Chapter 12: consolidation of a foreign subsidiary Flashcards
Non-monetary assets
items that are not fixed in relation to monetary units (inventory, plant, equipment, common stock, deferred income)
remeasured using historical rate - as are their related revenue/expense/gain/loss accounts (CoGS, amortization, depreciation)
Balancing accounting for remeasurement
Remeasurement gain or loss
included in income statement for period under “other income” or “other loss”
since exchange rate gain or loss would be income if originally in USD
Temporal method
Method used to remeasure the financial statements from the recording currency to the functional currency
Monetary assets and liabilities: remeasured at current rate
non-monetary assets and liabilities: remeasured at historical rate at time of purchase
Revenues and expenses (not related to non-monetary assets): remeasured at average rate for the period
equity accounts: historical rate
imbalances included into net income
Remeasurement
method to restate foreign entity statements to US dollars
- restatement of foreign entity statements from recording currency into functional currency (so only done if recording currency is not the functional currency)
should product result as if transactions had initially been recorded in functional currency
differentiates into monetary vs non-monetary assets and liabilities
non-monetary items considered monetary assets
equity, trading, and available for sale securities
considered monetary assets = remeasured using current rates
monetary assets and liabilties
Assets and liabilities that represent rights to receive or obligations to pay a fixed number of currency unites in the future
remeasured using current exchange rate
subject to gains and losses from exchange rate
Translation adjustment for differential
Required because amortization of differential is translated at average rate but balance sheet accounts translated at current rate
Difference to OCI as translation adjustment =
difference between beginning differential (at historical rate)
less amortization for period (at average rate)
= calculated remaining differential
vs end differential at current rate
aka brings calculated differential in line with translated differential
Amortization of differential for a foreign subsidiary
Must be done in terms of foreign subsidiary’s FUNCTIONAL currency
beginning differential in foreign currency / life in years of underlying amortizable/depreciable asset
x average exchange rate
= differential amortization entry
then must also recognize any translation adjustment for the differential (between calculated amount and directly translated amount of ending remaining differential)
Basic consolidation entry for foreign subsidiary
ALL AT TRANSLATED OR REMEASURED AMOUNTS
DR Common stock
DR Retained earnings (beginning)
DR Income from sub (consolidation calculated proportional amount)
DR (NCI in net income of sub if applicable)
CR Dividends declared
CR investment in subsidiary
CR NCI in net assets of sub
Consolidation entries to reclassify differential and amortized excess of foreign subsidiary
Amortized excess (translated amount recorded by parent)
DR Operation Expense
CR income from subsidiary
Excess value reclassification (translated end of the year value after amortization at current rate)
DR Asset
CR Investment in subsidiary
consolidation entry for OCI from subsidiary
Must be adjusted off against investment in subsidiary (because it’s an equity account!)
DR/CR depends on the balance
accumulated depreciation consolidation entry for foreign subsidiary
Normal entry
must translate foreign currency balance at time of acquisition based on current rate
Difference to consolidated statements of foreign subsidiary with NCI
Along with NCI share in net assets, net income, and dividends there will be an NCI share of accumulated other comprehensive income
Accounting for a change in foreign affiliate’s functional currency
Treated as change in estimate
changes current and prospective reporting
no change in prior periods
Translation
MOST COMMON METHOD
A method of restating foreign entities statements into US dollars
- used when recording currency = functional currency (to translate functional currency to reporting currency
liabilities and assets: translated at current rates
revenue and expenses: translated at average rates for report periods
equity items: translated at historical rates
any adjustments resulting from using different rates goes to comprehensive income
Current rate method
Method to translate financial statements from functional currency to dollars
SEC rules for foreign private issuers
if statements are filed in strict accordance with IFRS they do not need to be translated into GAAP (but only if private!)
Translation adjustment
difference in account balances stemming from changes in exchange rate
Current exchange rate
exchange rate at end of trading day on balance sheet date
Historical date
Exchange rate that was in effect when a given transaction initially took place
Average exchange rate
Simple or weighted average exchange rate for a period of time (depends on what more accurately reflects rates)
Exchange rate used to measure revenues and expenses (except if remeasuring non-monetary assets and liabilties)
ASC 830
- guidelines for translating balances stated in foreign currency to US dollars for preparation of consolidated financial statements in US dollars
Functional currency
The currency of the primary economic environment in which the entity operates
generally the currency of the environment in which an entity primary generates and expends cash
depends if operation is self-contained and integrated into its environment (local currency = functional currency) or if extension of parent and integrated with the parent (parent functional currency = functional currency
Translation rate for material gain or loss from a specific event
Use rate for specific day rather than average
General translation rate for income statement items
Revenue and expenses
gains and losses
all at average exchange rate for the income statement periods
(should theoretically be historical rate for transaction date but that is too complicated so assume that revenue/expenses/gains/losses are recognized evenly over the period)
Translation rate for assets and liabilities
Current exchange rate, aka spot rate on balance sheet date
Translation rate for equity accounts
Historical exchange rate
Rate on the LATTER of:
- date parent company acquired investment in foreign entity, or
- date the subsidiary had the stockholder’s equity transactions
dividends at rate on DATE OF DECLARATION
Translated retained earnings
rather than determine historical rate, carry forward the previous period’s ending retained earnings and add current years additions/ subtract dividends
Translation adjustment
balancing item to make debits = credits when there are difference based on the exchange rates used
goes to other comprehensive income
Other comprehensive income
Changes in net assets of a business enterprise from non-owner sources
closed to accumulated other comprehensive income
Process of consolidating wholly owned foreign subsidiary
1) translate trial balance information using pertinent rates (on translation schedule)
Assets and liabilities: current rate
Income statement items: average rate (unless major, then historical)
Equity = historical (retained earnings taken from previous period)
translation adjustment = other comprehensive income
2) consolidation worksheets
Parent’s equity method entries with foreign subsidiary
Same entries but translated to USD equivalent
- share of dividend x declaration date rate
- income x average rate
- amortization of differential (in terms of subsidiary’s functional currency)
- translation of differential (if translation creates additional translation adjustment for differential)
- share of translation adjustment (no further translation needed) to OCI
entries if dividends from foreign subsidiary are NOT paid on the declaration date
Parent: receivable recorded on declaration date at current rate would have to be adjusted with gain or loss recognized on balance sheet date and payment date
(gain or loss–> income for period)
Subsidiary: any dividend payable liability translated at current rate on balance sheet date
AOCI - translation adjustment account
Exchange rate at end of period > beginning = credit balance (gain)
Exchange rate at end of period < beginning = debit balance (loss)
Proving translation adjustment = difference in calculated end net assets vs translated end net assets
Net assets at beginning of the year x beginning of the year rate will be adjusted by changes in net asset position
+ net income x average rate for period
- dividends x historic rate at declaration date
= calculated net assets
vs
End of year net assets in functional currency x EOY rate
difference should equal change in OCI translation adjustment
Indications that local (foreign) currency is functional currency
FC = foreign currency
- cash flow is primarily in FC and do not affect parent’s cash flows
- sales prices are determined by local competition or government regulations, not responsive to exchange rates
- active local sales market for products, significant exports
- labor, materials, other costs primary local
- financing predominately obtained from and denominated in local currency. Operations generate funds to cover financing needs
- few intercompany transactions with parent
Factors indicating that the parent’s currency (US dollar) is functional currency
- subsidiary’s cash flows directly impact parent’s and are available to the parent company
- sales prices are responsive to short terms exchange rate changes and world-wide competition
- sales markets primarily in parent country or denominated in parent’s currency
- production components (expenses) generally from parent’s country
- financing primarily provided by parent or otherwise in USD
- frequent intercompany transactions
Severe inflation
inflation exceeding 100% over a three year period
foreign entities with severe inflation required to use dollar as functional currency and do remeasurement
Functional currency if subsidiary is in location with severe inflation
Currency of parent (US dollar) should be used as the functional currency
otherwise does not reflect market value/ historical cost
Restatement when recording currency is not the functional currency BUT the functional currency is the reporting currency
Remeasure (temporal method) recording to functional currency before consolidation
Restatement when recording currency is the same as the functional currency
Translate functional currency statements to reporting currency before consolidation
Restatement when recording currency is not the functional currency AND the functional currency is not the reporting currency
1) remeasure recording currency to functional currency (temporal method)
2) translate functional currency to reporting currency (current rate method)
3) consolidate
Equity method entries recording amortization of differential for foreign subsidiary when translating
Amortization (yearly rate in FCU x average exchange rate
DR income from subsidiary
CR investment in subsidiary
Recognition of translation adjustment on differential
uses Investment in Subsidiary and OCI- translation adjustment
debit vs credit depends on the needed adjustment
Remeasurement of plant and equipment (or other non-monetary items)
Non-monetary acquired with subsidiary: remeasured at historical rate on the date of acquisition
Non-monetary items acquired after acquisition: remeasured using rate on date of purchase
COGS calculation for remeasurement
Beginning inventory x historical rate on purchase
+ purchases at average rate for period (or historical rate if known/ reasonable)
= goods available for sale
- ending inventory x historical rate on purchase
= COGS for remeasurement
Remeasurement of operating expenses
Expenses associated with non-monetary items (depreciation) x historical rate for underlying item
period expenses x average rate (considered incurred evenly)
Remeasurement gain or loss on consolidated income statement
Offset against any foreign currency gain or loss and then reported on the income statement under “other income” or “other losses”
Differences in consolidated remeasured foreign subsidiary vs domestic subsidiary
- Remeasured gain or loss offset against foreign currency transaction gain or loss and included in income statement
- otherwise no difference
- because differential is in USD there are no extra entries for that (only usual amortization of differential)
- accumulated depreciation on acquisition is remeasured at historical rate for acquisition date
