CHAPTER 19

1. CHAPTER 19 TRANSLATING FOREIGN STATEMENTS: THE TEMPORAL METHOD & THE FUNCTIONAL CURRENCY CONCEPT

2. 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

3. 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.

4. 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”).

5. The Temporal Method: “Don’t Make Any Changes” • Use exchange rates for assets and liabilitiesthatresult 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

6. 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.

7. The Temporal Method: What’s Relevant and What’s NOT “Sustained” • What is relevant? • How it is valued (cost, LCM, NRV, FMV). • What’s notrelevant? • Whether it is current or noncurrent(in the balance sheet). • Maintaining the account item relationshipsthatexist in theforeign currency statements. “Overruled”

8. 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 > Monetary Liabilities = A net monetary assetposition. • Monetary Assets <Monetary Liabilities= A net monetary liabilityposition.

9. 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

10. The Temporal Method: The Income Statement--Which Rates? • Items Not Having Passed Through the B/S: • Use spot rateat date when the item was recognized in the income statement. • Items HavingPassed Through the B/S: • Usehistorical spot rate--the rate at the date the item enteredthe balance sheet. WSJ 4/15/04.... $1.61

11. 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

12. The Temporal Method:Compared With the Current Rate Method--P/L Current Rate Temporal MethodMethod 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

13. The Temporal Method: What and Where Time! • WHAT are the effects of exchange rate changescalled? • “Remeasurement Gains and Losses” • WHERE are the effects of exchange rate changes reported?” • In earnings.

14. 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 unrealizedis relevant--CANNOTREPORT CURRENTLY IN EARNINGS .

15. 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. LCUsExchange RateU.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

16. The Functional Currency Concept:Created By A Mere 4:3 Vote • SUMMARY OF FUNCTIONAL CURRENCY CONCEPT: • For each foreign unit, identify the currency itprimarily uses to generate and expend cash. • If a foreign currency, use the current rate method. • If the U.S. dollar, use the temporal method.

17. The Functional Currency Concept:Presumed Types of Foreign Operations • Relatively AutonomousUnits: • Expected to have the foreign currency as the functional currency. • Relatively NonautonomousUnits: • Expected to have the U.S. dollar as the functional currency. Observation: In the real world, its not that cut and dried.

18. The Functional Currency Concept:When To Disregard FASB’s Indicators • When Operating in a Highly Inflationary Economy (approximately 100% cumulative inflation over 3-year period) -- • Mustuse the temporal method. Currency depreciates in value.

19. Distinguishing “Translation”from “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)

20. 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.

21. 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.

22. End of Chapter 19(Appendix material follows) • Time to Clear Things Up--Any Questions?

23. 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.

24. U.S. Taxation of Foreign Subsidiary Earnings: FASB’s Rules • FASB Says: • Record parent-level taxes on foreign sub’s income in the year the income is earned. • Exception: If sub’s earnings are expected to be REINVESTED INDEFINITELY, no parent-level taxes need be recorded.

25. 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 orrecord taxes that have not been recorded. • Do not restate prior periods.

26. 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 parent’s books--it is a tax to the RECIPIENT.