Multinational Accounting: Translation of Foreign Entity Statements

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Baker / Lembke / King
Multinational Accounting Translation of Foreign
Entity Statements
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Electronic Presentation by Douglas Cloud
Pepperdine University
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Differences in Accounting Principles
Four major models of accounting

• The U.S. model, which focuses on the information
  needs of the common stockholder through the
  application of generally accepted accounting
  principles.

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Differences in Accounting Principles
Four major models of accounting
The British model, which focuses on the
information needs of bondholders, creditors, and
preferred stockholders.
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Differences in Accounting Principles
Four major models of accounting
The French-Italian-Spanish model, which is based
on the information needs of the taxing
authorities.
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Differences in Accounting Principles
Four major models of accounting
The German and Scandinavian countries model,
which is extremely conservative and uses large
number of reserves to reduce income to its lowest
level possible.
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Determining the Functional Currency
FASB 52 provides specific guidelines for
translating foreign currency financial statements.
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Determining the Functional Currency
What is functional currency?
FASB 52 defines it as the currency of the
primary economic environment in which the entity
operates.
Normally, that is the currency of the environment
in which an entity primarily generates and
expends cash.
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Functional Currency Indicators
Factors indicating Foreign Currency (Local
Currency) is the Functional Currency
Factors indicating U.S. Dollar (Parents
Currency) is the Functional Currency
Indicator
Directly impact the parents current cash flows
and are readily available to the parent company
Primarily in foreign currency and do not affect
parents cash flows
Cash flows
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Functional Currency Indicators
Factors indicating U.S. Dollar (Parents
Currency) is the Functional Currency
Factors indicating Foreign Currency (Local
Currency) is the Functional Currency
Indicator
Primarily determined by local competition or
local government regulations
Responsive to short-term changes in exchange rate
and worldwide competition
Sales prices
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Functional Currency Indicators
Factors indicating U.S. Dollar (Parents
Currency) is the Functional Currency
Factors indicating Foreign Currency (Local
Currency) is the Functional Currency
Indicator
Sales markets
Active local sales markets for companys
products might be significant amount of exports
Sales market mostly in parents country, or sales
contracts are denominated by parents currency
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Functional Currency Indicators
Factors indicating U.S. Dollar (Parents
Currency) is the Functional Currency
Factors indicating Foreign Currency (Local
Currency) is the Functional Currency
Indicator
Expenses
Labor, materials, and other costs are primarily
local costs
Production components generally obtained from the
parent
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Functional Currency Indicators
Factors indicating U.S. Dollar (Parents
Currency) is the Functional Currency
Factors indicating Foreign Currency (Local
Currency) is the Functional Currency
Indicator
Primarily obtained from and denominated in local
current units, entitys operations generate funds
sufficient to service financing needs.
Financing
Primarily from the parent, or other dollar
denominated financing
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Functional Currency Indicators
Factors indicating U.S. Dollar (Parents
Currency) is the Functional Currency
Factors indicating Foreign Currency (Local
Currency) is the Functional Currency
Indicator
Inter-company transactions and arrange-ment
Frequent intercompany transactions with parents
or foreign entity is an investment or financing
arm for the parent
Few intercompany transactions with parent
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Translation Versus Remeasurement
Translation is the most common method used and is
applied when the local currency is the foreign
entitys functional currency.
Remeasurement is the restatement of the foreign
entitys financial statements from the local
currency used by the entity into the foreign
entitys functional currency.
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Translating Foreign Entitys Trial Balance
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Translation and Consolidation
On January 1, 20X1, Peerless Products (U.S.)
purchases 80 percent of the outstanding capital
stock of German Company (Germany) for 54,000.
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Translation and Consolidation
Relevant direct spots exchange rates (/ 1) are
Date
Rate
January 1, 20X1 1.20 October 1,
20X1 1.36 December 31, 20X1 1.40 20X1
average 1.30
Jan. 1, 20X1 Investment in Germany Company
Stock 54,000 Cash 54,000 Purchase
of Germany Company stock.
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Translation and Consolidation
1/1/X1 80
P
Investment cost 54,000 Book value of
investment Common stock 48,000 Retained
earnings 12,000 Total 60,000 Percent of
German Companys stock acquired by Peerless
Company x .80 (48,000) Differentia
l attributed to goodwill 6,000
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January 1, 20X1 Workpaper
Peerless
German Eliminations
Item Products Company
Debits Credits Consolidated
Investment in German Co. Stock 54,000 Dif
ferential Common Stock 500,000 48,000 Retaine
d Earnings 300,000 12,000 Noncontrolling
Interest
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January 1, 20X1 Workpaper
Peerless
German Eliminations
Item Products Company
Debits Credits Consolidated
Investment in German Co. Stock 54,000 54,0
00 Differential 6,000 Common
Stock 500,000 48,000 48,000 500,000 Retained
Earnings 300,000 12,000 12,000 300,000 Noncontrol
ling Interest 12,000 12,000
Noncontrolling Interest (48,000 12,000) x
.20 12,000
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January 1, 20X1 Workpaper
Peerless
German Eliminations
Item Products Company
Debits Credits Consolidated
Investment in German Co. Stock 54,000 54,0
00 Differential 6,000 6,000 Patent 6,000 6,0
00 Common Stock 500,000 48,000 48,000 500,000 Ret
ained Earnings 300,000 12,000 12,000 300,000 N
oncontrolling Interest 12,000 12,000
Assign differential
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Dec. 31, 2001--Translation Trial Balance

Balance Exchange Balance,
Item
Rate

Cash 10,750 1.40 15,050 Foreign Currency
Units 3,000 1.40 4,200 Receivables 10,500 1.40 14,
700 Inventory 5,000 1.40 7,000 Plant and
Equipment 50,000 1.40 70,000 Cost of Goods
Sold 22,500 1.30 29,250 Operating
Expenses 14,500 1.30 18,850 Foreign Currency
Transaction Loss 500 1.30 650 Dividends Paid
6,250 1.36 8,500 Total Debits 123,000 168,2
00
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Dec. 31, 2001--Translation Trial Balance

Balance Exchange Balance,
Item
Rate

Accumulated Depreciation 7,500 1.40 10,500 Account
s Payable 3,000 1.40 4,200 Bonds
Payable 12,500 1.40 17,500 Common
Stock 40,000 1.20 48,000 Retained Earnings
(1/1) 10,000 12,000 Sales 50,000 1.30
65,000 Total 128,000 157,200 Accumulated Other
Comprehensive Income-- Translation
Adjustment 11,000 Total Credits 168,200
From the January 1, 20X1, translation workpaper.
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Proof of Translation Adjustment

Translation

Rate

Peerless Products and Subsidiary
Net assets at beginning of year 50,000
1.20 60,000 Adjustment for changes in net
assets position during year Net income for
year 12,500 1.30 16,250 Dividends paid (
6,250) 1.36 (8,500) Net assets translated at
Rates during year 67,750 Rates at end of
year 56,250 1.40 78,750 Change in other
comprehensive income-- translation adjustment
during year (net increase) 11,000 Accumulated
other comprehensive income-- translation
adjustment, 1/1 -0- Accumulated other
comprehensive income-- translation adjustment,
12/31 (credit) 11,000
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Translated Balance Sheet--12/31/X1
Translated Balance Sheet, 12/31/X1
Net assets 78,750 Common stock 60,000 Retained
earnings 7,750 (net income less
dividends) Accumulated other
comprehensive income--translation
adjustment 11,000 78,750 78,750
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Entries on Parent Companys Books
On October 1, 20X1, Peerless Products received
a dividend of DM 10,000 and immediately
converted it to U.S. dollars.
October 1, 20X1 Cash 6,800 Investment in
German Company Stock 6,800 Dividend received
from foreign subsidiary.
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Entries on Parent Companys Books
Equity in the net income of foreign subsidiary is
recorded on December 31, 20X1.
December 31, 20X1 Investment in German Company
Stock 13,000 Income from Subsidiary 13,000 Equ
ity in net income of foreign subsidiary.
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Entries on Parent Companys Books
Amortization of the parents portion of the
differential assigned to the patent is recorded
on December 31, 20X1
December 31, 20X1 Income from Subsidiary 650 Inv
estment in German Company Stock 650 Amortize
differential.
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Entries on Parent Companys Books
An entry is needed to record the portion of the
translation adjustment on the increase in the
differential on the investment in foreign
subsidiary.
December 31, 20X1 Investment in German Company
Stock 950 Other Comprehensive Income--
Translation Adjustment 950 Recognize
translation adjustment on increase in
differential.
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Entries on Parent Companys Books
Peerless Products share of the translation
adjustment is recorded on December 31, 20X1.
December 31, 20X1 Investment in German Company
Stock 8,800 Other Comprehensive Income--
Translation Adjustment 8,800 Parents share of
change in translation adjustment from
translation of subsidiarys accounts.
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Situations Requiring Remeasurement
1. A foreign sales branch or subsidiary of a U.S.
manufacturer which primarily takes orders from
foreign customers for U.S.-manufactured goods,
which bills and collects from foreign customers.
2. A foreign division, branch, or subsidiary
which primarily manufactures a subassembly that
is shipped to a U.S. plant. 3. A foreign shipping
subsidiary which primarily transports ore from a
U.S. Companys foreign mines to the United States
for processing. 4. A foreign subsidiary which is
primarily a conduit for Eurodollar borrowing to
finance operations in the United States 5. The
foreign entity is located in a hyperinflationary
economic environment.
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(No Transcript)
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Remeasuring a Foreign Entitys Trial Balance
Income statement accounts
Weighted-average exchange rate, except revenue
from nonmonetary items (historical exchange rate)
Revenue--
Weighted-average exchange rate, except costs
related to nonmonetary items (historical exchange
rate)
Expenses--
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Remeasuring a Foreign Entitys Trial Balance
Balance sheet accounts
Current exchange rate Historical exchange
rate Historical exchange rate Prior periods
balance plus income less dividends
-Monetary accounts -Nonmonetary
accounts -Equity capital accounts -Retained
earnings
Remeasurement gain or loss
Included in net income
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Chapter Twelve
The End