(Advanced Financial

Accounting and Reporting

Part 2)
LECTURE AID

2017

ZEUS VERNON B. MILLAN

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Chapter 23 The Effects of Changes in Foreign
Exchange Rates

Learning Objectives

• Define an entity’s functional currency.

• Account for foreign currency transactions.
• Translate the financial statements of a
foreign operation.

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Two ways of conducting foreign activities

1. Foreign currency transactions – individual

entities often enter into transactions in a foreign
currency.

2. Foreign operations – groups often include overseas

entities.

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Two main accounting issues

• Exchange rates are constantly changing. Therefore, the

principal issues in accounting for foreign activities are
determining:
1. Which exchange rate(s) to use; and
2. How to report the effects of changes in exchange rates
in the financial statements.

AFAR PART 2: Zeus Vernon B. Millan

Functional currency

• When preparing financial statements, a reporting entity must

identify its functional currency.

• Functional currency is the currency of the primary

economic environment in which the entity operates.

• The primary economic environment in which an entity

operates is normally the one in which it primarily generates
and expends cash.

AFAR PART 2: Zeus Vernon B. Millan

Factors in determining functional currency
Primary factors
An entity’s functional currency is:
1. The currency that mainly influences:
o Sales prices
o Cost of goods sold / Cost of services provided
Secondary factors
2. The currency in which funds from financing activities are
generated.
3. The currency in which receipts from operating activities are
usually retained.

AFAR PART 2: Zeus Vernon B. Millan

Foreign currency transactions

• Initial recognition :
The foreign currency amount is translated at the spot exchange
rate at the date of the transaction.

• Subsequent recognition: At the end of each reporting period:

1. Foreign currency monetary items are re-translated using
the closing rate;
2. Non-monetary items that are measured at historical cost in a
foreign currency shall be translated using the exchange rate at
the date of the transaction; and
3. Non-monetary items that are measured at fair value in a
foreign currency shall be translated using the exchange rates at
the date when the fair value was determined.

AFAR PART 2: Zeus Vernon B. Millan

Monetary items

• Monetary items – are units of currency held and assets

and liabilities to be received or paid in a fixed or
determinable number of units of currency.

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Recognition of exchange differences

• When a foreign currency transaction occurred in one period and

settled in another period:
a. The exchange difference between the transaction date and the
end of reporting period is recognized in the period of
transaction, while
b. The exchange difference between the end of the previous
reporting period and the date of settlement is recognized in the
period of settlement.

• When a foreign currency transaction occurred and settled in the

same period, all the exchange difference is recognized in that period.
AFAR PART 2: Zeus Vernon B. Millan
Foreign operations

• A foreign operation is an entity that is a subsidiary,

associate, joint venture or branch of a reporting entity,
the activities of which are based or conducted in a
country or currency other than those of the reporting
entity.

AFAR PART 2: Zeus Vernon B. Millan

Translation to the presentation currency
1. Assets and liabilities are translated at the closing rate at the date
of the statement of financial position.
2. Income and expenses, including other comprehensive income, are
translated at spot exchange rates at the dates of the
transactions. For practical reasons, average rates for a period
may be used, if they provide a reasonable approximation of the spot
rates when the transactions took place. However, if exchange rates
fluctuate significantly, the use of the average rate is inappropriate.
3. The resulting exchange difference is recognized in other
comprehensive income.

AFAR PART 2: Zeus Vernon B. Millan

Step 2: Analysis of net assets
Acquisition Consolidation Net
XYZ, Inc. date date change
(in wons) (in wons) (in wons)
Share capital 800,000 800,000
Retained earnings 3,200,000 4,160,000
Totals at carrying amounts 4,000,000 4,960,000
a
FVA at acquisition date 1,600,000 1,600,000
Subsequent depreciation of FVA NIL -
Net assets at fair value (in wons) 5,600,000 6,560,000 960,000

a
The fair value adjustment at acquisition date is determined as follows:
Acquisition-date fair value of XYZ's net assets (in wons) 5,600,000
Acquisition-date carrying amount of XYZ's net assets (in wons) (4,000,000)
FVA - attributable to undervalued land (in wons) 1,600,000
Multiply by: Closing rate ₱0.05
FVA - attributable to undervalued land (in pesos) ₱80,000

No subsequent depreciation of FVA is recognized because the FVA

relates to land, i.e., non-depreciable asset.

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How much is the goodwill as of December 31, 2001

Formula #1:
Consideration transferred (in wons) 6,000,000
Non-controlling interest in the acquiree (5.6M x 20%) – (Step 2) 1,120,000
Previously held equity interest in the acquiree -
Total 7,120,000
Fair value of net identifiable assets acquired (Step 2) (5,600,000)
Goodwill at acquisition date 1,520,000
Accumulated impairment losses since acquisition date -
Goodwill, net – current year (in wons) 1,520,000
Multiply by: Closing rate ₱0.05
Goodwill, net – current year (in pesos) ₱76,000

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How much is the non-controlling interest in the net
assets of the subsidiary (NCI) as of December 31, 2001?

XYZ's net assets at fair value – Dec. 31, 20x1 (in wons) (Step 2) 6,560,000
Multiply by: NCI percentage 20%
Total 1,312,000
Add: Goodwill to NCI net of accumulated impairment losses -
NCI in net assets – Dec. 31, 20x1 (in wons) 1,312,000
Multiply by: Closing rate ₱0.05
NCI in net assets – Dec. 31, 20x1 (in pesos) ₱65,600
No goodwill is attributed to NCI because NCI is measured at proportionate share.

AFAR PART 2: Zeus Vernon B. Millan

How much is the consolidated retained earnings as of
December 31, 2001?
ABC's retained earnings – Dec. 31, 20x1 ₱2,580,000
Consolidation adjustments:
ABC's share in the net change in XYZ's net assets (a) ₱30,720
Unamortized deferred gain (Downstream only) -
Gain or loss on extinguishment of bonds -
Impairment loss on goodwill attributable to Parent -
Net consolidation adjustments 30,720
Consol. retained earnings – Dec. 31, 20x1 ₱2,610,720
(a)
ABC’s share in the net change in XYZ’s net assets is computed as:
Net change in XYZ’s net assets (in wons) (Step 2) 960,000
Multiply by: Controlling interest 80%
ABC’s share in the change in XYZ’s net assets (in wons) 768,000
Multiply by: Average exchange rate 0.04
ABC’s share in the net change in XYZ’s net assets (in pesos) ₱30,720

AFAR PART 2: Zeus Vernon B. Millan

How much is the total translation gain or loss to be
recognized in other comprehensive income in 2001?
Share in translation
difference
ABC Co. XYZ, Inc.
(80%) (20%)
1) Translation of XYZ’s opening net assets
Net assets, Jan. 1 - at opening rate (5.6M x ₱0.03) 168,000
Net assets, Jan. 1 - at closing rate (5.6M x ₱0.05) 280,000
Increase in opening net assets – gain 112,000 89,600 22,400

Cumulative translation difference – Jan. 1 - - -

2) Translation of changes in net assets during the period:

Profit - at average rate (960K x ₱0.04) 38,400
Profit - at closing rate (960K x ₱0.05) 48,000
Increase in profit - FOREX gain 9,600 7,680 1,920

3) Translation of goodwill
Goodwill, Dec. 31 - at opening rate (1.52M x₱0.03) 45,600
Goodwill, Dec. 31 - at closing rate (1.52M x ₱0.05) 76,000
Increase in goodwill - FOREX gain 30,400 30,400 -

Total translation gain – OCI 152,000 127,680 ₱24,320

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How much is the consolidated profit in 2001?

Parent Subsidiary Consolidated

(a)
Profits before adjustments 1,440,000 38,400 1,478,400
Consolidation adjustments:
Unrealized profits - - -
Unamortized def. loss - - -
Dividend income - N/A -
Net consolidation adjustments - - -
Profits before FVA 1,440,000 38,400 1,478,400
Depreciation of FVA - - -
Impairment of goodwill - - -
Consolidated profit 1,440,000 38,400 1,478,400
Other comprehensive income:
Translation gain - (Step 5A) - - 152,000
Consolidated comp. income 1,440,000 38,400 1,630,400

AFAR PART 2: Zeus Vernon B. Millan

How much is the total consolidated comprehensive
income in 2001?

Owners Consoli-
of parent NCI dated
ABC's profit before FVA - (Step 6) 1,440,000 N/A 1,440,000
(b)
Share in XYZ’s profit before FVA 30,720 7,680 38,400
Depreciation of FVA - - -
Impairment of goodwill - - -
Profit of loss 1,470,720 7,680 1,478,400
Other comprehensive income:
Share in translation gain - (Step 5A) 127,680 24,320 152,000
Comprehensive income 1,598,400 32,000 1,630,400
(b)
Shares in XYZ’s profit before FVA (Step 6): (38,400 x 80%); (38,400 x 20%)

AFAR PART 2: Zeus Vernon B. Millan

 Consolidated
ASSETS (pesos)
Investment in subsidiary -
Other assets [1.5M + (140K x 0.54)] 1,575,600
Goodwill (Step 3) 10,260
TOTAL ASSETS 1,585,860

LIABILITIES AND EQUITY

Liabilities [250K + (20K x .54)] 260,800
Share capital (Parent only) 800,000
Retained earnings (Step 5) 514,040
Translation differences (Parent only) - Step 5A 4,540
Equity attributable to owners of the parent 1,318,580
NCI in net assets (Step 4) 6,480
Total equity 1,325,060
TOTAL LIABILITIES AND EQUITY 1,585,860

AFAR PART 2: Zeus Vernon B. Millan

 Consolidated
(pesos)
Revenues [1.2M + (150,000 x .52)] 1,278,000
Expenses [500K + (120,000 x .52)] (562,400)
Profit for the year 715,600
Other comprehensive income:
Translation gain (Step 5A) 4,960
Comprehensive income 720,560

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  QUESTIONS????
 REACTIONS!!!!!

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IFA PART 1A: Zeus Vernon B. Millan
 END

AFAR PART 2: Zeus Vernon B. Millan