Illustrative Problem

Pedro Inc, a parent located in Canada has functional currency of C$ dollar. On 1 January 2017, it
set up a wholly owned subsidiary, HK Ltd. in Hong Kong with a paid-up capital of HK$80
million. It remitted US$10 million to Hong Kong for this investment. On 31 March 2017, HK
Ltd purchased an office building for an amount of HK$40 million.

Revenues from operating activities are denominated in the US dollar. Purchases are also
denominated in the US dollar. Wages, salaries and other operating expenses are denominated in
both the US dollar and the HK dollar. HK Ltd considers that the currency of the primary
economic environment in which it operates is the US dollar. However, for statutory reasons, it
keeps its accounting books and records in the HK currency.

The summarized accounts of HK Ltd for the financial year ended 31 December 2017, extracted
from its accounting records, together with the summarized accounts of Pedro Inc., are as follows:
HK Ltd Pedro Inc.
HK$'000 C$'000
Revenue 60,000 80,000
Expenses (30,000) (40,000)

Operating profit 30,000 40,000

Taxation (6,000) (11,200)

Profit after tax and retained 24,000 28,800

Retained profits brought forward — 8,200

Retained profits carried forward 24,000 37,000

Share capital of HK$1/C$1 each 80,000 60,000

104,000 97,000

Property, plant and equipment 40,000 50,200

Investment in HK Ltd, at cost — 40,000
HK dollar bank deposit 10,000 —
US dollar bank account 30,000 —
Bank balances — 10,000
Trade receivables 24,000 18,800
Payables — (22,000)

104,000 97,000

The relevant exchange rates between HK dollar, C$ dollar, and US dollar are as follows;

Per unit of US$

HK$ C$
1 January 2017 8.000 4.000
31 March 2017 7.750 3.875
Average for the year (AR) 7.500 3.750

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 31 December 2017 7.000 3.500

Required:

a. Re-measure HK Ltd's financial statements from its HK dollar accounts to its US dollar
functional currency accounts.
b. Translate the financial statements of the US functional currency account and present the
consolidated financial statements of Pedro Inc. in C$.

Solution

a. Re-measurement of HK$ accounts to the US$ functional currency:

Presentation Exchange rate Functional
currency currency
HK$'000 US$'00
Revenue 60,000 AR - 7.50 8,000
Expenses (30,000) AR = 7.50 (4,000)

Operating profit 30,000 4,000

Exchange gain (balancing) — 1,104
Taxation (6,000) AR = 7.50 (800)

Profit after taxation 24,000 4,304

Share capital 80,000 HR = 8.00 10,000

104,000 — 14,304

Property, plant and equipment 40,000 HR = 7.75 5,161

HK$ bank deposit 10,000 CR = 7.00 1,429
US$ bank balance 30,000 CR = 7.00 4,286
Trade receivables 24,000 CR = 7.00 3,428

104,000 14,304

Proof of exchange gain:

HK$ Rate US$
Opening monetary items (80,000 – 40,000) 40,000
At closing rate 7.00 5,715
At opening rate 8.00 5,000

Gain on opening net monetary items 715

Monetary item for the period before purchase 40,000
of office building (1 January 2017 – 31 March
2017)
At rate before utilization of cash 7.75 5,161

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 At opening rate 8.00 5,000

Exchange gain for three months 161

Increase in monetary items during the year 24,000
At closing rate 7.00 3,428
At average rate 7.50 3,200

228

Total exchange gain to profit or loss 1,104

Translation of US$ Functional Currency Accounts to C$ and Consolidation

HK Ltd Pedro Adjust- Conso-
Inc. ments lidated
US$'000 Rate C$'000 C$'000 C$'000 C$'000
Revenue 8,000 3.750 30,000 80,000 110,000
Expenses (4,000) 3.750 (15,000) (40,000) (55,000)
Exchange gain 1,104 3.750 4,140 4,140
Taxation (800) 3.750 (3,000) (11,200) (14,200)

Profit after tax 4,304 16,140 28,800 44,940

Retained profits b/f — — 8,200 8,200
Retained profits c/f 4,304 16,140 37,000 5,514
Exchange reserve* — *(6,076) *(6,706)
Share capital 10,000 4.000 40,000 60,000 (40,000) 60,000

14,304 50,064 97,000 107,064

5,161 3.500 18,064 50,200 68,264

Investment in HK Ltd — — 40,000 (40,000) —
Property, plant and 3,428 3.500 11,998 18,800 30,798
equipment
Bank balance 5,715 3.500 20,002 10,000 30,002
Payables — — (22,000) (22,000)

14,304 50,064 97,000 107,064

*For presentation, the exchange translation difference is recognized in other comprehensive

income and retained in an exchange translation reserve in equity. The proof of exchange
translation loss is as follows:

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 C$’000
Opening net assets [10,000 x (3.50 – 4.00)] 5,000
Increase in net assets [4,304 x (3.75 – 3.50)] 1,076

Total exchange loss reorganized in OCI 6,076

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