Chapter 7.translation of Foreign Currency Financial Statement

CHAPTER 7:
TRANSLATION OF FOREIGN
CURRENCY FINANCIAL
STATEMENTS
Hanoi, 2020
.VNU.EDU.VN - HTTP://IS.VNU.EDU.VN - HTTP://IS.VNU.EDU.VN
CHAPTER 7
This chapter focus on translation of foreign currency financial statement into

parent company report’ currency for purpose if preparing consolidated financial
statement.
Example:
INTERNATIONAL SCHOOL
CHAPTER TOPICS
• Conceptual issues of foreign currency financial

statements translation
• Difference between balance sheet exposure and
transaction exposure
• Methods of financial statement translation
• Temporal and current rate methods illustrated
• U.S. GAAP, IFRS, and other standards related to
translation
• Hedging of balance sheet exposure
LEARNING OBJECTIVES
1. Describe the conceptual issues involved in translating

foreign currency financial statements
2. Explain balance sheet exposure and how it differs from
transaction exposure
3. Describe the concepts underlying the current rate and
temporal methods of translation
4. Apply the current rate and temporal methods of translation
and compare the results of the two methods
5. Describe the requirements of applicable International
Financial Reporting Standards (IFRS) and U.S. generally
accepted accounting principles (GAAP)
6. Discuss hedging of balance sheet exposure
TWO CONCEPTUAL ISSUES
1. Appropriate exchange rate to be used in translating each

financial statement item
2. How should the translation adjustment that inherently

arises from the translation process be reflected in the
consolidated financial statements
BALANCE SHEET EXPOSURE
• Assets and liabilities translated at the current exchange

rate are exposed to risk of a translation adjustment
• When foreign currency appreciates, a net asset
exposure results in a positive translation adjustment
• When foreign currency appreciates, a net liability
exposure results in a negative translation adjustment
• Assets and liabilities translated at the historical
exchange rate are not exposed to a translation
adjustment
TRANSLATION METHODS
Four major methods of translating foreign currency financial

statements have been used worldwide:
(1) the current/noncurrent method,
(2) the monetary/nonmonetary method,
(3) the current rate (or closing rate) method and
(4) the temporal method
TRANSLATION METHODS
I. Current/Noncurrent Method
 Current assets and liabilities are translated at the
current exchange rate
 Noncurrent assets and liabilities and stockholders’
equity accounts are translated at historical exchange
rates
 There is no theoretical basis for this method
 Method is seldom used in any countries and is not
allowed by U.S. GAAP or IFRS
TRANSLATION METHODS
II. Monetary/Nonmonetary Method

 Concerns with monetary assets and liabilities
Translated at the current exchange rate
 Concerns with nonmonetary assets and liabilities and
stockholders’ equity accounts
Translated at historical exchange rates
• The translation adjustment measures the net foreign
exchange gain or loss on current assets and
liabilities as if these items were carried on the
parent’s books.
TRANSLATION METHODS
III. Current Rate Method

 Objective is to reflect that the parent’s entire
investment in a foreign subsidiary is exposed to
exchange risk
 All assets and liabilities are translated at the current
exchange rate
 Equity accounts are translated at historical exchange
rates
 Revenues and expenses are translated at Average
rate
TRANSLATION METHODS
IV. Temporal Method

– Objective is to translate financial statements
• As if the subsidiary had been using the parent’s
currency
– Items carried on subsidiary’s books at historical cost
• Including all stockholders’equity items, are translated
at historical exchange rates
– Items carried on subsidiary’s books at current value
are translated at current exchange rates
– Income statement items are translated at the
exchange rate in effect at the time of the transaction
TRANSLATION OF RETAINED EARNINGS
• Stockholders’ equity items are translated at historical

exchange rates under both the temporal and current rate
methods
 This creates somewhat of a problem in translating
retained earnings, which is a composite of many
previous transactions:
 Revenues, expenses, gains, losses, and declared
dividends occurring over the life of the company
Exchange Rates Used under the Current Rate
Method and the Temporal Method for Selected
Financial Statement Items
Exchange Rates Used under the Current Rate
Method and the Temporal Method for Selected
Financial Statement Items
COMPLICATING ASPECTS OF THE
TEMPORAL METHOD
• Keeping track of the historical rates for inventory, prepaid
expenses, fixed assets, and intangible assets is necessary
under temporal method and not under current rate method
 Translating these assets at historical rates makes
application of the temporal method more complicated than
the current rate method
 Calculation of Cost of Goods Sold (COGS)
 Fixed Assets, Depreciation, Accumulated
Depreciation
TEMPORAL METHOD
• Calculation of Cost of Goods Sold (COGS)
- Under Current rate method:
COGS in FC x Average ER = COGS in PC
- Under temporal method:
COGS in PC = Beginning in inventory in PC (1) + Purchases
in PC (2) – Ending in inventory in PC (3)
(1) Beginning inventory in FC x Historical ER (e.g. 4 th
Quarter Year 1) = Beginning in inventory in PC
(2) Purchases in FC x Average ER, Year 2 = Purchases in PC
(3) Ending in inventory in PC = Ending in inventory in FC x
Historical ER (e.g. 4th Quarter Year 2)
Example
In FC. In 2010
• Jan 1, 2010. Inventory : 600,000
• Purchase in 2010: 6,200,000
• Dec 31, 2010. Inventory: 800,000
• Rate:
Average of Jan, 2010 : FC=$1.00
Average of 2010: FC = $0.95
Average of December, 2010: FC= $0.91
Dec 31, 2010: FC= $0.90 – Current rate
Calculation COGs 2010 in PC under:

1. Current Rate method
2. Temporal Method
TEMPORAL METHOD
Fixed Assets, Depreciation, Accumulated Depreciation
• Under the temporal method
The fixed assets, accumulated depreciation acquired at
different times must be translated at different (historical)
exchange rates.
• Under current rate method
The fixed assets, accumulated depreciation acquired at
different times must be translated at current exchange rate.
Example?
EXAMPLE
• Jan 1, Year 1. Purchase FC1,000 with rate $1.00 per FC

• Jan 1, Year 2. Purchase FC4,000 with rate $1.20 per FC
• Both equipment have a five-years useful life.
• Dec 31, Year 2. Exchange rate is $1.50 per FC
• Average Exchange rate is $1.40 per FC
I. Under current rate method
II. Under temporal method
1. Assets value in Dec 31, year 2 in PC ($)
2. Depreciation Expense Year 2 in PC ($)
3. Accumulated depreciation at Dec 31, Year 2
DISPOSITION OF TRANSLATION
ADJUSTMENT
• Translation gain or loss in net income
– Translation adjustment is considered to be a gain or loss
analogous to the gains and losses arise from foreign
currency transaction
– Should be reported in income in the period in which the
fluctuation in exchange rate occurs
• Cumulative translation adjustment in stockholders’ equity
– The alternative to reporting the translation adjustment as a
gain or loss in net income is to include it in stockholders’
equity as a component of other comprehensive income
– This treatment defers the gain or loss in stockholders’ equity
until it is realized in some way
Translation Process Illustrated
• Translation of financial Statements: Current Rate Method

• Example:
• Translation of financial Statements: Temporal Method

• Example:
Comparison of the results from applying the
two different methods
• The use of different translation methods can have a
significant impact on consolidated financial Statements
Items Translation Method

Current Rate Temporal Difference
Net income 772.800 806.600 + 4,4%
Total Assets 3.485.300 3.614.100 + 3,7%
Total Equity 1.365.000 1.493.800 + 9,44%
Return on 56,62% 53,99% -4,63%

equity
TEMPORAL AND CURRENT RATE METHODS
Translation methods illustrated

• U.S. Inc. owns Juarez, SA, a subsidiary in Mexico which
was established January 1, 2010
• Juarez’s balance sheet items as of 12/31/10, in pesos:
Cash 1,000 Accounts payable 2,000
Accounts rec. 2,000 Long-term debt 6,000
Inventory 2,500 Capital stock 3,000
Fixed assets 8,000 Retained earnings 1,500
Accum. depr. 1,000
• Translation methods illustrated

• Juarez’s income statement items for 2010, in pesos:
Sales 20,000 Depr. exp. 1,000
COGS 14,000 Interest exp. 500
S,G,&A exp. 2,500 Income tax exp. 500

– There was no beginning inventory
– Inventory, which is carried at cost, was acquired
evenly during the last quarter of 2010
– Purchases were made evenly throughout year
– Fixed assets were acquired on January 1, 2010
– Capital stock was sold on January 1, 2010

• Relevant exchange rates (U.S. dollar per Mexican peso):
January 1, 2010 $0.10
Average for 2010 $0.095
Average for 4th quarter 2010 $0.09
December 31, 2010 $0.08
• Current Rate Method – Income Statement

Income Statement – 2010
Sales 1,900
COGS 1,330
Gross profit 570
S,G,&A 238
Depreciation expense 95
Interest expense 48
Income tax expense 47
Net income 142
• Current Rate Method – Balance Sheet
Balance Sheet – December 31, 2010

Cash 80 Accounts payable 160
Accounts Rec. 160 Long-term debt 480
Inventory 200 Capital stock 300
Fixed Assets, net 545 Retained earnings 142
Total assets 985 Cumulative translation adj. (97)
Total liab. & S.E. 985
• Temporal Method – Income Statement
Income Statement – 2010

Sales 1,900
COGS 1,343
Gross profit 557
S,G,&A 238
Depreciation expense 100
Interest expense 48
Income tax expense 47
Remeasurement gain 101
Net income 225
• Temporal Method – Balance Sheet

Balance Sheet – December 31, 2010
Cash 80 Accounts payable 160
Accounts Rec. 160 Long-term debt 480
Inventory 225 Capital stock 300
Fixed Assets, net 700 Retained earnings 225
Total assets 1,165 Total liab. & S.E. 1,165
Translation methods illustrated – Summary

• Current Rate Method
– All assets and liabilities are translated at current rate
– This results in net asset exposure
– Net asset exposure and devaluing foreign currency results in
translation loss
– Translation adjustment included in equity
• Temporal Method
– Primarily monetary assets and liabilities are translated at current
rate
– This results in net liability exposure
– Net liability exposure and devaluing foreign currency result in
translation gain
– Translation gain included in current income
End of Chapter 7

Chapter 7.translation of Foreign Currency Financial Statement

Uploaded by

Copyright:

Available Formats

You might also like

Chapter 7.translation of Foreign Currency Financial Statement

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 7.translation of Foreign Currency Financial Statement

Uploaded by

Copyright:

Available Formats

CHAPTER 7:

This chapter focus on translation of foreign currency financial statement into

• Conceptual issues of foreign currency financial

1. Describe the conceptual issues involved in translating

TWO CONCEPTUAL ISSUES

1. Appropriate exchange rate to be used in translating each

2. How should the translation adjustment that inherently

BALANCE SHEET EXPOSURE

• Assets and liabilities translated at the current exchange

Four major methods of translating foreign currency financial

II. Monetary/Nonmonetary Method

III. Current Rate Method

IV. Temporal Method

TRANSLATION OF RETAINED EARNINGS

• Stockholders’ equity items are translated at historical

Calculation COGs 2010 in PC under:

• Jan 1, Year 1. Purchase FC1,000 with rate $1.00 per FC

Translation Process Illustrated

• Translation of financial Statements: Current Rate Method

• Translation of financial Statements: Temporal Method

Items Translation Method

Total Equity 1.365.000 1.493.800 + 9,44%

Return on 56,62% 53,99% -4,63%

TEMPORAL AND CURRENT RATE METHODS

Translation methods illustrated

TEMPORAL AND CURRENT RATE METHODS

• Translation methods illustrated

TEMPORAL AND CURRENT RATE METHODS

• Translation methods illustrated

TEMPORAL AND CURRENT RATE METHODS

• Translation methods illustrated

TEMPORAL AND CURRENT RATE METHODS

• Current Rate Method – Income Statement

TEMPORAL AND CURRENT RATE METHODS

• Current Rate Method – Balance Sheet

Balance Sheet – December 31, 2010

TEMPORAL AND CURRENT RATE METHODS

• Temporal Method – Income Statement

Income Statement – 2010

TEMPORAL AND CURRENT RATE METHODS

• Temporal Method – Balance Sheet

TEMPORAL AND CURRENT RATE METHODS

Translation methods illustrated – Summary

You might also like