chapter 13 international accounting standards & translating foreign currency transactions

CHAPTER 13

INTERNATIONAL ACCOUNTING STANDARDS

& TRANSLATING

FOREIGN CURRENCY TRANSACTIONS

FOCUS OF CHAPTER 13• International Accounting Standards:

– The Diversity of Worldwide GAAP– Efforts to Harmonize Worldwide GAAP

• Currency Exchange Rates• Causes of Exchange Rate Fluctuations• Translating Foreign Currency Transactions

(importing and exporting) into U.S. Dollars

The Diversity of Worldwide GAAP:An Almost Unbelievable Cornucopia

• Everything from soup to nuts.• The United States is part of the problem

—many U.S. standards are either rarely used or not used at all overseas:– LIFO inventory method.– Deferred income taxes.– Goodwill capitalization.

Internationalize Accounting Standards: The Grand Dream

• World GAAP—so many hurdles.• All are for it—BUT few countries are

willing to change their own GAAP.

International Accounting Standards: World GAAP’s Advantages

• Having a Uniform World GAAP:– Would greatly streamline the quarterly

and year-end consolidation process for the accountants of publicly-owned companies.

Efforts To Internationalize Accounting Standards: Progress Has Been Slow

• The International Accounting Standards Board [“Committee” prior to 2001] (created in 1973—London based)

• IASB Standards to date: Minimal impact—still fairly easy to comply with virtually all IASB Standards.

Efforts To Internationalize Accounting Standards: Capital Market Forces

• The Capital Markets—A much-needed injection:– Relatively recent trend of raising capital

in world markets has given greatly added emphasis to the desirability of having a world GAAP. The BIG

advantage:• Would greatly streamline the process

by eliminating the need to comply with multiple GAAPs in offering securities.

Efforts To Internationalize Accounting Standards: The FASB Hops Aboard

• 2/97: FASB issues FAS 128 “Earnings Per Share” conforming U.S. GAAP with world GAAP.

• 6/01: FASB abolished the pooling of interests method conforming U.S. GAAPwith world GAAP.

Currency Exchange Rates:Terminology

• Conversion: Actually going to the bank and physically exchanging currencies.

Currency Exchange Rates:Terminology

• Translation: The process of applying an exchange rate to a foreign currency amount so that an amount can be expressed in dollars.

100,000 x $1.25 = $125,000

Currency Exchange Rates:Terminology

• Expressing Directly:

100,000 x $1.25 = $125,000

• Expressing Indirectly:

100,000 ÷ .80 = $125,000

Currency Exchange Rates:Terminology

• It is CUSTOM to always express certain currencies directly (British pound):

• It is CUSTOM to always express certain currencies indirectly (Japanese yen):

1

1$ = 110

= $1.60

Currency Exchange Rates:Terminology

• FOREIGN CURRENCY STRENGTHENS:

– Direct exchange rate goes UP.

After: 1 = $1.64 Before: 1 = $1.60

– Indirect exchange rate goes DOWN.

Before: $1 = .625 After: $1 = .610

Currency Exchange Rates:Terminology

• Foreign currency strengthens:– It becomes more expensive to buy.

• Imports cost more.• Exports cost foreign customers less.

• Foreign currency weakens:– It becomes less expensive to buy.

• Imports cost less.• Exports cost foreign customers more.

Currency Exchange Rates:Why Do They Change?

• Inflationary Factors:– Foreign inflation makes the DIRECT

exchange rate decrease.– Domestic inflation makes the DIRECT

exchange rate increase.• Noninflationary Factors:

– Anything and everything else.

The Foreign Exchange Market:

The Biggest Market of All

• An OTC market—not an organized exchange such as the NYSE.

• Open 24 hours a day.• $1.5 trillion per day.• The market-makers: Several hundred

banks located throughout the world.

Translating Importing & Exporting Transactions: Terminology

• Denominated: The currency in which an FX transaction is to be settled.

• Measured: The currency in which an FX transaction is recorded in the books and records.

British pounds

Translating Importing & Exporting Transactions: The Relevant Dates

• Order (or Commitment) Date: The date the purchase or sales order is issued.

• Transaction Date: The date that title passes and the parties record the sale and purchase.

• Intervening F/R (or B/S) Date: Dates between the transaction date and the settlement date.

• Settlement Date: The date that the debtor pays the creditor.

Translating Importing & Exporting Transactions: FX Gains & FX Losses

• The One-Transaction View (non-GAAP):– Treat as an adjustment to either:

• Cost of item acquired. • Sales price of item sold.

• The Two-Transaction View (GAAP):– Recognize currently in earnings.

Recognizing Currently FX Gains & FX Losses at Intervening F/R Dates

• Does it matter if FX gains & losses at intervening balance sheet dates are unrealized?

Recognizing Currently FX Gains & FX Losses At Intervening F/R Dates

• NO! Because an economic gain or loss has occurred.

Dear Ann: I Just Don’t Know!

Dear Ann: My Intel stock has gone up in value $400,000. My accountant says the gain is unrealized. Should I feel good or not? Perplexed Peter Cruising in TahitiDear Peter: Feel good. If you have any doubts about feeling good, sell the stock and buy it back the same day. Then the gain will be realized—but you will still be “IN THE SAME BOAT.” Ann Anders

Review Question #1

On 11/9/06, Selco recorded a sale denominated in 100,000 euros. The customer paid on 1/5/07. Direct exchange rates were: 11/9/06—$.90; 12/31/06—$.95; and 1/5/07—$.92. What does Selco report in earnings in 2006? A. Sales of $90,000 and FX Gain of $5,000 .B. Sales of $90,000 and FX Loss of $5,000. C. Sales of $90,000 and no FX gain or loss.D. Sales of $95,000 and no FX gain or loss. E. Sales of $85,000 and no FX gain or loss.

Review Question #1With Answer

On 11/9/06, Selco recorded a sale denominated in 100,000 euros. The customer paid on 1/5/07. Direct exchange rates were: 11/9/06—$.90; 12/31/06—$.95; and 1/5/07—$.92. What does Selco report in earnings in 2006? A. Sales of $90,000 and FX Gain of $5,000.B. Sales of $90,000 and FX Loss of $5,000. C. Sales of $90,000 and no FX gain or loss.D. Sales of $85,000 and no FX gain or loss. E. Sales of $95,000 and no FX gain or loss.

Review Question #2On 12/28/06, Purco recorded an inventory purchase denominated in 100,000 euros. Purco paid the vendor on 1/12/07. Direct exchange rates were: 12/21/06—$1.10; 12/31/06—$1.11; and 1/12/07—$1.15. What does Purco report at 12/31/06? A. Inventory of $110,000 and FX Gain of $1,000.B. Inventory of $110,000 and FX Loss of $1,000. C. Inventory of $110,000 and no FX gain/loss.D. Inventory of $109,000 and no FX gain/loss.E. Inventory of $111,000 and no FX gain/loss.

Review Question #2With Answer

On 12/28/06, Purco recorded an inventory purchase denominated in 100,000 euros. Purco paid the vendor on 1/12/07. Direct exchange rates were: 12/21/06—$1.10; 12/31/06—$1.11; and 1/12/07—$1.15. What does Purco report at 12/31/06? A. Inventory of $110,000 and FX Gain of $1,000.B. Inventory of $110,000 and FX Loss of $1,000. C. Inventory of $110,000 and no FX gain/loss.D. Inventory of $109,000 and no FX gain/loss.E. Inventory of $111,000 and no FX gain/loss.

End of Chapter 13(Appendix 13A follows)

• Time to Clear Things Up—Any Questions?

APPENDIX 13AGOING INTERNATIONAL

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FOCUS OF APPENDIX 13A• Globalization of Business:

– Ways to Export– Ways to Manufacture Overseas– Reasons for Manufacturing Overseas

• International Accounting Standards:– The Diversity of Worldwide GAAP– Efforts to Harmonize Worldwide

GAAP

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Going International: Ways to Export(Choices Galore)

• Independent distributor.• Foreign commission agent.• Foreign marketing branch.• Foreign marketing subsidiary.• Export trade vehicle (FSC or IC-DISC).

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Ways to Export: The Concept of Physical Presence

• Defined: Having an “operation” overseas. Examples: SALES OFFICE, WAREHOUSE, FACTORY, EMPLOYING FOREIGN CITIZENS AS SALES PERSONNEL.

• To make a determination:– Review foreign tax laws.– Review tax treaty.

• Significance: Subject to taxation in the foreign country. File a foreign

income tax return.

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Foreign Earnings: DOUBLE Corporate Taxation???

• Income of foreign units are taxed overseas and in the U.S—BUT DON’T PANIC.

• U.S. tax laws allow a “foreign tax credit.”

Tax Calculation for Brazil U.S. Pretax income of foreign unit... 100,000 100,000Applicable tax rate....................... 20% 35% Income taxes owed.................. 20,000 35,000Less--Allowable tax credits........ (20,000) U.S. taxes owed........................ 15,000

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Foreign Earnings: When Are U.S. Taxes Actually Paid?

• 3 possibilities exist:– Foreign branches:

• When INCOME is earned.– Foreign subsidiaries:

• When DIVIDENDS are paid.• When INCOME is earned (applies to

“Subpart F” income)

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Reasons for Manufacturing Overseas: The List is Long

• The lure of cheap labor• Tax holidays.• To establish a visible presence.• Lax environmental laws.

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Reasons for Manufacturing Overseas: The List is Long

• High literacy rates & safe environments.• A Strong work ethic.• Loan guarantees, grants, subsidies.• The fluctuating exchange rate problem.

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Risks of Investing Overseas:All That Glitters Is Not Gold

• Expropriation—the seizure of assets by the foreign government.

• Devaluations/weakening of the foreign currency.

• Currency transfer restrictions Wouldn’t it be nice to be able to bring the profits home?

• Wars and civil disorders.• Government mandated changes in the

investment climate.

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End of Appendix 13A

• Time to Clear Things Up—Any Questions?

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