Foreign Currency Financial Statements

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Foreign currency translation is the process of expressing a foreign entity’s functional currency financial statements in the reporting currency. Translation adjustments are included in the cumulative translation adjustment (CTA) account, which is a component of other comprehensive income.

Functional Currency

Currency of the primary economic environment in which the entity operates :

  • Customer receipts.
  • Liability payments.

Other factors :

–Setting of sales prices.

–Sales market.

–Expenses.

–Financing.

–Intercompany transactions.

Functional Currency Determines Method

Restatement Methods

  • Temporal method

–Use if functional currency is the US dollar

  • Current rate method

–Use if the functional currency is the local currency

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Highly Inflationary Economy

Inflation and Functional Currency

In a highly inflationary economy

Functional currency  ———  Parent’s
                                                             reporting currency

Functional currency   ——— US Dollar
for subsidiaries of US firms in highly inflationary economies.

Highly inflationary = cumulative inflation of 100% or more over 3 years.

Translation on Acquisition Date

Translation at Acquisition

  • Foreign assets and liabilities are translated using the current rate method.
  • If functional currency = local currency :
    – Translation is appropriate.
    – Analysis of fair value/book value differentials is performed in local currency.
    – Results are translated at current rates.

Remeasurement at Acquisition

  • Foreign assets and liabilities are translated using the current rate method.
  • If functional currency = US$ or reporting currency :
    – Remeasurement is appropriate
    – Analysis of fair value/book value differentials is performed in US$
    The ‘earliest’ historical rate generally used in remeasurement is the date of the acquisition.

Noncontrolling Interest

  • For both, remeasurement and translation, the consolidation process is applied to the financial statements as restated in US$.
  • Measures of noncontrolling interest, noncontrolling interest share, and controlling interest share are computed in US$.

Current Rate Method and Temporal Method

Current Rate Method

Translating the adjusted trial balance:

Debits

  • Assets, contra liabilities = year end rate
  • Expenses = average rate
  • Dividends = historical rate

Credits

  • Liabilities, contra assets = year end rates
  • Equity = historical
  • Except retained earnings;
    – Use last year’s translated amounts
    – If first year, use historical rate
  • Revenues = average rate

Subtotal debits and credits. The difference is accumulated other comprehensive income from the translation adjustment.

Temporal Method

Remeasuring the adjusted trial balance:

Debits

  • Assets, contra liabilities = Year end or historical rates
  • Expenses = historical or average rate
  • Dividends = historical rate

Credits

  • Liabilities, contra assets = year end or historical rates
  • Equity = historical
  • Except retained earnings;
    – Use last year’s translated amounts
    – If first year, use historical rate
  • Revenues = average or historical rate

Subtotal debits and credits. The difference is an exchange gain or loss for the current period from the remeasurement process.

Translation Adjustments and Remeasurement Gain/Loss

Balancing the Worksheet

Mathematically:

  • Apply the temporal (remeasurement) or current rate (translation) rule to all accounts
  • Subtotal debits and credits
  • Balance the worksheet by including the difference with the lower subtotal (debits or credits)
  • Label the difference appropriately

Adjustment or Gain/Loss

Remeasurement results in :

–Exchange gains or losses

–Credit to balance = exchange gain

–Debit to balance = exchange loss

–Include the gain or loss in calculating net income in US dollars.

Translation results in :

–Translation adjustment, part of accumulated other comprehensive income

–Include as part of stockholders’ equity;

  • Debit to balance = deduct from equity
  • Credit to balance = add to equity

Equity Method for Foreign Investments

Equity Method Investee

  • A US firm has a foreign investment it accounts for under the equity method.

–If functional currency is the local currency

–Translation is appropriate

  • At acquisition

–Analyze fair value and book values, compute goodwill – in local/functional currency

  • Annually

–Translate statements into US dollars

–Record other comprehensive income for translation adjustment

Consolidation of Foreign Subsidiaries

Consolidating Foreign Subsidiaries

  • The parent uses the appropriately translated or remeasured subsidiary financial statements in its consolidation worksheet.
  • Income from the subsidiary and Investment in subsidiary are eliminated.
  • Subsidiary equity accounts are eliminated (including accumulated OCI).
  • Worksheet procedures are similar to that for domestic subsidiaries.

Hedge of Net Investment

Hedge a Foreign Investment

  • Investee’s functional currency = local currency

–Effective hedges qualify for hedge treatment

–”Gains or losses” are;
translation adjustments
      – included in accumulated OCI

  • Investee’s functional currency = reporting currency

–”Hedging” is treated as speculative

–Gains or losses are currently recognized in income

 

SUMBER :

  1. Advanced Accounting, 10th edition by Floyd A. Beams, Robin P. Clement,  Joseph H. Anthony, and Suzanne Lowensohn
  2. https://www.pwc.com/us/en/cfodirect/publications/accounting-guides/foreign-currency-reporting.html

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