#07– Foreign Currency Accounting (2.6)

Question 0

Purpose of the Standards

Answer 0

Standards for foreign currency accounting are designed to:
– provide information regarding the effects of exchange rate changes on an enterprise’s cash flow and equity
– Recognize in income from continuing operations the effects of adjustments for currency exchange rate changes that impact cash flows and exclude from net income those adjustment that do not impact cash flows.

Question 1

Foreign Currency Accounting

Answer 1

Foreign currency accounting is concerned with foreign currency transactions and transactions

Foreign currency transactions = transactions with a foreign entity denominated in a foreign currency

Foreign currency translation = conversion of financial statements of a foreign entity into financial statements expressed in the domestic currency

Question 2

Exchange rate – Direct vs Indirect Rate

Answer 2

Exchange rate = price of one unit of a currency expressed in units of another currency

Direct method = Domestic price of one unit of another currency e.g. 1 Euro = $1.47

Indirect method = foreign price of one unit of the domestic currency e.g. 0.68 Euros = $1

Question 3

Exchange Rate - Spot, forward & Historical

Answer 3

Current exchange rate or spot rate = exchange rate at the current date.

Forward exchange rate = exchange rate existing now for exchanging two currencies at a specific future date

Weighted average rate = exchange rate calculated to take into account exchange rate fluctuations for the period.
– The average rate, when applied to a transaction normally assumed to have occurred evenly through the period, approximates the effect of separate translation of each item.

Historical exchange rate = rate on date of issuance of stock or acquisition of assets

Forward Exchange Contract = agreement to exchange at a future specified date and rate a fixed amount of currencies of different countries.

Question 4

Reporting vs Functional Currency

Answer 4

Reporting currency = currency of entity ultimately reporting financial results of the foreign entity.

Functional currency = currency of the primary economic environment in which the entity operations
- usually the local currency or the reporting currency

Question 5

Foreign Currency Translation & Remeasurement (Definitions)

Answer 5

Foreign Currency Translation = Restatement of financial statements in FUNCTIONAL currency to REPORTING currency
I.e. Functional ➡️ Reporting

Foreign Current Remeasurement = restatement of financial statements in FOREIGN currency to FUNCTIONAL currency when reporting currency is NOT Functional currency
- Financial statements must be restated in entity’s functional currency prior to translating the financial statements from the functional currency to the reporting currency.

Question 6

Foreign Financial Statement Translation

Answer 6

Must restate foreign subsidiary’s financial statements to parent’s company’s functional currency before parent company can consolidate financial statements of the foreign subsidiary

1. Prepare foreign subsidiary’s statements in accordance with GAAP/IFRS
2. Determine the functional currency
3. Determine the appropriate exchange rates
4. Remeasure and/or translate the financial statements

Question 7

Local Currency = Functional Currency – Criteria (GAAP)

Answer 7

Foreign entity’s local currency = functional currency if

1. It is currency of primary economic environment in which the company operates
2. Foreign operations are relatively self-contained and integrated within the country
3. Day-to-day operations do not depend on the parent’s or investor’s functional currency, and
4. The local economy of the foreign entity is NOT highly inflationary

Question 8

Foreign Financial Statement Translation

– Foreign subsidiary’s Functional Currency

Answer 8

The foreign subsidiary’s functional currency will be one of the following:

1. The local currency of the foreign entity
2. Some other currency
3. The parent’s reporting currency

The identity of the functional currency of the foreign entity determines the conversion methodology to use.

The local currency is the functional currency only if if it is the currency of the primary economic environment and
– the foreign operations are relatively self-contained and integrated within the country, and
– the day-to-day operations do not depend on the parent’s or investor’s functional currency, and
– the local economy of the foreign entity is not highly inflationary (i.e. cumulated inflation over the last 3 years < 100%)

Question 9

Foreign Financial Statement Translation

– Foreign Subsidiary’s Functional Currency: IFRS

Answer 9

Under IFRS, the following factors are considered in determining an entity’s functional currency (the first three have priority over the rest)

1. the currency that influences sales prices for goods and services
2. The currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. The currency that mainly influences labor, material, and other costs of providing goods and services
4. the currency in which funds from financing activities are generated
5. The currency in which receipts from operating activities are usually retained
6. Whether the activities of the foreign operation are an extension of the parent’s activity or are carried out with a significant amount of autonomy
7. Whether transactions with the parent are a large or small portion of the foreign entity’s activities
8. Whether cash flows generated by the foreign operation directly affect the cash flow of the parent and are available to be remitted to the parent
9. Where the operating cash flows generated by the foreign operation are sufficient to service existing and normally expected debt or whether the foreign entity will need funds from the parent to service its debt.

Question 10

Foreign Financial Statement Translation – Conversion Methodology
> Foreign Entity’s Functional Currency = Foreign entity’s local currency

Answer 10

TRANSLATE foreign currency (functional)&raquo_space;> reporting currency

Used when
– Foreign subsidiary is relatively self-contained and independent
– Foreign entity operated primarily in the local markets
– Dayd-to-day operations of the subsidiary doe not depend on the reporting currency

Question 11

Foreign Financial Statement Translation – Conversion Methodology
> Foreign Entity’s Functional Currency = Parent’s Reporting Currency

Answer 11

REMEASURE foreign currency&raquo_space;> reporting currency (functional)

Used when
– Foreign subsidiary highly integrated with parent and serves primarily as a sales outlet for the parent
– Day-to-day operations of subsidiary depend not reporitn currency
– Foreign subsidiary operations in highly inflationary economy

Question 12

Foreign Financial Statement Translation – Conversion Methodology
> Foreign Entity’s Functional Currency = Some other currency that is not the parent’s reporting currency

Answer 12

REMEASURE foreign currency&raquo_space;> functional currency (other current)
then
TRANSLATE functional currency&raquo_space;> reporting currency

Question 13

Foreign Financial Statement Translation – Conversion Methodology
> Translation

Answer 13

1st step = Income statement
– @ Weighted average rate
–Transfer net income to retained earnings

2nd step = Balance Sheet
– Assets and Liabilities @ current/year-end rate
– Common stock and APIC @ historical rate
– Roll forward retained earnings

Plug translation adjustment to other comprehensive income
– Translation adjustments = difference between debits and credits on translated trial balance

Question 14

Foreign Financial Statement Translation – Conversion Methodology
> Remeasurement

Answer 14

1st step = Balance Sheet
– Monetary items @ current/year-end rate
– Non-monetary items @ historical rate

2nd Step = Income statement
– Non balance sheet related items @ Weighted average rate
– Balance sheet related items @ Historical rate
– Depreciation/PP&E
– Cost of goods sold/inventory
– Amortization/bonds and intangibles

Plug currency gain or loss to income statement, to get net income to the required amount needed to adjust retained earnings in order to make the balance sheet balance.

Question 15

Foreign Financial Statement Translation – Conversion Methodology
> IFRS

Answer 15

GAAP requires remeasurement when a foreign subsidiary operates in a highly inflationary economy
vs.
IFRS – first restate for effects of inflation then convert from from foreign currency to reporting currency using current/year-end rate for all elements of income statement and balance sheet

Question 16

Individual Foreign Transactions – Gains and Losses

Answer 16

Foreign currency transactions gains and losses are due to change in exchange rate between date of sale and when payment made
– has to involve independent companies: transactions between subsidiaries and parents of a permanent financing nature are not considered foreign currency transactions

Gain or loss recognized in current income must be computed at each balance sheet date on all recorded transactions denominated in foreign currencies that have not been settled.
– Difference between exchange rate used in recording transactions in dollars and the exchange rate at the balance sheet date is an unrealized gain or loss on the foreign currency transaction.

Question 17

Individual Foreign Transactions – Types of Foreign Currency Transactions

Answer 17

Operating transactions – import, export, borrowing, lending, and investing transactions

Forward exchange contracts – agreements to exchange two different urgencies at a specific future date and at a specific rate

Question 18

Individual Foreign Transactions – Valuation of Assets and Liabilities

Answer 18

Record assets and liabilities resulting from foreign currency transactions should be recorded using the exchange rate in effect at the date of the transaction.

Question 19

Determining functional currency (IFRS)

Answer 19

1. Currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. Currency that mainly influences labor, material, and other costs of providing goods and services

Question 20

Determining functional currency (IFRS)

Answer 20

1. Currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. Currency that mainly influences labor, material, and other costs of providing goods and services

Question 21

Determining functional currency (IFRS)

Answer 21

1. Currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. Currency that mainly influences labor, material, and other costs of providing goods and services

Question 22

Determining functional currency (IFRS)

Answer 22

1. Currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. Currency that mainly influences labor, material, and other costs of providing goods and services

Question 23

Determining functional currency (IFRS)

Answer 23

1. Currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. Currency that mainly influences labor, material, and other costs of providing goods and services

Question 24

Determining functional currency (IFRS)

Answer 24

1. Currency that influences sales prices for goods and services
2. Currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services
3. Currency that mainly influences labor, material, and other costs of providing goods and services