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Chapter 10

Chapter 10. Translation Of Foreign Currency Financial Statements. Basic Issues. Treatment of exchange gains and losses For transactions: Immediately to Net Income For statements: To Net or Comprehensive Income. Accounting Principles.

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Chapter 10

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  1. Chapter 10 Translation Of Foreign Currency Financial Statements

  2. Basic Issues • Treatment of exchange gains and losses • For transactions: Immediately to Net Income • For statements: To Net or Comprehensive Income

  3. Accounting Principles • CICA- Statements must be adjusted to reflect Canadian GAAP • Will not be an issue after changeover to IFRSs

  4. Classification - CICA • Integrated Foreign Operation: A foreign operation that is financially or operationally interdependent with the reporting enterprise such that the exposure to exchange rate changes is similar to the exposure that would exist had the transactions and activities of the foreign operation been undertaken by the reporting enterprise. A foreign subsidiary that : Raises its capital in Canadian markets Purchases its merchandise or other goods in Canadian markets or Sells its goods in Canadian markets

  5. Classification - CICA • Self-Sustaining Foreign Operation: Self-sustaining foreign operation — A foreign operation that is financially and operationally independent of the reporting enterprise such that the exposure to exchange rate changes is limited to the reporting enterprise's net investment in the foreign operation. A foreign subsidiary that: Raises its capital in the foreign market Purchases its merchandise or other goods in the foreign market or Sells its goods in the foreign market. *HB provides additional guidance on classification but must use professional judgment

  6. Classification – IAS No. 21 • Functional Currencyis the currency of the primary economic environment in which the entity operates.

  7. Classification – IAS No. 21 • Paragraph 9 The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash.

  8. Classification – The Future • The integrated/self-sustaining guidance will disappear with the changeover

  9. Translation Method Integrated Foreign Operations • Paragraph 1651.07For integrated foreign operations, the reporting enterprise's exposure to exchange rate changes is similar to the exposure that would exist had the transactions and activities of the foreign operation been undertaken by the reporting enterprise. Therefore, the financial statements of the foreign operation are expressed in a manner that is consistent with the measurement of domestic transactions and operations. The translation method that best achieves this objective is the temporal method, because it uses the Canadian dollar as the unit of measure.

  10. Application of the Temporal Method • Expenses and Revenues • Generally at average rates

  11. Application of the Temporal Method • Amortization Expense • A write-off of items carried at historical cost • at historic rates

  12. Application of the Temporal Method • Cost Of Sales • Opening inventory at historic • Purchases at average • Closing inventory at historic

  13. Application of the Temporal Method • Sales of Capital Assets • Proceeds at current rate on transaction date • Cost at historical rate from acquisition date

  14. Translation MethodSelf-Sustaining Foreign Operation • Paragraph 1651.08For self-sustaining foreign operations, the reporting enterprise's exposure to exchange rate changes is limited to its net investment in the foreign operation. Therefore, measuring such operations as if they had carried out their activities in Canadian dollars is considered to be less relevant than measuring the overall effect of changes in the exchange rate on the net investment in such operations. The financial statements of the foreign operation are expressed in Canadian dollars in a manner that does not change the financial results and relationships of the foreign operation. The translation method that best achieves this objective is the current rate method, because it uses the currency of the foreign operation as the unit of measure.

  15. Current Rate Method • The current rate method is a method of translation that translates assets, liabilities, revenues and expenses in a manner that retains their bases of measurement in terms of the foreign currency (i.e., it uses the foreign currency as the unit of measure). In particular: • assets and liabilities are translated at the exchange rate in effect at the balance sheet date; • revenue and expense items (including depreciation and amortization) are translated at the exchange rate in effect on the dates on which such items are recognized in income during the period.

  16. Current Rate MethodShareholders’ Equity • Accumulated Other Comprehensive Income This account will contain the net exchange gain or loss that has resulted from the translation of assets and liabilities since the acquisition of the foreign operation. This amount can be either positive (a net gain) or negative (a net loss) with respect to the total shareholders’ equity balance.

  17. Current Rate MethodShareholders’ Equity • Retained EarningsThis balance will reflect the cumulative translated income of the foreign operation, exclusive of exchange gains and losses and reduced by dividends declared.

  18. Current Rate MethodShareholders’ Equity • Common SharesAs all of the exchange gains and losses have been allocated to Accumulated Other Comprehensive Income, the contributed capital account, Common Shares, will have to be translated at the historic exchange rate applicable to its issue date. This seeming anomaly is the only approach that will produce a total Shareholders’ Equity that equals the difference between assets and liabilities when these balances are translated at current rates. It is likely that you will have a better grasp of this point after you have worked through the comprehensive example that is presented later in this Chapter.

  19. Why The Current Rate Method Example On January 1, 2008, when €1 = $1.40, a Canadian company established a subsidiary with an investment of €200,000. The subsidiary borrows €800,000 and invests the €1,000,000 in Land. On December 31, 2008, €1 = $1.50.

  20. Why The Current Rate Method

  21. Highly Inflationary Economies • Current rate method uses foreign currency as unit of measure • Not good if highly inflationary economy • Use temporal method for self-sustaining

  22. Exchange Gains And LossesIntegrated Operations • Paragraph 1651.20 An exchange gain or loss of the reporting enterprise that arises on translation or settlement of a foreign currency-denominated monetary item or a non-monetary item carried at market should be included in the determination of net income for the current period. (January, 2002) • Paragraph 1651.24 Exchange gains and losses arising on the translation of financial statements of an integrated foreign operation should be accounted for in accordance with paragraph 1651.20. (July, 1983)

  23. Exchange Gains And LossesSelf-Sustaining Foreign Operations • Paragraph 1651.29Exchange gains and losses arising from the translation of the financial statements of a self-sustaining foreign operation should be recognized in a separate component of other comprehensive income, except when the economic environment of the foreign operation is highly inflationary relative to that of the reporting enterprise, in which case such exchange gains and losses should be treated in accordance with paragraph 1651.20. (October, 2006)

  24. Why The Difference? Example A French subsidiary of a Canadian company borrows €1,000,000 when the exchange rate is €1 = $1.40. This results in a translated value of $1,400,000. If the exchange rate goes to €1 = $1.50, the new translated value will be $1,500,000.

  25. Why The Difference? • If integrated foreign operation • Would have to use Canadian dollar revenues to buy Euros • There would be an exchange of currencies • This would result in a real economic loss

  26. Why The Difference • If self-sustaining foreign operation • Euro debt will be repaid with Euro revenues • There would be no exchange of currencies • There would be no real economic loss

  27. Reduction In Net Investment • Paragraph 1651.31An appropriate portion of the exchange gains and losses accumulated in the separate component of accumulated other comprehensive income should be included in the determination of net income when there is a reduction in the net investment. (October, 2006)

  28. Exchange Gain or LossIntegrated Operations

  29. Exchange Gain or LossSelf-Sustaining Operations

  30. Exchange Gain or LossDifference in Calculation • Integrated Foreign Operations • Changes in Net Monetary Assets • Self Sustaining Foreign Operations • Changes in Net Assets

  31. Changes In Classification • Paragraph 1651.36When there are significant changes in the economic facts and circumstances that require the translation method applied to a particular foreign operation to be changed, the change in method should be accounted for prospectively. Disclosure should be made of the reasons for the change in the translation method. (July, 1983)

  32. Equity Method Investments • Paragraph 1651.38The financial statements of a foreign investee accounted for by the equity method (see "Investments", Section 3051) are first translated into Canadian dollars in accordance with this Section; then the equity method is applied.

  33. International Convergence IAS No. 21 – Effects Of Foreign Exchange Rates IAS No. 29 – Financial Reporting In Hyperinflationary Economies

  34. International Convergence:Differences Classification Of Foreign Operations Section 1651 classifies foreign operations as either integrated or self-sustaining. While the results are likely to be similar, IAS No. 21 classifies foreign operations on the basis of their functional currency. The appropriate accounting is then determined based on whether the functional currency is the reporting currency of the investor or, alternatively, the reporting currency of the foreign operation.

  35. International Convergence:Differences Hyperinflationary Economies Section 1651 requires the application of the temporal method to translate the financial statements of foreign operations that are located in hyperinflationary economies.In contrast, IAS No. 29 requires that the financial statements of such foreign operations be restated to remove the effects of price level change. In addition, IAS No. 29 provides considerable guidance with respect to the implementation of this restatement.

  36. Homework • Chapter 9 – Problems 1 to 4 • Chapter 10 – Problem 1,3 and 6

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