Foreign Currency Financial Statements1.ppt

1、Translating the financial statements of foreign operations,1,Foreign Currency Financial Statements,Foreign Currency Financial Statements,2,1: Functional Currency,Functional Currency,3,For an entitys financial statements to provide relevant information: All transactions and events must be expressed i

2、n a common unit of measurement So all transactions must be translated into functional currency Currency of the primary economic environment in which the entity operates How would you determine an entitys functional currency?,Determining Functional Currency,Guidelines: Customer receipts Liability pay

3、ments Other factors Setting of sales prices currency that mainly influences sales prices Sales market where is it? Expenses currency that mainly influences the cost of providing goods and services Financing Intercompany transactions,4,Determining functional currency (cont),How would you determine fu

4、nctional currency for a company which: Is incorporated in 1 country; Has the majority of its shareholders in another country; and Does the majority of its business in yet another country? May choose currency of country of incorporation But this will not always result in useful financial statements,5

5、,Determining functional currency (cont),Red Ltd is an Australian company listed on the Australian Securities Exchange (ASX) and the New York Stock Exchange (NYSE): It sources most of the labour for manufacturing its products from several Asian-Pacific countries. All sales of its product are invoiced

6、 in US dollars and the majority of its debt is with US banks. The past three share issues by Red Ltd have been on the NYSE. Its shareholders are located as follows: New York (15%), Australia (75%) and Tonga (10%).,6,Determining functional currency (cont),Identify the functional currency of Red Ltd T

7、he functional currency of Red Ltd is US dollars. Although the cost of labour depends on the currency of several unspecified Asian-Pacific countries there is more evidence to support US dollars as the functional currency. The indicators that suggest this are the invoicing of sales in US dollars, hold

8、ing the majority of its debt with US banks and using the NYSE as the location for the three most recent share issues,7,Reporting currency,Once a reporting entity has identified its functional currency. the next step is to choose its presentation currency. the currency in which the financial statemen

9、ts are presented may differ from the functional currency. How would you determine presentation currency of an entity?,8,Reporting currency (cont),What is the reporting currency of Red Ltd likely to be? Only one reporting currency is allowed Since Red Ltd is an Australian company with 75% of its shar

10、eholders located in Australia, it seems reasonable to expect that its reporting currency would be Australian dollars. However, since its functional currency is US dollars, it is possible that Red Ltd would select US dollars as its reporting currency. The ultimate decision would rest with the managem

11、ent of Red Ltd.,9,Foreign based operations,When reporting currency is different from the reporting entitys functional currency the functional currency financial statements of each entity within the reporting entity (e.g. parent, subsidiaries, associates) are restated into the entitys presentation cu

12、rrency This topic - illustrate restatement of financial statements of foreign based operations.,10,Foreign Currency Financial Statements,11,2: Functional Currency Determines Method,Foreign based operation,An entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the a

13、ctivities of which are conducted in a currency other than that of the reporting entity.,12,Objective of restatement,The purpose of restating financial statements to reporting currency is to express the underlying amounts, as measured in the functional currency. in a different currency The parent ent

14、ity must restate the financial statements of the foreign-based operation into its reporting currency before it can combine or consolidate them with its financial statements,13,Objective of restatement (cont),The main objective of restatement is not to evaluate the performance of the managers of the

15、foreign operations, but to incorporate the results of the foreign operations into the economic entitys financial statements. The restatement must preserve financial results and relationships in the foreign financial statements,14,Important to note:,The restatement procedure involves work-sheet adjus

16、tments only. Restatement involves no entries in the books of the parent entity or any associated overseas operation. After each item in the financial statements of the overseas operation has been translated into the presentation currency, the statements will probably not balance. The balancing item

17、is an exchange difference,15,Restatement Methods,Temporal method Current rate method Choice depends on functional currency of the foreign based operation,16,Restatement Methods,Current rate method Use if the reporting currency and the functional currency of the foreign entity are the same Example: U

18、s companys French subsidiary uses Euro as its recording and functional currency Translate foreign entity financial statements into parent entitys reporting currency exchange rate fluctuations will not affect the reporting entitys (groups) cash flows Effects are reported as adjustments in OCI,17,Rest

19、atement Methods,18,Temporal method Use if functional currency is the currency of the parent (in your text: US dollars), not the local currency but reporting currency is local currency Requires remeasurement into the functional currency Requires use of various exchange rates Remeasurement of monetary

20、 assets and liabilities will affect reporting entitys income Not commonly used,Restatement Methods (cont),Examples: A Mexican subsidiary of a US firm has the Peso as its functional currency.,19,Restatement Methods (cont),A Japanese subsidiary of a US firm has the US dollar as its functional currency

21、.,20,Restatement Methods (cont),An Australian subsidiary of a US firm, keeping its own records in Australian dollars, determines its functional currency is the euro.,21,Temporal method - remeasurement,Monetary assets and liabilities are: Translated at the current exchange rate (at financial year end

22、) Other assets and liabilities, equity and dividends are: Translated at the rates current when the transactions occurred (historical rates) Retained earnings is not restated For income statement items: Historical rates BUT - The average rate for the period is usually applied This method results in a

23、 translation gain or loss: included in the income statement as part of profit,22,Current-rate method - translation,Assets and liabilities are translated at the current exchange rate Income statement items are translated at the exchange rate current when the transactions occurred (use an average rate

24、 usually) Equity items other than retained earnings are translated at historical rates Dividends at rate on date of declaration Any translation gain or loss is accumulated in shareholders equity as OCI,23,Assets,24,Liabilities and Equity,25,Remeasurement Translation,Revenues and Expenses,26,Remeasur

25、ement Translation,Note that current rate, as used for income statement items, is usually the average rate for the year. Firms with seasonal business fluctuations would use a weighted average rate.,Foreign Currency Financial Statements,27,3: Highly Inflationary Economy,Inflation and Functional Curren

26、cy,28,ignore this section in your textbook you are not required to know this,Foreign Currency Financial Statements,29,4: Translation on Acquisition Date,Translation at Acquisition,30,Foreign assets and liabilities are translated using the current rate method. If functional currency = local currency

27、Translation is appropriate Analysis of fair value/book value differentials is performed in local currency Results are translated at current rates,Remeasurement at Acquisition,31,Foreign assets and liabilities are translated using the current rate method. If functional currency = US$ or reporting cur

28、rency 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,32,For both, remeasurement and translation, the consolidation process is applied

29、 to the financial statements as restated in US$. Measures of noncontrolling interest, noncontrolling interest share, and controlling interest share are computed in US$.,33,5: Current Rate Method and Temporal Method,Foreign Currency Financial Statements,Current Rate Method,34,Translating the adjusted

30、 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 years translated amounts If first year, use historical rate Revenues = avera

31、ge rate,Subtotal debits and credits. The difference is accumulated other comprehensive income from the translation adjustment.,Translation,35,All assets are at year end rates. Expenses are at the average rate for the year. The accumulated OCI from the translation adjustment is calculated last, after

32、 credits (next slide).,Translation (cont.),36,Contra assets and liabilities are at year end rate. Revenues and expenses are at average rate for the year. Subtotal debits and credits. The debits happen to be $28,600 less than the credits. This is the debit to accumulated OCI at the end of the year.,T

33、emporal Method,37,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

34、Use last years 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.,Remeasurement Worksheet,38,Cash and receivables use year end rate.

35、 Dividends and Advance are reciprocal amounts from parent. The exchange loss is the last step in the worksheet. It balances the debits with the credits (next slide).,Remeasurement (cont.),39,Accumulated depreciation uses the same rate as the plant assets and their depreciation expense. Bonds payable

36、 are monetary and use the year end rate like other receivables and payables. Adding the debits and credits will find that the debits are $3,300 less than the credits. This is the exchange loss.,40,6: Translation Adjustments and Remeasurement Gain/Loss,Foreign Currency Financial Statements,Balancing

37、the Worksheet,41,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,

38、42,Remeasurement (temporal) 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 (current rate) results in Translation adjustment, part of accumulated other comprehensive i

39、ncome Include as part of stockholders equity Debit to balance = deduct from equity Credit to balance = add to equity,43,7: Equity Method for Foreign Investments,Foreign Currency Financial Statements,Equity Method Investee,44,A US firm has a foreign investment it accounts for under the equity method.

40、 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,Equity Method Entries,4

41、5,The income is from the translated income statement, with appropriate amortizations for fair value/book value differences. OCI will be debited or credited for the change in that account during the period.,Amortization of differentials,46,On 12/31/08, Pat acquired Star. Star had unrecorded patent of 100,000. The exchange rate was $1.50. The patent is amortized over 10 years. The average and year end exchange rates are $1.45 and $1.40.,47,8: Consolidation of Foreign Subsidiaries,Foreign Currency Financial Statements,Consolidating