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Chapter Ten
Translation of Translation of Foreign Foreign
Currency Currency Financial Financial
StatementsStatements
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International Acquisitions
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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
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In addition, many countries have different accounting rules that
we must consider before translating the sub’s financial
statements.
Translation of Financial Statements
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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)
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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)
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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.
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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.
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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.
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Determining a Subsidiary’s Functional Currency
Exh.10-2
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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.
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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 $.
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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.
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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:
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Current Rate Method Example
Determine the appropriate
exchange rates to use for each
account.
Determine the appropriate
exchange rates to use for each
account.
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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.
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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.
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Current Rate Method Example
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Determine the appropriate
exchange rates to use for each
account.
Determine the appropriate
exchange rates to use for each
account.
Current Rate Method Example
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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.
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Current Rate Method Example
The net income is taken from the income
statement.
The net income is taken from the income
statement.
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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.
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Current Rate Method Example
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Current Rate Method Example
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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.
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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.
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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.
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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
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Current Rate Method Example
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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.
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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.