Translation and Consolidation of

1
Chapter 12

• Translation and Consolidation of
• the Financial Statements of
• Foreign Operations

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Learning Objectives

• How do you consolidate statements of foreign
  operations which are produced in a foreign
  currency?
• Outline the differences between the different
  translation methods
• To differentiate between an integrated and a
  self-sustaining foreign operation, and describe
  the translating method and unit of measure that
  is used in the translation of each type

3
Learning Objectives

• To prepare translated financial statements for
  each type of foreign operation (self-sustaining
  and integrated)
• To use translated financial statements to prepare
  consolidated financial statements
• Where sub is 100 owned and there is no purchase
  discrepancy
• Where sub is lt 100 owned and there is a purchase
  discrepancy to be amortized

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Introduction

• Two major accounting questions are posed by the
  translation of foreign currency financial
  statements
• What exchange rates are appropriate?
• How should the resulting exchange gains and loses
  be reflected in the financial statements?

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Translation of Financial Statements

• Translation is the conversion of a set of
  financial statements, originally prepared in one
  currency, to another currency (often so that a
  subsidiary may be consolidated with the parent)
• Textbook describes methods used prior to Section
  1650 was issued. Read for general interest only.

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What type of foreign operation is it?

• First step is to determine the type of foreign
  operation
• Self-sustaining foreign operation
• Integrated foreign operation
• Two types of statement translation (to be defined
  later)
• Current method
• Temporal method

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Types of foreign operations

• Integrated foreign operation - is one which is
  financially or operationally inter-dependent with
  the reporting enterprise such that the exposure
  to exchange rate changes is similar to the
  exposure which would exist had the transactions
  and activities of the foreign operation been
  undertaken by the reporting enterprise (CICA
  Handbook, 1650.03)

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Types of foreign operations

• Self-sustaining foreign operation is one which
  is financially and operationally independent of
  the reporting enterprise such that the exposure
  to exchange rate changes is limited to the
  reporting enterprises net investment in the
  foreign operation (CICA Handbook, 1650.03)

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WHICH TYPE OF OPERATION IS IT?

• Exhibit 12.1 looks at 6 factors which are used
  to determine whether an operation is integrated
  or self-sustaining

a
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Rules for Translation method

• Integrated foreign operations
• Use TEMPORAL METHOD
• Self-sustaining foreign operations
• Use CURRENT METHOD
• EXCEPT
• If highly inflationary economy, then use TEMPORAL
  METHOD to not distort statements
• (ie. cumulative inflation rate of 100 over 3
  years)

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TRANSLATION METHODS

• The logic behind the translation methods is to
  best reflect the entitys economic exposure to
  changing exchange rates.
• In situations where the accounting principals
  used are different from Canadas, the foreign
  operation financial statements must be adjusted
  to conform to Canadian GAAP and then translated
  into Canadian dollars
• F/X gains and losses
• If the operation is INTEGRATED, then it is as if
  the parent company conducted all transactions
  itself
• Therefore all f/x gains and losses are shown in
  income

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TRANSLATION METHODS

• If the operation is SELF-SUSTAINING, the risk to
  the parent is limited to the investment in the
  operation and day-to-day cash flows shouldnt
  affect the parent because they arent realized
  until parents investment in sub is sold
• Therefore all f/x gains and losses are shown on
  the balance sheet
• Prior to Oct 2006 shown in Shareholders equity
  in Cumulative translation adjustment
• After Oct 2006 shown in Shareholders equity
  other comprehensive income
• When parent sells all or part of its investment
  in the sub, the cumulative f/x gains and losses
  are moved off the balance sheet into income
• Unrealized losses for the current year are shown
  in comp income on the Income Statement

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DESCRIPTION OF TRANSLATION METHODS

• CURRENT METHOD
• For self-sustaining operations
• TEMPORAL METHOD
• for integrated operations
• For self-sustaining operations in high
  inflationary environments

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1. CURRENT METHOD

• Income statement Average historical rate
• All assets and liabilities on B/S Current rate
• Equity average historical rates for the years
  (calculated)
• Unrealized f/x gains/losses shown in Other
  comprehensive income (equity section of B/S)
• Note financial ratios where B/S items are
  compared are identical whether statements are in
  Cdn or foreign currency

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2. TEMPORAL METHOD

• Income statement average historical rate
• Monetary items on B/S Current rate
• Nonmonetary items on B/S historical rates
  (generally, the rate on the date of acquisition
  of the item)
• Equity historical rates
• (ie the average historical rate for each year-
  ie. calculated)
• Notes
• Depreciation uses the rate of when asset was
  aquired or date of purchase of the sub
• COGS is calculated based on rates of Beg
  inventory (ie. Beg rate), End inventory (rate at
  which EI was purchased) , and purchases (avg rate
  for yr).
• Financial ratios where B/S items are compared
  will be different depending on whether statements
  are in Cdn or foreign currency

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SUMMARY OF EXCHANGE RATES

• EXHIBIT 12.5

b
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EXAMPLE

• On Dec 31, yr 1 P acquired 100 of S in Venezuela
  at a cost of 2,000,000 B. Exchange rate is B1
  0.128.
• 1) What is journal entry on acquisition?
• 2) How would you translate the balance sheet on
  acquisition under both methods?

c
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Example contd

• On Dec 31, year 2 (ie. after 1 year of
  operations), how would you translate the
  financial statements, assuming
• A) the subsidiary is self-sustaining
• B) the subsidiary is integrated

d
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CALCULATION OF GAIN/LOSS

• SELF-SUSTAINING
• Compare
• Actual net assets _at_ current rate xxx
• Calculated net assets _at_ hist rates xxx
• Beg. Balance _at_ beg x-rate
• Net income _at_ avg for the yr
• Less dividends _at_ hist rate
• Difference f/x gain or loss xxx

e
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CALCULATION OF GAIN/LOSS

• INTEGRATED
• Compare
• Actual net monetary position _at_ current rate xx
• Calculated net monetary position xx
• Beg position _at_ beg rate
• Sales _at_ avg rate
• Less Purchases _at_ avg rate
• Less other exp _at_ avg rate
• Less dividends _at_ avg rate
• Difference f/x gain or loss xx

f
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PURCHASE DISCREPANCY AND NON-CONTROLLING INTEREST

• Temporal method (integrated) no issue
• Just amortize as normal
• Current method (self-sustaining)
• Creates additional f/x gain or loss

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EXAMPLE

• Year of acquisition no issue
• After subsequent operations
• Amortize GW and FV increments based on historical
  rates
• Calculate GW based on todays rate
• The difference is an unrealized f/x gain/loss

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Amortization

• Goodwill beg balance _at_ beg x-rate
• Impairment loss _at_ avg rate
• (A) Calculated goodwill xxxxxx
• Actual goodwill
• Goodwill in foreign currency xxx
• Less impairment in for. currency xxx
• Actual goodwill xxx
• (B) _at_ current exchange rate xxxx
• Gain/loss A - B

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Amoritization

• Same idea would hold true for fair value
  increments but the depreciation would be done at
  the exchange rate in effect when the asset was
  purchased (or when the company was bought)

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CONSOLIDATION ENTRIES

• Same as normal except that there is a new f/x
  gain and loss
• Impairment loss xxx
• Other comp. income (dr or cr) xxx
• Goodwill xxx
• Non-controlling interest is calculated as normal
• Beg Non-Controlling Interest
• Less Non-controlling interest in comp. income
• Less Non-controlling interest in dividends paid

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Other Considerations

• Other items that must be considered when a
  foreign subsidiary is been consolidated
• Lower of cost and market (compare market and cost
  at CDN values)
• Intercompany profit