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Translation of Foreign Financial Statements

Translation of Foreign Financial Statements. Foreign currency translation. The process of expressing amounts denominated or measured in foreign currencies into amounts measured in the reporting currencies of the domestic entity. FASB’s Statement No. 52. Adopted a functional currency approach

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Translation of Foreign Financial Statements

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  1. Translation of Foreign Financial Statements

  2. Foreign currency translation • The process of expressing amounts denominated or measured in foreign currencies into amounts measured in the reporting currencies of the domestic entity C11

  3. FASB’s Statement No. 52 • Adopted a functional currency approach • The previous standard (SFAS No. 8) employed the temporal method C11

  4. Functional currency • The currency of the primary economic environment in which the entity generates and expends cash • A number of factors must be evaluated in order to properly identify the functional currency C11

  5. Objectives of the translation process • Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise’s cash flows and equity • 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. GAAP C11

  6. Expected economic effects of a rate change The foreign entity is a conduit: • Cash inflows/outflows are affected • Translation gains/losses should be included in net income C11

  7. Expected economic effects of a rate change (con’t) The foreign entity is not a conduit: • Cash inflows/outflows are not affected • No translation gains/losses should be included in net income (include as a component of other comprehensive income) C11

  8. Reflect financial results and relationships in conformity with U.S. GAAP • If not affected by rate changes, the relationship between accounts (e.g., current ratio, debt / equity ratio) should be the same after translation as they were before • If affected by rate changes, relationships between accounts are different than they were prior to translation, therefore, reflecting the economic effect of rate changes • Foreign financial statements should be restated into U.S. GAAP before translation begins C11

  9. The translation process Identify the “Books of Record” (BR) currency and the “Functional Currency” (FC) Convert foreign financial statements to GAAP Start Is FC the inflationary currency? Use functional method to get FC into $’s No Is BR = FC? Yes Yes End apply the remeasurement process (shown later) No C11

  10. The translation of financial statement accounts C11

  11. The translation of financial statement accounts (con’t) • Monetary items: rights to receive or pay an amount of money which is: • (a) fixed or • (b) determinable without reference to future prices of specific goods/services; that is, its value does not change according to changes in price levels. C11

  12. Accounting for the translation adjustment • The adjustment is NOT included in net income • The adjustment is shown as a separate component of other comprehensive income (OCI) • The adjustment may be recognized as a component of net income when there is a partial or complete sale/liquidation of the investment in the foreign entity C11

  13. Reconciliation of the annual translation adjustment • Net assets at the beginning of the period multiplied by the change in exchange rates during the period • [100,000 FC  ($1.05 - $1.00)] = $5,000 • Increase in net assets (excluding capital transactions) multiplied by the difference between the current rate and the average rate used to translate income • [50,000 FC  ($1.05 - $1.03)] = $1,000 continued . . . C11

  14. Reconciliation of the annual translation adjustment (con’t) • Increase in net assets due to capital transactions (including investments by the domestic investor) multiplied by the difference between the current rate and the rate at the time of the capital transaction [60,000 FC  ($1.05 - $1.00)] = 3,000 Translation adjustment (credit) = $9,000 C11

  15. Special issues related to consolidating the foreign subsidiary • The translation adjustment is allocated between the controlling and noncontrolling interests • Any excess of cost over book value is translated at the end of the period exchange rate • Any amortization of excess is translated at the average exchange rate for the period C11

  16. Special issues related to consolidating the foreign subsidiary (con’t) • Unrealized intercompany profits must be eliminated using the rate of exchange which existed at the date of the intercompany transaction C11

  17. Special issues related to the sophisticated equity method The investment account includes: • The investor’s share of the investee’s translated net income • Amortization of any excess of cost over book value • The investor’s share of the cumulative translation adjustment C11

  18. Remeasured financial statements • The remeasurement process is intended to produce financial statements that are the same as if the entity’s transactions had been originally recorded in the functional currency • Remeasurement is based on the temporalmethod C11

  19. The foreign entity’s financial statements are prepared in a currency that is not the functional currency. The functional currency may be another foreign currency the U.S.dollar The foreign entity’s functional currency is that of a highly inflationary economy Remeasurement is necessary when C11

  20. The remeasurement process Identify the “Books of Record” (BR) currency and the “Functional Currency” (FC) Convert foreign financial statements to GAAP Start A No Is FC = inflationary currency? Is FC = $? Is BR = FC? Use Temporal method Yes Yes No No Yes Use Temporal method to get into functional currency End Use Temporal method A A End apply the translation process shown earlier C11

  21. Remeasurement of financial statement accounts C11

  22. Special remeasurement issues • Application of lower of cost or market for inventory • Historical exchange rates for purchase accounting • Remeasured financial statements may still need to be translated • Equity method of accounting for an investment should include the appropriate share of remeasurement gains or losses C11

  23. Disclosure requirements An analysis of the cumulative translation adjustment including: • Beginning and ending amount of cumulative translation adjustments • The aggregate adjustment for the period resulting from translation adjustments and gains and losses from certain hedges and intercompany balances C11

  24. Disclosure requirements (con’t) • The amount of income taxes for the period allocated to translation adjustments • The amounts transferred from cumulative translation adjustments in OCI and included in determining net income for the period as a result of the sale or complete or substantially complete liquidation of an investment in a foreign entity C11

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