FOREIGN CURRENCY TRANSLATION

Elisabeth Penti Kurniawati

bet@staff.uksw.edu
FEB430
 FOREIGN CURRENCY TRANSLATION

Process of restating Financial Statement

information from one currency to another
Restating various foreign currency balances to
single currency equivalents
Reasons for Translation:
A SINGLE CURRENCY FRAMEWORK IS REQUIRED
(for branch & subsidiary activities, traditionally
currency of the parent company)
 Additional Reasons for Translation:
Recording foreign currency transactions
Reporting international branch and subsidiary
activities
Reporting the results of independent operations
abroad
Required for centralized planning, evaluation,
coordination, and control
Expanded scale of international investment:
To list its shares on a foreign stock exchange
Contemplates a foreign acquisition or joint venture
Wants to communicate its operating result and financial
positions to its foreign stockholders
 THE PROBLEMS:
Foreign exchange rates are seldom fixed (not
stable)
Variety of translations methods
Different treatments of translation gains and
losses
Difficult to compare financial results from:
One company to another
One period to the next
 Reasons for exchange rate changes, (Gernon &
Meek, 2001):
Trade balance of payments surpluses or deficits
Export > Import Surplus Appreciated Currency
Relative rates of inflation
Higher Rates of Inflation Depreciated Currency
Relative interest rates
Higher Interest Rates Appreciated Currency
Political factors and government intervention
Political Stability Appreciated Currency
Governments buy/sell currencies Change Exchange Rates
 BACKGROUND AND TERMINOLOGY
CONVERSION
The physical exchange of one currency for
another
TRANSLATION
Simply a change in monetary expression
(No physical exchange occurs, no accountable transaction
takes place analogues to translating)
THE FOREIGN EXCHANGE RATE
The price of a unit of one currency
expressed in terms of another
 FOREIGN EXCHANGE MARKET
PARTICIPANTS:

BANKS AND OTHER CURRENCY DEALERS,

whose profit constitute the spreads between bid
price and offering/ asking price
BUSINESS ENTERPRISES,
in connection with importing, exporting and
investment activities
INDIVIDUALS,
as tourists or making payments abroad
PROFESSIONAL TRADERS,
by speculating that currency values will either rise/ fall
 FOREIGN EXCHANGE MARKET:

Facilitates the transfer of international

payments
(e.g., from importers to exporters)
Allows international purchases or sales to
be made on credit (e.g., bank LC)
Provides a means for individuals or
business to protect themselves form risks
of unstable currency values
 FOREIGN CURRENCY TRANSACTIONS TAKE
PLACE IN THE:

SPOT MARKETS, immediately, exchange rates are

influenced by differences in inflation rates, differences
in national interest rates, forces of supply and demand
FORWARD MARKETS, are agreement to exchange a
specified amount of one currency for another at some
future date, exchange rates are influenced by
differences in national interest rates and expectations
of future exchange rates
SWAP MARKETS, involves the simultaneous spot
and forward transactions
 SPOT MARKETS
Exchange rates may be Cash balance of US
expressed in two ways:
DIRECT QUOTE
Number of domestics
currency units needed to
acquire a unit of foreign
currency
($0.022737 = 1 Rupee)
INDIRECT QUOTE
Price of a unit of the
domestic currency in terms
of the foreign currency
(43.98 Rupees = 1 USD)
subsidiary located in
Bombay, India on
January 31 is Rpe
1,000,000
USD equivalent is:
Direct Quote
Rpe 1,000,000 X $0.022737
= $22,737
Indirect Quote
Rpe 1,000,000 : Rpe43.98
= $22,737
 FORWARD MARKETS
Quotations are expressed Spot Swiss francs are offered
from the spot rate at: at $0.5368, while 6-month
forward franc is offered at $
DISCOUNT
0.5433
PREMIUM
Swiss francs are selling at a
Forward Premium premium of 2.4%:
(Discount): = [$0.5433-$0.5368] x 12/6
[FORWARD RATE - SPOT RATE] x 12/n $0.5368
SPOT RATE = 0.0242
or
= [Swf1.8630-Swf1.8407] x 12/6
Swf1.8407
= 0.0242
 SWAP MARKETS
Investors use swap
transactions to take
advantage of higher interest
rate in a foreign country
while simultaneously
protecting themselves
against unfavorable
movements in the foreign
exchange rates
Swap transactions involves:
SPOT PURCHASE AND
FORWARD SALE
SPOT SALE AND
FORWARD PURCHASE
Interest rates in US>
Switzerland
Swiss investors purchase USD
in the spot market and invest
them in higher-yielding USD
debt instruments (6-months
US Treasury notes)
If USD loses value relative to
Swiss franc in the 6
months investors would
lose this yield advantage
To protect: investors
simultaneously sell the USD
they expect to receive in 6
months at the guaranteed
forward rate
 Foreign Currency Translation
Key Definitions (Radebaugh & Gray, 2006):
Functional Currency - Currency of the primary
economic environment in which the company
operations;
Reporting Currency - Currency which a parent
company uses to prepare its financial statements;
and
Local Currency - Currency of a particular country,
usually one in which a foreign subsidiary is operating.
 FINANCIAL STATEMENT EFFECTS OF
ALTERNATIVE TRANSLATION RATES
THREE EXCHANGE RATES CAN BE USED:
CURRENT RATE
EXCHANGE RATE PREVAILING AS OF THE FINANCIAL
STATEMENT DATE
translation gains or losses
HISTORICAL RATE
EXCHANGE RATE PREVAILING WHEN A FOREIGN CURRENCY
ASSET WAS FIRST ACQUIRED OR A FOREIGN CURRENCY
LIABILITY WAS INCURRED
no translation gains or losses
AVERAGE RATE
A SIMPLE OR WEIGHTED AVERAGE OF EITHER CURRENT OR
HISTORICAL RATES
 FINANCIAL STATEMENT EFFECTS OF
ALTERNATIVE TRANSLATION RATES
EXCHANGE GAINS AND LOSSES:
TRANSLATION GAINS AND LOSSES
Unsettled transaction
Hanya di atas kertas supaya Laporan Keuangan 1 valuta

TRANSACTION GAINS AND LOSSES

Settled transaction
Transaksi riil (jual/ beli, utang/ piutang), perlu adjustment
dalam Laporan Keuangan
 Gains and losses on settled transactions
arises whenever the exchange rates used to book the
original transaction differs from the rate used at
settlement (e.g. transaction loss)

US parent company borrows FC1,000 when the

exchange rate is FC2 = $1 and then converts the
proceeds to dollars
It will receive $500 and record a $ 500 liability on its
book.
If the foreign exchange rate rises to FC1= $1 when the
loan is repaid, the US company will have to pay out
$1,000
The company has suffered a $ 500 conversion loss
 Gains and losses on unsettled transactions
arises whenever financial statements are prepared
before a transaction is settled (e.g. translation loss)

Assume that the FC1,000 is borrowed during year 1 and

repaid during year 2
If the exchange rate prevailing at the financial statement
date is FC1.5 = $1, the dollar equivalent of the FC1,000
loan will be $667
Creating an exchange loss of $167 ($500 - $667)
Unrealized exchange loss
 FOREIGN CURRENCY TRANSLATION
2 TYPES OF TRANSLATION METHODS :
SINGLE RATE METHOD
MULTIPLE RATE METHODS :
CURRENT-NONCURRENT METHOD
MONETARY-NONMONETARY METHOD
TEMPORAL METHOD
Four major methods have been used. Of these four,
the Current and Temporal methods are the most
common (Radebaugh & Gray, 2006)
 FOREIGN CURRENCY TRANSLATION
2 TYPES OF TRANSLATION METHODS :
SINGLE RATE METHOD
CURRENT RATE OR WEIGHTED AVERAGE OF CURRENT RATE
MULTIPLE RATE METHODS :
CURRENT-NONCURRENT METHOD
CURRENT ASSETS & LIABILITIES ARE TRANSLATED AT THE CURRENT RATE
NONCURRENT ASSETS & LIABILITIES ARE TRANSLATED AT HISTORICAL RATE
INCOME STATEMENT ITEMS ARE TRANSLATED AT AVERAGE RATES
DEPRECIATION & AMORTIZATION CHARGES ARE TRANSLATED AT THE HISTORICAL RATES
MONETARY-NONMONETARY METHOD
MONETARY ASSETS & LIABILITIES (CASH, RECEIVABLES, PAYABLES, INCLUDING LONG-TERM
DEBT) ARE TRANSLATED AT CURRENT RATE
NONMONETARY ITEMS (FIXED ASSETS, LONG TERM-INVESTMENTS, INVENTORIES) ARE
TRANSLATED AT THE HISTORICAL RATE
INCOME STATEMENT ITEMS ARE TRANSLATED AT AVERAGE RATES
TEMPORAL METHOD (VALUATION BASES)
MONETARY ASSETS & LIABILITIES (CASH, RECEIVABLE, LIABILITIES) ARE TRANSLATED AT THE
CURRENT RATE
NONMONETARY ITEMS (FIXED ASSETS, INVESTMENT, INVENTORIES) ARE TRANSLATED AT
HISTORICAL RATE
INCOME STATEMENT ITEMS ARE TRANSLATED AT AVERAGE RATES
 Translation Methods (Saudagaran, 2004):
Current Rate Current/ Non- Monetary/ Non- Temporal
Accounts
Method current Method monetary Method Method
Cash C C C C
Current Receivables C C C C
Inventories
- Cost C C H H
- Market C C H C
Long-term Receivables C H C C
Long-term Investment
- Cost C H H H
- Market C H H C
Property, plant, and Equipment C H H H
Intangible Assets (Long-term) C H H H
Current Liabilities C C C C
Long-term debt C H C C
Paid-in Capital H H H* H
Retained Earnings B B B B
Revenues A A A A
Cost of Goods Sold A A H H
Depreciation Expense A H H H
Amortization Expense A H H H
 Translation Methodologies:
Current Rate Method
All liabilities and assets translated at current
rates.
Net worth translated at historic rates.
All revenue and expense items translated at
average rates.
All gains/ losses are taken into shareholders
equity.
 Translation Methodologies:
Current/ Non-current

Current liabilities and assets translated at

current rates.
Non-current assets and liabilities and
equity translated at historical rates.
 Translation Methodologies:
Monetary/ Non-monetary

Monetary liabilities and assets translated

at current rates.
Non-monetary assets and liabilities and
equity translated at historical rates.
 Translation Methodologies:
Temporal Method
Cash, receivables, payables translated at current
rates.
Other liabilities and assets translated at current or
historic rates.
Assets and liabilities carried at past exchange prices translated at
historic rates.
Assets and liabilities carried at current purchase/ sale exchange
rates or future exchange prices would be carried at current rates.
Revenue and expense items translated at average exchange rate
All translation gains/ losses taken into income statement.
Mexican Subsidiary Balance Sheet (in thousands)
Current- Monetary-
Current
PESOS $.0006=PI Temporal
$.0004=PI
Non Current Non Monetary
Assets H C
Cash 300.000 180 120 120 120 120
Account Receivable 600.000 360 240 240 240 240
Inventories 900.000 540 360 360 540 360
Fixed Assets (net) 1.800.000 1.080 720 1.080 1.080 1.080
Total 3.600.000 2.160 1.440 1.800 1.980 1.800

Liabilities & Owners' Equity

Short -term Payables 900.000 540 360 360 360 360
Long-term Debt 1.200.000 720 480 720 480 480
Stockholders' Equity 1.500.000 900 600 720 1.140 960
Total 3.600.000 2.160 1.440 1.800 1.980 1.800

Translation gain (loss) ($) (300) (180) 240 60

CR : $.0004=PI
*Assume inventories are carried at LOCOM. If they were carried at historical cost, the temporal
balance sheet would be identical to the monetary-non monetary method

Mexican Subsidiary Income Statement (in thousands)

Current- Monetary-
Current
PESOS $.0006=PI Temporal
$.0004=PI
Non Current Non Monetary
Sales 4.000.000 2.400 1.600 1.600 1.600 1.600
Cost of Sales 2.000.000 1.200 800 800 1.200 1.200
Depreciation 180.000 108 72 108 108 108
All Other Expenses 800.000 480 320 320 320 320
Income before Tax 1.020.000 612 408 372 (28) (28)
Income Tax (30%) (306.000) (184) (122) (122) (122) (122)
Translation gain (loss) (300) (180) 240 60
Net Income (loss) 714.000 428 (14) 70 90 (90)

CR : $.0004=PI