Download International accounting ch6 Foreign Currency

Frederick D. S. Choi
Gary K. Meek
INTERNATIONAL ACCOUNTING
Chapter 6: Foreign Currency
Translation
LEARNING OBJECTIVE:
1.
Describe the nature of foreign currency
transactions done in the spot, forward, and
swap markets.
2.
Understand the foreign currency translation
terms.
3.
Explain the difference between a translation
gain or loss and a transaction gain or loss.
4.
Comprehend alternative foreign currency
translation methods that exist and their
rationale.
LEARNING OBJECTIVE:
5.
Evaluate which of the available foreign currency
translation methods are best under which specific
business and currency market conditions.
6.
Compare and contrast the financial statement
effects of the temporal versus the current rate
method of foreign currency translation.
7.
Understand the relationship between foreign
currency translation and inflation.
8.
Appreciate how foreign currency translation is
handled outside the United States.
FOREIGN CURRENCY TRANSACTIONS
FOREIGN CURRENCY TRANSACTIONS
SINGLE-TRANSACTION PERSPECTIVE
TWO-TRANSACTION PERSPECTIVE

Under a two-transaction perspective, collection of
the foreign currency receivable is considered a
separate event from the sale that gave rise to it.
EXAMPLE 1
On September 1, 2015, Cormorant Company
purchased merchandise from Osaka Company of
Japan for 20,000,000 yen payable on October 1, 2015.
The spot rate for yen was $0.0079 on September 1
and the spot rate was $0.0077 on October 1.
Required:

1.
2.
3.
Did the exchange rate strength or weaken from
September to October and what are the implications
for Cormorant’s business?
What journal entry did Cormorant record on
September 1, 2015?
What journal entry did Cormorant record on
October 1, 2015?
EXAMPLE 2
On October 15, 2015, Ibis Corporation, a French
company, ordered merchandise listed on the Internet
for 20,000 Euros from Spoonbill Corporation, a US
corporation, which immediately accepted the order.
The Euro rate was $1.20 US on October 15.
On
November 15, 2015 Spoonbill shipped the goods and
billed Ibis the purchase price of 20,000 Euros when
the Euro rate was $1.30 US. Ibis paid the bill on
December 10, 2015. Three days later Spoonbill
exchanged the 20,000 Euros for US dollars when the
Euro rate was $1.28US.
Required:
Compute the foreign currency gains or losses on the
December 31, 2015 financial statements and show your
calculations.

EXAMPLE 3
On November 1, 2013, the Penguin Corporation, a US
corporation, purchased an extruding machine from
Shearwater Corporation, a UK company. The
purchase price was $10,000 and Penguin agreed to
pay in pounds on February 1, 2014. Both corporations
are on a calendar year accounting period. Assume
that the spot rates for the British pound on November
1, 2013, December 31, 2013, and February 1, 2014,
are $1.60, $1.62, and $1.66, respectively.
Required:

Record the November 1, December 31, and February 1
transactions in the General Journals of Penguin
Corporation and Shearwater Corporation. If no entry is
required on a particular date, indicate “No entry” in the
General Journal.
FOREIGN CURRENCY
TRANSLATION

Companies operating internationally use a
variety of methods to express, in terms of their
domestic currency, the assets, liabilities,
revenues, and expenses that are stated in a
foreign currency.
SINGLE RATE METHOD

The single rate method, long popular in Europe,
applies a single exchange rate, the current or
closing rate, to all foreign currency assets and
liabilities. Foreign currency revenues and
expenses are generally translated at exchange
rates prevailing when these items are recognized.
For convenience, however, revenues and
expenses are typically translated by an
appropriately weighted average of current
exchange rates for the period.
MULTIPLE RATE METHODS
CURRENT–NONCURRENT METHOD
 a foreign subsidiary’s current assets (assets that
are usually converted to cash within a year) and
current liabilities (obligations that mature within
a year) are translated into their parent
company’s reporting currency at the current rate.
Noncurrent assets and liabilities are translated
at historical rates.
MULTIPLE RATE METHODS
CURRENT–NONCURRENT METHOD

Income statement items (except for depreciation
and amortization charges) are translated at
average rates applicable to each month of
operation or on the basis of weighted averages
covering the whole period being reported.
Depreciation and amortization charges are
translated at the historical rates in effect when
the related assets were acquired.
MULTIPLE RATE METHODS
CURRENT–NONCURRENT METHOD
 Unfortunately, this method does not often square
with reality. Using the year-end rate to translate
current assets implies that all foreign currency
cash, receivables, and inventories are equally
exposed to exchange risk; that is, will be worth
more or less in parent currency if the exchange
rate changes during the year.
MULTIPLE RATE METHODS
MONETARY–NONMONETARY METHOD
a
balance sheet classification scheme to
determine
appropriate
translation
rates.
Monetary assets and liabilities; that is, claims to
and obligations to pay a fixed amount of currency
in the future are translated at the current rate.
Nonmonetary items—fixed assets, long-term
investments, and inventories are translated at
historical rates. Income statement items are
translated under procedures similar to those
described for the current–noncurrent framework.
MULTIPLE RATE METHODS
MONETARY–NONMONETARY METHOD
Note, however, that the monetary–nonmonetary
method also relies on a classification scheme to
determine appropriate translation rates. This may
lead to inappropriate results. For example, this
method translates all nonmonetary assets at
historical rates, which is not reasonable for assets
stated at current market values (such as
investment securities and inventory and fixed
assets written down to market).
MULTIPLE RATE METHODS
MONETARY–NONMONETARY METHOD

Multiplying the current market value of a
nonmonetary asset by a historical exchange rate
yields an amount in the domestic currency that is
neither the item’s current equivalent nor its
historical cost. This method also distorts profit
margins by matching sales at current prices and
translation rates against cost of sales measured
at historical costs and translation rates.
MULTIPLE RATE METHODS
TEMPORAL METHOD
In the temporal method, monetary items such as
cash, receivables, and payables are translated at
the current rate. Nonmonetary items are
translated at rates that preserve their original
measurement bases. Specifically, assets carried on
the foreign currency statements at historical cost
are translated at the historical rate.
MULTIPLE RATE METHODS
TEMPORAL METHOD
When nonmonetary items abroad are valued at
historical cost, the translation procedures resulting
from the temporal method are virtually identical to
those produced by the monetary–nonmonetary
method. The two translation methods differ only if
other asset valuation bases are employed, such as
replacement cost, market values, or discounted
cash flows.
MULTIPLE RATE METHODS
The current rate method presumes that the entire
foreign operation is exposed to exchange rate risk since
all assets and liabilities are translated at the year-end
exchange rate.
The current–noncurrent rate method presumes that
only the current assets and liabilities are so exposed,
while the monetary–nonmonetary method presumes
that monetary assets and liabilities are exposed.
In contrast, the temporal method is designed to
preserve the underlying theoretical basis of accounting
measurement used in preparing the financial
statements being translated.
WHICH IS BEST?
The object of translation is to change the unit of
measure for financial statements of foreign
subsidiaries to the domestic currency, and to make
the foreign statements conform to accounting
principles generally accepted in the country of the
parent company. We think these objectives are best
achieved by translation methods that use historical
rates of exchange.
WHICH IS BEST?
The temporal principle is appropriate, as it changes
a measurement in foreign currency into a
measurement in domestic currency without
changing the basis of measurement. The temporal
translation method is easily adapted to processes
that make accounting adjustments during the
translation.
WHICH IS BEST?
When this is so, adjustments for differences
between two or more sets of accounting concepts
and practices are made along with the translation
of currency amounts. For example, inventories or
certain liabilities may be restated according to
accounting practices different from those originally
used. The temporal principle can accommodate any
asset valuation framework, be it historical cost,
current replacement price, or net realizable values.
WHICH IS BEST?
The current rate method is also useful when the
accounts of an independent company are translated
for the convenience of foreign stockholders or other
external user groups.
WHICH IS BEST?
It is also appropriate when price-level-adjusted
account are translated to another currency. If
reliable price-level adjustments are made in a
given set of accounts and if domestic price-level
changes for the currency are reflected closely in
related foreign exchange rate movements, the
current rate translation of price-level adjusted data
yields results that are comparable to translating
historical cost accounts under the historical rate
translation method.
APPROPRIATE CURRENT RATE
Thus far we have referred to rates of exchange used
in translation methods as either historical or
current. Average rates are often used in income
statements for expediency. The choice of an
appropriate exchange rate is not clear-cut because
several exchange rates are in effect for any
currency at any time. There are buying and selling
(bid and ask) rates, spot rates and forward rates,
official rates and free-market rates, and so on.
APPROPRIATE CURRENT RATE

We believe that an appropriate translation rate
should reflect economic and business reality as
closely as possible. The free-market rate quoted
for spot transactions in the country where the
accounts to be translated originate is a rate that
appropriately measures current transaction
values.
TRANSLATION GAINS AND LOSSES
Exclusion of translation adjustments in current
income is generally advocated because these
adjustments merely result from a restatement
process. Changes in the domestic currency
equivalents of a foreign subsidiary’s net assets are
unrealized and have no effect on the local currency
cash flows generated by the foreign entity.
Therefore, it would be misleading to include such
adjustments in current income. Under these
circumstances,
translation
adjustments
are
accumulated separately as a part of consolidated
equity.
TRANSLATION WHEN LOCAL CURRENCY
IS THE FUNCTIONAL CURRENCY
If the functional currency is the foreign currency in
which the foreign entity’s records are kept, its
financial statements are translated to dollars using
the current rate method. Resulting translation
gains or losses are disclosed in a separate
component of consolidated equity. This preserves
the financial statement ratios as calculated from
the local currency statements. The following
current rate procedures are used:
TRANSLATION WHEN LOCAL CURRENCY
IS THE FUNCTIONAL CURRENCY
1. All foreign currency assets and liabilities are
translated to dollars using the exchange rate
prevailing as of the balance sheet date; capital
accounts are translated at historical rates.
2. Revenues and expenses are translated using the
exchange rate prevailing on the transaction date,
although weighted average rates can be used for
expediency.
3. Translation gains and losses are reported in a
separate component of consolidated stockholders’
equity. These exchange adjustments do not go into
the income statement until the foreign operation is
sold or the investment is judged to have
permanently lost value.
TRANSLATION WHEN THE PARENT
CURRENCY IS THE FUNCTIONAL CURRENCY
When the parent currency is a foreign entity’s
functional currency, its foreign currency financial
statements are remeasured to dollars using the
temporal method. All translation gains and losses
resulting from the translation process are included
in determining current period income. Specifically:
TRANSLATION WHEN THE PARENT
CURRENCY IS THE FUNCTIONAL CURRENCY
1. Monetary assets and liabilities and nonmonetary
assets valued at current market prices are
translated using the rate prevailing as of the
financial statement date; other nonmonetary items
and capital accounts are translated at historical
rates.
2. Revenues and expenses are translated using
average exchange rates for the period except those
items related to nonmonetary items (e.g., cost of
sales and depreciation expense), which are
translated using historical rates.
3. Translation gains and losses are reflected in
current income.
TRANSLATION WHEN FOREIGN CURRENCY IS
THE FUNCTIONAL CURRENCY
A foreign entity may keep its records in on foreign
currency when its functional currency is another
foreign currency. In this situation, the financial
statements are first remeasured from the local
currency into the functional currency (temporal
method) and then translated into U.S. dollars using
the current rate method. Assume a German parent
company owns a wholly-owned affiliate in Mexico.
The Mexican affiliate subcontracts most of its
production to Brazilian vendors. Hence, the
Mexican affiliate’s functional currency is deemed to
be the Brazilian real.
EXAMPLE 1:
For each of the 12 accounts listed in the table
below, select the correct exchange rate to use when
either remeasuring or translating a foreign
subsidiary for its US parent company.
Codes
C
H
A
=
=
=
Current exchange rate
Historical exchange rate
Average exchange rate
… EXAMPLE 1:
US dollar is
the functional
Currency
1.
Accounts receivable
2.
Marketable debt securities
carried at cost
3.
Inventories carried at cost
4.
Deferred income
5.
Goodwill
6.
Other paid-in capital
7.
Depreciation
8.
Refundable deposits
9.
Common stock
10.
Accumulated depreciation on
Buildings
11.
Deferred income tax liabilities
12.
Accounts payable
The foreign
currency is the
functional
Currency
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 2
The following assets of Oriole Corporation’s Romanian
subsidiary have been converted into US dollars at the
following exchange rates:
Current
Rates
Accounts
receivable
Trademark
$
Property plant
and equipment
Totals
$
850,000
Historical
Rates
$
875,000
600,000
575,000
1,200,000
900,000
2,650,000
$
2,350,000
If the functional currency of the subsidiary is the US dollar, the assets
should be reported in the consolidated financial statements of Oriole
Corporation and Subsidiary in the total amount of
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 3
On January 1, 20X5, Pegler Corporation, a US company, acquired 100%
of Selmic Corporation of Canada, paying an excess of 90,000 Canadian
dollars over the book value of Selmic’s net assets. The excess was
allocated to undervalued equipment with a three-year remaining useful
life. Selmic’s functional currency is the Canadian dollar. Exchange
rates for Canadian dollars for 20X5 are:
January 1, 20X5
Average rate for 20X5
December 31, 20X5
$.77
.75
.73
Required:
1. Determine the depreciation expense stated in US dollars on the
excess allocated to equipment for 20X5.
2. Determine the unamortized excess allocated to equipment on
December 31, 20X5.
3. If Selmic’s functional currency was the US dollar, what would be
the depreciation expense on the excess allocated to the
equipment for 20X5?
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 4
Peake Corporation, a US company, formed a British subsidiary on January
1, 20X5 by investing £450,000 in exchange for all of the subsidiary’s
no-par common stock. The British subsidiary, Searle Corporation,
purchased real property on April 1, 20X5 at a cost of £500,000, with
£100,000 allocated to land and £400,000 allocated to a building. The
building is depreciated over a 40-year estimated useful life on a
straight-line basis with no salvage value. The British pound is Searle’s
functional currency and its reporting currency. The British economy does
not have high rates of inflation. Exchange rates for the pound on
various dates were:
January 01, 20X5
April 01, 20X5
December 31, 20X5
20X5 average rate
=
=
=
=
1£
1£
1£
1£
=
=
=
=
$1.50
$1.51
$1.58
$1.56
Searle's adjusted trial balance is presented below for the year ended
December 31, 20X5.
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 4 (CONT.)
Debits:
Cash
Accounts receivable
Inventory
Building
Land
Depreciation expense
Other expenses
Cost of good sold
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Retained earnings
Equity adjustment
Sales revenue
Total credits
Required: Prepare Searle's:
1. Translation working papers;
2. Translated income statement; and
3. Translated balance sheet.
£
£
£
£
220,000
52,000
59,000
400,000
100,000
7,500
110,000
220,000
1,168,500
7,500
111,000
450,000
0
0
600,000
1,168,500
EXAMPLE 4 …
Searle Corporation
Translation Working Papers
Debits
Cash
Accounts receivable
Inventory
Building
Land
Depreciation expense
Other expenses
Cost of goods sold
220,000
52,000
59,000
400,000
100,000
7,500
110,000
220,000
x $1.58
x $1.58
x $1.58
x $1.58
x $1.58
x $1.56
x $1.56
x $1.56
=
=
=
=
=
=
=
=
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Sales revenue
Retained earnings
Total credits
Credit differential
7,500
111,000
450,000
600,000
x $1.58
x $1.58
x $1.50
x $1.56
=
=
=
=
$
347,600
82,160
93,220
632,000
158,000
11,700
171,600
343,200
$
1,839,480
$
$
11,850
175,380
675,000
936,000
0
1,798,230
$
41,250
EXAMPLE 4 …
Searle Corporation
Translated Income Statement
For the Year Ended December 31, 20X5
Sales revenue
$
Expenses:
Cost of goods sold
Depreciation expense
Other expenses
Net income
936,000
( 343,200 )
( 11,700 )
( 171,600 )
$
409,500
EXAMPLE 4 …
Searle Corporation
Translated Balance Sheet
December 31, 20X5
Cash
Accounts receivable
Inventory
Building-net
Land
Total assets
$
Accounts payable
Common stock
Retained earnings
Accumulated comprehensive income
Total liabilities & equities
$
$
$
347,600
82,160
93,220
620,150
158,000
1,301,130
175,380
675,000
409,500
41,250
1,301,130
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 5
Searle Corporation, a British subsidiary of Peake Corporation (a US
company) was formed by Peake on January 1, 20X5 in exchange for all of
the subsidiary's common stock. Searle has now ended its second year of
operations on December 31, 20X6. Relevant exchange rates are:
January 01, 20X5 = 1£ = $1.50
December 31, 20X6 = 1£ = $1.65
20X6 average rate = 1£ = $1.63
Searle's adjusted trial balance is presented below for the calendar year
20X6. The amount of equity adjustment carried over from 20X5 is a credit
balance of $41,250 (in dollars).
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 5 (CONT.)
In Pounds
Debits:
Cash
Accounts receivable
Inventory
Building
Land
Depreciation expense
Other expenses
Cost of good sold
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Retained earnings
Sales revenue
Total credits
£
£
£
£
75,000
362,000
41,000
400,000
100,000
10,000
133,000
380,000
1,501,000
17,500
154,750
450,000
262,500
616,250
1,501,000
EXAMPLE 5…
Searle Corporation
Translation Working Papers
Debits
Cash
Accounts receivable
Inventory
Building
Land
Depreciation expense
Other expenses
Cost of goods sold
75,000
362,000
41,000
400,000
100,000
10,000
133,000
380,000
x $1.65
x $1.65
x $1.65
x $1.65
x $1.65
x $1.63
x $1.63
x $1.63
=
=
=
=
=
=
=
=
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Sales revenue
Retained earnings
Accumulated comprehensive
income
Total credits
Credit differential
17,500
154,750
450,000
616,250
262,500
x $1.65
x $1.65
x $1.50
x $1.63
=
=
=
=
$
123,750
597,300
67,650
660,000
165,000
16,300
216,790
619,400
$
2,466,190
$
28,875
255,338
675,000
1,004,487
409,500
$
41,250
2,414,450
$
51,740
EXAMPLE 5…
Searle Corporation
Translated Income Statement
for the year ended December 31, 20X6
Sales revenue
$
Expenses:
Cost of goods sold
Depreciation expense
Other expenses
Net income
Retained earnings, January 1, 20X6
Retained earnings, December 31, 20X6
1,004,487
( 619,400 )
( 16,300 )
( 216,790 )
$
$
151,997
409,500
561,497
EXAMPLE 5…
Searle Corporation
Translated Balance Sheet
December 31, 20X6
Cash
Accounts receivable
Inventory
Building-net
Land
Total assets
$
$
123,750
597,300
67,650
631,125
165,000
1,584,825
Accounts payable
$
Common stock
Retained earnings
Accumulated comprehensive income ($41,250 + $51,740)
Total liabilities & equities
$
255,338
675,000
561,497
92,990
1,584,825
EXAMPLE 6
The Pearce Corporation, a US corporation, formed a British subsidiary
on January 1, 20X7 by investing £550,000 in exchange for all of the
subsidiary’s no-par common stock. The British subsidiary, Seakam
Corporation, purchased real property on April 1, 20X7 at a cost of
£500,000, with £100,000 allocated to land and £400,000 allocated to
the building. The building is depreciated over a 40-year estimated
useful life on a straight-line basis with no salvage value. The US
dollar is Seakam’s functional currency, but it keeps its records in
pounds. The British economy does not experience high rates of
inflation. Exchange rates for the pound on various dates are:
January 01, 20X7
April 01, 20X7
December 31, 20X7
20X7 average rate
=
=
=
=
1£
1£
1£
1£
=
=
=
=
$1.40
$1.42
$1.45
$1.44
Seakam's adjusted trial balance is presented below for the year ended
December 31, 20X7.
EXAMPLE 6 (CONT.)
In Pounds
Debits:
Cash
Accounts receivable
Notes receivable
Building
Land
Depreciation expense
Other expenses
Salary expense
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Retained earnings
Equity adjustment
Sales revenue
Total credits
Required: Prepare Seakam's:
£
£
£
£
200,000
72,000
99,000
400,000
100,000
7,500
115,000
208,000
1,201,500
7,500
100,000
550,000
0
0
544,000
1,201,500
EXAMPLE 6 …
Seakam Corporation
Translation Working Papers
Debits
Cash
Accounts receivable
Notes receivable
Building
Land
Depreciation expense
Other expenses
Salary expense
200,000
72,000
99,000
400,000
100,000
7,500
115,000
208,000
x
x
x
x
x
x
x
x
$1.45
$1.45
$1.45
$1.42
$1.42
$1.42
$1.44
$1.44
=
=
=
=
=
=
=
=
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Sales revenue
Retained earnings
Total credits
Credit differential
7,500
100,000
550,000
544,000
0
x
x
x
x
$1.42
$1.45
$1.40
$1.44
=
=
=
=
$
290,000
104,400
143,550
568,000
142,000
10,650
165,600
299,520
$
1,723,720
$
$
10,650
145,000
770,000
783,360
0
1,709,010
$
14,710
EXAMPLE 6 …
Seakam Corporation
Translated Income Statement
For the Year Ended December 31, 20X7
Sales revenue
Expenses:
Salary expense
Depreciation expense
Other expenses
Income before exchange gains or losses
Exchange gains
Net income
Retained earnings, January 1, 20X7
Retained earnings, December 31, 20X7
$
783,360
(
(
(
$
$
$
299,520 )
10,650 )
165,600 )
307,590
14,710
322,300
0
322,300
EXAMPLE 6 …
Seakam Corporation
Translated Balance Sheet
December 31, 20X7
Cash
Accounts receivable
Notes receivable
Building-net
Land
Total assets
$
Accounts payable
Common stock
Retained earnings
Total liabilities & equities
$
$
$
290,000
104,400
143,550
557,350
142,000
1,237,300
145,000
770,000
322,300
1,237,300
EXAMPLE 7
Seakam Corporation, a British subsidiary of Pearce Corporation (a US
company) was formed by Pearce on January 1, 20X7 in exchange for all
of the subsidiary's common stock. Seakam has now ended its second
year of operations on December 31, 20X8. Relevant exchange rates are:
January 01, 20X7
April 01, 20X7
December 31, 20X8
20X8 average rate
=
=
=
=
1£
1£
1£
1£
=
=
=
=
$1.40
$1.42
$1.37
$1.36
Seakam's adjusted trial balance is presented below for the calendar
year 20X8.
EXAMPLE 7 (CONT.)
In
Pounds
Debits:
Cash
Accounts receivable
Notes receivable
Building
Land
Depreciation expense
Other expenses
Salary expense
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Retained earnings
Sales revenue
Total credits
Required: Prepare Seakam's:
1. Translation working papers;
2. Translated income statement; and
3. Translated balance sheet.
£
£
£
£
172,000
308,000
98,000
400,000
100,000
10,000
117,000
376,000
1,581,000
17,500
200,000
550,000
213,500
600,000
1,581,000
EXAMPLE 7…
Seakam Corporation
Translation Working Papers
Debits
Cash
Accounts receivable
Notes receivable
Building
Land
Depreciation expense
Other expenses
Salary expense
172,000
308,000
98,000
400,000
100,000
10,000
117,000
376,000
x
x
x
x
x
x
x
x
$1.37
$1.37
$1.37
$1.42
$1.42
$1.42
$1.36
$1.36
=
=
=
=
=
=
=
=
Total debits
Credits
Accumulated depreciation
Accounts payable
Common stock
Sales revenue
Retained earnings
Total credits
Debit differential
17,500
200,000
550,000
600,000
213,500
x
x
x
x
$1.42
$1.37
$1.40
$1.36
=
=
=
=
$
235,640
421,960
134,260
568,000
142,000
14,200
159,120
511,360
$
2,186,540
$
$
24,850
274,000
770,000
816,000
322,300
2,207,150
$
20,610
EXAMPLE 7…
Seakam Corporation
Translated Income Statement
For the Year Ended December 31, 20X8
Sales revenue
Expenses:
Salary expense
Depreciation expense
Other expenses
Income before exchange gains or losses
Exchange loss
Net income
Retained earnings, January 1, 20X8
Retained earnings, December 31, 20X8
$
816,000
(
(
(
$
(
$
$
511,360
14,200
159,120
131,320
20,610
110,710
322,300
433,010
)
)
)
)
EXAMPLE 7…
Seakam Corporation
Translated Balance Sheet
December 31, 20X8
Cash
Accounts receivable
Notes receivable
Building-net
Land
Total assets
$
Accounts payable
Common stock
Retained earnings
Total liabilities & equities
$
$
$
235,640
421,960
134,260
543,150
142,000
1,477,010
274,000
770,000
433,010
1,477,010
EXAMPLE 8
On January 1, 20X4, Pearl Corporation, a US firm, acquired a 70%
interest in Segar Corporation, a foreign company, for $120,000,
when Segar’s stockholders’ equity consisted of 300,000 local
currency units (LCU) and retained earnings of 100,000 LCU. At the
time of the acquisition, Segar’s assets and liabilities were fairly
valued except for a patent that did not have any recorded book
value. All excess purchase cost was attributed to the patent, which
had an estimated economic life of 10 years at the date of
acquisition. The exchange rate for LCUs on January 1, 20X4 was
$.40.
A summary of changes in Segar’s stockholders’ equity during 20X4
and the exchange rates for LCUs is as follows:
LCU
Rates
Dollars
Stockholders’ equity
1/1/X4
Net income
Dividends 12/1/X4
Equity adjustment
Stockholders’ equity
12/31/X4
400,000
100,000
( 50,000
$ .40C
.42A
)
.43C
$
450,000
.44C
$
160,000
42,000
( 21,500
17,500
198,000
)
EXAMPLE 8 …
Required: Determine the following:
1.
Fair value of the patent from Pearl’s investment in
Segar on January 1, 20X4.
2.
Patent amortization for 20X4.
3.
Unamortized patent at December 31, 20X4.
4.
Equity adjustment from the patent.
5.
Income from Segar for 20X4.
6.
Investment in Segar balance at December 31, 20X4.
EXAMPLE 8 …
Patent Fair Value
Cost of 70% interest
$
Book value acquired 400,000 LCU x $.40 x
70% =
Patent in dollars
120,000
( 112,000 )
$
8,000
Patent in LCU = $8,000/$.40 per LCU =
20,000
EXAMPLE 8 …
Patent amortization for 20X4
Patent: 20,000 LCU/10
2,000 LCU per year
years
=
2,000 LCU per year x $.42 equals $
amortization of:
840
EXAMPLE 8 …
Unamortized patent
Patent (20,000 LCU – 2,000
LCU) x $.44 =
$
7,920
EXAMPLE 8 …
Equity adjustment from patent
Beginning patent
(from Req. 1)
$
Patent amortization (from Req. 2)
8,000
(
840
Subtotal
7,160
Ending goodwill 18,000 LCU x $.44 =
7,920
Equity adjustment
$
760
)
EXAMPLE 8 …
Income from Segar
Equity in income ($42,000 x
70%)
Less: Patent amortization
Income from Segar
$ 29,400
( 840
$ 28,560
)
EXAMPLE 8 …
Investment in Segar balance at December 31, 20X4
Cost, January 1, 20X4
$
Add: Income for 20X4 (from Req. 5)
Less: Dividends ($21,500 x 70%)
(
Add: Equity adjustment from patent (from Req. 4)
Add: Equity adjustment from translation
($17,500 x 70%)
Investment balance, December 31, 20X4
$
Check:
Book value: $198,000 x 70% =
Unamortized patent (from Req. 3)
Investment balance
$
$
120,000
28,560
15,050
760
12,250
146,520
138,600
7,920
146,520
)
FOREIGN CURRENCY
TRANSLATION AND INFLATION
Use of the current rate to translate the cost of
nonmonetary assets located in inflationary
environments will eventually produce domestic
currency equivalents far below their original
measurement bases.
FOREIGN CURRENCY
TRANSLATION AND INFLATION
At the same time, translated earnings would be
greater
because
of
correspondingly
lower
depreciation charges. Such translated results could
easily mislead rather than inform. Lower dollar
valuations would usually understate the actual
earning power of foreign assets supported by local
inflation, and inflated return on investment ratios
of foreign operations could create false expectations
of future profitability.