Bài giảng môn Kế toán, kiểm toán - Chapter 8: Translation of foreign currency financialstatements

Chapter 8:Translation of ForeignCurrency FinancialStatementsConceptual issues of foreign currency financial statements translationDifference between balance sheet exposure and transaction exposureMethods of financial statement translationTemporal and current rate methods illustratedU.S. GAAP, IFRS, and other standards related to translationHedging of balance sheet exposure Chapter Topics  8-2Learning Objectives Describe the conceptual issues involved in translating foreign currency financial statementsExplain balance sheet exposure and how it differs from transaction exposureDescribe the concepts underlying the current rate and temporal methods of translationApply the current rate and temporal methods of translation and compare the results of the two methodsDescribe the requirements of applicable International Financial Reporting Standards (IFRS) and U.S. generally accepted accounting principles (GAAP)Discuss hedging of balance sheet exposure8-3Two conceptual issuesAppropriate exchange rate to be used in translating each financial statement itemHow should the translation adjustment that inherently arises from the translation process be reflected in the consolidated financial statements8-4Balance Sheet ExposureAssets and liabilities translated at the current exchange rate are exposed to risk of a translation adjustmentWhen foreign currency appreciates, a net asset exposure results in a positive translation adjustmentWhen foreign currency appreciates, a net liability exposure results in a negative translation adjustmentAssets and liabilities translated at the historical exchange rate are not exposed to a translation adjustment8-5Translation MethodsCurrent/Noncurrent Method Current assets and liabilities are translated at the current exchange rateNoncurrent assets and liabilities and stockholders’ equity accounts are translated at historical exchange ratesThere is no theoretical basis for this methodMethod is seldom used in any countries and is not allowed by U.S. GAAP or IFRS8-6Translation MethodsMonetary/Nonmonetary MethodConcerns with monetary assets and liabilitiesTranslated at the current exchange rateConcerns with nonmonetary assets and liabilities and stockholders’ equity accountsTranslated at historical exchange ratesThe translation adjustment measures the net foreign exchange gain or loss on current assets and liabilities as if these items were carried on the parent’s books8-7Translation MethodsTemporal MethodObjective is to translate financial statementsAs if the subsidiary had been using the parent’s currencyItems carried on subsidiary’s books at historical cost Including all stockholders’equity items, are translated at historical exchange ratesItems carried on subsidiary’s books at current value are translated at current exchange ratesIncome statement items are translated at the exchange rate in effect at the time of the transaction8-8Translation MethodsCurrent Rate MethodObjective is to reflect that the parent’s entire investment in a foreign subsidiary is exposed to exchange riskAll assets and liabilities are translated at the current exchange rateEquity accounts are translated at historical exchange ratesRevenues and expenses are translated at the exchange rate in effect at the date of accounting recognition8-9Translation of Retained EarningsStockholders’ equity items are translated at historical exchange rates under both the temporal and current rate methodsThis creates somewhat of a problem in translating retained earnings, which is a composite of many previous transactions:Revenues, expenses, gains, losses, and declared dividends occurring over the life of the company8-10Complicating Aspects of the Temporal MethodKeeping track of the historical rates for inventory, prepaid expenses, fixed assets, and intangible assets is necessary under temporal method and not under current rate methodTranslating these assets at historical rates makes application of the temporal method more complicated than the current rate methodCalculation of Cost of Goods Sold (COGS)Application of the Lower of Cost or Market RuleFixed Assets, Depreciation, Accumulated Depreciation8-11DISPOSITION OF TRANSLATION ADJUSTMENTTranslation gain or loss in net incomeTranslation adjustment is considered to be a gain or loss analogous to the gains and losses arise from foreign currency transactionShould be reported in income in the period in which the fluctuation in exchange rate occursCumulative translation adjustment in stockholders’ equityThe alternative to reporting the translation adjustment as a gain or loss in net income is to include it in stockholders’ equity as a component of other comprehensive incomeThis treatment defers the gain or loss in stockholders’ equity until it is realized in some way8-12Temporal and Current Rate MethodsTranslation methods illustratedU.S. Inc. owns Juarez, SA, a subsidiary in Mexico which was established January 1, 2010Juarez’s balance sheet items as of 12/31/10, in pesos:Cash 1,000 Accounts payable 2,000Accounts rec. 2,000 Long-term debt 6,000Inventory 2,500 Capital stock 3,000Fixed assets 8,000 Retained earnings 1,500Accum. depr. 1,0008-13Temporal and Current Rate MethodsTranslation methods illustratedJuarez’s income statement items for 2010, in pesos:Sales 20,000 Depr. exp. 1,000COGS 14,000 Interest exp. 500S,G,&A exp. 2,500 Income tax exp. 5008-14Temporal and Current Rate MethodsTranslation methods illustratedThere was no beginning inventoryInventory, which is carried at cost, was acquired evenly during the last quarter of 2010Purchases were made evenly throughout yearFixed assets were acquired on January 1, 2010Capital stock was sold on January 1, 2010 8-15Temporal and Current Rate MethodsTranslation methods illustratedRelevant exchange rates (U.S. dollar per Mexican peso):January 1, 2010 $0.10Average for 2010 $0.095Average for 4th quarter 2010 $0.09December 31, 2010 $0.088-16Temporal and Current Rate MethodsCurrent Rate Method – Income StatementIncome Statement – 2010Sales 1,900COGS 1,330Gross profit 570S,G,&A 238Depreciation expense 95Interest expense 48Income tax expense 47Net income 1428-17Temporal and Current Rate MethodsCurrent Rate Method – Balance SheetBalance Sheet – December 31, 2010Cash 80 Accounts payable 160 Accounts Rec. 160 Long-term debt 480Inventory 200 Capital stock 300Fixed Assets, net 545 Retained earnings 142Total assets 985 Cumulative translation adj. (97) Total liab. & S.E. 985 8-18Temporal and Current Rate MethodsTemporal Method – Income StatementIncome Statement – 2010Sales 1,900COGS 1,343Gross profit 557S,G,&A 238Depreciation expense 100Interest expense 48Income tax expense 47Remeasurement gain 101Net income 2258-19Temporal and Current Rate MethodsTemporal Method – Balance SheetBalance Sheet – December 31, 2010Cash 80 Accounts payable 160 Accounts Rec. 160 Long-term debt 480Inventory 225 Capital stock 300Fixed Assets, net 700 Retained earnings 225Total assets 1,165 Total liab. & S.E. 1,165 8-20Temporal and Current Rate MethodsTranslation methods illustrated – SummaryCurrent Rate MethodAll assets and liabilities are translated at current rateThis results in net asset exposureNet asset exposure and devaluing foreign currency results in translation lossTranslation adjustment included in equityTemporal MethodPrimarily monetary assets and liabilities are translated at current rateThis results in net liability exposureNet liability exposure and devaluing foreign currency result in translation gainTranslation gain included in current income8-21U.S. GAAPFASB ASC 830, Foreign Currency Matters( formerly SFAS 52, Foreign Currency Translation) is the relevant accounting standardRequires identification of functional currencyFunctional currency is the primary currency of the foreign subsidiary’s operating environmentThe standard includes a list of indicators as guidance for the foreign currency decisionWhen functional currency is U.S. Dollar, temporal method is requiredWhen functional currency is foreign currency, current rate method is required8-22U.S. GAAP RequirementsHighly Inflationary Economies – U.S. GAAPU.S. GAAP defines such economies as those with cumulative 100% inflation over a period of three years (with compounding—average of 26% per year for three years in a row)Temporal method required—translation gains/losses reported in income8-23IFRS IAS 21, The Effects of Changes in Foreign Exchange Rates is the relevant accounting standardUses the functional currency approach developed by the FASBThe standard includes a list, similar to the FASB list, of indicators as guidance for the foreign currency decisionThe standard’s requirements pertaining to hyperinflationary economies are substantially different from U.S. GAAP8-24IFRS RequirementsHyperinflationary Economies – IFRSIAS 21 and 29 use the term hyperinflationary economiesIAS 21 is not as specific in defining hyperinflationary economies as is U.S. GAAP, but does suggest that a cumulative three-year rate approaching or exceeding 100% is evidenceIAS 21 requires restatement of the foreign financial statements for inflation per IAS 29IAS 21 then requires the use of the current exchange rate to translate the restated financial statements, including all balance sheet accounts as well as all income statement accountsIAS approach is substantially different from U.S. GAAP8-25Hedging Balance Sheet ExposureCompanies that have foreign subsidiaries with highly integrated operations use the temporal methodTemporal method requires translation gains and losses to be recognized in incomeLosses negatively affect earnings, and both gains and losses increase earnings volatilityThese gains and losses result from the combination of balance sheet exposure and exchange rate fluctuationsForeign exchange gains and losses on foreign currency borrowings or foreign currency derivatives employed to hedge translation based exposure (under the current rate method)8-26Hedging Balance Sheet ExposureCompanies can hedge against gains and losses by using foreign currency forward contracts, options, and borrowings8-27End of Chapter 88-28