Chapter 12: consolidation of a foreign subsidiary

Question 1

Non-monetary assets

Answer 1

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)

Question 2

Balancing accounting for remeasurement

Answer 2

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

Question 3

Temporal method

Answer 3

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

Question 4

Remeasurement

Answer 4

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

Question 5

non-monetary items considered monetary assets

Answer 5

equity, trading, and available for sale securities

considered monetary assets = remeasured using current rates

Question 6

monetary assets and liabilties

Answer 6

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

Question 7

Translation adjustment for differential

Answer 7

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

Question 8

Amortization of differential for a foreign subsidiary

Answer 8

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)

Question 9

Basic consolidation entry for foreign subsidiary

Answer 9

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

Question 10

Consolidation entries to reclassify differential and amortized excess of foreign subsidiary

Answer 10

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

Question 11

consolidation entry for OCI from subsidiary

Answer 11

Must be adjusted off against investment in subsidiary (because it’s an equity account!)

DR/CR depends on the balance

Question 12

accumulated depreciation consolidation entry for foreign subsidiary

Answer 12

Normal entry
must translate foreign currency balance at time of acquisition based on current rate

Question 13

Difference to consolidated statements of foreign subsidiary with NCI

Answer 13

Along with NCI share in net assets, net income, and dividends there will be an NCI share of accumulated other comprehensive income

Question 14

Accounting for a change in foreign affiliate’s functional currency

Answer 14

Treated as change in estimate
changes current and prospective reporting
no change in prior periods

Question 15

Translation

Answer 15

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

Question 16

Current rate method

Answer 16

Method to translate financial statements from functional currency to dollars

Question 17

SEC rules for foreign private issuers

Answer 17

if statements are filed in strict accordance with IFRS they do not need to be translated into GAAP (but only if private!)

Question 18

Translation adjustment

Answer 18

difference in account balances stemming from changes in exchange rate

Question 19

Current exchange rate

Answer 19

exchange rate at end of trading day on balance sheet date

Question 20

Historical date

Answer 20

Exchange rate that was in effect when a given transaction initially took place

Question 21

Average exchange rate

Answer 21

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)

Question 22

ASC 830

Answer 22

• guidelines for translating balances stated in foreign currency to US dollars for preparation of consolidated financial statements in US dollars

Question 23

Functional currency

Answer 23

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

Question 24

Translation rate for material gain or loss from a specific event

Answer 24

Use rate for specific day rather than average

Question 25

General translation rate for income statement items

Answer 25

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)

Question 26

Translation rate for assets and liabilities

Answer 26

Current exchange rate, aka spot rate on balance sheet date

Question 27

Translation rate for equity accounts

Answer 27

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

Question 28

Translated retained earnings

Answer 28

rather than determine historical rate, carry forward the previous period’s ending retained earnings and add current years additions/ subtract dividends

Question 29

Translation adjustment

Answer 29

balancing item to make debits = credits when there are difference based on the exchange rates used

goes to other comprehensive income

Question 30

Other comprehensive income

Answer 30

Changes in net assets of a business enterprise from non-owner sources

closed to accumulated other comprehensive income

Question 31

Process of consolidating wholly owned foreign subsidiary

Answer 31

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

Question 32

Parent’s equity method entries with foreign subsidiary

Answer 32

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

Question 33

entries if dividends from foreign subsidiary are NOT paid on the declaration date

Answer 33

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

Question 34

AOCI - translation adjustment account

Answer 34

Exchange rate at end of period > beginning = credit balance (gain)
Exchange rate at end of period < beginning = debit balance (loss)

Question 35

Proving translation adjustment = difference in calculated end net assets vs translated end net assets

Answer 35

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

Question 36

Indications that local (foreign) currency is functional currency

Answer 36

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

Question 37

Factors indicating that the parent’s currency (US dollar) is functional currency

Answer 37

• 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

Question 38

Severe inflation

Answer 38

inflation exceeding 100% over a three year period

foreign entities with severe inflation required to use dollar as functional currency and do remeasurement

Question 39

Functional currency if subsidiary is in location with severe inflation

Answer 39

Currency of parent (US dollar) should be used as the functional currency

otherwise does not reflect market value/ historical cost

Question 40

Restatement when recording currency is not the functional currency BUT the functional currency is the reporting currency

Answer 40

Remeasure (temporal method) recording to functional currency before consolidation

Question 41

Restatement when recording currency is the same as the functional currency

Answer 41

Translate functional currency statements to reporting currency before consolidation

Question 42

Restatement when recording currency is not the functional currency AND the functional currency is not the reporting currency

Answer 42

1) remeasure recording currency to functional currency (temporal method)
2) translate functional currency to reporting currency (current rate method)
3) consolidate

Question 43

Equity method entries recording amortization of differential for foreign subsidiary when translating

Answer 43

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

Question 44

Remeasurement of plant and equipment (or other non-monetary items)

Answer 44

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

Question 45

COGS calculation for remeasurement

Answer 45

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

Question 46

Remeasurement of operating expenses

Answer 46

Expenses associated with non-monetary items (depreciation) x historical rate for underlying item

period expenses x average rate (considered incurred evenly)

Question 47

Remeasurement gain or loss on consolidated income statement

Answer 47

Offset against any foreign currency gain or loss and then reported on the income statement under “other income” or “other losses”

Question 48

Differences in consolidated remeasured foreign subsidiary vs domestic subsidiary

Answer 48

• 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