11.Foreign Transactions Flashcards
What is Functional Currency?
- 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
What is Reporting Currency?
Currency the parent company prepares its FS
What are some analysis issues with the FX transactions?
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.
What happens with respect to FX gains/losses when the BS date occur before the transaction is settled?
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.
How is Temporal Method applied to the Balance Sheet?
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.
How is the Temporal Method applied to the Income Statement?
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
How Volatile is the remeasurement gain/loss in the income statement
more volatile than under the current rate method.
How if the current Rate method applied to balance sheet and income statement.
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
How is the Temporal Method applied to the Inventory and COGS?
Firms cost flow assumption must also be considered when tracking the historical rates of firms purchases
What is CTA - Cumulative Translation Adjustment
A plug figure and is the accumulated balance of all the translation gains/losses.
What is the impact of changing exchange rate exposures under the current rate method
Net assets/Net Monetary assets - Gains on appreciating local currency
Net liabilities/Net monetary liabilities - Loss on appreciating local currency
Exposure to Changing Exchange Rates Under current rate Method
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.
Exposure to Changing Exchange Rates Under the Temporal rate Method
Under the temporal Method, can eliminate their exposure to changing FX by balancing monetary assets and monetary liabilities
○ When balance, no gain/loss
What are the 2 Methods used to remeasure or translate the FS of a sub to parent reporting
Re-measurement - converting using the temporal method
Translation - uses current rate/all-current method
what determines under which method you translate?
The translation method is determined by the functional currency relative to the parent’s presentation currency.
What factors decide the functional currency?
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
what is the appropriate translation method when Functional currency is the same as parent presentation currency
Temporal method
what is the appropriate translation method when Functional currency and the parents reporting currency differ
Current rate method
what is the appropriate translation method when Local currency, functional currency and reporting currency
Current rate / Temporal method
What is the translation method to be used in a Hyperinflationary environment under IFRS and US GAAP
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.
What is the procedure for restating Inflation in the Income Statement
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
What is a Hyperinfationary environment?
- 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.
What is the procedure for restating Inflation in the Balance Sheet
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
What is to be done re: Translations in a HyperInflationary Environment?
○ 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
What Disclosures should be analysed in FX
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.
What are the reasons for the change in ETR on account of Foreign Operations.
Changes in tax rates
Change in mix of profits from different countries
What are the Effect of components of sales on the sustainability of sales growth?
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.
What is % change in sales excluding currency effect
% change in Sales - Impact of Currency = % change in sales excluding currency effect
What are Major Sources of FX Risks and where to find the info?
- 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
- Disclosures as part of MD&A may include the impact of currency value changes on profits
Are Pure ratios affected by the current rate method?
Pure IS and BS are unaffected by the current rate method -i.e. Local currency trends and relationships are preserved.
What happens with mixed ratio under the current rate method?
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
What happens to the translated ratio when the FX currenct is depreciating
When FX Currency is depreciating, the translated ratio is larger than the original ratio. Vise versa when FX currency is appreciating.
