A.Translating Foreign Currency Financial Statements
1
C10.0022-Notes – 11/18/02
©John Bildersee 2002
A.Translating foreign currency financial statements
1.Statement of foreign sub reported in the foreign currency
2.Has to be converted into US currency
3.Balance sheet balances could be translated based on the rate existing at the time of the original event
a.Called the historical rate
b.No reported exchange gains or losses
4.Balance sheet balances could be translated based on exchange rate at that time
a.Called the current rate
b.Translation rate changes from time to time
i)Result is an exchange gain or loss
ii)Called a translation gain or loss
iii)The difference between dollar equivalents of a constant foreign currency balance at two points in time
(1)Stronger foreign currency increases dollar values
(2)Weaker foreign currency reduces dollar values
B.Application issues under SFAS 52
1.Need to determine the way to convert from one currency to another
a.Translation using the temporal method (used in SFAS 8)
b.Translation using the current method
2.Need to determine the relative importance of the currencies used by the firm
a.Reporting currency ($)
b.Functional currency (major foreign currency)
c.Local currency (minor foreign currency)
3.Deal with translation issues first
4.Deal with currency definitions later
C.Translation methods
1.Temporal method
a.Current rate used
i)Monetary assets
ii)Items valued at current prices
iii)Cash, A/R, inventories carried at market, most liabilities
b.Historical rate used
i)Nonmonetary assets
ii)Items valued at historical cost
iii)PPE, inventories carried at cost
c.Exposed position
i)Based on items translated at current prices
ii)Monetary Assets – monetary liabilities
(1)Assets > liabilities -> gain when US currency weakens
(2)Assets > liabilities -> loss when US currency strengthens
(3)Assets < liabilities -> loss when US currency weakens
(4)Assets < liabilities -> gain when US currency strengthens
d.Translation gain or loss is reported in company’s net income
i)Income is remeasured
ii)Today called remeasurement.
2.Current rate method
a.Assets and liabilities translated at current rate
b.Historical rate used for contributed capital accounts
c.Average rate for current period for revenue and expense accounts
d.Exposed position
i)All assets – all liabilities
(1)Assets > liabilities -> gain when US currency weakens (Net debit position and $/fc rises}
(2)Assets > liabilities -> loss when US currency strengthens
(3)Assets < liabilities -> loss when US currency weakens
(4)Assets < liabilities -> gain when US currency strengthens
e.Translation gain or loss is NOT reported in the income statement
f.Translation gain or loss is reported as ‘Other Comprehensive Income’
g.Accumulated in shareholders’ equity section of the statement
D.Summary of temporal method
1.Monetary accounts translated at current rate
2.Real assets and capital stock translated at historical rate
3.Income statement accounts
a.At historical rates
b.Most items turn over quickly so this may be average for the year
4.Results carried in the income statement
5.Start with beginning position at beginning rate
a.Add sales at correct rate
b.Subtract expenses at correct rate
c.May be average rate
6.Gives translated position based on history and events
7.Calculate ending position at ending rate
a.Difference between translated position and calculated ending position is the translations adjustment
b.This is a plug
E.Summary of current rate method
1.All accounts translated at current rate
2.Income statement accounts
a.At average rate
b.Irrespective of timing of flows
3.Results for year in shareholders’ equity account
a.Income not affected by translation problems
b.More sources of change than temporal method
4.Start with beginning (net asset) position at beginning rate
5.Add increases in net assets at current rate
6.Gives translated position based on history and events
7.Calculate ending position at ending rate
a.Difference between translated position and calculated ending position is the translations adjustment
b.This is a plug
F.Summary of both
1.Adjustments are imperfect
2.Variety of rates
3.Results cannot be exact
4.Net result is an approximation
5.Adjustments are basically a sophisticated plug
a.Temporal method – historical rates designed to maintain old values in a new world
b.Current method – mix of beginning average and ending rates so that translation is a plug
c.On sale results could leave a shadow of the foreign sub
i)Translation leftover is removed
ii)Adds to gain or loss on sale
iii)Per SFAS 52 – “In the period in which sale or liquidation occurs, the cumulative translation adjustment related to the particular entity must be removed from other comprehensive income and reported as part of the gain or loss on sale of the investment.”
iv)Removes plug
G.Relationships among currencies under SFAS 52
1.Companies may do business in several currencies
2.Different currencies for different firms
3.Coca Cola has about 60 currencies
4.Company currencies
a.All parts of a company have a local currencies
b.Local currency can be the reporting currency – US GAAP - dollars
c.Local currency can be a functional currency – major foreign currency for firm – permanent presence in firm
i)Cash Flow indicators – in functional currency
ii)Sales related indicators – local economic forces
iii)Expense indicators
iv)Financing indicators – local sources
v)Intercompany relationship indicators – not strong
vi)Functional currency can also be a reporting currency
vii)U.S. currency is also a functional currency
d.Local currency can be a truly local currency – minor foreign currency for firm – could have temporary presence in firm
i)Company is not heavily invested in area
ii)Sales office
iii)Sales in other currencies
iv)Reliance on other countries for funding
H.Relationships among a company’s currencies
1.Going from a truly local currency to a functional currency
a.Called remeasurement of translation
b.Use temporal method – affects income
2.Going from a truly local currency to a reporting currency
a.Called remeasurement – affects income
b.Use temporal method of translation
3.Going from a functional currency to a reporting currency
a.Called translation
b.Use current rate method
i)No impact on income
ii)Really a convenience measurement
4.Can go from truly local currency to functional currency to reporting currency
a.If sales branch is an extension of foreign operation and foreign operation has to be translated to US dollars.
b.First, remeasurement into functional currency
c.Impacts income of major foreign sub
d.Then, translate into reporting currency
e.Translation affects shareholders’ equity