TRANSLATION OF FOREIGN CURRENCY

FINANCIAL STATEMENTS

CHAPTER THIRTEEEN

Summary by A. Hosseini

LEARNING OBJECTIVES:

CHAPTER OUTLINE

  1. TRANSLATION METHODOLOGIES
    1. Accounts of foreign subsidiaries are restated or translated into the parent company’s currency primarily for reporting consolidated financial statements. The translation involves two key issues:
      1. The exchange rates at which various accounts are translated
      2. The subsequent treatment of gains or losses.
    2. Current / Noncurrent method
      1. Current assets and liabilities are translated at current exchange rates
      2. Noncurrent assets, liabilities, and stockholder's equity are translated at historical rates.
    3. Monetary / Nonmonetary method
      1. Monetary assets and liabilities are translated at current rate
      2. Nonmonerary assets, liabilities, and stockholder's equity are translated at historical rates.
    4. Temporal method
      1. Cash, receivables, and payables are translated at current rate.
      2. Assets and liabilities carried at past exchange prices are translated at historical rates.
    5. Current Rate method
      1. All assets and liabilities are translated using the current rate
      2. Only the equity accounts are translated using historical rates.
  2. FASB STATEMENT 52
    1. Dictates methods US companies can use to translate foreign subsidiaries financial statements. Current or temporal method is used depending on the functional currency of subsidiary.
      1. The functional currency is the primary currency of the subsidiary's operations.
      2. There are several factors that influence the determination of functional currency:
        1. Cash flows: either primarily in FC or directly affect parent's cash flow
        2. Sales prices: not affected by exchange rate changes or affected
        3. Sales market: primarily local or in parent's country.
        4. Financing: obtained in FC or parent's currency; FC or parent's cash flow used to servive obligations.
        5. Intercompany transactions: low volume verses high volume.
    2. Remeasuring using Temporal Method
      1. If the functional currency is the US dollar, balances are remeasured in US dollars using the temporal method. Adjustments are reported as gains or losses in income.
      2. Following procedures are used to apply temporal method:
        1. Remeasure cash, receivables, and liabilities at the current balance sheet date.
        2. Remeasure inventory, fixed assets, and capital stock at the appropriate historical exchange rates.
        3. Remeasure most revenues and expenses at the average rate for the year; cost of sales and depreciation expense are translated at relative historical rates.
        4. Take all remeasurement gains or losses directly to the income statement.
    3. Translation using the Current Rate method
      1. If the functional currency is the foreign currency, balances are translated using current method and a translation adjustment is reported on the balance sheet.
      2. Following steps are taken with application of the current rate method:
        1. Total assets and liabilities are translated at the current exchange rate.
        2. Stockholders' equity accounts are translated at appropriate historical rates
        3. All revenue and expense items are translated at the average rate.
        4. Dividends are translated at the exchange rate in effect when issued.
        5. Translation gains and losses are taken to a special accumulated translation adjustment account in stockholder's equity.
    4. Intercompany Transactions
      1. Parents and subsidiaries engage in various types of intercompany transactions which can result in profits that can be related to exchange rate changes.
      2. If an intercompany loan is considered short term, exchange gains or losses would be recognized in the subsidiary's income statement and translated into dollars using an average rate for the year the loan is carried.
      3. If the loan is long-term, the exchange gain would be included in the equity section under the current method or the income statement if temporal method is used.
      4. The intercompany proftis that are eliminated through consolidation are are based on the exchange rates at the dates of the sales or transfers.
    5. High Inflationary Economies
      1. A highly inflationary economy is a country where the cumulative inflation exceeds 100 percent over a three-year period.
      2. Foreign subsidiaries located in highly inflationary economies must use the temporal method under FASB 52.
    6. FASB 52 requires the following information to be disclosed
      1. The aggregate transaction gain or loss included in income.
      2. An analysis of the changes during the period of the translation adjustment balance in stockholders' equity:
        1. Beginning and ending amount of cumulative translation adjustments
        2. The aggregate adjustment for the period resulting from translation adjustments and gains / losses from certain hedges and intercompany balances.
        3. The amount of income taxes for the period allocated to the adjustments.
        4. The amounts transferred from cumulative translation adjustments and included in determining net income resulting from sale or liquidation of foreign investments.

     

  3. NON-U.S. TRANSLATION PRACTICES
    1. General European practices
      1. The EU does not provide any guidelines for foreign currency or translation accounting. Most European countries allow both current and temporal rates, and most tend to use the current method.
      2. German companies generally use a form of the temporal method and do not make a distinction based on functional currency.
      3. The French use the temporal method for integrated foreign companies and the current method for self-sustaining foreign subsidiaries. Gains and losses are treated the same as in US.
      4. The Japanese use the temporal method. Translation adjustments for subsidiaries are reported as an asset or liability and for branches taken to income.
    2. The United Kingdom
      1. SSAP(Statement of Standard Accounting Practice) 20 allows the use of the closing rate method or the temporal method, depending on the operation relationship between subsidiary and parent.
      2. British regulation similar to FASB 52, but contain important differences:
        1. SSAP does not provide specific rules for foreign currency transactions.
        2. In highly inflationary economies, SSAP recommends that companies adjust, where possible, to current price levels verses mandating use of temporal method.
        3. SSAP does not require the same level of disclosure as FASB 52 dictates.
    3. Canadian standards
      1. For translation, the temporal and current methods can be used depending on the relationship between the subsidiary and parent; similar to FASB 52.
      2. If foreign subsidiary operates in a high inflation economy, temporal method is used.
    4. International Accounting Standards
      1. International Accounting Standard 21 contains guidelines for both transactions and translations of financial statements.
      2. Both the closing rate and temporal methods are used, depending on the operating characteristics of the foreign operations. Gains or losses are taken to stockholders' equity.
      3. Operations in highly inflationary countries must be adjusted for local inflation before translation into the reporting currency.