Foreign Currency Translations

Foreign Currency TranslationsReported by: Gwapa

First, lets review on the important parts in FCT that my group mates discussed eralier2 translation Methods:

current/closing rate method used to adjust from FC to RC of the parent Assets and liabilities (both monetary and non-monetary) are translated @ closing rate Income and expense items of foreign operations are translated @ exchange rates at the dates of the transactions Translation G/L are reported in OCI

2. Temporal/remeasurement method used to adjust from LC to FC (when the financial statements of the entity is prepared in a currency other than its functional currency.Monetary assets and liabilities are translated using the current exchange rate Non-monetary assets and liabilities are translated using the historical rate

Historical rate - historical exchange rate refers to the exchange rate in effect when the firm first recorded a particular transaction. The historical exchange rate for inventories, property, plant, and equipment means the exchange rate at the time the firm acquired these items. The historical exchange rate for bonds payable and common stock means the exchange rate at the time the firm issued these securities. Current exchange rate - refers to the exchange rate at the date of the balance sheet for balance sheet items and refers to the average exchange rate during the current period for income statementitems

1

Steps in the translation and consolidation of foreign entity1. Receive foreign entitys financial statements, which are reported in foreign currency2. Translate the statements in foreign currency to Philippine peso. Each foreign entity account balance must be individually translated into its Philippine peso equivalent as follows:

3. Consolidate the translated foreign entitys accounts, which are now stated in Philippine peso, with the Philippine companys accountsAccount in foreign currency unitsAppropriate exchange rateAccount in Philippine peso equivalent valueX=

Accountants of the Philippine company usually perform the following steps in the translation and consolidation of the foreign entity2

Comparison of the Two Methods

Balance SheetCurrent/Closing Rate MethodRemeasurement (temporal) MethodMonetary assets and liabilitiesCurrent/closing rateCurrent/closing rateNon-monetary items at historical costCurrent/closing rateHistorical rateNon-monetary items at Fair valueCurrent/closing rateRate at the date of the revaluation or fair value determination*Capital stocks and pre-acquisition retained earningsHistorical (or actual) rateHistorical (or actual) rate

First, lets review on the important parts in FCT that my group mates discussed eralier2 translation Methods:

current/closing rate method used to adjust from FC to RC of the parent Assets and liabilities (both monetary and non-monetary) are translated @ closing rate Income and expense items of foreign operations are translated @ exchange rates at the dates of the transactions Translation G/L are reported in OCI

2. Temporal/remeasurement method used to adjust from LC to FC (when the financial statements of the entity is prepared in a currency other than its functional currency.Monetary assets and liabilities are translated using the current exchange rate Non-monetary assets and liabilities are translated using the historical rate

*For subsidiaries that have been acquired by the parent, the exchage rate at the date of acquisition serves as the HR for items that have been acquired before the date of acquisition of the subsidiaryCurrent exchange rate - refers to the exchange rate at the date of the balance sheet for balance sheet items and refers to the average exchange rate during the current period for income statement itemsA- average exchange rate used to approximate the rate on the date these elements were recognized. Usually, the average rate is used for items whose transactions are numerous and occur evenly throughout the year (purchases, sales, operating expenses)Historical rate - historical exchange rate refers to the exchange rate in effect when the firm first recorded a particular transaction. The historical exchange rate for inventories, property, plant, and equipment means the exchange rate at the time the firm acquired these items. The historical exchange rate for bonds payable and common stock is the exchange rate at the time the firm issued these securities. 3

Comparison of the Two MethodsBalance SheetCurrent/Closing Rate MethodRemeasurement (temporal) MethodPost-acquisition retained EarningsNot translated using a single exchange rate. This is a cumulative figure that is carried forward from year to yearNot translated using a single exchange rate. This is a cumulative figure that is carried forward from year to yearTranslation gains nor lossesOther comprehensive income (FCT G/L)Taken to income statement as gains or losses; remeasurement gain or loss arising from the revaluation of a non-monetary items is taken to OCI if the revaluation G/L are taken to OCI

FCTR accumulated from year to year until the investment in foreign operation is disposed. It s also a component of stockholders equity.4

Income StatementCurrent/Closing Rate MethodRemeasurement (temporal) MethodSales, purchases, expenses and income items that result to outflow or inflow of monetary itemsHistorical rate or actual rate (average rate may be used for practical purposes)Historical rate or actual rate (average rate may be used for practical purposes)

Cost of SalesHistorical rate or actual rate at the date when inventory is sold or average rate if the cost of sales is evenly spread outHistorical rate or actual rate at the date when inventory is sold or average rate if the cost of sales is evenly spread outDepreciation, amortization and any other allocation of non-monetary itemsHistorical or actual rate at the date when the expense is incurred, or average if the expense is incurred evenly throughout the yearHistorical rate of original acquisition (either at the date of purchase for historical cost items or the date of valuation for items carried at fair value)Dividends and other appropriation of profitsHistorical or Actual rateRate at the date of the revaluation or fair market value determination

*on the assumption that the items are evenly spread out over the periodAverage rates are usually used for for items whose transactions are numerous and occur evenly during throughout the year (sales, purchase)

5

Translation to Currency of Reporting Entity Per Account ClassificationAssetsCurrent/Closing Method Exchange RateTemporal Method Exchange RateCash, demand deposits, and time deposits (M)CurrentCurrent

Marketable securities carried at cost (N)Equity securitiesDebt securitiesCurrentCurrentHistoricalHistoricalMarketable securities carried at fair value (N)CurrentCurrent

Accounts and notes receivable and related unearned discounts (M)CurrentCurrentAllowance for uncollectible accounts and notes (M)CurrentCurrent

So the following are the list of monetary and non-monetary items that will be translated to the reporting entity on account classification basis. C current exchange rateH historical rate (where r6

AssetsCurrent/Closing Method Exchange RateTemporal Method Exchange RateInventories (N)Carried at costCarried at lower of cost or marketCurrent Current Historical*Prepaid insurance, advertising, and rent (N)Current HistoricalPrepaid interest (M)Current Current Refundable deposits (M)Current Current PPE (N)Current HistoricalAccum. Depreciation on PPE (N)Current HistoricalCash surrender value of life insurance (M)Current Current Patents, trademarks, licenses and formulas (N)Current HistoricalGoodwill (N)Current HistoricalOther intangible assets (N)Current Historical

When the books are not maintained in the functional currency and the lower of cost or market rule is applied to inventories, inventories at cost are remeasured at historical rates. Then the historical cost in the functional currency is compared to the market in the functional currency7

AssetsCurrent/Closing Method Exchange RateTemporal Method Exchange RateDeferred charges and credits, except deferred income taxes and policy acquisition cost for life insurance companies (N)Current Historical

Deferred income taxes (N)CurrentCurrent

Deferred income taxes are considered non-monetary items that needs to be remeasured8

LiabilitiesCurrent/Closing Method Exchange RateTemporal Method Exchange RateAccounts and notes payable and overdrafts (M)CurrentCurrentAccrued expenses (M)CurrentCurrentLiability of refundable expenses (M)CurrentCurrentNon-refundable deposits (N)CurrentHistoricalDeferred income tax liabilities (N)CurrentCurrentDeferred/Unearned revenue (N)CurrentHistorical Other deferred credits (N)CurrentHistorical Bonds payable and other long term debt (M)CurrentCurrent

The use of historical rates to translate capital stocks and pre-acquisition RE serves its two purposes:To ensure that in the consolidation worksheet, the share capital and RE will be cleanly eliminated against the cost of investment to arrive at goodwill as of the date of acquisitionTo throw out the cumulative translation difference from the date of acquisition.

Stockholders equityCurrent/Closing Method Exchange RateTemporal Method Exchange RateCommon stock (N)Historical Historical Preferred stock carried at issuance price (N)Historical Historical Other paid-in capital (N)Historical Historical Retained earnings (residual amount)Not translatedNot remeasured

The use of historical rates to translate capital stocks and pre-acquisition RE serves its two purposes:transal;ting @ HC will result to the translated amount being the same as the original cost of investment. This ensure that in the consolidation worksheet, the share capital and RE will be cleanly eliminated against the cost of investment to arrive at goodwill as opf the date of acquisition

10

Income Statement related to monetary ItemsSales, purchase, expenses and income items that result to outflow or inflow of monetary itemsAverageAverage

Income statement items related to nonmonetary itemsCost of goods soldAverageHistoricalDepreciation on PPEAverageHistoricalAmortization of intangible items (e.g. patents)AverageHistoricalAmortization of deferred income taxesAverageCurrentAmortization of deferred charges and creditsAverageHistoricalAmortization of policy acquisition costs for life insurance companiesAverageHistorical

Para dali ra ninyo ma classify kung unsa nga rates ang gamiton for that particular account, remember that under the closing rate method all assets and liabilities sa BS kay translated using the current rate and only the equity items are translated using the Historical rates. (CLASH) Income statement items are translated using the average rateFor the temporal method, all monetary items are translated using the current rate while the non-monetary items kay historical rates na.For income statement, (CACHAT) ang gamiton na rate kay ang historical rate, but when there is an assumption that the items are evenly spread throughout the ;period, then we use the average rate 11

Illustration: Translation of Foreign Subsidiarys Financial StatementAssume that on January 2, 20x4, P Company, a Philippine based company, acquired for US$ 2,000,000 an 80% interest in S Company maintains its books in US dollars and they are in conformity with GAAP in the Philippines (parents functional and presentation currency is the peso). S companys financial statements are prepared in the local currency unit (the foreign currency unit dollars).Exchange rate for the US dollars for the 20x4 fiscal year are as follows:

DateSpot RateJanuary 2, 20x4 (date of acquisition)40.00September 1, 20x440.10December 31, 20x440.25Average for the fourth quarter40.22Average for the year40.20

BACK

Please take note that : In translating the income statement accounts, it is assumed that revenues were generated and expenses were incurred evenly during the year. It is also assumed that the company uses the FIFO cost flow assumption and that the ending inventory was acquired during the last quarter.

2 translation Methods:

current/closing rate method used to adjust from FC to RC of the parentAssets and liabilities (both monetary and non-monetary) are translated @ closing rate Income and expense items of foreign operations are translated @ exchange rates at the dates of the transactions and average rates if the transactions are numerous and occur evenly throughout the yearTranslation G/L are reported in OCI

2. Temporal/remeasurement method used to adjust from Foreign currency/local currency to fuinctionalMonetary assets and liabilities are translated using the current exchange rate Non-monetary assets and liabilities are translated using the historical rate

12

Translation into the presentation currencyFunctional Currency is local Currency Unit US Dollars(Current/Closing Rate Method)

Functional Currency is Local Currency Unit - US DollarsCombined Statement of Income and Retained EarningsAdjusted Trial Balance ($)Transaction Exchange RateAdjusted Trial Balance (Pesos)Sales 3,020,000Cost of Goods Sold1,850,000Depreciation Expense100,000Other Expenses655,000Income Tax Expense 82,000Net Income to RE333,000Retained Earnings 1/1 480,000Total813,000Less: Dividends declared 9/1/20x4 300,000RE, 12/31 to Balance Sheet 513,000

121,404,00074,370,0004,020,00026,331,000 3,296,40013,386,600 19,200,00032,586,6 12,030,000 20,556,600

RatesA40.20

A40.20

A40.20

A40.20

A40.20

H40.10

1

Following the steps in the translation and consolidation of foreign entity 1. Receive foreign entitys financial statements, which are reported in foreign currency2. Translate the statements in foreign currency to Philippine peso. Each foreign entity account balance must be individually translated into its Philippine peso equivalent : (account in FC * exchange rate)3. Consolidate the translated foreign entitys accounts, which are now stated in

Using the current/closing method, it translates revenues, expenses, and net income using the average exchange rate during the periodRE not translated. This is a cumulative figure that is carried forward from year to yearRE set equal to the ending balance of last year. So since this is the first year of acquisition,the balance is set equal to the jan 2 balance (480000v 14

Balance sheetCash 930,000 Accounts Receivable 608,000 Inventory (FIFO) 830,000 Land 500,000 Buildings (net) 650,000 Equipment (net) 430,000 Total 3,948,000 Accounts Payable 640,000 Short-term notes payable 635,000 Bonds payable 900,000 Common stock, P10 par 960,000 Paid-in Capital in excess of par 300,000 RE, from above 513,000 Total 3,948,000 Foreign Currency Translation Reserve Gain Total 3,948,000

C 40.25

C 40.25

C 40.25

C 40.25

C 40.25

C 40.25

C 40.25

C 40.25

C 40.25

H 40.00

H 40.00

406,650 158,907,000

37,432,500 24,472,000 33,407,50020,125,000 26,162,500 17,307,500 158,907,000 25,760,000 25,558,750 36,225,000 38,400,000 12,000,000 20,556,600 158,500,350

As for assets and liabilities (monetary or non-monetary) they are translated using the current rate and as for the CS and paid-in, it is translated using the historical rate which is necessary for elimination of reciprocal parent investment and subsidiary equity accounts.However, inequality will result between the total debit account balances and the total credit balances because the accounts are translated using different rates. (CS and RE using Historical rate) and due to the entitys exposure to exchange risk (The risk of an investment's value changing due to changes in currency exchange rates. ) which is related to the set of accounts that are translated using the current/closing rate. Item that are transalated using the HR preserve their original amlounts and do not give rise to transalation differences.So what is this FCTR? This is a balancing amount that reconciles the total debit and credit balances after the individual accounts have been translated. It is taken to OCI and accumulated from year to year until the investment in the foreign operation is disposed of. The movement of FCTR is disclosed in the statement of changes in equity.

15

Verification of the Translation Adjustment Current/Closing rate method (Direct Method)US $Translation Exchange RateReporting Currency (Pesos)1/2 Exposed net asset position 1,740,000 40.00 69,600,000 adjustments for changes in net asset position during year: - Net Income for the year 333,000 40.20 13,386,600 Dividends declared (300,000)40.10 (12,030,000) Net asset position translated using rate in effect at the date of each transaction 70,956,600 12/31 Exposed net asset position 1,773,00040.25 71,363,250 Change in cumulative translation adjustment during the year -- net increase 406,650 1/2 Cumulative translation adjustment 012/31 Cumulative translation adjustment 406,650

The foreign currency translation reserved under this method may be verified by a direct computationSince only the assets and liabilities are translated using the current/closing rate only the net assets are exposed to currency fluctuations and results to a translation gain or loss. - the beginning balance is zero since this was the first year the investment was held1st column reconciles the net asset position of the subsidiary at the beg of the year to the net asset position at the end of the year. NOTE: only the transactions that affected stockholders equity will cause a change in net asset position

Translations: Beg exposed net assets translated using the exchange rate in effect at the beg of the periodThe increases and decreases in the net asset position are translated using the exchange rate at the date the transactions were assumed to occur.The ending exposed net asset translated using the current exchange rate

- For the adjustment- the translation adjustment have a credit balance because the spot rate at the end of the year is higher that the exchange rate at the beginning of the year or the average for the period. If the the exchange rate have decreased during the period, the translation adjustments would have a debit balance. Debit balances would be viewed as a net cumulative gains while debit balances reflect net cumulative losses.- It is taken to OCI and accumulated from year to year until the investment in the foreign operation is disposed of. The movement of FCTR is disclosed in the statement of changes in equity.

16

Condensed Balance Sheet for S Company on Jan 2, 20x4 : Monetary assets - - - - - - - - 1,100,000Monetary Liabilities - - - - - - - 1,800,000Nonmonetary assetsCommon stock - - - - - - - - - - 960,000 Inventory - - - - - - - - - - - 760,000Paid-in capital inexcess of par - - - - - - - - - - - - 300,000 Fixed Assets - - - - - - - - - 1,680,000Retained Earnings -- - - - - - - - 480,000Total 3,540,000Total 3,540,000

Net Assets: 3,540,000 1,800,000 = $1,740,000Back

Under the closing/current rate method, since assets and liabilities are translated at the closing rate, the net assets (total assets minus total liabilities) are exposed to changes in exchange rates.17

Statement of Comprehensive IncomeS CompanyStatement of Comprehensive IncomeFor the Year ended Dec. 31, 20x4Net IncomeP 13,386,600Other Comprehensive Income 406,560Comprehensive IncomeP 13,379,250

For the third step in the translation and consolidation of foreign entity- Consolidate the translated foreign entitys accounts, which are now stated in Philippine peso, with the Philippine companys accounts

18

Common StockPaid-in Capital in excess of parRetained EarningsOCITotalBalance, 1/1/20x4P 38,400,00P 12,000,000P 19,200,000P 0P 69,600,000Comprehensive income: Net Income OCIP 13,386,600406,650P 13,386,600 406,650Comprehensive IncomeP 83,393, 290Dividends declared (12,030,000) (12,030,000)Balance, 12/31/20x4P 38,400,000P 12,000,000P 20,556,600P 406,650P 71, 363,250

S CompanyStatement of Shareholders EquityFor the Year ended Dec. 31, 20x4

Common stock 960000 * 40 (beg spot rate)Paid-in 960000 * 40RE 480,000 * 40

Remember: Para dali ra nnyo ma memorize kung unsa na rates ang gamiton under the current/closing rate method, tanan balance shhet accounts uses current except for the equity accounts which uses the historical rate.For the income statement all revenue and expense accounts kay historical or actual, or average if assumed to be evnly spread throughout the year19

Translation into the Functional CurrencyFunctional currency is Philippine peso(Remeasurement or temporal method)

Functional Currency is Local Currency Unit - US DollarsCombined Statement of Income and Retained EarningsAdjusted Trial Balance ($)Transaction Exchange RateAdjusted Trial Balance (Pesos)Sales 3,020,000Cost of Goods Sold1,850,000scheduleDepreciation Expense100,000Other Expenses655,000Income Tax Expense 82,000NI before remeasurement lossRemeasurement loss - Dr 0Net Income to RE333,000Retained Earnings 1/1 480,000Total813,000Less: Dividends declared 9/1/20x4 300,000RE, 12/31 to Balance Sheet 513,000

121,404,00074,201,4004,000,00026,331,000 3,296,40013,575,200 201,85013,373,350 19,200,00032,573,350 12,030,000 20,543,350

A40.20

A40.20

A40.20

H40.00

H40.00

bbxnj

The transaltion loss is related to those accounts translated at the current exchange rate.\RE- cuimulative figure21

Verification of the Translation adjustment (temporal method) US ($)Translation Exchange RateReporting Currency (pesos)1/2 Exposed Net monetary liability position700,00040.0028,000,000Adjustments for changes in net monetary position during the year:Less: Increase in cash and receivables from sales(3,020,000)40.20(121,404,000)Add: decrease in monetary assets or increase in monetary liabilities Purchases Other Expenses Income Taxes Dividends declared

1,920,000655,00082,000 300,00040.2040.2040.2040.1077,184,00026,331,0003,296,400 12,030,000Net monetary liability position translated using rate in effect at date of each transaction25,437,400Less: 12/31 Exposed net monetary liability position 637,00040.25 25,639,250Remeasurement gain (loss) (201,850)

A translation g/l results from the application of temporal method .It is a loss because S company maintains a net monetary liabaility position throughout the. And an increasing rate will produce a translation loss on an exposed net monetary liability position22

Schedule: Translation of Cost of goods SoldAccounts($)Remeasurement exchange RatePesosBeg inventory (assumed)760,000H40.0030,400,000Purchases (assumed) 1,920,000A40.20 77,184,000Total 2,680,000107,584,000Less: Ending Inventory 830,000A40.22 33,382,600Cost Of Goods Sold 1,850,000 74,201,400

BACK

Balance sheetCash 930,000 Accounts Receivable 608,000 Inventory (FIFO) 830,000 ScheduleLand 500,000 Buildings (net) 650,000 Equipment (net) 430,000 Total 3,948,000 Accounts Payable 640,000 Short-term notes payable 635,000 Bonds payable 900,000 Common stock, P10 par 960,000 Paid-in Capital in excess of par 300,000 RE, from above 513,000 Total 3,948,000

bbbb C 40.25

C 40.25

C 40.25

C 40.25

C 40.25

H 40.00

H 40.00

H 40.00

H 40.00

H 40.00

37,432,500 24,472,000 33,382,600 20,000,000 26,000,000 17,200,000 158,487,100 25,760,000 25,558,750 36,225,000 38,400,000 12,000,000 20,543,350 158,487,100

Translation using a Trial Balance Approach Current/Closing rate MethodRemeasurement/Temporal Method

Problem 1Certain balance sheet accounts of a foreign subsidiary of RR company have been stated in pesos as follows:Stated atCurrent ratesHistorical ratesAccounts receivable, currentP 200,000220,000Accounts receivable, long term100,000110,000Prepaid Insurance50,00055,000Goodwill80,00080,000

This subsidiarys functional currency is a foreign currency. What total should RRs balance sheet include for the preceding items?ANSWER: 430,000 (current/closing rate method)2. This subsidiarys functional currency is the peso. What total should RRs balance sheet include for the preceding items?ANSWER: 440,000 (remeasurement)

Problem 22. LL corporation owns a foreign subsidiary with 2600,000 LCU of PPE before accumulated depreciation on Dec. 31,20x4. Of this amount, 1700,000 LCU were acquired in 20x2 when the rate of exchange was 1.5 LCU = P1, and 900,000 LCU were acquired in 20x3 when the rate of exchange was 1.6 LCU = P1. The rate of exchange in effect on December 31, 20x4 was 1.9 LCU = P1. the weighted average of exchange rates that were in effect during 20x4 was 1.8 LCU = P1. Assuming that the PPE are depreciated using the straight line method over a 10-year period with no salvage value.How much depreciation expense relating to the foreign subsidiarys PPE should be charged in LLs Statement of Income for 20x4?

ANSWER: Functional currency LCU = P144,444 Functional Currency is peso = P169,583

Problem 3A wholly owned subsidiary of NN Inc. has certain expense accounts for the year ended December 31, 20x4 stated in local currency units as follows:

LCUDepreciation of Equipment (related assets were purchase 01/01,20x2)120,000Provision for Uncollectible Accounts80,000Rent200,000

Peso Equivalent value of 1 LCUJanuary 01, 20x2P 0.50December 31,20x40.40Average 20x40.44

What peso amount should be included in NN Inc.s 20x4 consolidated income statement to reflect these expenses? Functional currency LCU?Functional currency is peso?Answers: 1. P 176,000 2. P 183,200

Problem 4Certain balance sheet accounts in a foreign subsidiary of SS company on Dec. 31, 20x4 have been restated in pesos as follows:Stated atCurrent ratesHistorical ratesAccounts receivable, currentP 100,000110,000Accounts receivable, long term50,00055,000Prepaid Insurance25,00030,000Patents40,00045,000

What total should be included in SS balance sheet for Dec 31, 20x4 for the above items?

Functional currency LCU = ANS: 215,000 (current/closing rate method)Functional currency is pesos = ANS: 225,000 (remeasurement)

For 1 ang FC kay ang currency in which the entity operates29