Translation of foreign currency financial statements.pptx

advanced financial accounting

1. Translation of foreign currency financial statements PREPARED BY : 1 . SELAMAWIT BERHANU …………… . GSE/3566/14 2 . WENDYERAD SIMEGNE ……………. GSE/7643/14 3 . YESHIWAS TADESE …………………... GSE/5932/14 4 . ZELALEM LAMBORO …………………GSE/2137/14 5. ZEWDNEH GASHAW………………... GSE/2312/14 SUBMITTED TO INSTRUCTOR: DR. SEWALE Addis Ababa Ethiopia Submission date: January,2022

2. Translation of foreign currency financial statements

3. Translation of foreign currency financial statements Introduction   Companies establish operations in foreign countries for a variety of reasons including to develop new markets for their products, take advantage of lower production costs, or gain access to raw materials. Some multinational companies have reached a stage in their development in which domestic operations are no longer considered to be of higher priority than international operations.

4. Translation of foreign currency financial statements Foreign operations create numerous managerial problems for the parent company that do not exist for domestic operations. Some of these problems arise from cultural differences between the home and foreign countries. Other problems exist because foreign operations generally are required to comply with the laws and regulations of the foreign country . For example, most countries require companies to prepare financial statements in the local currency using local accounting rules. To prepare worldwide consolidated financial statements, a parent company must

5. (1) Convert the foreign GAAP financial statements of its foreign operations into parent company GAAP and (2) Translate the financial statements from the foreign currency into parent company currency.   This conversion and translation process must be carried out regardless of whether the foreign operation is a branch, joint venture, majority-owned subsidiary, or affiliate accounted for under the equity method. Translation of foreign currency financial statements

6. We have two methods of translating financial statement 1. The Current method ( T ranslation method) 2. The Temporal method (Re-measurement method) The basic assumption underlying The current rate method is a foreign operation represents a foreign currency net asset and if the foreign currency decreases in value against the parent currency, a decrease in the parent currency value of the foreign currency net asset occurs. Translation of foreign currency financial statements

7. Translation of foreign currency financial statements This decrease in parent currency value of the net investment will be reflected by reporting a negative (debit balance) translation adjustment in the consolidated financial statements. If the foreign currency increases in value, an increase in the parent currency value of the net asset occurs and will be reflected through a positive (credit balance) translation adjustment Current Method Limitation :- The translation adjustment that arises when using the current rate method is unrealized. It can become a realized gain or loss only if the foreign operation is sold (for its book value) and the foreign currency proceeds from the sale are converted into U.S. dollars.

8. Translation of foreign currency financial statements The basic objective underlying The temporal method of translation is to produce a set of Parent currency–translated financial statements as if the foreign subsidiary had actually used the parent currency in conducting its operations. The following rule is consistent with the temporal method’s underlying objective : 1. Assets and liabilities carried on the foreign operation’s balance sheet at historical cost are translated at historical exchange rates to yield an equivalent historical cost in U.S. dollars .

9. Translation of foreign currency financial statements 2 . Conversely, assets and liabilities carried at a current or future value are translated at the current exchange rate to yield an equivalent current value in U.S. dollars . Temporal Method Limitation :- Because liabilities (current plus long term) usually are more than assets translated at the current exchange rate, a net liability exposure generally exists when the temporal method is used. In translating this financial statements the next thing we need is to identify the functional currency . A functional currency is identified by currency which is used by the company for sales price, sales market, payment to employee, expenses, financing, COGS, intercompany transaction and etc.

10. The functional currency may be 1. The local currency of the foreign entity 2. The parent company currency 3. The currency of a third country Translation of foreign currency financial statements

11. 1. The local currency of the foreign entity Most of the time the local currency is the functional currency. For example a parent company operating in USA that have a subsidiary in Canada which uses Canadian dollar for different activities. In this case the functional currency (FC) is the local currency. 2. Parent company currency There are two case in which the functional currency can be the parent company currency. Translation of foreign currency financial statements

12. When the subsidiary operate in a highly inflated economy . To determine if the economy is highly inflated we will add the inflation rate of the last 3 years and if the summation is more than 100% then we call this highly inflated economy. When the subsidiary uses the parent company currency for different activity like for sales price, sales market, payment to employee, expenses, financing, COGS, intercompany transaction and etc. then the functional currency is the parent company currency. Translation of foreign currency financial statements

13. Translation of foreign currency financial statements 3. The currency of a third country This happen when the subsidiary use a currency other than the local currency and the parent company currency. For example parent company located at USA which have a subsidiary in F rance that uses EUR for different activity like sales price, sales market, payment to employee, expenses, financing, COGS, intercompany transaction and etc. In this case the functional currency is the EUR which is the currency of third country.

14. After we identify the functional currency (FC) then we can chose which translation method to use. 1 st determine the functional currency. FC is the local currency FC is parent currency FC is Third country currency If the foreign economy is highly inflationary (FC is Parent currency)   ↓ ↓ ↓ ↓ 2 nd identify which method to use. The current method. The T emporal method. The T emporal method. (Adjustment goes to I/S) The T emporal method.   ↓ ↓ ↓ ↓ 3 rd the adjustment goes to. Adjustment is on Balance sheet (OCI) Adjustment is on income statement Current method . (Adjustment goes to B/S) Adjustment goes to income statement. Translation of foreign currency financial statements

15. Translation of foreign currency financial statements Before going to examples we need to identify which rate to use in each scenario’s. We have three kinds of exchange rate. 1. Current rate (the rate on date of f/s preparation) 2. Historical rate (the rate on the date of transaction occurred) 3. Average rate (the weighted average exchange rate)

16. Translation of foreign currency financial statements current rate   Temporal Method Exchange Rate Current Rate Method Exchange Rate Balance Sheet Items     Cash and receivables Current Current Marketable securities Current Current Inventory at market Current Current Inventory at cost Historical Current Prepaid expenses Historical Current Property, plant, and equipment Historical Current Intangible assets Historical Current Current liabilities Current Current Deferred income Historical Current Long-term debt Current Current Capital stock Historical Historical Additional paid-in capital Historical Historical Retained earnings Composite Composite Dividends Historical Historical Income Statement     Revenues Average Average Most expenses Average Average Cost of goods sold Historical Average Depreciation of property, plant, and equipment Historical Average Amortization of intangibles Historical Average

17. Translation of foreign currency financial statements temporal method Translation of Retained Earnings Stockholders’ equity items are translated at historical exchange rates under both the temporal and current rate methods. At the end of the first year of operations, foreign currency (FC) retained earnings (R/E) is translated as follows:   Beginning R/E in FC (last yr ending)   +   Net income (from translated income statement)   -   Dividend (historical Exchange rate)   =   Ending R/E in FC

18. Calculation of Cost of Goods Sold Under the current rate method , the account Cost of Goods Sold (COGS) in foreign currency (FC ) is simply translated using the average-for-the-period exchange rate (ER): COGS in FC X Average ER = COGS in $ Under the Temporal method Beginning inventory in FC X Historical ER (4thQ 2010) = Beginning inventory in $ + Purchases in FC X Average ER (2011) = + Purchases in $ - Ending inventory in FC X Historical ER (4thQ 2011) = - Ending inventory in $ COGS in FC COGS in $

19. Translation of foreign currency financial statements Illustration : - Assume that USCO (a U.S.-based company) forms a wholly owned subsidiary in Switzerland (SWISSCO) on December 31, 2010. On that date, USCO invested $300,000 in exchange for all of the subsidiary’s common stock. Given the exchange rate of $0.60 per Swiss franc (CHF), the initial capital investment was CHF 500,000, of which CHF 150,000 was immediately invested in inventory and the remainder held in cash. Thus, SWISSCO began operations on January 1, 2011, with stockholders’ equity (net assets) of CHF 500,000 and net monetary assets of CHF 350,000 .

20. Translation of foreign currency financial statements Furthermore during 2011, SWISSCO purchased property and equipment, acquired a patent, and purchased additional inventory, primarily on account. It negotiated a five-year loan to help finance the purchase of equipment. It sold goods, primarily on account, and incurred expenses. It generated income after taxes of CHF 470,000 and declared dividends of CHF 150,000 on October 1, 2011. The income statement, retained earnings statement, and the balance sheet is as follows:

21. Translation of foreign currency financial statements SWISSCO Income Statement For Year Ending December 31, 2011 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,000,000) Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000,000 Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (100,000) Amortization expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,000) Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (220,000) Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . 670,000 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (200,000) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470,000

22. Translation of foreign currency financial statements SWISSCO Statement of Retained Earnings For Year Ending December 31, 2011 Retained earnings, 1/1/11 . . . . . . . . . . . . . . . . . . . . . . . . . . –0– Net income, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . 470,000 Less: Dividends, 10/1/11 . . . . . . . . . . . . . . . . . . . . . . . . . (150,000) Retained earnings, 12/31/11 ….. . . . . . . . . . . . . . . . . . . . . . 320,000

23. Translation of foreign currency financial statements SWISSCO Balance Sheet December 31, 2011 Assets CHF Liabilities and Equity CHF Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130,000 Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600,000 Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . .200,000 Total current liabilities . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . 600,000 Inventory* . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . .. 400,000 Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 Total current assets . . . . . . . . . . . . . . . . . . . . . . . . 730,000 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850,000 Property and equipment . . . . . . . . . . . . . . . . . .. 1,000,000 Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . .. . . . 100,000 Accumulated depreciation . . . . . . . . . . . . . . . . . ( 100,000) Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . .. . . . . 400,000 Patents, net . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . .40,000 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320,000 Total equity . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 820,000   Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,670,000 Total liabilities and equity . . . . . . . . . . . . . . . . . . . . .. . . . . 1,670,000

24. Translation of foreign currency financial statements Relevant exchange rates (in U.S. dollars) are as follows: January 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.60 Rate when property and equipment were acquired and long-term debt was incurred, March 15, 2011 . . . . . . . . . . . . . . . . 0.61 Rate when patent was acquired, April 10, 2011 . . . . . . . . . . . . . . . 0.62 Average 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.65 Rate when dividends were declared, October 1, 2011 . . . . . . . . . . 0.67 Average fourth quarter 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.68 December 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.70

25. Translation of foreign currency financial statements Translation of the above financial statements using current method will be as follows : Table 1.1 Translation of Income statement using Current Method SWISSCO Income Statement For Year Ending December 31, 2011   Translation Rate USD Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CHF 4,000,000 0.65 A $ 2,600,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,000,000) 0.65 A (1,950,000) Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000,000   650,000 Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (100,000) 0.65 A (65,000) Amortization expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,000) 0.65 A (6,500) Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (220,000) 0.65 A (143,000) Income before income taxes . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 670,000   435,500 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (200,000) 0.65 A (130,000) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470,000   305,500

26. Translation of foreign currency financial statements SWISSCO Statement of Retained Earnings For Year Ending December 31, 2011   CHF Translation Rate USD Retained earnings, 1/1/11 –0–   –0– Net income, 2011 470,000 From Above 305,500 Less: Dividends, 10/1/11 (150,000) 0.67 H (100,500) Retained earnings, 12/31/11 320,000   205,000 Table 1.2 Translation of Retained earning statement using current Method

27. Translation of foreign currency financial statements SWISSCO Balance Sheet December 31, 2011 Assets CHF Translation Rate USD Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CHF 130,000 0.70 C $ 91,000 Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000 0.70 C 140,000 Inventory* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .400,000 0.70 C 280,000 Total current assets . . . . . . . . . . . . . . . . . . . . . .. . . . . 730,000   511,000 Property and equipment . . . . . . . . . . . . . . . . . . . . . .1,000,000 0.70 C 700,000 Accumulated depreciation . . .. . . . . . . . . . . . . . . . . . (100,000) 0.70 C (70,000) Patents, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 0.70 C 28,000 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . 1,670,000   $1,169,000 Liabilities and Equity CHF   USD Accounts payable . . . . . . . . . . . . . . . . . . . . . . . CHF 600,000 0.70 C $ 420,000 Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . 600,000   420,000 Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 0.70 C 175,000 Total liabilities . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . 850,000   595,000 Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 0.60 H 60,000 Additional paid-in capital . . . . . . . .. . . . . . . . . . . . . . 400,000 0.60 H 240,000 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . 320,000 From Above 205,000 Cumulative translation adjustment To balance 69,000 Total equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 820,000   574,000 Total liabilities and equity . . . . . . . . . . . . . . . . . . . . 1,670,000   $ 1,169,000 Table 1.3 Translation of balance sheet using current Method

28. Translation of foreign currency financial statements Computation of Translation Adjustment Based on the process just described, the translation adjustment for SWISSCO in this example is calculated as follows : Net asset balance, 1/1/11 . . . . . . . . . . . . . . . . CHF 500,000 X 0.60 = $ 300,000 Change in net assets: Net income, 2011 . . . . . . . . . . . . . . . . . . . 470,000 X 0.65 = 305,500 Dividends declared, 10/1/11 . . . . . . . . . . (150,000) X 0.67 = (100,500) Net asset balance, 12/31/11 . . . . . . . . . . . . . . CHF 820,000 $ 505,000 Net asset balance, 12/31/11 at current exchange rate . . . . . . . . . . . . . . . CHF 820,000 X 0.70 = 574,000 Translation adjustment, 2011 (positive). . . . …………………………………..$ ( 69,000 )

29. Translation of foreign currency financial statements Translation of the above financial statements using Temporal method will be as follows : Table 2.1 Translation of income statement using Temporal Method SWISSCO Income Statement For Year Ending December 31, 2011 CHF Re-measurement Rate USD Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CHF 4,000,000 0.65 A $ 2,600,000 Cost of goods sold . . . . . . . . . . . . . . . . . . . . . (3,000,000) Calculation ( 1,930,500 ) Gross profit . . . . . . . . .. . . . . . . . . . . . . . . . . . . 1,000,000   669,500 Depreciation expense . . . . . . . . . . . . . . . . . . . . (100,000) 0.61 H (61,000) Amortization expense . . . . . . . . . . . . . . . . . . . . . (10,000) 0.62 H (6,200) Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . (220,000) 0.65 A (143,000) Income before income taxes . . . . . . . . . . . . . . . . 670,000   459,300 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . (200,000) 0.65 A (130,000) Re-measurement Loss To Balance ( 47,000 ) Net income . . . . . . . . . . . . . . . . . . . . . . . . . CHF 470,000   $ 282,300

30. Translation of foreign currency financial statements Cost of good sold will be computed as follows: Beginning inventory , 1/1/11 . . . . . . CHF 150,000 x 0.60 = $ 90,000 Plus: Purchases, 2011 . . . . . . . . . . . . . . . 3,250,000 x 0.65 = 2,112,500 Less: Ending inventory, 12/31/11 . . . . . . . (400,000) x 0.68 = (272,000) Cost of goods sold, 2011 . . . . . . . . . CHF 3,000,000 $ 1,930,500 COGS =beginning Inv + Purchase – ending Inv (3,000,000 = 150,000+P – 400,000) P = 3,250,000

31. Translation of foreign currency financial statements The re-measurement loss can be calculated by considering the impact of exchange rate changes on the subsidiary’s balance sheet exposure. Under the temporal method, SWISSCO’s balance sheet exposure is defined by its net monetary asset or net monetary liability position. SWISSCO began 2011 with net monetary assets (cash) of CHF 350,000. During the year, however, expenditures of cash and the incurrence of liabilities caused monetary liabilities (accounts payable + long-term debt = CHF 850,000) to exceed monetary assets (cash + accounts receivable = CHF 330,000). A net monetary liability position of CHF 520,000 exists at December 31, 2011.

32. Translation of foreign currency financial statements Computation of Re-measurement Loss Net monetary assets, 1/1/11 . . . . . . . . . . . . . . . . . . CHF 350,000 x 0.60 = $ 210,000 Increase in monetary assets: Sales , 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000,000 x 0.65 = 2,600,000 $ 2,810,000.00 Decreases in monetary assets and increases in monetary liabilities: Purchases , 2011 . . . . . . . . . . . . . . . . . . . . . . . . . (3,250,000) x 0.65 = ( 2,112,500) Other expenses, 2011 . . . . . . . . . . . . . . . . . . . . . (220,000) x 0.65 = ( 143,000) Income taxes, 2011 . . . . . . . . . . . . . . . . . . . . . . . ( 200,000) x 0.65 = (130,000) Purchase of property and equipment, 3/15/11 . . . (1,000,000) x 0.61 = (610,000) Acquisition of patent, 4/10/11 . . . . . . . . . . . . . . . ( 50,000) x 0.62 = ( 31,000) Dividends , 10/1/11 . . . . . . . . . . . . . . . . . . . . . . . ( 150,000) x 0.67 = (100,500) 3,127,000.00 Net monetary liabilities, 12/31/11 . . . . . . . . . . . . . . CHF (520,000 ) $ (317,000.00) Net monetary liabilities, 12/31/11 at the current exchange rate . . . . . . . . . . . . . . . . . CHF (520,000) x 0.70 = ( 364,000.00) Re-measurement loss . . . . . . . . . . . . . . . . . . . . . . $ ( 47,000.00 )

33. Translation of foreign currency financial statements The re-measurement loss is computed by translating the beginning net monetary asset position and subsequent changes in monetary items at appropriate exchange rates and then comparing this with the dollar value of net monetary liabilities at yearend based on the current exchange rate :

34. Translation of foreign currency financial statements Table 2.2 Translation of Retained Earning statement SWISSCO Statement of Retained Earnings For Year Ending December 31, 2011 CHF Re-measurement Rate USD Retained earnings, 1/1/11 . . . . . . . . . . . . . . . CHF –0–   $ –0– Net income, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . 470,000   282,300 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (150,000) 0.67 H (100,500) Retained earnings, 12/31/11 . . . . . . . . . . . . . . CHF 320,000   $ 181,800

35. Translation of foreign currency financial statements Table 2.3 Translation of Balance sheet Temporal Method SWISSCO Balance Sheet December 31, 2011 Assets CHF Re-measurement Rate USD Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CHF 130,000 0.70 C 91,000 Accounts receivable . . . . . . . . . . . . . . . . . . .. . . 200,000 0.70 C 140,000 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 0.68 H 272,000 Total current assets . . . . . . . . . . . . . . . . . . . . . 730,000   503,000 Property and equipment . . . . . . . . . . . . . . . . 1,000,000 0.61 H 610,000 Less: Accumulated depreciation . . . . . . . . . . . (100,000) 0.61 H (61,000) Patents, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000 0.62 H 24,800 Total assets . . .. . . . . . . . . . . . . . . . . . . . CHF 1,670,000   $ 1,076,800 Liabilities and Equities     Accounts payable . . . . . . . . . . . . . . . . . . . . CHF 600,000 0.70 C $ 420,000 Total current liabilities . . . . . . . . . . . . . . . . . . . 600,000   420,000 Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 0.70 C 175,000 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 850,000   595,000 Common stock . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 0.60 H 60,000 Additional paid-in capital . . . . . . . . . . . . . . . . . 400,000 0.60 H 240,000 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . 320,000 To balance 181,800 Total equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 820,000   481,800 Total liabilities and equity . . . . . . . . . . . . CHF 1,670,000   $ 1,076,800

36. Translation of foreign currency financial statements HEDGING BALANCE SHEET EXPOSURE Management of Parent companies could wish to avoid reporting re-measurement losses in net income because of the perceived negative impact this has on the company’s stock price. Parent companies can hedge balance sheet exposure by using a derivative financial instrument, such as a forward contract or foreign currency option, or a non derivative hedging instrument, such as a foreign currency borrowing.

37. Translation of foreign currency financial statements To illustrate, assume that SWISSCO’s functional currency is the Swiss franc; this creates a net asset balance sheet exposure. USCO believes that the Swiss franc will depreciate, thereby generating a negative translation adjustment that will reduce consolidated stockholders’equity . USCO could hedge this balance sheet exposure by borrowing Swiss francs for a period of time, thus creating an offsetting Swiss franc liability exposure. As the Swiss franc depreciates, the U.S. dollar value of the Swiss franc borrowing decreases and USCO will be able to repay the Swiss franc borrowing using fewer U.S. dollars. This generates a foreign exchange gain, which offsets the negative translation adjustment arising from the translation of SWISSCO’s financial statements.

38. Translation of foreign currency financial statements As an alternative to the Swiss franc borrowing, USCO might have acquired a Swiss franc put option to hedge its balance sheet exposure. A put option gives the company the right to sell Swiss francs at a predetermined strike price. As the Swiss franc depreciates, the fair value of the put option should increase, resulting in a gain.

39. IFRS-Translation of foreign currency financial statements IAS 21, “The Effects of Changes in Foreign Exchange Rates,” provides guidance in IFRS with respect to the translation of foreign currency financial statements. IAS 21 generally follows the functional currency approach introduced by the FASB. Under IAS 21, as is true under U.S. GAAP, a foreign subsidiary’s financial statements are translated using the current rate method when a foreign currency is the functional currency and using the temporal method when the parent company’s currency is the functional currency. Significant differences between IFRS and U.S. GAAP relate to (a) the hierarchy of factors used to determine the functional currency and (b) the method used to translate the foreign currency statements of a subsidiary located in a hyperinflationary country.

40. IFRS-Translation of foreign currency financial statements Although stated differently, the factors to be considered in determining the functional currency of a foreign subsidiary in IAS 21 generally are consistent with U.S. GAAP functional currency indicators. Specifically, IAS 21indicates that the primary factors to be considered are: 1. The currency that mainly influences sales price. 2. The currency of the country whose competitive forces and regulations mainly determine sales price. 3. The currency that mainly influences labor, material, and other costs of providing goods and services.

41. IFRS-Translation of foreign currency financial statements Other factors to be considered are: 1. The currency in which funds from financing activities are generated. 2. The currency in which receipts from operating activities are retained. 3. Whether the foreign operation carries out its activities as an extension of the parent or with a significant degree of autonomy. 4. The volume of transactions with the parent. 5. Whether cash flows generated by the foreign operation directly affect the cash flows of the parent. 6. Whether cash flows generated by the foreign operation are sufficient to service its debt .

42. IFRS-Translation of foreign currency financial statements Under IAS 21,the financial statements of a foreign subsidiary located in a hyperinflationary economy are translated into the parent’s currency using a two-step process. First, the financial statements are restated for local inflation in accordance with IAS 29, “Financial Reporting in Hyperinflationary Economies.” Second, each financial statement line item, which has now been restated for local inflation, is translated using the current exchange rate. In effect, neither the temporal method nor the current rate method is used when the subsidiary is located in a country experiencing hyperinflation. Because all balance sheet accounts, including stockholders’ equity, are translated at the current exchange rate, a translation adjustment does not exist.

43. IFRS-Translation of foreign currency financial statements Restatement of financial Statement The basic principle in IAS 29 is that the financial statement of an entity that reports in currency of a hyperinflation economy should be stated in terms of the measuring unit current at the balance sheet date. Comparative figures for prior period(s) should be restated into the same current measuring unit. {IAS 29.8} Restatement are made by applying a general price index. Items such as monitory item that are already stated at the measuring unit at the balance sheet date are not restated. Other item are restated based on the change in the general price index between the date those item were acquired or incurred and the balance sheet date.

44. Translation of foreign currency financial statements Reference You tube lecture ( Farhat’s Accounting Lectures) Professor Farhat HOYLE__ Advanced_Accounting 10ed https://www.iasplus.com/en/standards/ias/ias29