11.Foreign Transactions

Question 1

What is Functional Currency?

Answer 1

• The currency of the primary economic environment in which the entity operates.
• It can be the same as local currency or other currency
• Same currency as it earns and expenses cash

Question 2

What is Reporting Currency?

Answer 2

Currency the parent company prepares its FS

Question 3

What are some analysis issues with the FX transactions?

Answer 3

No guidance to include FX gains/loss in operating or non-operating income.

IFRS and US GAAP requires disclosures

Comparability of operating margins between entities would be diminished if the compared entities used different methods.

Question 4

What happens with respect to FX gains/losses when the BS date occur before the transaction is settled?

Answer 4

Balance sheet amounts are adjusted based on the FX rate on the balance sheet date and unrealized gain/loss in the income statement

Once the transaction is settled additional gain/loss is recognized if the FX rate changes after the balance sheet date.

Question 5

How is Temporal Method applied to the Balance Sheet?

Answer 5

Monetary assets and liabilities are remeasured using the current FX rate

Non-monetary assets and liabilities are remeasured at the historical rate

Non-monetary assets measured on FV on balance sheet are translated current FX rate.

Question 6

How is the Temporal Method applied to the Income Statement?

Answer 6

Common stock and dividends are remeasured at the historical rate

Expenses related to non-monetary assets are remeasured based on historical rates at the time of the purchase

Revenue and other expenses are translated at the average rate

Question 7

How Volatile is the remeasurement gain/loss in the income statement

Answer 7

more volatile than under the current rate method.

Question 7

How if the current Rate method applied to balance sheet and income statement.

Answer 7

All income statement accounts are translated at transaction date FX or average rate FX

All balance sheet accounts are translated at the current rate except for common stock

Common stock is translated at the historical rate on the date of issuance

Dividends translated at the rate that applied when they were declared

Question 7

How is the Temporal Method applied to the Inventory and COGS?

Answer 7

Firms cost flow assumption must also be considered when tracking the historical rates of firms purchases

Question 8

What is CTA - Cumulative Translation Adjustment

Answer 8

A plug figure and is the accumulated balance of all the translation gains/losses.

Question 8

What is the impact of changing exchange rate exposures under the current rate method

Answer 8

Net assets/Net Monetary assets - Gains on appreciating local currency

Net liabilities/Net monetary liabilities - Loss on appreciating local currency

Question 9

Exposure to Changing Exchange Rates Under current rate Method

Answer 9

Under Current Rate method, exposure is the net asset position of the sub.

Local currency appreciating results in a gain

Local currency depreciating results in a loss.

Can’t eliminate the exposure it requires total assets and liabilities balance. Therefore it would eliminate equity.

Question 10

Exposure to Changing Exchange Rates Under the Temporal rate Method

Answer 10

Under the temporal Method, can eliminate their exposure to changing FX by balancing monetary assets and monetary liabilities
○ When balance, no gain/loss

Question 11

What are the 2 Methods used to remeasure or translate the FS of a sub to parent reporting

Answer 11

Re-measurement - converting using the temporal method

Translation - uses current rate/all-current method

Question 12

what determines under which method you translate?

Answer 12

The translation method is determined by the functional currency relative to the parent’s presentation currency.

Question 13

What factors decide the functional currency?

Answer 13

Currency that influences sales prices for goods and services

Country determining sale price through the competitive forces and regulations

Currency influencing labour, material and other costs

Currency from which funds are generated
Receipts from operating activities are usually retained

Question 13

what is the appropriate translation method when Functional currency is the same as parent presentation currency

Answer 13

Temporal method

Question 14

what is the appropriate translation method when Functional currency and the parents reporting currency differ

Answer 14

Current rate method

Question 15

what is the appropriate translation method when Local currency, functional currency and reporting currency

Answer 15

Current rate / Temporal method

Question 16

What is the translation method to be used in a Hyperinflationary environment under IFRS and US GAAP

Answer 16

US GAAP- the functional currency is considered to be the parent’s reporting currency and the Temporal method

IFRS - subs FS are restated for inflation and then translated using the current FX rate.

Question 16

What is the procedure for restating Inflation in the Income Statement

Answer 16

Income statement items are rested by multiplying the change in price index from the date the transactions occur

The net purchasing power gain or loss is recognized in the income statement based on the net monetary asset or liability exposure

Question 17

What is a Hyperinfationary environment?

Answer 17

• Hyper inflationary environment is one where cumulative inflation exceeds 100% over a 3 year period. (more than 26% over 3 years)
  Hyperinflationary environment - local currency rapidly depreciates relative to the parent’s presentation currency due deteriorating purchase power.

Question 17

What is the procedure for restating Inflation in the Balance Sheet

Answer 17

Non-monetary A + L are restated for inflation using a price index

No restatement of restate monetary A+L

Components of SE are restated by applying the change in price index from beginning of the period or date of contribution

RE is a plug

Question 18

What is to be done re: Translations in a HyperInflationary Environment?

Answer 18

○ Functional currency is considered to be the parents presentation currency
Temporal method used to remeasure FS

○ Using current rate to translate B/S accounts will results in lower assets and liabilities after the translation

Real value of non-monetary assets and liabilities are not affected by hyper inflation as local currency denominated value increase to offset the impact of inflation.
* Adjusting the non-monetary assets and liabilities for inflation not allowed under US GAAP but allowed under IFRS

Question 19

What Disclosures should be analysed in FX

Answer 19

When there are multiple Subs - the CRA and re-measurement gains/losses and parent co.’s ratios include the effects of all the subs

What little information that is available is found in the financial statement footnotes and the management discussion and analysis section of the annual report.

Comparison is difficult

One solution involves adding the change in the CTA to the firm’s net income.

Question 20

What are the reasons for the change in ETR on account of Foreign Operations.

Answer 20

Changes in tax rates

Change in mix of profits from different countries

Question 21

What are the Effect of components of sales on the sustainability of sales growth?

Answer 21

Sales growth owing to an increase in volumes or prices is considered more sustainability than sales growth due to appreciation of foreign currencies in which the sales were made.

Organic growth in sales is defined as growth in sales excluding the effects of acquisitions/divestitures and currency effects.

Foreign currency effect on sales disclosed on the MD&A of the annual report.

Question 22

What is % change in sales excluding currency effect

Answer 22

% change in Sales - Impact of Currency = % change in sales excluding currency effect

Question 23

What are Major Sources of FX Risks and where to find the info?

Answer 23

• FX risk reflects the effects of changes in currency values on the assets and liabilities of a business and future sales
  
  • Disclosures as part of MD&A may include the impact of currency value changes on profits
    ○ Helps estimate the impact of currency value changes on earnings going forward
    ○ Sensitivity analysis can be done to improve forecasts and understand risks
    Need to inquire hedging tools employed

Question 24

Are Pure ratios affected by the current rate method?

Answer 24

Pure IS and BS are unaffected by the current rate method -i.e. Local currency trends and relationships are preserved.

Question 25

What happens with mixed ratio under the current rate method?

Answer 25

The current rate method results in small changes in mixed ratios because the numerator and denominator are translated at different FX rates.

Direction will depend on the relationship between the FX rate used on the denominator and numerator.

Mixed ratios calculated from financial statements translated using the current rate method will be different than the same ratio calculated from the local currency statements before translation

Question 26

What happens to the translated ratio when the FX currenct is depreciating

Answer 26

When FX Currency is depreciating, the translated ratio is larger than the original ratio. Vise versa when FX currency is appreciating.