Accounting 401 Advanced Accounting Foreign Currency Translation A. Background 1.

In the past there were four approaches that could be used to convert foreign financial statement information to the reporting currency, U.S. dollars. Those methods were: Current-Non-current Method, Monetary-Non-monetary Method, Temporal Method, and the Current Rate Method. 2. Under the current-non-current method, current assets and current liabilities were translated using the current exchange rate, while noncurrent assets and liabilities were translated using historical exchange rate(s). Later, amendments changed certain assets and liabilities to the current rate. Income statement items, for the most part, were translated using the average exchange rate for the period. The translation gain or loss was included on the current income statement. 3. Under the monetary-non-monetary method, monetary assets and liabilities were translated with current exchange rates, while nonmonetary assets and liabilities were translated with historical rate(s). The income statement items and the translation gain or loss were handled similarly to the current-non-current method. 4. The other two approaches will be discussed later in these notes. Translation Gains and Losses 1. Since foreign exchange rates vary, translation gains or losses will arise and be included in the translated financial statements. 2. Both current and historical exchange rates are used to convert the accounts. a. The current exchange rate is the spot exchange rate on the balance sheet date. b. Historical exchange rate(s) represent past spot rate(s) that existed when the transaction(s) occurred c. A companys exposure to translation gains or losses comes from those accounts converted using current exchange rates. Those accounts converted using historical rate(s) are fixed in dollar equivalents. That is, the change in current exchange rates will not affect them.

B.

C.

Methods Used Today to Convert Foreign Currency Financial Statements 1. Temporal Method a. Accounts measured at current prices are converted using current exchange rates. Examples cash, receivables, inventory carried at market value and most liabilities. b. Accounts measured using historical information are converted using historical exchange rate(s). Examples inventories carried at cost and plant and equipment assets. c. The objective of the conversion process is to present the financial statements as if all transactions occurred in U.S. dollars. d. With this method, a companys exposed position is its net assets measured at current prices. If the company holds net assets and the direct exchange rate increases, a translation gain will result. If the company holds net liabilities and the direct exchange rate increases, a translation loss results. e. When the temporal method is used, translation gains or losses are reported on the translated income statement. f. For income statement items, the average exchange rate for the period is used for most items except those such as cost of goods sold and depreciation which have a direct relationship to accounts on the balance sheet that are converted using historical exchange rates. Thus, cost of goods sold and depreciation are converted using the same historical exchange rates as those used for inventory and plant assets. g. Under SFAS 52, this process of conversion is referred to as remeasurement. 2. Current Rate Method a. Assets and liabilities are translated using the current exchange rate. b. Historical exchange rates are used for paid-in or contributed capital accounts and the average exchange rate is used for all income statement accounts. c. A companys exposed position is its net assets. If the company has a positive net asset balance and the direct exchange rate increases, a translation gain results. d. The translation gain or loss goes directly to stockholders equity and is included with the item Accumulated Other Comprehensive Income. e. Under SFAS 52, this approach is referred to as translation.

D.

Illustration Marshall, Inc., a U.S. corporation acquired 100% of the outstanding common stock of Tea Time, Ltd., a British food company, on January 2, 20X8 for 820,000 British pounds. Tea Times functional currency is the British pound and company records are in British pounds. Tea Times net assets had fair market values equal to book values on the date of the combination. Assume that any U.S. and British generally accepted accounting principles questions have already been resolved. Pertinent direct exchange rate information follows: At January 2, 20X8 At October 15, 20X8 At December 31, 20X8 Weighted average for 20X8 $1.564 per British pound $1.577 $1.582 $1.571

Assume that all dividends by the subsidiary were declared on October 15, 20X8. Translated beginning retained earnings are $797,640. Using the worksheet on my web page, complete the translation and determine the translation gain or loss.