Consolidated Financial Statements: Foreign Currency Translation Adjustments Flashcards
What is the exchange rate?
it is the price of one unit of a currency expressed in units of another currency; the rate at which two currencies will be exchanged at equal value; the exchange rate may be expressed as:
direct method - the domestic price of one unit of another currency (ex. one euro costs $1.47)
indirect method - the foreign price of one unit of the domestic currency (ex. 0.68 euro buys $1.00)
What is the current exchange rate?
it is the exchange rate at the current date, or for immediate delivery of currency, often referred to as the spot rate
What is the historical exchange rate?
it is the rate in effect at the date of issuance of stock or acquisition of assets
What is the weighted average rate?
it is calculated to take into account the exchange rate fluctuations for the period; it would be impractical to account for the actual exchange rate in effect for numerous, recurring transactions (ex. sales); the average rate, when applied to a transaction normally assumed to have occurred evenly throughout the period, approximates the effect of separate translations of each item
What does denominated or fixed in a currency mean?
a transaction is denominated or fixed in the currency used to negotiate and settle the transaction, either in U.S. dollars or a foreign currency
What is reporting currency?
it is the currency of the entity ultimately reporting financial results of the foreign entity
What is the functional currency?
it is the currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency
What is foreign currency translation?
it is the restatement of financial statements denominated in the functional currency to the reporting currency using appropriate rates of exchange
What is foreign currency remeasurement?
it is the restatement of foreign financial statements from the foreign currency to the entity’s functional currency in the following situations:
the reporting currency is the functional currency & the financial statements must be restated in the entity’s functional currency prior to translating the financial statements from the functional currency to the reporting currency
What are monetary items?
assets and liabilities that are fixed or denominated in dollars regardless of changes in specific prices or the general price level (ex. accounts receivable)
What are nonmonetary items?
assets and liabilities that fluctuate in value with inflation and deflation (ex. a building)
Foreign financial statement translation
before a parent company can consolidate the financial statements of a foreign subsidiary, the subsidiary’s foreign currency financial statements must be restated in the parent company’s reporting currency; the method used to restate the foreign subsidiary’s financial statements is determined by the functional currency of the foreign entity
the functional currency of a foreign entity determines the conversion methodology to use; the functional currency can be the entity’s local currency, the currency of the reporting entity, or the currency of another country; under U.S. GAAP, an entity’s local currency qualifies as the functional currency if it is the currency of the primary economic environment in which the company operates, and all of the following conditions exist:
the foreign operations are relatively self-contained and integrated within the country
the day-to-day operations do not depend on the parent’s or investor’s functional currency
the local economy of the foreign entity is not highly inflationary, which is defined as cumulative inflation of 100% over 3yrs
How to determine the appropriate exchange rates
the functional currency of the foreign entity determines the exchange rates to be used in converting account balances and the treatment of the gains or losses associated with the translation process
1) if the reporting currency equals the functional currency for the parent company, then the remeasurement method must be used for the foreign subsidiary
the remeasurement method must be used when the foreign subsidiary is highly integrated with the parent and serves primarily as a sales outlet for the parent; day-to-day operations of the subsidiary depend on the reporting currency; the foreign subsidiary operates in a highly inflationary economy
2) if the foreign currency equals the functional currency for the foreign subsidiary, then the translation method must be used to reach the reporting currency of the parent company
the translation method must be used when the foreign subsidiary is relatively self-contained and independent and operates primarily in local markets; day-to-day operations of the subsidiary do not depend on the reporting currency
3) when the functional currency of the foreign subsidiary differs from both the subsidiary’s local currency and the reporting currency, the subsidiary’s financial statements must first be remeasured from the local currency to the functional currency, and then must be translated from the functional currency to the reporting currency
Remeasurement method (temporal method)
if the financial statements of the foreign subsidiary are not in the subsidiary’s functional currency, the financial statements are remeasured to the functional currency starting with the balance sheet
step 1 - balance sheet: monetary items (current/year-end rate) and nonmonetary items (historical rate)
step 2 - income statement: non-balance sheet related items (weighted average rate) and balance sheet related items (historical rate…items include: depreciation/PP&E, COGS/inventory, and amortization/bonds and intangibles)
step 3 - remeasurement gain/loss (income statement): gain/loss so net income is at the amount necessary for retained earnings plug
Translation method (current rate method)
if the financial statements of the foreign subsidiary are in the subsidiary’s functional currency, the financial statements are translated to the reporting currency starting with the income statement
step 1 - income statement: all income statement items (weighted average rate) and ten transfer net income to retained earnings
step 2 - balance sheet: assets/liabilities (current/year-end rate), common stock/APIC (historical rate), and retained earnings (roll-forward); translated retained earnings is equal to the beginning translated retained earnings plus translated net income for the current period less translated dividends declared for the current period
step 3 - translation gain/loss (other comprehensive income): the gain/loss goes to accumulated other comprehensive income; the translation adjustment is equal to the difference between the debits and credits in the translated trial balance
