13

13
Translation of Financial
Statements of Foreign Affiliates

Advanced Accounting, Fifth Edition

Learning
Learning Objectives
Objectives
1.

Distinguish between the current exchange rate and the

historical exchange rate.

2.

Understand the objectives of financial statement

translation.

3.

Identify the functional currency of a foreign entity.

4.

Compare the two methods used to convert the financial

statements of a foreign entity into U.S. dollars.

5.

Distinguish between the circumstances under which each of

the two methods is appropriate under current GAAP.

Learning
Learning Objectives
Objectives
6.

Explain the factors involved in translating the statements

of a foreign entity operating in a highly inflationary
economy.

7.

Translate the statements of a foreign entity when the

functional currency is the local currency.

8.

Translate the statements of a foreign entity when the

functional currency is the U.S. dollar.

9.

Understand the concept of comprehensive income in the

context of foreign currency translation.

10. Identify the disclosure requirements for firms with foreign

entities.

Translation
Translation of
of Financial
Financial Statements
Statements
A U.S. company may be involved in foreign activities
through the operations of a:
branch,
subsidiary, or
investee company.

Accounts of foreign activities, maintained in a foreign

currency, must be restated into U.S. dollars before they
are combined or consolidated or the equity method of
accounting applied.

Accounting
Accounting for
for Operations
Operations in
in Foreign
Foreign Countries
Countries
A foreign subsidiary is consolidated if the parent company
owns, directly or indirectly, a controlling interest in the
voting stock of the subsidiary. Exceptions include:
The intent to control is likely to be temporary.
Control does not actually rest with the parent company.

Restriction on withdrawal of assets

Exchange restrictions.

Foreign statements that are not in conformity with GAAP in the

United States must be adjusted to conform to U.S. standards
before conversion into U.S. dollars.

Translating
Translating Statements
Statements of
of Foreign
Foreign Affiliates
Affiliates
The conversion from another currency into the
currency of the parent company is frequently called
translation.
Translation Process

Financial
Statements in
Euros

Current
Exchange Rate
Historical
Exchange Rate

Financial
Statements in
U.S. Dollars

LO 1 Current versus historical exchange rates.

Translating
Translating Statements
Statements of
of Foreign
Foreign Affiliates
Affiliates
Translation Adjustment or Translation Gain or Loss
The difference between translating some accounts using
the current exchange rate and others using the historical
exchange rate.
Current standards require the translation adjustment (gain
or loss) be reported
Not a
currently in income or
Choice
deferred as a component of stockholders equity,
depending on the method used to translate the accounts.
LO 1 Current versus historical exchange rates.

Objectives
Objectives of
of Translation
Translation
Functional Currency Concept
Objective of Translation FASB ASC section 830-30:
1.

Provide information regarding the exposed economic effects

of an exchange rate change on an enterprises cash flows and
equity [par. 4(a)].

2.

Reflect in consolidated statements the financial results

measured in their functional currencies in conformity with
U.S. GAAP [par. 4(b)].

The Board believes that the operating performance and financial

condition of a foreign entity are best measured by expressing its accounts in
the currency of the economic environment in which it primarily conducts its
operations and generates and expends its cash, its functional currency.
LO 2 Objectives of translation.

Translation
Translation Methods
Methods
Current rate method

Translation

All assets and

liabilities.

Current exchange
rate.

Revenues and
expenses.

Exchange rate on the

date each transaction
occurred.

LO 4 Two methods of conversion.

Translation
Translation Methods
Methods
Temporal Method
Monetary assets and liabilities
(cash, a/r, a/p).
Assets and liabilities carried
at historical cost.
Assets and liabilities carried
at current values.
Revenues and expenses
related to assets and
liabilities translated at
historical rates.
Other revenues and expenses.

Translation
Current exchange rate.
Historical exchange
rates.
Current exchange rate.
Historical exchange
rates.
Exchange rate on date
transaction occurred.
LO 4 Two methods of conversion.

Identifying
Identifying the
the Functional
Functional Currency
Currency
The Functional Currency may be
1.

The local currency of the foreign entity,

2. The U.S. dollar, or

3. The currency of a third country.

Economic Indicators of Functional Currency:

Cash flow

Expenses

Sales prices

Financing

Sales market

Intercompany transactions

LO 3 Identifying the functional currency.

Identifying
Identifying the
the Functional
Functional Currency
Currency

Review Question
Indicators that the local currency is also the functional
currency include all of the following except:
a. The majority of the cash flows are in the local
currency.
b. Sales prices are determined by local market conditions.
c. Financing is generally from the parent or guaranteed by
the parent.
d. Production costs and expenses are determined by local
conditions.
LO 3 Identifying the functional currency.

Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial Statements
Statements
Remeasurement is the process of translating the accounts
of a foreign entity into its functional currency when they
are stated in another currency.
Translation. Accounts measured in the functional
currency are translated into the reporting currency using
the current rate method.

Translation may be used synonymously with the current method,

remeasurement is used synonymously with the temporal method.
LO 4 Which methods of conversion to use.

Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial Statements
Statements
Accounts stated in local currency of foreign entity.
Is the foreign
economy highly
inflationary?
Functional
currency (FC) is
U.S. Dollar.

No

Is the FC the
U.S. dollar?

Yes
Remeasure to
U.S. dollars using
temporal method.

Determine the functional

currency (FC) per
economic indicators.

No

Is the FC the
local currency?

No
Remeasure to
FC using
temporal method.

Yes

Translate to
U.S. dollars using
current rate
method.

LO 4 Which methods of conversion to use.

Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial Statements
Statements
Foreign Entity Operates in Highly Inflationary Economy
It is the Boards belief that the currency of a country
that has a highly inflationary economy has lost its utility
as a store of value and cannot be a functional measuring
unit.
This means the foreign financial statements should be
translated using the temporal method.

LO 6 Factors in a highly inflationary economy.

Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial Statements
Statements
Foreign Entity in Economy that is Not Highly Inflationary
Functional currency must be identified. Translation process:
1. Local currency is the functional currency.
Current rate method.
Translation adjustment recorded as a component of
stockholders equity.

2. U.S. dollar is the functional currency.

Temporal method.
Translation adjustment reported in income statement.

Translation
Translation of
of Foreign
Foreign Currency
Currency Financial
Financial Statements
Statements
Books kept in
local currency

Local
currency
Remeasurement

Not
necessary

Temporal
method

Temporal
method

Functional
currency

Local
currency

U.S.
dollar

A third
currency

Translation

Current
rate method

Not
necessary

Current
rate method

U.S. dollar

U. S. dollars

Translation
Translation Current
Current Rate
Rate Method
Method
Current Rate Method

Translation

Assets and liabilities

Current exchange rate

Paid-in capital

Historical rate

Beginning R/E

Equals ending balance of last year

Dividends

Historical rate when dividend is

declared

Revenue and Expenses

Average exchange rate

Cumulative translation
adjustment

Balance amount in the balance

sheet

Current year translation

adjustment

Other comprehensive income

(shareholders equity)

Translation
Translation Current
Current Rate
Rate Method
Method
Exercise 13-4: On January 1, 2008, Trenten Systems, a U.S.based company, purchased a controlling interest in Grant
Management Consultants located in Zurich, Switzerland.
Direct exchange rates for Swiss franc are:
Dollars per Franc
January 1, 2008
December 31, 2008
Average for 2008
Dividend declaration and payment date

$.5987
.5321
.5654
.5810

Required: Translate the year-end balance sheet and income

statement of the foreign subsidiary using the current rate method
of translation.

Translation
Translation Current
Current Rate
Rate Method
Method
Exercise 13-4: (Current Rate Method)
Income Statement
Revenue
Operating expenses
Net income
Retained earnings 1/1

Swiss
Francs

Translation
Rate

U.S. Dollars

75,000
(30,000)
45,000
10,000
55,000
(15,000)
40,000

0.5654
0.5654

Cash and receivables

Net property, plant, equipment
Total assets

55,000
37,000
92,000

0.5321
0.5321

29,266
19,688
48,954

Accounts payable
Common stock
Retained earnings

32,000
20,000
40,000
92,000

0.5321
0.5987

17,027
11,974
22,715
51,716
(2,762)
48,954

Dividends
Retained earnings 12/31

0.5987
0.5810

42,405
(16,962)
25,443
5,987
31,430
(8,715)
22,715

Balance Sheet

Cumulative translation adjustment

Total liab. & equity

92,000

Translation
Translation Current
Current Rate
Rate Method
Method
Exercise 13-4: Prepare a schedule to verify the
Swiss
Translation
translation adjustment.
Exposed net asset position - 1/1

Francs

Rate

30,000

$.5987

17,961

45,000

.5654

25,443

(15,000)

.5810

(8,715)

Adjustment for changes in net asset position:

Net income
Dividends
Net asset position translated
Exposed net asset position - 12/31
Cumulative translation adjustment (debit)

--60,000

34,689
.5321

31,926
(2,763)

LO 7 The functional currency is the local currency.

Translation
Translation Current
Current Rate
Rate Method
Method

Review Question
Under the current method of currency translation, which
of the following balance sheet accounts is translated at
historical exchange rates?
a. Cash
b. Accounts Receivable
c. Bonds Payable
d. Common Stock
LO 7 The functional currency is the local currency.

Translation
Translation Temporal
Temporal Method
Method
Temporal Method
Monetary assets and liabilities
(cash, a/r, a/p).
Assets and liabilities carried
at historical cost.
Assets and liabilities carried
at current values.
Revenues and expenses
related to assets and
liabilities translated at
historical rates.
Other revenues and expenses.

Translation
Current exchange rate.
Historical exchange
rates.
Current exchange rate.
Historical exchange
rates.
Exchange rate on date
transaction occurred.

Translation
Translation Temporal
Temporal Method
Method
Exercise 13-5: On January 1, 2008, Trenten Systems, a U.S.based company, purchased a controlling interest in Grant
Management Consultants located in Zurich, Switzerland.
Direct exchange rates for Swiss franc are:
Dollars per Franc
January 1, 2008
December 31, 2008
Average for 2008
Dividend declaration and payment date

$.5987
.5321
.5654
.5810

Required: Convert (remeasure) the financial statements of the

foreign subsidiary using the temporal method of translation.
LO 7 The functional currency is the local currency.

Translation
Translation Temporal
Temporal Method
Method
Exercise 13-5: (Temporal Method)
Income Statement
Revenue
Operating expenses: depreciation
Operating expenses: other
Translation loss
Net income
Retained earnings 1/1
Dividends
Retained earnings 12/31

Swiss
Francs
75,000
(3,000)
(27,000)
45,000
10,000
55,000
(15,000)
40,000

Translation
Rate
0.5654
0.5987
0.5654

0.5987
0.5810

U.S. Dollars
42,405
(1,796)
(15,266)
(198)
25,145
5,987
31,132
(8,715)
22,417

Balance Sheet
Cash and receivables
Net property, plant, equipment
Total assets

55,000
37,000
92,000

0.5321
0.5987

29,266
22,152
51,418

Accounts payable
Common stock
Retained earnings
Total liab. & equity

32,000
20,000
40,000
92,000

0.5321
0.5987

17,027
11,974
22,417
51,418

Translation
Translation Temporal
Temporal Method
Method
Exercise 13-5: Prepare a schedule to verify the
Swiss
Translation
translation gain or loss.
Francs

Rate

(10,000)

$.5987

(5,987)

75,000

.5654

42,405

Other operating expenses

(27,000)

.5654

(15,266)

Dividends

(15,000)

.5810

(8,715)

Net monetary liability position - 1/1

Adjustment for changes in net monetary position:

Increase in cash and receivables from sales
Less: Decrease in net asset position:

Net asset position translated

Net monetary asset position-12/31
Translation gain (loss)

--23,000

12,437
.5321

12,238
(199)

Financial
Financial Statement
Statement Disclosure
Disclosure
Companies are required to disclose certain items, as follows:
1.

The aggregate translation gain or loss included in the

determination of net income for the period.

2.

An analysis of the cumulative translation adjustment equity

account should be provided in a separate statement or note
or as part of a statement of changes in equity.

3.

Exchange rate changes that occur after the balance sheet

date and their effect on unsettled foreign currency
transactions, if significant.
LO 10 Required disclosure.

Date
Date of
of Acquisition
Acquisition
Illustration: Recall that on January 2, 2012, P Company
acquired for 2,000,000 francs an 80% interest in SFr. Company.
The direct exchange rate for francs on January 2, 2012, was
$.15. The entry to record the acquisition is
Investment in SFr Company
Cash

300,000
300,000

Date
Date of
of Acquisition
Acquisition
On January 2, SFr Company reported common stock of 960,000 francs,
additional paid-in capital of 300,000 francs, and retained earnings of
480,000 francs for a net asset balance of 1,740,000 francs. The
difference between implied and book value in francs and dollars is
allocated to land and buildings.

After
After Acquisition
Acquisition
P Company accounts for its investment by the cost method. In this
case, SFr Company declared and paid a 300,000 franc dividend on
September 1 when the direct exchange rate was $.16. The book
entry to record the dividend receipt is:

Cash

38,400

Dividend income
(300,000 francs x $.16 = $48,000 x .80 = $38,400)

38,400

After
After Acquisition
Acquisition
Workpaper entries assuming current rate method.

Consolidation
Consolidation Assuming
Assuming Temporal
Temporal Method
Method
The major differences between the workpapers are as follows:
1.

Under the temporal method,

the translation gain or loss is included in the subsidiarys income statement

and becomes a part of its ending retained earnings balance.

The controlling interest in the gain or loss is recognized as part of

consolidated net income in the current period.

In subsequent periods the gain or loss is included in consolidated retained

earnings as part of the reciprocity entry.

2.

The unamortized portion of the difference assigned to land and

buildings and the amortization for the current period retain their
historical dollar values since such nonmonetary assets are translated
using historical rates.

Remeasurement
Remeasurement and
and Translation
Translation of
of Transactions
Transactions
FASB ASC section 8302020 defines a foreign currency
transaction as one that is denominated in a currency other than
the entitys functional currency.
1.

At the transaction date, the current exchange rate is used to

measure and record a foreign currency transaction in the
functional currency of the recording entity.

2. At subsequent balance sheet dates, recorded balances that

are denominated in a currency other than the functional
currency are adjusted to the functional currency using the
current exchange rate.
3. Any transaction gain or loss resulting from this procedure is
recognized currently in income.

Intercompany
Intercompany Receivables
Receivables and
and Payables
Payables
FASBASC paragraph 83020351 requires that transaction
gains and losses on intercompany receivables and payables be
recognized in the period that the exchange rate changes.
The procedures for doing so are similar to those discussed in
the preceding section.
However, a company is required to distinguish between
transactions that are of a long-term investment nature and
other transactions.

Elimination
Elimination of
of Intercompany
Intercompany Profit
Profit
Profits and losses attributable to intercompany
sales or transfers are eliminated on the basis of
the exchange rate at the date of each sale or
transfer.
The use of averages or reasonable
approximations of specific rates in effect on
the due date of each transaction is permitted.

Liquidation
Liquidation of
of aa Foreign
Foreign Investment
Investment
Upon the sale of part or all of an investment in
a foreign entity, a pro-rata share of the amount
included in the accumulated translation
adjustment equity account associated with that
foreign investment is removed and reported as
part of the gain or loss from the disposition of
the investment.

Copyright
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