Chapter Six

Foreign currency financial statements

When a parent company owns different subsidiaries in foreign countries, the financial statements of the foreign subsidiaries should be translated (remeasured) into the parent company currency in order to consolidate the financial statements of the parent and subsidiaries.

Q: How do we translate (remeasure) the financial statements of the foreign subsidiaries??

We have 2 methods: 1- The temporal method. 2- The current method. The choice of the method depends on the functional currency of the foreign subsidiary.

Q: What is the functional currency??

It is the currency which the foreign subsidiary transacts in its country and we have 2 cases: The functional currency of the The functional currency of subsidiary is its the subsidiary is the

local currency.
1) The financial statements of the sub. should be translated using the current method. 2) The translation gain or loss should be included in the owners' equity section in the balance sheet as a translation adjustment.

parent company currency.

1) The financial statements of the sub. should be remeasured using the temporal method. 2) The remeasurement gain or loss should be included in the income statement.

Q: How can we translate or remeasure the financial statements of the subsidiary??

The rates should be used depend on the method as follows:

Items

Current method (translation)

Temporal method (remeasurement)

1) B.SH. items: Assets: Cash AR Inventory (cost) Inventory(market) -------Fixed assets Acc. Dep. Liab. & O.E. AP,NP,. Long term liab. ----Common stock APIC RE(31/12) 2) Income S. items: Sales & revenues Cash expenses (variable & fixed) Depreciation ------------------------3)R/E statement: R/E(1/1) N/I Dividends

CR CR CR CR --CR CR CR CR ---HR HR From R/E. S.

CR CR HR CR ---HR HR CR CR ---HR HR From R/E.S.

AR AR AR -----------------------------------------------Given From I/S Declaration date

AR AR HR --------------------Given From I/S Declaration date

Note:
CR: The current rate (The rate at the balance sheet date). HR: The historical rate (The rate at the item's acquisition date). AR: The average rate (The rate during the year).

Example (1)
An American company owns 100% of stock of German company at the beginning of 2006. The B.SH., IS & RE of the subsidiary on 31/12/2011 as follow: Balance sheet Assets 31/12/2011 L&OE Cash 60 AP 100 AR 100 NP 200 Land 200 Building 500 Common stock 100 A.D. (100) RE 360 760 Total 760 Total Income statement & R/E. For the period ended in 31/12/2011 260 (include Depreciation of 20) (160) 100

Revenues - Expenses NI

+ RE (1/1) 260 RE( 31/12) 360 Additional information: 1- All land & building, NP, C/S occurred in 1/1/2006. 2- No dividends occurred in 2011 3- The translated 1/1/2011 of RE = GM 104. 4- Exchange rates: 1/1/2006 1 GM = .3 31/12/2011 = .55 Average of 2011 = .53 If the functional currency of the German company is the GM .

Required:

1- Prepare the work sheet for translation. 2- Prepare the translated IS & RE 3-Prepare the translated B.SH.
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Solution
The functional currency of the German company is the GM (its local currency) so we translate the financial statements using the current method as follows:

1) Preparing the work sheet for translation:

Items Cash AR Land Building AP NP C/S RE (1/1) Revenues Expenses Total
Translation adjustment (gain) Bal. before translation

rate .55 .55 .55 .55 .55 .55 .30 -.53 .53

Bal. after translation

Dr 60 100 200 400

Cr

Dr 33 55 110 220

Cr

100 200 100 260 260 160 920 920

55 110 30 104* 137.8 84.8 502.8 436.8 66.0

* RE (1/1) given.

1) Preparing the translated IS & RE:

IS & RE For the period ended on 31/12/2011 Revenues 137.8 -Expenses ( 84.8) --------------NI 53.0 + RE 1/1 104.0 -Dividends (----) ----------------------RE 31/12 157.0*
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3) Preparing the translated B.SH.:

Assets Cash AR Land Building Balance sheet At 31/12/2011 33 AP 55 NP Liab.&OE 55 110 30 157* 66 418

110 CS 220 RE Translation adjustment 418 Total

Total

Example (2)
The same facts in ex. (1) If you know that: 1- The functional currency of the German company is the $ . 2-The remeasured 1/1/2011 of RE= GM 26.

Required:
1-Prepare the work sheet for remeasurement. 2- Prepare the remeasured IS & RE 3- Prepare the remeasured B.SH.

Solution
The functional currency of the German company is the $ (The parent co. currency) so we remeasure the financial statements using the temporal method as follows:

1)Preparing the work sheet for the remeasurement:

Item Cash AR Land Building AP NP C/S RE (1/1) Revenues Expenses Depreciation Total Remesurement (Loss)
Bal. before remeasurement

rate .55 .55 .30 .30

Bal. after remeasurement

Dr 60 100 200 400

Cr

Dr 33 55 60 120

Cr

100 200 100 260 260 140 20 920

.55 .55 .30 -.53 .53 .30

55 110 30 26* 137.8 74.2 6.0 348.2 10.6

920

358.8

* RE (1/1) given.

2) Preparing the remeasured IS & RE:

IS & RE For the period ended on 31/12/2011 Revenues - Expenses - Depreciation - Remeasurment loss ( 74.2) (6.0) (10.6) --------------137.8

NI + RE 1/1 -Dividends RE 31/12

(90.8) -------------47.0 26.0 (----) -------------73.0*

3) Preparing the remeasured B.SH.:

Assets Cash AR Land Building Balance sheet At 31/12/2011 33 AP 55 NP 60 120 CS RE Liab.&OE 55 110 30 73*

Total

268

Total

268