Conversion of foreign financial statements

Question 1

Types of questions:

Answer 1

• Determine what is the functional currency

- What rate is used to convert an item to convert to USD

Question 2

what is local currency?

Answer 2

The currency in which the foreign books and initial financial statements are prepared

Question 3

What is reporting currency?

Answer 3

Reporting currency- the currency in which the final, often consolidated, statements are prepared

Question 4

What is the functional currency?

Answer 4

The currency of the primary economic environment in which an entity operates

Question 5

How do you determine the functional currency?

Answer 5

When foreign operations are relatively self-contained and integrated within the country of location.

• Purchases are in foreign currency
• Sales are in foreign currency
• Banking is in foreign currency

Question 6

When the functional currency is the local currency, which method do you use?

Answer 6

Current Rate Method:

1) Assets and liabilities use the spot rate at that date
2) Equity is going to be converted at historical rate
3) Income statement is converted at average rates.

Question 7

When foreign operations are an extension and integral component of the U.S. entity’s operations, then the foreign entity is operating in the USD (the foreign entity couldn’t exist without the parent companyand Foreign entity’s cash flows are in USD), which method do you use?

Answer 7

The functional currency will be USD.

Method used: Remeasurement Method (temporal method)

Question 8

What is the process for the remeasurement method?

Answer 8

1) Monetary assets and liabilities are measured at the current rate
2) Non-monetary assets are converted using the historical rate at the time they were originated.

(Monetary- readily determinable cash value)

3) Equity (historical rate)
4) Income statement at weighted average rate or historical rate

Question 9

How do you determine if an economy is hyperinflationary? How does that impact the functional currency?

Answer 9

A local economy is hyperinflation if the cumulative inflation rate is 100% or more over a 3-year period.

A local currency is so unstable, it cannot be the functional currency. Therefore it would be the USD instead.

Question 10

Prior to converting the financial statements to USD, what step must be completed before?

Answer 10

Make any GAAP adjustments to the foreign subsidiaries financial statements

Question 11

What rate do you use for equity accounts under the conversion method?

Answer 11

1) Paid in capital- Historical rate
2) Retained earnings is NOT converted, it is computed

Beginning retained earnings HR
+ NET INCOME AVERAGE
- Dividends HR
= Ending RE

Question 12

What rates are used on the income statement for the current rate method?

Answer 12

1) For items that occurred evenly through the year- Weight Average
2) For significant items that occurred at one point in time during the year, use the historical rate.

Question 13

Once you’ve completed the translation, you will not balance because you are using different rates for different items on the financial statements. How do you adjust for this?

Answer 13

Translation adjustment, it is the amount needed to balance debit and credits.

This adjustment goes to OCI, because there is no cash flow impact.

Question 14

What is the process of remeasurement conversion?

Answer 14

1) Convert monetary assets and liabilities using the current rate as of the balance sheet date

2) Non- Monetary items- Use Historical Rate
3) Capital accounts- Use Historical Rates
4) Retained Earnings- Not converted, it’s computed

Beginning (HR)
+ NI (VARIOUS)
- DIVIDENDS (HR)
Ending

5) Revenues and Expense that occurred evenly (Weight Average)
6) For items that relate to non-monetary items or occurred on one date- Use historical items

The remeasurement adjustment will be a gain or loss which will flow through to retained earnings.

Question 15

What are monetary asset accounts?

Answer 15

• Cash

- Receivables

Question 16

What are non monetary assets?

Answer 16

• Inventory
• Equipment (equipment existing at the date of purchase will use the historical rate when you acquired the company, equipment purchased after acquisition you will use the historical rate the date it was actually purchased)

Question 17

Under the remeasurment method, how is cost of goods sold computed?

Answer 17

Beginning inventory: (HR- ACQUISITION DATE)
+ Purchases: (Weighted Average)
- Ending Inventory: (HR date the invt was bought)
= Cost of goods sold

Question 18

How do you measure depreciation expense and accumulated depreciation under the remeasurment method?

Answer 18

Equipment bought at acquisition will use the historical rate at the date of acquisition.

Equipment purchased after will use the historical rate on the date the equipment was purchased.

Question 19

What are examples of monetary liabilities?

Answer 19

A/P and Notes Payable

Question 20

When the functional currency is not the local currency nor the reporting currency, how do you handle this situation?

Answer 20

Remeasure from local currency to the functional currency
Translate from functional to reporting currency

There will be two conversion adjustments- Income statement
Translation adjustment- OCI

Question 21

What are major differences between US GAAP and IFRS?

Answer 21

US GAAP: Functional currency is based on economic activities

IFRS: Based on primary and secondary indicators

US GAAP: Hyperinflationary countries are remeasured as if it equals the reporting currency
IFRS: Indexed to GPI and then translated.