FOREIGN CURRENCY FINANCIAL STATEMENTS

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FOREIGN CURRENCY FINANCIAL STATEMENTS

• Chapter 6

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SFAS No. 52 Goal

• Establish standards for converting account
  balances measured in foreign currencies into U.S.
  dollar equivalents
• Goal to enable preparation of journal entries
  and, if appropriate, consolidated financial
  statements

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SFAS No. 52 Objectives

• To provide information generally compatible with
  the expected economic effects of an exchange rate
  change on an cash flows and equity

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SFAS No. 52 Objectives

• Attributes of Compatibility
• Regarding equity exists when changes in
  exchange rates result in comparable changes in
  equity

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SFAS No. 52 Objectives

• Attributes of Compatibility
• Regarding cash flow exists when changes in
  exchange rates that impact cash flows appear on
  the income statement and changes that do not
  impact cash flows do not appear on the income
  statement

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SFAS No. 52 Objectives

• Reflect in consolidated statements the financial
  results and relationships of the individual
  consolidated entities as measured in their
  functional currencies in conformity with U.S.
  generally accepted accounting principles

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Currencies

• Local currency currency of the country where
  the foreign entity is located
• Functional currency currency of the entitys
  primary economic environment
• Reporting currency currency used by the parent
  company
• Foreign currency currency other than the
  entitys functional currency

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Identifying Functional Currency

• Foreign currency is the functional currency when
• Foreign operation relatively self-contained
• Operations not dependent on parents economic
  environment
• Operating unit generates and expends foreign
  currency
• Net cash flows can be reinvested or converted and
  distributed to parent

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Identifying Functional Currency

• Parent currency is the functional currency when
• Foreign operation are an extension of parents
  operations
• Operations are dependent on parents economic
  environment
• Change in assets and liabilities directly impact
  parents cash flows

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Highly Inflationary Environment

• Foreign currency is too unstable to be functional
  currency
• High inflation may distort asset and liability
  values when converted into U.S. dollars
• Highly inflationary is defined as cumulative
  three year inflation rate approximately 100
  percent

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Steps in Converting Foreign Financial Statements

• Modify foreign info. to conform to U.S. GAAP
• Temporal Method
• Remeasure (if necessary) foreign subsidiarys
  trial balance into the functional currency
• Current Rate Method
• Translate (if necessary) foreign subsidiarys
  trial balance into parent reporting currency

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Date of Acquisition Foreign Subsidiary
Consolidation

• All subsidiary trial balance accounts are
  converted into U.S. dollars using the date of
  acquisition exchange rate
• (Market value book value) in U.S. dollars is
  purchase differential
• Worksheet elimination prepared using U.S. dollar
  amounts

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Subsequent to Date of Acquisition

• Foreign financial information is converted into
  U.S. dollars using the temporal and/or current
  rate methods
• If parent has significant influence, equity
  method journal entries are prepared
• If parent has control, consolidated financial
  statements are prepared

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Temporal Method

• Purpose revalue financial records so they
  appear as they would if maintained in functional
  currency
• Monetary accounts converted at balance sheet date
  exchange rate
• Nonmonetary accounts (balance sheet and
  associated income statement accounts) converted
  at historical exchange rates
• Equity accounts converted using historical
  exchange rates

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Example Temporal Monetary Accounts

• Illustration 4
• (all amounts in thousands)
• Dec 31
• Account Zloty Ex Rate Dollars
• Cash 2,650 .22 583
• A/Rec 2,810 .22 6,18.2
• C/Liab 5,200 .22 1,144

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Example Temporal Monetary Accounts

• Spot rate results in dollar amount that would be
  given up or received if monetary account were
  settled on the balance sheet date

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Example Temporal Nonmonetary Accounts

• Illustration 4 Cost of Goods Sold
• (all amounts in thousands)
• Zloty Ex Rate Dollars
• Beg Inv 3,590 .24 861.6
• Purchase 11,130 .20 2,226.0
• Available 14,720 3,087.6
• End Inv 5,220 .18 939.6
• COGS 9,550 2,148.0

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Example Temporal Nonmonetary Accounts

• Converting inventory at date of inventory
  purchase exchange rate maintains historical cost
  in functional currency (U.S. dollar) under
  temporal method
• Average exchange rate is used for purchases
  because of large number of purchase transactions

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Example Temporal Income Statement Excluding Items
Associated with Nonmonetary Accounts

• Remeasure using the average exchange rate for the
  period

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Example Temporal Equity Accounts

• Stock and Additional Paid in Capital Exchange
  rate that existed at date of acquisition
  (historical rate)
• Dividends Exchange rate that existed at the
  declaration date
• Retained Earnings Date of acquisition amount
  (in U.S. dollars) plus income (in U.S. dollars)
  less dividends declared (in U.S. dollars)

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Balancing Temporal Method Trial Balance

• After remeasuring all trial balance accounts
• Debit or Credit usually needed to equate debits
  and credits
• Balancing debit or credit Adjustment is
  Remeasurement Gain or Loss
• Remeasurement Gain or Loss included in
  measurement of income (See Illustration 6)

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Equity Method Journal Entries Temporal Method

• Journal Entries identical in number and format to
  domestic subsidiary
• Recognition of Pratts ownership interest in
  Fabrykas net income
• Recognition of Pratts ownership interest in
  dividends declared by Fabryka
• Amortization of Pratts purchase differentials

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Worksheet Eliminations Temporal Method

• Worksheet eliminations identical in number and
  format to domestic subsidiary basic worksheet
  eliminations

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Current Rate Method

• Purpose convert the trial balance into the
  reporting currency with as little change in the
  relationships as possible

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Example Current Rate Method Balance Sheet Accounts

• All asset and liability accounts translated at
  balance sheet date exchange rate (current rate)
• One exchange rate is used because only the unit
  of measure is changed, relationships among
  accounts held constant, where possible

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Example Current Rate Method Balance Sheet Accounts

• Stock and Additional Paid in Capital Translate
  using exchange rate that existed at date of
  acquisition (historical rate)
• Retained Earnings Date of acquisition amount
  (in U.S. dollars) plus income (in U.S. dollars)
  less dividends declared (in U.S. dollars)

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Example Current Rate Income Statement Accounts

• Translate all income statement accounts using the
  average exchange rate for the period

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Example Current Rate Method Equity Accounts

• Stock and Additional Paid in Capital Exchange
  rate that existed at acquisition date
  (historical rate)
• Dividends Exchange rate that existed at the
  declaration date
• Retained Earnings Date of acquisition amount
  (in U.S. dollars) plus income (in U.S. dollars)
  less dividends declared (in U.S. dollars)

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Balancing Current Rate Method Trial Balance

• After translating all trial balance accounts
• Balancing Debit or Credit usually needed to
  equate debits and credits
• Balancing debit or credit is Cumulative
  Translation Adjustment
• Cumulative Translation Adjustment is separate
  equity adjustment (not included in the
  calculation of net income)