© The McGraw-Hill Companies, Inc., 2004

Slide 10-1

McGraw-Hill/Irwin

Chapter Ten

Translation of Translation of Foreign Foreign

Currency Currency Financial Financial

StatementsStatements

© The McGraw-Hill Companies, Inc., 2004

Slide 10-2

McGraw-Hill/Irwin

International Acquisitions

© The McGraw-Hill Companies, Inc., 2004

Slide 10-3

McGraw-Hill/Irwin

If we control our subsidiaries, why don’t they all use the U.S. $ as their

currency?

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 $.

Translation of Financial Statements

© The McGraw-Hill Companies, Inc., 2004

Slide 10-4

McGraw-Hill/Irwin

In addition, many countries have different accounting rules that

we must consider before translating the sub’s financial

statements.

Translation of Financial Statements

© The McGraw-Hill Companies, Inc., 2004

Slide 10-5

McGraw-Hill/Irwin

To translate a foreign subsidiary’s financial

statements into U.S. $, we must use both:

Historical Exchange Rates, and

Current Exchange Rates.

Exchange Rates Used in Translation

© The McGraw-Hill Companies, Inc., 2004

Slide 10-6

McGraw-Hill/Irwin

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.

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.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-7

McGraw-Hill/Irwin

Balance Sheet Exposure

Balance sheet items translated Balance sheet items translated at at currentcurrent exchange rates exchange rates

change in $ value from one change in $ value from one balance sheet to the next are balance sheet to the next are

exposed to translation exposed to translation adjustments.adjustments.

Balance sheet items translated Balance sheet items translated at at currentcurrent exchange rates exchange rates

change in $ value from one change in $ value from one balance sheet to the next are balance sheet to the next are

exposed to translation exposed to translation adjustments.adjustments.

Balance sheet items translated Balance sheet items translated at at historicalhistorical exchange rates do exchange rates do not change in $ value from one not change in $ value from one balance sheet to the next and balance sheet to the next and

are NOT subject to balance are NOT subject to balance sheet exposure.sheet exposure.

Balance sheet items translated Balance sheet items translated at at historicalhistorical exchange rates do exchange rates do not change in $ value from one not change in $ value from one balance sheet to the next and balance sheet to the next and

are NOT subject to balance are NOT subject to balance sheet exposure.sheet exposure.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-8

McGraw-Hill/Irwin

Balance Sheet Exposure

Net Asset Balance Sheet Net Asset Balance Sheet ExposureExposure

When assets translated at When assets translated at current rates > liabilities current rates > liabilities

translated at current rates.translated at current rates.

Net Asset Balance Sheet Net Asset Balance Sheet ExposureExposure

When assets translated at When assets translated at current rates > liabilities current rates > liabilities

translated at current rates.translated at current rates.

Net Liability Balance Sheet Net Liability Balance Sheet ExposureExposure

When liabilities translated at When liabilities translated at current rates > assets current rates > assets

translated at current rates.translated at current rates.

Net Liability Balance Sheet Net Liability Balance Sheet ExposureExposure

When liabilities translated at When liabilities translated at current rates > assets current rates > assets

translated at current rates.translated at current rates.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-9

McGraw-Hill/Irwin

Parent

Subsidiary

Translation MethodsCurrent Rate MethodCurrent Rate Method

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.

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

McGraw-Hill/Irwin

Translation MethodsTemporal MethodTemporal 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.

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 * Certain expenses are related to assets carried at historical costs which in turn are translated at historical rates. These costs which in turn are translated at historical rates. These expenses MUST therefore be translated at historical rates expenses MUST therefore be translated at historical rates e.g. cost of goods sold, depreciation & amortization.e.g. cost of goods sold, depreciation & amortization.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-11

McGraw-Hill/Irwin

Translation of Retained Earnings

Since R/E is a composite of many previous transactions, translating R/E requires special attention.

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:

Ending R/E from year 1, becomes Beginning R/E in Year 2.

At the end of the first year of operations:

Ending R/E from year 1, becomes Beginning R/E in Year 2.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-12

McGraw-Hill/Irwin

Calculation of Cost of Goods Sold

Current Rate Method - translate using the weighted average rate for the current period = simple!

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

Apply Lower-of-Cost-or-Market using the foreign exchanges rates.

Temporal Method - decompose COGS into its component parts and translate each part using the

appropriate rate

Apply Lower-of-Cost-or-Market using the foreign exchanges rates.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-13

McGraw-Hill/Irwin

Fixed Assets and Accumulated Depreciation

Current Rate Method - translate fixed fixed assetsassets and accumulated accumulated

depreciationdepreciation using the spot rate as of the balance sheet date.

Current Rate Method - translate fixed fixed assetsassets and accumulated accumulated

depreciationdepreciation 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.

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.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-14

McGraw-Hill/Irwin

Depreciation Expense

Current Rate Method - translate depreciation expense using the

weighted-average rate for the current period

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.

Temporal Method - translate depreciation expense using the

various historical rates related to the underlying assets.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-15

McGraw-Hill/Irwin

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

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.

Temporal Method - the gain must be computed indirectly, using different rates.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-16

McGraw-Hill/Irwin

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)

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)

© The McGraw-Hill Companies, Inc., 2004

Slide 10-17

McGraw-Hill/Irwin

TranslationU.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)

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)

© The McGraw-Hill Companies, Inc., 2004

Slide 10-18

McGraw-Hill/Irwin

Applies the “local currency perspective”.

Use current rate method.

Translation adjustment appears in

the equity section.

Applies the “local currency perspective”.

Use current rate method.

Translation adjustment appears in

the equity section.

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.

Temporal method still applies.

Temporal method still applies.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-19

McGraw-Hill/Irwin

Functional Currency

To determine whether a subsidiary is integrated with the parent or operates

independently, SFAS 52 introduced the concept of functional currencyfunctional currency.

To determine whether a subsidiary is integrated with the parent or operates

independently, SFAS 52 introduced the concept of functional currencyfunctional currency.

A company’s A company’s functional functional currencycurrency is the primary is the primary currency of the foreign currency of the foreign

entity’s operating entity’s operating environment. environment.

A company’s A company’s functional functional currencycurrency is the primary is the primary currency of the foreign currency of the foreign

entity’s operating entity’s operating environment. environment.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-20

McGraw-Hill/Irwin

Functional Currency

To determine whether a subsidiary is integrated with the parent or operates

independently, SFAS 52 introduced the concept of functional currencyfunctional currency.

To determine whether a subsidiary is integrated with the parent or operates

independently, SFAS 52 introduced the concept of functional currencyfunctional currency.

U.S. Dollar

U.S. Dollar

Use the Temporal Method for translation.

Local Currenc

y

Local Currenc

y

Use the Current Rate Method for

translation.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-21

McGraw-Hill/Irwin

Determining a Subsidiary’s Functional Currency

Exh.10-2

© The McGraw-Hill Companies, Inc., 2004

Slide 10-22

McGraw-Hill/Irwin

Highly Inflationary Economies

In highly inflationary In highly inflationary economies, SFAS 52 mandates economies, SFAS 52 mandates the use of the the use of the Temporal MethodTemporal Method

for translation.for translation.

In highly inflationary In highly inflationary economies, SFAS 52 mandates economies, SFAS 52 mandates the use of the the use of the Temporal MethodTemporal Method

for translation.for translation.

Disappearing Plant ProblemDisappearing Plant ProblemIf the Current Method were If the Current Method were used, the US $ equivalent used, the US $ equivalent

would be VERY small due to would be VERY small due to the rapidly increasing the rapidly increasing

exchange rate.exchange rate.

Disappearing Plant ProblemDisappearing Plant ProblemIf the Current Method were If the Current Method were used, the US $ equivalent used, the US $ equivalent

would be VERY small due to would be VERY small due to the rapidly increasing the rapidly increasing

exchange rate.exchange rate.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-23

McGraw-Hill/Irwin

Current Rate Method Example

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 $.

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

McGraw-Hill/Irwin

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.

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.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-25

McGraw-Hill/Irwin

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:

© The McGraw-Hill Companies, Inc., 2004

Slide 10-26

McGraw-Hill/Irwin

Current Rate Method Example

Determine the appropriate

exchange rates to use for each

account.

Determine the appropriate

exchange rates to use for each

account.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-27

McGraw-Hill/Irwin

Current Rate Method Example

Weighted average rates are generally

used for Sales, COGS, and other recurring

expenses.

Weighted average rates are generally

used for Sales, COGS, and other recurring

expenses.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-28

McGraw-Hill/Irwin

Current Rate Method Example

The actual historical rate is used when we

can identify it efficiently.

The actual historical rate is used when we

can identify it efficiently.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-29

McGraw-Hill/Irwin

Current Rate Method Example

© The McGraw-Hill Companies, Inc., 2004

Slide 10-30

McGraw-Hill/Irwin

Determine the appropriate

exchange rates to use for each

account.

Determine the appropriate

exchange rates to use for each

account.

Current Rate Method Example

© The McGraw-Hill Companies, Inc., 2004

Slide 10-31

McGraw-Hill/Irwin

Current Rate Method Example

The beginning R/E is carried over from the

prior year.

The beginning R/E is carried over from the

prior year.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-32

McGraw-Hill/Irwin

Current Rate Method Example

The net income is taken from the income

statement.

The net income is taken from the income

statement.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-33

McGraw-Hill/Irwin

Current Rate Method Example

Dividends are translated at the historical rate on the date of declaration.

Dividends are translated at the historical rate on the date of declaration.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-34

McGraw-Hill/Irwin

Current Rate Method Example

© The McGraw-Hill Companies, Inc., 2004

Slide 10-35

McGraw-Hill/Irwin

Current Rate Method Example

© The McGraw-Hill Companies, Inc., 2004

Slide 10-36

McGraw-Hill/Irwin

Current Rate Method Example

All assets and liabilities are translated at

the current rate at the balance

sheet date.

All assets and liabilities are translated at

the current rate at the balance

sheet date.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-37

McGraw-Hill/Irwin

Current Rate Method Example

Common Stock is translated at the historical rate at

the time the stock was issued.

Common Stock is translated at the historical rate at

the time the stock was issued.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-38

McGraw-Hill/Irwin

Current Rate Method Example

The Ending R/E comes from the statement of

retained earnings.

The Ending R/E comes from the statement of

retained earnings.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-39

McGraw-Hill/Irwin

Current Rate Method Example

The translation adjustment is:

The difference between Net Assets at current rates and Net

Assets at historical rates added to the translation

adjustment balance at the beginning of the year:

$41,511 + $69,841 = $111,352

The translation adjustment is:

The difference between Net Assets at current rates and Net

Assets at historical rates added to the translation

adjustment balance at the beginning of the year:

$41,511 + $69,841 = $111,352

© The McGraw-Hill Companies, Inc., 2004

Slide 10-40

McGraw-Hill/Irwin

Current Rate Method Example

© The McGraw-Hill Companies, Inc., 2004

Slide 10-41

McGraw-Hill/Irwin

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.

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.

© The McGraw-Hill Companies, Inc., 2004

Slide 10-42

McGraw-Hill/Irwin

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

Many companies also include a description of the translation procedures in Note 1.

An analysis of the change in the cumulative translation adjustment. can be on the Statement of

Retained Earnings or in the Notes

Many companies also include a description of the translation procedures in Note 1.