Chapter 12

Multinational
Accounting: Issues in
Financial Reporting and
Translation of Foreign
Entity Statements
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 Learning Objective 12-1

Understand and explain the

recent efforts toward
convergence to one set of global
accounting standards and the
current state of that effort.

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 General Overview
 Accountants preparing financial statements
of global companies must consider:
 Differences across national boundaries in
accounting principles.
 Differences in currencies used to measure the
operations of companies operating in different
countries.

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 Convergence of Accounting Principles
(1 of 3)
 International Financial Reporting Standards (IFRS)
 Standards published by the International Accounting
Standards Board (IASB).
 Widely accepted.
 Mandated or permitted in over 100 countries.
 FASB was actively working with the IASB to improve the
quality of standards and to “converge” their two sets of
standards until recently.

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 Convergence of Accounting Principles
(2 of 3)
 SEC rules
 Allow foreign private issuers to file statements
prepared in accordance with IFRS as issued by the IASB
without reconciliation to U.S. GAAP (January 4, 2008).
 Possible next steps once thought probable—today
appear much less likely:
 Allow U.S. issuers to choose between IFRS and U.S.
GAAP.
 Require U.S. issuers to use IFRS.

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 Convergence of Accounting Principles
(3 of 3)

 Methods used to measure economic activity

differ around the world.
 Benefits of adoption of a single set of globally
accepted accounting standards:
 Increased quality of information available to investors.
 Reduced costs of compliance for companies that are
currently using multiple reporting frameworks.
 Enhanced global capital markets.
 Improved access to capital in the global markets.
 Enhanced comparability across companies for users.

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 Learning Objective 12-2

Determine the functional

currency and understand the
ramifications of different
functional currency
designations.

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 Determination of the Functional Currency
(1 of 3)

 Two major issues that must be addressed when

financial statements are restated from a foreign
currency into U.S. dollars:
 Which exchange rate should be used to translate
foreign currency balances to domestic currency?
 How should translation gains and losses be accounted
for? Should they be included in income?

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 Determination of the Functional Currency
(2 of 3)
 Exchange rates that may be used in converting
foreign currency values to the U.S. dollar:
 Current rate
 Exchange rate at the end of the trading day on the balance sheet
date.
 Historical rate
 Exchange rate that existed when an initial transaction took place.
 Average rate for the period
 Usually a simple average for a period of time and is usually the
exchange rate used to measure revenues and expenses.

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 Determination of the Functional Currency
(3 of 3)
 Functional currency
 “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.”
 Used to differentiate between foreign operations that are
self-contained and integrated into a local environment,
and those that are an extension of the parent and
integrated with the parent.

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 Learning Objective 12-3

Understand and explain the

differences between translation
and remeasurement.

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 Big Picture: Foreign Currencies
Pepper, Inc. and Salt, Inc.
Consolidated Worksheet as of December 31, 2009
Currency: Apples Currency: Oranges Consolidation Entries
Pepper Salt DR CR
Consoli-
dated
 Assumptions:
Income Statement:
Sales 1,235,000 780,000
 Pepper is a U.S.-
Cost of Sales (598,000) (370,500)
Depreciation Expense
S&A Expense
(78,000)
(481,000)
(19,500)
(312,000)
based company
Equity in Net Income
Net Income
63,000
141,000 78,000
 Salt is based in Italy
Statement of RE:
Balance, 1/1/08 455,000 117,000 and the functional
Add: Net Income 141,000 78,000
Less: Dividends
Balance, 12/31/08
(104,000)
492,000
(45,500)
149,500
currency is the Euro.
Balance Sheet:
Cash
Accounts Receivable
77,500
123,500
32,500
78,000
 In order to “add them
Inventory
Investment in Salt:
149,500 156,000
up,” they need to be
Book Value 279,500
Excess Cost
Land
180,500
130,000 91,000
stated in the same
Build & Equip
Acc Depreciation
Covenant N-T-C
325,000
(273,000)
291,200
(76,700) currency.
Goodwill
Total Assets
Payables & Accruals
992,500
84,500
572,000
97,500
 Objective: Convert
Long-term Debt
Common Stock
26,000
390,000
195,000
130,000
oranges to apples.
Retained Earnings 492,000 149,500
Total Liab & Equity 992,500 572,000

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 Translation versus Remeasurement of
Foreign Financial Statements (1 of 10)
 Methods used to restate foreign entity statements
to U.S. dollars:
 The translation of the foreign entity’s functional currency
statements into U.S. dollars.
 The remeasurement of the foreign entity’s statements
into its functional currency.
 After remeasurement, the statements must then be translated to
the reporting currency if the functional currency is not the U.S.
dollar.
 No additional work is needed if the functional currency is the
U.S. dollar.

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 Translation versus Remeasurement of
Foreign Financial Statements (2 of 10)
 Translation
 The most common method used.
 Applied when the foreign entity’s recording currency is the
foreign entity’s functional currency.
 The current rate is used to convert recording currency
asset and liability accounts into U.S. dollars.
 Current rates are used to convert recording/functional
currency balance sheet account balances into U.S. dollars.
 Revenues and expenses are translated using the average
rate for the reporting period.
 Any translation adjustment that occurs is a component of
comprehensive income.
 This method is called the current rate method.
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 Translation versus Remeasurement of
Foreign Financial Statements (3 of 10)
 Remeasurement
 The restatement of the foreign entity’s financial
statements from the recording currency that the entity
used into the foreign entity’s functional currency.
 Required only when the functional currency is different
from the recording currency used to maintain the books
and records of the foreign entity.
 The method used is called the temporal method.

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 Translation versus Remeasurement of
Foreign Financial Statements (4 of 10)
 Remeasurement
 Monetary balance sheet items are remeasured using the
current rate.
 Nonmonetary balance sheet items (fixed assets, long-
term investments, inventories) are remeasured using
historical rates.
 Revenues and expenses are remeasured using the
average rate.
 Any imbalance that occurs because of these applications
is included in the income statement as a
remeasurement gain or loss.

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 Translation versus Remeasurement of
Foreign Financial Statements (5 of 10)
 Case 1: The recording currency is the functional
currency. Simply translate the financial statements
from the functional currency to the reporting
currency. No further work is necessary because the
consolidation and financial reports can now be
prepared in the reporting currency.

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 Translation versus Remeasurement of
Foreign Financial Statements (6 of 10)
 Case 2: The recording currency is not the functional
currency, but the functional currency is the
reporting currency. Simply remeasure the financial
statements from the recording currency to the
functional currency. No further work is necessary
because the consolidation and financial reports can
now be prepared in the functional currency (because
it is the reporting currency).

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 Translation versus Remeasurement of
Foreign Financial Statements (7 of 10)
 Case 3: The recording currency is not the functional
currency, and the functional currency is different
from the reporting currency. First, remeasure the
financial statements from the recording currency to
the functional currency. Second, translate the
financial statements from the functional currency to
the reporting currency so that the consolidation and
financial statements can be prepared in the
reporting currency.

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 Translation versus Remeasurement of
Foreign Financial Statements (8 of 10)
 Example: A U.S. company owns 100 percent of the stock of
an Argentinian company. The local currency in Argentina is
the peso. The subsidiary records and reports its financial
statements in the peso.
 Scenario 1: The company pays employees, buys inventory, and
conducts most of its operations in pesos. Thus, its functional
currency is the peso.
 Translate the financial statements to U.S. dollars.

 Scenario 2: The company buys and sells most of its inventory in

southern Brazil. It also pays many of its employees in Brazilian
reias. Thus, its functional currency is the Brazilian real.
 Remeasure the financial statements to reias.

 Then, translate them back to U.S. dollars.

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 Translation versus Remeasurement of
Foreign Financial Statements (9 of 10)
An overview of the methods a U.S. company would use to
restate a foreign affiliate’s financial statements in U.S. dollars
in each case:

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 Translation versus Remeasurement of
Foreign Financial Statements (10 of 10)
Recording Reporting Parent’s
Entity Currency
Currency Currency

Stand Functional Foreign

Alone Currency T Currency

Stand Foreign Functional

Alone Currency R Currency

Foreign Functional Functional Foreign

Operation Currency Currency T Currency

Foreign Foreign Foreign Functional

Operation Currency Currency R Currency
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 Translation versus Remeasurement of
Foreign Financial Statements
Balance sheet Items Closing Rate Method Remeasurement /
Temporal method
Share capital and pre-
acquisition retained Historical rate Historical rate
earnings
Post-acquisition retained Not translated using a Not translated using a
earnings single exchange rate single exchange rate
Monetary assets and Closing rate Closing rate
liabilities
Historical rate
Non-monetary assets and Closing rate (For items acquired before
liabilities acquisition date: rate at
acquisition date)

Non-monetary items at Rate at the date of the

fair value * Closing rate revaluation or FV
determination
Taken to income statement
Taken to equity (foreign (except for * is taken to
Translation gains or losses currency translation equity if the revaluation
reserve) gains or losses is taken to
equity)

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 Translation versus Remeasurement of
Foreign Financial Statements
Remeasurement /
Income Statements Items Closing Rate Method Temporal method

Sales, purchases, expenses

and income statement items
Actual / average rate Actual / average rate
that result in inflow/outflow
of monetary items

Historical rate of original

Costs of sales Actual / average rate
purchase of inventory

Historical rate of original

Depreciation, amortization
acquisition (if acquired before
and other allocation of non- Actual / average rate
acquisition date, use rate at
monetary items
acquisition date)

Dividends and other

Actual rate Actual rate
appropriation of profits
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 Learning Objective 12-5

Prepare consolidated financial

statements including a foreign
subsidiary after translation.

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 Group Exercise 1: Translation (1 of 4)
 On 1/2/X7, Padre Corp. (a U.S.-based company)
formed a new subsidiary in Honduras, Sucursal Inc.,
with an initial investment of 150,000 Honduras
Lempiras (HNL).
 Assume Sucursal:
Purchases inventory evenly throughout 20X7. The ending


inventory is purchased 11/30/X7.

 Uses straight-line depreciation on fixed assets.

 Declares and pays dividends on 11/30/X7.

 Purchased the fixed assets on 4/1/X7.

 Uses Lempiras as the functional currency.

REQUIRED: Prepare a schedule to translate Sucursal’s financial

statements on 12/31/X7 to U.S. dollars.
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 Group Exercise 1: Translation (2 of 4)
Honduras U.S.
Account Rate Exchange Rates
Limpiras Dollars   
Cash 25,000 1/2/X7 0.0553
Accounts Receivable 60,000 4/1/X7 0.0550
Inventory 160,000 11/30/X7 0.0535
Note Receivable 25,000 12/31/X7 0.0532
Plant and Equipment 350,000 Average 0.0545
Cost of Goods Sold 160,000
Depreciation Expense 10,000
Other Expenses 90,000
Dividends 80,000
Total Debits 960,000  

Accumulated Depreciation 10,000

Accounts Payable 60,000
Bonds Payable 180,000
Mortgage Payable 230,000
Common Stock 150,000
Sales 330,000
Total Credits 960,000  

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 Group Exercise 1: Translation (3 of 4)
Honduras U.S. Exchange Rates
Account Rate
Limpiras Dollars    1/2/X7 0.0553
Cash 25,000 0.0532 1,330 4/1/X7 0.0550
Accounts Receivable 60,000 0.0532 3,192 11/30/X7 0.0535
Inventory 160,000 0.0532 8,512 12/31/X7 0.0532
Note Receivable 25,000 0.0532 1,330 Average 0.0545
Plant and Equipment 350,000 0.0532 18,620
Cost of Goods Sold 160,000 0.0545 8,720
Depreciation Expense 10,000 0.0545 545
Other Expenses 90,000 0.0545 4,905
Dividends 80,000 0.0535 4,280
Total Debits 960,000   51,434

Acc. OCI— Translation Adjustment   382

Adjusted Total Debits     51,816

Accumulated Depreciation 10,000 0.0532 532

Accounts Payable 60,000 0.0532 3,192
Bonds Payable 180,000 0.0532 9,576
Mortgage Payable 230,000 0.0532 12,236 Note: Beginning Retained
Common Stock 150,000 0.0553 8,295 Earnings does not appear in
Sales 330,000 0.0545 17,985 the trial balance because it is
zero.
Total Credits 960,000   51,816
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 Group Exercise 1: Translation (4 of 4)

The resulting journal entry on Padre’s books:

Other Comprehensive Income 382

Investment in Sucursal 382

The eliminating Entries:

Investment in Sucursal 382

Other Comprehensive Income 382

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 Group Exercise 1: Translation

If Padre has 80% ownership in Sucursal:

The resulting journal entry on Padre’s books:

Other Comprehensive Income 305.6

Investment in Sucursal 305.6

The eliminating Entries:

Investment in Sucursal 305.6

NCI in NA 76.4
Other Comprehensive Income 382
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 QUIZ
On January 1, 2008, Pace Company acquired all of the outstanding stock of Spin PLC, a
British Company, for $350,000. Spin's net assets on the date of acquisition were 250,000
pounds (£). On January 1, 2008, the book and fair values of the Spin's identifiable assets
and liabilities approximated their fair values except for property, plant, and equipment and
trademarks. The fair value of Spin's property, plant, and equipment exceeded its book value
by $25,000. The remaining useful life of Spin's equipment at January 1, 2008, was 10 years.
The remainder of the differential was attributable to a trademark having an estimated
useful life of 5 years. Spin's trial balance on December 31, 2008, in pounds, follows:

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 QUIZ
Additional Information:
1. Spin uses the FIFO method for its inventory. The beginning inventory was acquired on
December 31, 2007, and ending inventory was acquired on December 26, 2008.
Purchases of £300,000 were made evenly throughout 2008.
2. Spin acquired all of its property, plant, and equipment on March 1, 2006, and uses
straight-line depreciation.
3. Spin's sales were made evenly throughout 2008, and its operating expenses were
incurred evenly throughout 2008.
4. The dividends were declared and paid on November 1, 2008.
5. Pace's income from its own operations was $150,000 for 2008, and its total
stockholders' equity on January 1, 2008, was $1,000,000. Pace declared $50,000 of
dividends during 2008.
6. Exchange rates were as follows:
Required:
1. Prepare a schedule translating the trial
balance from British pounds into U.S. dollars.
Assume the pound is the functional currency.
2. Assume that Pace uses the fully adjusted
equity method. Record the journal entries of
it’s investment and journal entries to
recognize translation adjustment during
2008.
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 Quiz - Solution

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 Quiz - Solution

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 Conclusion

The End

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