TRANSLATING FOREIGN STATEMENTS: THE TEMPORAL METHOD

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CHAPTER 19

• TRANSLATING FOREIGN STATEMENTS THE TEMPORAL
  METHOD THE FUNCTIONAL CURRENCY CONCEPT

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FOCUS OF CHAPTER 19

• The Temporal Method of Translation
• The Objectives of Translation under FAS 52
• The Functional Currency Concept
• U.S. Taxation of Foreign Subsidiary Earnings

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The Temporal Method The Definition of Temporal

• The dictionary defines temporal as of or
  nearthe temples (of the head).Not much help
  there!
• Furthermore, the termtemporal is not
  specifically used in FAS 52.

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The Temporal Method Temporal--The Defining
Moment

• The term temporal first appeared as an
  accounting term in AICPA Research Study No. 12
  (1972).
• Defined Expressing foreign currency amounts in
  dollars without changing their attributes.
• Attribute The manner of valuing an item (such
  as cost, LCM, NRV, FMV).

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The Temporal Method Dont Make Any Changes

• Use exchange rates for assets and
  liabilitiesthat result in preserving the
  VALUATION BASIS.
• Assets carried at value-based prices are
  expressed in dollars using the spot rate.
• Assets carried at historical cost are expressed
  in dollars using historical rates.

WSJ 12/31/04.... 1.44
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The Temporal Method Identifying The Driver

• SUMMARY The valuation basis is the
  driver--that is, the determinant of the
  exchange rate to use to translate an asset or
  liability. Thus the driver must be identified.

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The Temporal Method Whats Relevant and Whats
NOT

• What is relevant?
• How it is valued (cost, LCM, NRV, FMV).
• Whats not relevant?
• Whether it is current or noncurrent(in the
  balance sheet).
• Maintaining the account item relationships that
  exist in the foreign currency statements.

Sustained
Overruled
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The Temporal Method What Winds Up Being the
Focus?

• The result of applying the temporal method
  generally enables one to view the method as a
  focus on the net monetary position
• Monetary Assets gt Monetary Liabilities A
  net monetary asset position.
• Monetary Assets lt Monetary Liabilities A
  net monetary liability position.

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The Temporal Method Is It Monetary or Is It
Nonmonetary?

• Monetary Items
• Cash and accounts obligated to be settled in cash
  (includes investments in BONDS they have a due
  date).
• Nonmonetary Items
• Accounts that are not monetary items (includes
  investments in STOCKS).

Oil
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The Temporal Method The Income
Statement--Which Rates?

• Items Not Having Passed Through the B/S
• Use spot rate at date when the item was
  recognized in the income statement.
• Items Having Passed Through the B/S
• Use historical spot rate--the rate at the date
  the item entered the balance sheet.

WSJ 4/15/04.... 1.61
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The Temporal Method Just Passing Through to P/L

• Items That Pass Through the B/S on Their Way to
  the Income Statement
• Inventory
• Depreciable fixed assets
• Intangible assets
• Prepaid expenses
• Deferred charges
• Unearned income

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The Temporal Method Compared With the Current
Rate Method--P/L

Current Rate Temporal
Method
Method Rates to be used for Items not having
passed through the B/S......................
CR CR Items having
passed through the B/S......................
CR HR Type of rate for
items having passed through the B/S.........
EXIT ENTRY
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The Temporal Method What and Where Time!

• WHAT are the effects of exchange rate changes
  called?
• Remeasurement Gains and Losses
• WHERE are the effects of exchange rate changes
  reported?
• In earnings.

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The Temporal Method Again, The FASB Is NOT
Consistent

• FASB says
• Whether the effects of exchange rate changes as a
  result of using the temporal method are
  unrealized is not relevant--MUST REPORT CURRENTLY
  IN EARNINGS.
• Whether the effects of exchange rate changes as a
  result of using the current rate method are
  unrealized is relevant--CANNOT REPORT CURRENTLY
  IN EARNINGS .

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The Temporal Method Method Achieves Inflation
Adjusted Reporting
Assumptions Foreign unit buys land on 1/1/04
when the direct exchange rate is 1.00. Foreign
country has 25 inflation in 2004. Exchange
rate at 12/31/04 is .80--the .20 decrease is
due entirely to the foreign inflation.
LCUs
Exchange Rate U.S. Dollars
1/1/04.............. 1,000 HC x 1.00
HR 1,000 HC Inflation adj.. 250
x (.20) -0-
12/31/04.......... 1,250 CV x .80
CR 1,000
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The Functional Currency ConceptCreated By A
Mere 43 Vote

• SUMMARY OF FUNCTIONAL CURRENCY CONCEPT
• For each foreign unit, identify the currency it
  primarily uses to generate and expend cash.
• If a foreign currency, use the current rate
  method.
• If the U.S. dollar, use the temporal method.

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The Functional Currency ConceptPresumed Types
of Foreign Operations

• Relatively Autonomous Units
• Expected to have the foreign currency as the
  functional currency.
• Relatively Nonautonomous Units
• Expected to have the U.S. dollar as the
  functional currency.

Observation In the real world, its not that cut
and dried.
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The Functional Currency ConceptWhen To
Disregard FASBs Indicators

• When Operating in a
• Highly Inflationary Economy
• (approximately 100 cumulative inflation over
  3-year period) --
• Must use the temporal method.

Currency depreciates in value.
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Distinguishing Translationfrom Remeasurement

• TRANSLATION (current rate method)
• REMEASUREMENT (temporal method)

Functional Currency (Francs)
Reporting Currency (U.S. Dollar)
Nonfunctional Currency (Pesos)
Functional ( Reporting) Currency (U.S. Dollar)
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Review Question 1

• Under the temporal method, which of the following
  accounts is translated into dollars using only
  the current exchange rate? A. Purchases. B.
  Cost of sales. C. Depreciation expense. D.
  Gain on equipment disposal. E. Retained
  earnings (ending balance). F. Injury loss
  settlement. G. None of the above.

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Review Question 2

• Under the temporal method, which of the following
  accounts is translated into dollars using the
  historical exchange rate? A. Inventory (LIFO).
  B. Income tax expense.C. Patent amortization
  expense. D. Deferred income taxes payable.E.
  Deferred charges.F. Bonds Payable
  (long-term).G. None of the above.

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End of Chapter 19 (Appendix material follows)

• Time to Clear Things Up--Any Questions?

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U.S. Taxation of Foreign Subsidiary Earnings
Overall Perspective

• FOREIGN SUBSIDIARIES
• Cannot file a consolidated tax return with their
  U.S. parent.
• U.S. PARENTS OF FOREIGN SUBSIDIARIES
• Cannot use the dividends received deduction.
• Can use foreign tax credits.

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U.S. Taxation of Foreign Subsidiary Earnings
FASBs Rules

• FASB Says
• Record parent-level taxes on foreign subs income
  in the year the income is earned.
• Exception If subs earnings are expected to be
  REINVESTED INDEFINITELY, no parent-level taxes
  need be recorded.

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U.S. Taxation of Foreign Subsidiary Earnings
We Changed Our Minds

• Change in Circumstances Concerning Reinvestment
  of Earnings
• Treat as a change in estimate.
• Unrecord taxes already recorded or record taxes
  that have not been recorded.
• Do not restate prior periods.

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U.S. Taxation of Foreign Subsidiary Earnings
The Fly in the Ointment

• The Dividend Withholding Tax
• The tax is paid to the foreign government at the
  time of the dividend payment.
• The taxes paid are recorded as tax expense on the
  parents books--it is a tax to the RECIPIENT.