ACCOUNTING

TRANSLATION
HELLO! 2

We are..
1. Fathinus Syafrizal
2. Tefi Putri Meliska
3. Amelia Saddana
4. Dinda Tria Lestari
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1.
OVERVIEW OF TRANSLATION
Let’s start with the first set of slides
OVERVIEW OF TRANSLATION 4

» Translation exposure, also called accounting

exposure, arises because financial statements of
foreign subsidiaries – which are stated in foreign
currency – must be restated in the parent’s
reporting currency for the firm to prepare
consolidated financial statements.
» The accounting process of translation, involves
converting these foreign subsidiaries financial
statements into US dollar-denominated statements.
OVERVIEW OF TRANSLATION (CONT’D) 5

» Translation exposure is the potential for an increase

or decrease in the parent’s net worth and reported
net income caused by a change in exchange rates
since the last translation.
» While the main purpose of translation is to prepare
consolidated statements, management uses
translated statements to assess performance
(facilitation of comparisons across many
geographically distributed subsidiaries).
OVERVIEW OF TRANSLATION (CONT’D) 6

Translation in principle is simple:

» Foreign currency financial statements must be restated in the
parent company’s reporting currency
» If the same exchange rate were used to remeasure each and
every line item on the individual statement (I/S and B/S), there
would be no imbalances resulting from the remeasurement
» What if a different exchange rate were used for different line
items on an individual statement (I/S and B/S)?
» An imbalance would result
OVERVIEW OF TRANSLATION (CONT’D) 7

Why would we use a different exchange rate in remeasuring

different line items?
» Translation principles in many countries are often a
complex compromise between historical and current
market valuation.
» Historical exchange rates can be used for certain
equity accounts, fixed assets, and inventory items,
while current exchange rates can be used for current
assets, current liabilities, income, and expense items.
SUBSIDIARY CHARACTERIZATION 8

» Most countries today specify the translation method used by a

foreign subsidiary based on the subsidiary’s business
operations (subsidiary characterization).
» For example, a foreign subsidiary’s business can be
categorized as either an integrated foreign entity or a self-
sustaining foreign entity.
» An integrated foreign entity is one that operates as an
extension of the parent, with cash flows and business lines
that are highly interrelated.
» A self-sustaining foreign entity is one that operates in the local
economic environment independent of the parent company.
FUNCTIONAL CURRENCY 9

» A foreign subsidiary’s functional currency is the currency

of the primary economic environment in which the
subsidiary operates and in which it generates cash flows.
» In other words, it is the dominant currency used by that
foreign subsidiary in its day-to-day operations.
» The US, requires that the functional currency of the
foreign subsidiary be determined based on the nature
and purpose of the subsidiary.
EXHIBIT 13.1
ECONOMIC INDICATORS FOR DETERMINING THE FUNCTIONAL
CURRENCY 10

» Go to next slide
11
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2.
TRANSLATION METHOD,
PROCEDURE, AND PRACTICE
Let’s start with the first set of slides
TRANSLATION METHOD 13

Two basic methods for the translation of foreign subsidiary

financial statements are employed worldwide:
» The current rate method
» The temporal method
Regardless of which method is employed, a translation
method must not only designate at what exchange rate
individual balance sheet and income statement items are
remeasured, but also designate where any imbalance is to
be recorded (current income or an equity reserve
account).
CURRENT RATE METHOD 14

The current rate method is the most prevalent in the world

today.
» Assets and liabilities are translated at the current rate of exchange
» Income statement items are translated at the exchange rate on the
dates they were recorded or an appropriately weighted average
rate for the period
» Dividends (distributions) are translated at the rate in effect on the
date of payment
» Common stock and paid-in capital accounts are translated at
historical rates
CURRENT RATE METHOD (CONT’D) 15

» Gains or losses caused by translation adjustments are not

included in the calculation of consolidated net income.
» Rather, translation gains or losses are reported separately and
accumulated in a separate equity reserve account (on the B/S)
with a title such as cumulative translation adjustment (CTA).
» The biggest advantage of the current rate method is that the
gain or loss on translation does not pass through the income
statement but goes directly to a reserve account (reducing
variability of reported earnings).
TEMPORAL METHOD 16

» Under the temporal method, specific assets are

translated at exchange rates consistent with the timing
of the item’s creation.
» This method assumes that a number of individual line
item assets such as inventory and net plant and
equipment are restated regularly to reflect market value.
» Gains or losses resulting from remeasurement are
carried directly to current consolidated income, and not
to equity reserves (increased variability of consolidated
earnings).
TEMPORAL METHOD (CONT’D) 17

If these items were not restated but were instead carried at historical
cost, the temporal method becomes the monetary/nonmonetary
method of translation.
» Monetary assets and liabilities are translated at current exchange
rates
» Nonmonetary assets and liabilities are translated at historical
rates
» Income statement items are translated at the average exchange
rate for the period
» Dividends (distributions) are translated at the exchange rate on
the date of payment
» Equity items are translated at historical rates
US TRANSLATION PROCEDURE 18

The US differentiates foreign subsidiaries on the basis of functional currency,

not subsidiary characterization.
» If the financial statements of the foreign subsidiary are maintained in
US dollars, translation is not required
» If the statements are maintained in the local currency, and the local
currency is the functional currency, they are translated by the current
rate method
» If the statements are maintained in local currency, and the US dollar is
the functional currency, they are remeasured by the temporal method
» If the statements are in local currency and neither the local currency
or the US dollar is the functional currency, the statements must first
be remeasured into the functional currency by the temporal method,
and then translated into US dollars by the current rate method
EXHIBIT 13.2
PROCEDURE FLOW CHART FOR UNITED STATES TRANSLATION
PRACTICE 19
INTERNATIONAL TRANSLATION PRACTICE 20

Many of the world’s largest industrial countries – as well as

the relatively newly formed International Accounting
Standards Committee (IASC) follow the same basic
translation procedure:
» A foreign subsidiary is an integrated foreign entity or a
self-sustaining foreign entity
» Integrated foreign entities are typically remeasured using
the temporal method
» Self-sustaining foreign entities are translated at the
current rate method, also termed the closing-rate method.
EXHIBIT 13.3
COMPARISON OF TRANSLATION METHODS EMPLOYED IN SELECTED COUNTRIES 21
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3.
TRANSLATION EXAMPLE
Let’s start with the first set of slides
TRIDENT EUROPE 23

The functional currency of Trident Europe is the euro,

and the reporting currency of its parent, Trident
Corporation, is the U.S. dollar
» Plant and equipment and long-term debt and
common stock issued some time in the past when the
exchange rate was $1.2760/€
» Inventory currently on hand was purchased or
manufactured during the immediately prior quarter
when the average exchange rate was $1.2180/€
EXHIBIT 13.4 TRIDENT EUROPE:
TRANSLATION LOSS JUST AFTER DEPRECIATION OF THE EURO 24

» Go to next slide
25
EXHIBIT 13.5 TRIDENT EUROPE:
TRANSLATION LOSS OR GAIN: COMPARISON OF CURRENT RATE AND TEMPORAL METHODS 26
TRIDENT EUROPE (CONT’D) 27

» As seen in exhibit 13.4 and 13.5, the translation loss or gain

is larger under the current rate method because inventory
and net plant and equipment, as well as all monetary
assets, are deemed exposed
» The managerial implications of this fact are very important
» Depending on accounting method of the moment,
management might select different assets and liabilities for
reduction or increase – as a result impacting “real”
decisions
EXHIBIT 13.6
COMPARISON OF TRANSLATION EEXPOSURE WITH OPERATING EXPOSURE,
DEPRECIATION OF EURO FROM $1.200/€ to $1.0000/€ FOR TRIDENT EUROPE 28
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4.
MANAGING TRANSLATION
EXPOSURE
Let’s start with the first set of slides
MANAGING TRANSLATION EXPOSURE 30

» The main technique to minimize translation exposure is called a balance

sheet hedge.
» A balance sheet hedge requires an equal amount of exposed foreign
currency assets and liabilities on a firm’s consolidated balance sheet.
» If this can be achieved for each foreign currency, net translation
exposure will be zero.
» If a firm translates by the temporal method, a zero net exposed position
is called monetary balance.
» Complete monetary balance cannot be achieved under the current rate
method.
MANAGING TRANSLATION EXPOSURE (CONT’D) 31

» The cost of a balance sheet hedge depends

on relative borrowing costs.
» These hedges are a compromise in which the
denomination of balance sheet accounts is
altered, perhaps at a cost in terms of interest
expense or operating efficiency, to achieve
some degree of foreign exchange protection.
WHEN COULD A BALANCE SHEET HEDGE BE JUSTIFIED? 32

If a firm’s subsidiary is using the local currency as the functional

currency, the following circumstances could justify when to use a
balance sheet hedge:
» The foreign subsidiary is about to be liquidated, so that the
value of its CTA would be realized
» The firm has debt covenants or bank agreements that state the
firm’s debt/equity ratios will be maintained within specific limits
» Management is evaluated on the basis of certain income
statement and balance sheet measures that are affected by
translation losses or gains
» The foreign subsidiary is operating in a hyperinflationary
environment
EXHIBIT 13.7
TRIDENT EUROPE, BALANCE SHEET EXPOSURE 33
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BIG
CONCEPT
Bring the attention of your
audience over a key concept
using icons or illustrations
YOU CAN ALSO SPLIT YOUR CONTENT 35

White
Is the color of milk and
fresh snow, the color
produced by the
combination of all the
colors of the visible
spectrum.
Black
Is the color of coal,
ebony, and of outer
space. It is the darkest
color, the result of the
absence of or complete
absorption of light.
IN TWO OR THREE COLUMNS 36

Yellow Blue Red

Is the color of Is the colour of Is the color of
gold, butter and the clear sky and blood, and
ripe lemons. In the deep sea. It is because of this it
the spectrum of located between has historically
visible light, violet and green been associated
yellow is found on the optical with sacrifice,
between green spectrum. danger and
and orange. courage.
A PICTURE IS WORTH A THOUSAND WORDS 37

A complex idea can

be conveyed with
just a single still
image, namely
making it possible
to absorb large
amounts of data
quickly.
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Want big impact?

USE BIG IMAGE.
USE CHARTS TO EXPLAIN YOUR IDEAS 39

White Gray Black

OUR PROCESS IS EASY 40

first second last

THANKS! 41

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