on which such items are
recognized in income during the period.
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Current Rate Method
Shareholders’ Equity

Accumulated Other Comprehensive Income
This account will contain the net exchange gain or loss
that has resulted from the translation of assets and
liabilities since the acquisition of the foreign operation.
This amount can be either positive (a net gain) or
negative (a net loss) with respect to the total
shareholders’ equity balance.
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Current Rate Method
Shareholders’ Equity

Retained Earnings
This balance will reflect the cumulative translated
income of the foreign operation, exclusive of exchange
gains and losses and reduced by dividends declared.
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Current Rate Method
Shareholders’ Equity
 Common
Shares
As all of the exchange gains and losses have been allocated
to Accumulated Other Comprehensive Income, the
contributed capital account, Common Shares, will have to be
translated at the historic exchange rate applicable to its issue
date.
This seeming anomaly is the only approach that will produce
a total Shareholders’ Equity that equals the difference
between assets and liabilities when these balances are
translated at current rates. It is likely that you will have a
better grasp of this point after you have worked through the
comprehensive example that is presented later in this
Chapter.
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Why The Current Rate Method
Example
On January 1, 2009, when €1 = $1.60, a
Canadian company established a subsidiary
with an investment of €3,000,000. The
subsidiary borrows €3,000,000 and invests
the €6,000,000 in Land.
On December 31, 2009, €1 = $1.70.
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Why The Current Rate Method
Balance Sheets
December 31, 2009
Temporal
Current Rate
Land (@ $1.60 & $1.70
$9,600,000
$10,200,000
Liabilities (@ $1.70)
$5,100,000
$5,100,000
4,500,000
5,100,000
$9,600,000
$10,200,000
Shareholders’ Equity (Residual)
Total Equities
The current rate method maintains economic relationships (e.g., debt is
still 50 percent of the total equities).
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Highly Inflationary Economies

Current rate method uses
foreign currency as unit of
measure
Not good if highly
inflationary economy
 Use temporal method for
self-sustaining

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Exchange Gains And Losses
Integrated Operations

Paragraph 1651.20 An exchange gain or loss of the
reporting enterprise that arises on translation or
settlement of a foreign currency-denominated monetary
item or a non-monetary item carried at market should be
included in the determination of net income for the
current period. (January, 2002)

Paragraph 1651.24 Exchange gains and losses
arising on the translation of financial statements of an
integrated foreign operation should be accounted for in
accordance with paragraph 1651.20. (July, 1983)
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Exchange Gains And Losses
Self-Sustaining Foreign Operations

Paragraph 1651.29 Exchange gains and losses
arising from the translation of the financial statements of
a self-sustaining foreign operation should be recognized
in a separate component of other comprehensive
income, except when the economic environment of the
foreign operation is highly inflationary relative to that of
the reporting enterprise, in which case such exchange
gains and losses should be treated in accordance with
paragraph 1651.20. (October, 2006)
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Why The Difference?
Example
A French subsidiary of a Canadian company borrows
€1,000,000 when the exchange rate is €1 = $1.55. This
results in a translated value of $1,550,000.
If the exchange rate goes to €1 = $1.65, the new
translated value will be $1,650,000.
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Why The Difference?

If integrated foreign
operation
Would have to use Canadian
dollar revenues to buy Euros
 There would be an exchange
of currencies
 This would result in a real
economic loss

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Why The Difference

If self-sustaining foreign
operation
Euro debt will be repaid with
Euro revenues
 There would be no exchange
of currencies
 There would be no real
economic loss

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Reduction In Net Investment

Paragraph 1651.31 An appropriate portion of
the exchange gains and losses accumulated in
the separate component of accumulated other
comprehensive income should be included in
the determination of net income when there is a
reduction in the net investment. (October, 2006)
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Exchange Gain or Loss
Integrated Operations
Translated
Amounts
Opening Net Monetary Assets (Liabilities)
Additions To Monetary Balances (e.g., Sales)
($1,500,000)
4,200,000
Reductions In Monetary Balances (e.g., Purchases)
( 2,900,000)
Computed Closing Net Monetary Assets (Liabilities)
($ 200,000)
Actual Closing Net Monetary Assets (Liabilities)
Exchange (Gain) Loss
300,000
($ 500,000)
*Numbers created for this example. Note exchange
gain is a negative number in this schedule.
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Exchange Gain or Loss
Self-Sustaining Operations
Translated
Amounts
Opening Net Assets (Liabilities)
($2,500,000)
Additions To Net Assets (e.g., Sales)
4,200,000
Reductions In Net Assets (e.g., Cost of Sales)
( 2,400,000)
Computed Closing Net Assets (Liabilities)
($ 700,000)
Actual Closing Net Assets (Liabilities)
(
Exchange (Gain) Loss
$ 200,000
900,000)
*Numbers created for this example. Note exchange loss
is a positive number in this schedule.
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Exchange Gain or Loss
Difference in Calculation

Integrated Foreign Operations


Changes in Net Monetary Assets
Self Sustaining Foreign Operations

Changes in Net Assets
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Changes In Classification

Paragraph 1651.36 When there are significant changes in the
economic facts and circumstances that require the translation
method applied to a particular foreign operation to be changed, the
change in method should be accounted for prospectively. Disclosure
should be made of the reasons for the change in the translation
method. (July, 1983)
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Changes In Classification

Self-Sustaining To Integrated


Accumulated OCI is carried forward
Carrying values at time of change become the
historical costs for items carried at historical value
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Changes In Classification

Integrated To Self-Sustaining


At time of change all items to current rate
Gain or loss to Accumulated OIC
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Disclosure

Paragraph 1651.37 The amount of exchange gain or loss
included in net income should be disclosed (see paragraphs
1651.20, 1651.24 and 1651.31). An entity may exclude from this
amount those exchange gains or losses arising on financial
instruments classified as held for trading in accordance with
"Financial Instruments — Recognition And Measurement", Section
3855.
An entity may also exclude from this amount exchange gains or
losses on available-for-sale financial assets and cash flow hedges
(see "Hedges", Section 3865) included in any gains or losses
removed from accumulated other comprehensive income and
included in net income for the period.
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Equity Method Investments

Paragraph 1651.38
The financial statements of a
foreign investee accounted for
by the equity method (see
"Investments", Section 3051)
are first translated into
Canadian dollars in accordance
with this Section; then the
equity method is applied.
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Other Issues

Foreign operations with transactions in
another foreign currency


Translate to foreign operations currency,
generally using the temporal method
Foreign operations with foreign operations

Will have to classify and translate as
appropriate
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Other Issues
Intercompany Balances

Paragraph 1651.41
With respect to integrated foreign operations, exchange gains
and losses relating to intercompany balances recorded by the
reporting enterprise or the foreign operation will be treated in
the same manner as those relating to other foreign currency
receivables or payables in accordance with paragraph
1651.20 (i.e., included in income).
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Other Issues
Intercompany Balances

Paragraph 1651.42
With respect to self-sustaining foreign operations, exchange gains
and losses on intercompany account balances that are not included
as part of the net investment are treated in the same manner as
those relating to normal foreign currency trade balances in
accordance with the appropriate requirements of this Section.
Exchange gains and losses on intercompany account balances that
form part of the net investment are recognized in the separate
component of other comprehensive income in accordance with
paragraph 1651.29.
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Other Issues
Intercompany Profits

Integrated operations


Use transaction date rate
Self-sustaining operations

Use transaction date rate
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Other Issues - Differences in
Financial Statement Dates

Paragraph 1651.44
When the date of the financial statements of the
foreign operation differs from that of the reporting
enterprise, those assets and liabilities which are
translated at the current rate would normally be
translated at the rate in effect at the balance
sheet date of the foreign operation, not at the rate
in effect at the balance sheet date of the
reporting enterprise. When there is a major
change in exchange rates between the balance
sheet dates of the foreign operation and the
reporting enterprise, the effect of the change
would be disclosed.
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Other Issues
Preference Shares

Integrated Operations


Use historic rate unless redemption is
required or imminent
Self-Sustaining Operations

Use current rate
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Other Issues
Lower of Cost and Market
Example
A German subsidiary has inventories
purchased for €1,000,000 when the
exchange rate was €1 = $1.65.
At the Balance Sheet date, these inventories
have a market value of €1,050,000. At this
time €1 = $1.50.
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Other Issues
Lower of Cost and Market
Analysis
The lower Euro figure is €1,000,000 cost.
Translated cost = $1,650,000 [(€1,000,000)($1.65)]
Translated market = $1,575,000 [(€1,050,000)($1.50)]
On a translated basis, market is the lower figure.
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Other Issues
Future Tax Assets and Liabilities

Paragraph 1651.52 Future income tax liabilities
and assets are monetary items and, as such, are
translated at the current rate.
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Other Issues
Cash Flow Statements

(a) Cash from operations would be translated at the
exchange rate at which the respective items are
translated for income statement purposes.

(b) Other items would be translated at exchange rates
in effect when the related transactions took place.

(c) The effect of subsequent exchange rate changes
on the cash flows during the period and on cash and
cash equivalents at the commencement of the period
would be disclosed, so that cash and cash equivalents at
the end of the period are translated at the exchange rate
in effect on that date.
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International Convergence
IAS No. 21 – The Effects Of Changes In
Foreign Exchange Rates
IAS No. 29 – Financial Reporting In
Hyperinflationary Economies
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International Convergence:
Differences
Classification Of Foreign Operations
Section 1651 classifies foreign operations as either
integrated or self-sustaining. While the results are likely to
be similar, IAS No. 21 classifies foreign operations on the
basis of their functional currency.
The appropriate accounting is then determined based on
whether the functional currency is the reporting currency of
the investor or, alternatively, the reporting currency of the
foreign operation.
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International Convergence:
Differences
Non-Monetary Items Carried At Fair Value
Section 1651 requires these balances to be translated using
the rate applicable to the Balance Sheet date. In contrast,
IAS No. 21 requires the use of the rate applicable to the date
when the fair value was measured.
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International Convergence:
Differences
Hyperinflationary Economies
Section 1651 requires the application of the temporal
method to translate the financial statements of foreign
operations that are located in hyperinflationary economies.
In contrast, IAS No. 29 requires that the financial statements
of such foreign operations be restated to remove the effects
of price level change. In addition, IAS No. 29 provides
considerable guidance with respect to the implementation of
this restatement.
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