Translation of

ForeignFinancial

Statements

C11 2

Foreign currency translation

The process of expressing amounts denominated or measured in foreign currencies into amounts measured in the reporting currencies of the domestic entity

C11 3

FASB’s Statement No. 52

Adopted a functional currency approach The previous standard (SFAS No. 8)

employed the temporal method

C11 4

Functional currency

The currency of the primary economic environment in which the entity generates and expends cash

A number of factors must be evaluated in order to properly identify the functional currency

C11 5

Objectives of the translation process Provide information that is generally compatible with the expected

economic effects of a rate change on an enterprise’s cash flows and equity Reflect in consolidated statements the financial results and relationships

of the individual consolidated entities as measured in their functional currencies in conformity with U.S. GAAP

C11 6

Expected economic effects of a rate change

The foreign entity is a conduit: Cash inflows/outflows are affected Translation gains/losses should be included in net

income

C11 7

Expected economic effects of a rate change (con’t)The foreign entity is not a conduit: Cash inflows/outflows are not affected No translation gains/losses should be included in net income

(include as a component of other comprehensive income)

C11 8

Reflect financial results and relationships in conformity with U.S. GAAP If not affected by rate changes, the relationship between accounts (e.g., current

ratio, debt / equity ratio) should be the same after translation as they were before If affected by rate changes, relationships between accounts are different than they

were prior to translation, therefore, reflecting the economic effect of rate changes Foreign financial statements should be restated into U.S. GAAP before translation

begins

C11 9

The translation process

Start

End

Convert foreign financial statements to GAAP

Identify the “Books of Record” (BR) currency and the

“Functional Currency” (FC)

Is FC the inflationarycurrency? Yes

No

Is BR = FC?

Use functional method to get FC into

$’s

Yes

Noapply the remeasurement process (shown later)

C11 10

The translation of financial statement accounts

Account Functional Method

Assets & Liabilities:At current values or monetary items(defined next slide)

Current

Not as current values of nonmonetaryitems (defined next slide)

Current

Revenues and Expenses:

Representing amoritzation of historicalamounts

Weighted Average

Not representing amoritzation ofhistorical amounts

Weighted Average

Equity accounts (excluding RE) Historical

Retained EarningsBeginning balance plus

translated net income lesstranslated dividends

Translation adjustment recorded as acomponent of

Other Comprehensive Income

C11 11

The translation of financial statement accounts (con’t)

Monetary items: rights to receive or pay an amount of money which is:

(a) fixed or

(b) determinable without reference to future prices of specific goods/services; that is, its value does not change according to changes in price levels.

C11 12

Accounting for the translation adjustment The adjustment is NOT included in net income The adjustment is shown as a separate component of other comprehensive

income (OCI) The adjustment may be recognized as a component of net income when there

is a partial or complete sale/liquidation of the investment in the foreign entity

C11 13

Reconciliation of the annual translation adjustmentNet assets at the beginning of the period

multiplied by the change in exchange rates during the period

[100,000 FC ($1.05 - $1.00)] = $5,000 Increase in net assets (excluding capital

transactions) multiplied by the difference between the current rate and the average rate used to translate income

[50,000 FC ($1.05 - $1.03)] = $1,000continued . . .

C11 14

Increase in net assets due to capital transactions (including investments by the domestic investor) multiplied by the difference between the current rate and the rate at the time of the capital transaction

[60,000 FC ($1.05 - $1.00)] = 3,000

Translation adjustment (credit) = $9,000

Reconciliation of the annual translation adjustment (con’t)

C11 15

Special issues related to consolidating the foreign subsidiary

The translation adjustment is allocated between the controlling and noncontrolling interests

Any excess of cost over book value is translated at the end of the period exchange rate

Any amortization of excess is translated at the average exchange rate for the period

C11 16

Special issues related to consolidating the foreign subsidiary (con’t)

Unrealized intercompany profits must be eliminated using the rate of exchange which existed at the date of the intercompany transaction

C11 17

Special issues related to the sophisticated equity method

The investor’s share of the investee’s translated net income

Amortization of any excess of cost over book value

The investor’s share of the cumulative translation adjustment

The investment account includes:

C11 18

Remeasured financial statements The remeasurement process is intended to produce financial

statements that are the same as if the entity’s transactions had been originally recorded in the functional currency

Remeasurement is based on the temporal method

C11 19

Remeasurement is necessary when The foreign entity’s financial statements are prepared in a currency that is

not the functional currency. The functional currency may be– another foreign currency– the U.S.dollar

The foreign entity’s functional currency is that of a highly inflationary economy

C11 20

The remeasurement process

Start

A

Convert foreign financial statements to

GAAP

Identify the “Books of Record” (BR) currency

and the “Functional Currency” (FC)

Is BR =

FC?

Is FC = inflationar

y currency?

Use Temporal method

Is FC = $?

A

Use Temporal method

End

Use Temporal method to get into

functional currency

End

Yes

No

Yes No

Yes

A apply the translation process shown earlier

No

C11 21

Remeasurement of financial statement accounts

Account Temporal Method

Assets & Liabilities:At current values or monetary items CurrentNot as current values or nonmonetaryitems

Historical

Revenues and Expenses:

Representing amoritzation of historicalamounts

Historical

Not representing amoritzation ofhistorical amounts

Weighted Average

Equity accounts (excluding RE) Historical

Retained EarningsBeginning balance plus

remeasured net income lessremeasured dividends

Translation adjustment recorded as acomponent of

Net Income

C11 22

Special remeasurement issues Application of lower of cost or market for inventory Historical exchange rates for purchase accounting Remeasured financial statements may still need to be translated Equity method of accounting for an investment should include the

appropriate share of remeasurement gains or losses

C11 23

Disclosure requirements

Beginning and ending amount of cumulative translation adjustments

The aggregate adjustment for the period resulting from translation adjustments and gains and losses from certain hedges and intercompany balances

An analysis of the cumulative translation adjustment including:

C11 24

Disclosure requirements (con’t) The amount of income taxes for the period allocated to translation

adjustments The amounts transferred from cumulative translation adjustments in OCI

and included in determining net income for the period as a result of the sale or complete or substantially complete liquidation of an investment in a foreign entity