Ch. 11 - Managing Translation Exposure

Translation Exposure - Accounting Exposure

Arises because financial statements of foreign subsidiaries, which are stated in foreign currency, must be restated in the parent’s reporting currency

Main purpose of translation

To prepare consolidated financial statements for use by inevstors, creditors, and governments

• Management also uses the translated statements to assess the perforance of foreign subsidiaries

Consolidation Accounting

Process of combining the financial results of all subsidiary companies into the combined financial results of the parents company

Reporting Currency

Currency that the reporting entity uses to prepare its financial statements for consolidated reporting

Foreign entity

Any distinct or separable business that prepared its financial statements in any currency other than the reporting currency of the parent comapny

Distinct and Separable Operation

If the foreign subsidiary operates completely separately from the parents company

Integrated Foreign Entity

The foreign subsidiary operates as an extension of the parents company

Functional Currency

Currency of the primary economic envrionment in which a distinct entity operates

Foreign Currency Financial Statements

Only the income statement and balance sheet need be translated for consolidation purposes

Foreign Currency Measurement (Remeasurement)

Process by which a foreign entity expresses transactions whose terms are denominated in a foreign currency in its functional currency

Foreign Currency Translation

If a foreign entity’s financial statements are maintained in a functional currency, and that functional currency is different from the reporting currency of the parents company, the process for preparation of the financial statements is termed translation

Translation Methods

• Current Rate Method

• Temproal Method

  • Both employed worldwide

Current Rate Method

• Gains or losses caused by translation adjustments are not included in the calculation of consolidated net income

• Translation gains or losses are reported separately and accumulated in a separate equity reserve account on the balance sheet

Temporal Method

Specific assets and liabilities are translated at exchange rates consistent with the timing of those items’ creation

• Assumes that a number of individual line item assets are restated regularly to reflect market value

• Gains or losses resulting from remeasurement are carried directly to current consolidated income, and not to equity reserves

Translating Monetary Assets and Liabilities through the Temporal Method

Translated at current exchange rates

Translating Nonmonetary Assets and Liabilities through the Temporal Method

Translated at historical rates

Translating Income Statement Items through the Temporal Method

Translated at the average exchange rate for the period

Translating Distribution and Dividends through the Temporal Method

Translated at the exchange rate on the date of payment

Translating Equity Items through the Temporal Method

• Common stock and paid-in capital accounts are translated at historical rates

• Year-end retained earnings consist of the original year-beginning retained earnings ± any income or loss for the year ± any imbalance from translation

USA Translation Procedures

DIfferentiates foreign subsidiaries on the basis of functional currency, not subsidiary characterization

If the financial statements of the foreign subsidiary of a US company are maintained in US dollars, then:

translation is not required

If the financial statements of the foreign subsidiary are maintained in the local currency, and the local currency is the functional currency, then

they are translated using the current rate method

If the financial statements of the foreign subsidiary are maintained in the local currency and the US dollar is the functional currency, then

they are remeasured using the temporal method

If the financial statements of foreign subsidiaries are maintained in the local currency and neither the local or US dollar is the functional currency, then

the statements must first be remeasured into the functional currency by the temporal method, then translated into dollars using the current rate method

Translation of Assets and Liablities through the Current Rate Method

Translated at current exchange rate

Translation of Income Statement Items through the Current Rate Method

Translated at the exchange rate on the dates they were recorded or an appropriately weighted average for the period

Translation of Distributions/Dividends through the Current Rate Method

Translated at the rate in effect on the date of payment

Translation of Equity Items through the Current Rate Method

• Common Stock and paid/in capital accounts are translated at historical rates

• Year-end retained earnings consist of the original year-beginning retained earnings ± any income or loss during the year