foreign currency translation presentation

7/21/2019 Foreign Currency Translation Presentation

1/49

Chapter 7

Translation of ForeignCurrency Financial

Statements


2/49

Translation of Foreign Currency Financial

Statements

Conceptual issues of foreign currency financialstatements translation.

Balance sheet vs. transaction exposure.

Methods of financial statement translation.

Temporal and current rate methods illustrated.

U.S. G!" #F$Ss" and other standards relatedto translation.

%edging &alance sheet exposure.


3/49

Translating Foreign Currency Financial

Statements -- Conceptual Issues

Foreign country operations usually prepare financialstatements using local currency as the monetary unit.

These financial statements must &e translated into homecountry currency.

These operations also typically use local G!.

Financial statements must &e translated into homecountry G!.

Learning Objective 1


4/49

Translating Foreign Currency Financial

Statements -- Conceptual Issues

Primary conceptual issues'ach financial statement item must &e translated using

some" hopefully relevant" exchange rate.(hat rate should &e used) the current exchange rate)The average exchange rate) the historical exchange rate)

Given that any ad*ustment is" at the point of translation"unreali+ed" ho, should the resulting ad*ustment &erecogni+ed) in current income) in an e-uity account on the &alance sheet)



5/49

Balance Seet !"posure

ssets and lia&ilities translated at the currentexchange rate are exposed to ris of atranslation ad*ustment.

(hen foreign currency appreciates" a net assetexposure results in a positive translationad*ustment.

(hen foreign currency appreciates" a net lia&ilityexposure results in a negative translation

ad*ustment.ssets and lia&ilities translated at the historical

exchange rate are not exposed to a translationad*ustment.

Learning Objective #


6/49

simple example

/et0s say 123 has a 4555 euro current notereceiva&le on its &oos. The euro6 direct rate is 4 on 464. 8n 496:4" it is 4.95.

Should ,e record;


7/49

nother simple example;

/et0s say 123 has land on its &oos that is held&y a su&sidiary located in the 'U. The land ,aspurchased on 464 for 4"555"555 euros ,hen theeuro6 direct rate ,as 4. 8n 496:4" it is .

=5=4.Should ,e record;?5)

nd if ,e do report a change" ,here should the offsettinggain &e reported)


8/49

(hat if;

#nflation differences caused the decline inthe value of the euro)#f the inflation differential ,as 45@" then;Before" 4"555"555'A4"555"555


9/49

The difference &et,een these t,oexamples

The receiva&le is a monetary asset.

The land is a nonmonetary asset.


10/49

#f inflation drives foreign exchange rate movements"and monetary6nonmonetary assets are affecteddifferently" ho, should FC effects &e accounted for)

Suppose" in the first case" the land is reportedat current cost instead of historical cost)


11/49

Methods devised to sort all this out

Current6noncurrent

Monetary6nonmonetary

Temporal

Current rate


12/49

Translation $eto%s

Current/Noncurrent MethodCurrent assets and lia&ilities are translated at the current

exchange rate.


13/49

#n our example;

The receiva&le ,ould &e classified ascurrent and translated using the currentrate.

The land ,ould &e classified asnoncurrent and translated at the historicalrate.


14/49

Curent6


15/49

Translation $eto%s

Monetary/Nonmonetary Method

Monetary assets and lia&ilities are translated at thecurrent exchange rate.


16/49

#n our example;

The receiva&le ,ould &e translated usingthe current rate.

The land ,ould &e translated at thehistorical rate" even is it ,ere consideredimpaired and thus reported at fair value.


17/49

Monetary6


18/49

Translation $eto%s

Temporal Method8&*ective is to translate financial statements as if the

su&sidiary had &een using the parent0s currency. #tems carried on su&sidiary0s &oos at historical cost"

including all stocholders0 e-uity items are translated athistorical exchange rates.

#tems carried on su&sidiary0s &oos at current value aretranslated at current exchange rates.

#ncome statement items are translated at the exchangerate in effect at the time of the transaction.

Learning Objective &


19/49

#n our example;

The receiva&le translated using thecurrent rate.

#f reported at historical cost" the land,ould &e translated at the historical rate.

#f reported at fair value" the land ,ould &etranslated at the current rate.


20/49

Temporal Method

dvantages/ines up ,ith valuation &asis used in

accounting. Thus the num&ers have most

meaning.isadvantages/ots of volatility in financial statements

!ossi&ility of disappearing assets in inflationaryeconomies.


21/49

Translation $eto%s

Current Rate Method8&*ective is to reflect that the parent0s entire

investment in a foreign su&sidiary is expose to

exchange ris.ll assets and lia&ilities are translated at thecurrent exchange rate.

Stocholders0 e-uity accounts are translated athistorical exchange rates.

#ncome statement items are translated at theexchange rate in effect at the time of thetransaction.

Learning Objective &


22/49

Current $ate Method

dvantagesSimple to do

$atios are not distorted

isadvantagesCan produce disparate results that are not

consistent ,ith the economics that are reallygoing on.

(hat does the FC ad*ustment)


23/49

#n our example;

The receiva&le ,ould &e translated usingthe current rate.

The land ,ould &e translated at thecurrent rate.


24/49

Temporal an% Current 'ate $eto%s

Translation meto%s illustrate%U.S. #nc. o,ns Iuare+" S" a su&sidiary in Mexico ,hich,as esta&lished Ianuary 4" 955?.Iuare+0s &alance sheet items as of 496:465?" in pesos.

Cash 4"555 ccounts paya&le 9"555

ccounts rec. 9"555 /ongterm de&t J"555

#nventory 9"?55 Capital stoc :"555

Fixed assets K"555 $etained earnings 4"?55

ccum. depr. 4"555

Learning Objective (


25/49


Translation meto%s illustrate%

Iuare+0s income statement items for 955?" in pesos.

Sales 95"555 epr. exp 4"555

C8GS 4>"555 #nterest exp. ?55S"G"L exp. 9"?55 #ncome tax exp. ?55



26/49



There ,as no &eginning inventory.

#nventory" ,hich is carried at cost" ,as ac-uired evenly

during the last -uarter of 955?.!urchases ,ere made evenly throughout year.

Fixed assets ,ere ac-uired on Ianuary 4" 955?.

Capital stoc ,as sold on Ianuary 4" 955?.



27/49



$elevant exchange rates U.S. dollar per Mexican pesoD

Ianuary 4" 955? 5.45

verage for 955? 5.5=?verage for >th-uarter 955? 5.5=

ecem&er :4" 955? 5.5K



28/49


Current 'ate $eto% ) Income Statement

Income Statement ) #**+

Sales 4"=55

C8GS 4"::5Gross profit ?75

S"G"L 9:K

epreciation expense =?

#nterest expense >K

#ncome tax expense >7

9



29/49


Current 'ate $eto% ) Balance SeetBalance Seet ) ,ecember &1 #**+

Cash K5 ccounts paya&le 4J5

ccounts $ec. 4J5 /ongterm de&t>K5#nventory 955 Capital stoc :55Fixed ssets" net ?>? $etained earnings 4>9

Total assets =K? Cumulativetranslation ad*. =7D

Total lia&. L S.'. =K?



30/49


Temporal $eto% ) Balance Seet

Balance Seet ) ,ecember &1 #**+

Cash K5 ccounts paya&le 4J5

ccounts $ec. 4J5 /ongterm de&t >K5

#nventory 99? Capital stoc :55

Fixed ssets" net 755 $etained earnings 99?

Total assets 4"4J? Total lia&. L S.'. 4"4J?



31/49


Temporal $eto% ) Balance Seet

Income Statement ) #**+

Sales 4"=55

C8GS 4":>:

Gross profit ??7

S"G"L 9:K

epreciation expense 455

#nterest expense >K

#ncome tax expense >7

$emeasurement gain 454


32/49


Translation meto%s illustrate% ) Summary

Current Rate Method

ll assets and lia&ilities translated at current rate.

This results in net asset exposure.


33/49


Translation meto%s illustrate% ) Summary

Temporal Method

!rimarily monetary assets and lia&ilities translated at

current rate.This results in net lia&ility asset exposure.


34/49

8ther #ssues

(hat is the appropriate current rate)

Translation gains6losses) eferred or&ooed) Sho,n in income or *ust e-uity)


35/49

Translation ccounting round the (orld

US

#F$S

iversity seen in other nations


36/49

%istory of Translation ccounting in US

!re4=J?; Current6


37/49

%istory of Translation ccounting in US

4=K4today; SFS ?9" ,hich has the follo,ingfeatures;Functional currency determines accounting.#f functional currency is the local currency use single

current rate. Gains and losses routed directly tostocholder0s e-uity.#f functional currency is US ollar" use the temporal

method and fully recogni+e gains6losses into earnings.#f functional currency is different from local currency or

US ollar" do &oth.


38/49

./S/ 0P an% IF'S 'e2uirements

./S/ 0P un%er SFS +#$e-uires identification of functional

currency.Functional currency is the primary

currency of the foreign su&sidiary0soperating environment.

The standard includes a list of indicatorsas guidance for the foreign currencydecision.

Learning Objective +


39/49

dvantages of SFS ?9

llo,s consideration of context.

#n most cases" eeps impact of FCexchange rate movements out ofearnings.

Much more accepted &y reportingcommunity than FS K ,as.


40/49

isadvantages of SFS ?9

From an investor0s vie,point" is there anyeconomic difference" in su&stance" &et,eencircumstances that distinguish the t,o methods.

#f not" ,hy have t,o different inds ofaccounting)

#nconsistent ,ith the notion of consolidation.


41/49


IF'S

#S 94" The Effects of Changes in Foreign ExchangeRates is the relevant accounting standard.

Uses the functional currency approach developed &y theFSB.

The standard includes a list" similar to the FSB list" ofindicators as guidance for the foreign currency decision.

The standard0s re-uirements pertaining tohyperinflationary economies are su&stantially differentfrom SFS ?9.



42/49


3igly Inflationary !conomies ) ./S/ 0P

SFS ?9 provides guidance on highly inflationaryeconomies.

SFS ?9 defines such economies as those ,ith 455@inflation over a period of three years.

SFS ?9 re-uires the use of the temporal method inthese cases of significant inflation.



43/49


3yperinflationary !conomies -- IF'Ss

#S 94 and 9= use the term hyperinflationary economies.

#S 94 is not as specific in defining hyperinflationary

economies as SFS ?9. #S 94 re-uires restatement of the foreign financial

statements for inflation per #S 9=" Financial Reportingin Hyperinflationary Economies.

#S 94 then re-uires the use of the current rate methodof translation on the restated financial statements.

#S approach is su&stantially different from SFS ?9.



44/49

3e%ging Balance Seet !"posure

Companies that have foreign su&sidiaries ,ith highlyintegrated operations use the temporal method.

The temporal method re-uires translation gains andlosses to &e recogni+ed in income.

/osses negatively affect earnings" and &oth gains andlosses increase earnings volatility.



45/49

3e%ging Balance Seet !"posure

These gains and losses result from the com&ination of&alance sheet exposure and exchange rate fluctuations.

Companies can also hedge to offset the effects of thetranslation ad*ustment to e-uity under the current rate

method.Companies can hedge against gains and losses &y using

foreign currency for,ard contracts" options" and&orro,ings.



46/49

Translation Proce%ures Internationally

Canada very similar to U.S." ho,ever under thetemporal method" some translations ad*ustmentscan &e deferred and amorti+ed.Mexico standards are silent" &ut SFS ?9 is

commonly follo,ed. #n cases ,here it is not"practice varies ,idely.Brazil current rate method is used ,ith gains andlosses included in income.

Japan significantly different from U.S. G! and#F$Ss" ,ith cumulative translation ad*ustmentreported as an asset or lia&ility.Korea only the current rate method is used.



47/49

8ne final pro&lem

%o, do ,e interpret reported FC gains andlosses" irrespective of ,here they sho, up)

'xample; Company has a large su&sidiary in the

'U. The su&sidiary has a large net assetposition. The 'uro depreciates more than >5@.%uge losses are reported.

The su&sidiary0s sales and profits syrocet"since they no, seem more competitive tocustomers than ever.


48/49

Thus" and strangely;

#n a ,orld of Nfloating rateO currency"sometimes a ,ea currency is good" anda strong currency is &adP

This explains ,hy" ,hen marets are tightor declining" nations compete ,ith eachother in a race to devalue their money the

mostP


49/49

Summary

ll inds of pro&lems arise ,hen the value ofmoney changes and is uncertain.

The economic impact of these changes vary as afunction of the inherent cause of the FC

movement and the type of holding asset6lia&ilitymonetary6nonmonetary current6noncurrentD.

ccounting limitations e.g." historical costD mix,ith this uncertainty" maing financial reporting

difficult at &est.The current paradigm is SFS ?9. This couldeasily change at any time" as it has several times&efore.

foreign currency translation presentation

Documents