Foreign currency transilition
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Foreign currency transilition

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FOREX Transilition

FOREX Transilition

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Foreign currency transilition Foreign currency transilition Presentation Transcript

  • Foreign Currency Translation FCT commonly known as Accounting Exposure, arises because financial statements of foreign affiliates which are stated in a foreign currency, must be restated in the parent companys reporting currency to prepare consolidated financial statements
  • Foreign Currency Translation To consolidate statements, the following must be consolidated:  Language  Accounting Concepts  Currency What should be included in consolidated statements?  Narrow View: Consolidated statements should include the parent firm and all domestic subsidiaries  Wide View: All subsidiaries, regardless of location, should be consolidated.
  • Why currency Translationneeded? • Manny company having subsidiary company in other country • Different country having different accounting rules
  • Translation Methods: Example• Suppose you had 100 British pounds on deposit in a London bank at the end of 1993 when the exchange rate is $1.80. To report the deposit on your 1994 Balance Sheet stated in dollars, you would translate the deposit at the current rate and you would report an asset of $180.• At the end of 1994, you still have the 100 pounds in the bank, but now the exchange rate is $1.70. To report the deposit on your 1994 Balance Sheet, it would now translate into $170 and you would have an imbalance of $10 to deal with.
  • Translation Methods: Example If you translated at the historical rate, you would still translate into $180 and there would be no imbalance
  • Exchange Rates Current rate--exchange rate prevailing as of the financial statement date Historical rate--exchange rate prevailing when a foreign currency asset was first acquired or a foreign currency liability was first incurred Average rate--simple or weighted average of either current or historical exchange rates
  • Two Major Issues 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? Translation methods may employ a single rate or multiple rates.
  • Translation Methods Current/Noncurrent Method Monetary/Nonmonetary Method Temporal Method Current Rate Method
  • Translation Models• Current-Noncurrent Model – Current items on the balance sheet are translated at the current rate. – Long-term items on the balance sheet are translated at the historical rate. – This method of foreign currency translation was generally accepted in the United States from the 1930 to1975
  •  COGS is translated at the current rate (it is based on inventory, a current asset) Depreciation is translated at the appropriate historical rate based on the date of acquisition of the assets Under this method, a foreign subsidiary with current assets in excess of current liability will cause a translation gain (loss) if the local currency appreciates (depreciates)
  • Current/Noncurrent Method Current assets translated at Balance Sheet Local Current/ Currency Noncurrent the spot rate. Cash 2,100 DM $1,050e.g. DM2=$1 Inventory 1,500 DM $750 Noncurrent Net fixed assets 3,000 DM $1,000 assets Total Assets 6,600 DM $2,800 translated at Current liabilities 1,200 DM $600 the historical Long-Term debt 1,800 DM $600 rate in effect Common stock 2,700 DM $900 when the Retained earnings 900 DM $700 item was first CTA -------- -------- recorded on Total Liabilities and 6,600 DM $2,800 the books. Equitye.g. DM3=$1
  • Monetary/Nonmonetary Method• All monetary balance sheet accounts (cash, marketable securities, accounts receivable, notes payable, accounts payable etc.) of a foreign subsidiary are translated at the current exchange rate.• All other nonmonetary balance sheet accounts (owners’ equity, fixed assets, long term investments, and inventories) are translated at the historical exchange rate in effect when the account was first recorded.
  • Monetary/Nonmonetary Method All monetary balance sheet accounts are Balance Sheet Local Monetary/ translated at Currency Nonmonetary the current Cash 2,100 DM $1,050 exchange rate. Inventory 1,500 DM $500 e.g. DM2=$1 Net fixed assets 3,000 DM $1,000 All other Total Assets 6,600 DM $2,550 balance sheet Current liabilities 1,200 DM $600 accounts are Long-Term debt 1,800 DM $900 translated at Common stock 2,700 DM $900 the historical Retained earnings 900 DM $150 exchange rate CTA -------- -------- in effect when Total Liabilities and 6,600 DM $2,550 the account Equity was first recorded. e.g.DM3=$1
  • difference between Current-Noncurrent andMonetary-Nonmonetary  This method differs substantially with respect to accounts such as inventory, long-term receivables and long-term debt
  • Temporal Method• The underlying principal is that assets and liabilities should be translated based on how they are carried on the firm’s books.• Balance sheet account are translated at the current exchange rate if they are carried on the books at their current value.• Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books.
  • Temporal Method• Items carried on the books at Balance Sheet Local Temporal their current Currency value are Cash 2,100 DM $1,050 translated at the Inventory 1,500 DM $900 spot exchange Net fixed assets 3,000 DM $1,000 rate. Total Assets 6,600 DM $2,950 e.g. DM2=$1 Current liabilities 1,200 DM $600 Long-Term debt 1,800 DM $900• Items that are Common stock 2,700 DM $900 carried on the Retained earnings 900 DM $550 books at CTA -------- -------- historical costs Total Liabilities and 6,600 DM $2,950 are translated at Equity the historical exchange rates. e.g. DM3=$1
  • Current Rate Method All balance sheet items (except for stockholder’s equity) are translated at the current exchange rate. Very simple method in application. A “plug” equity account named cumulative translation adjustment is used to make the balance sheet balance Translation gains or losses do not go through the income statement according to this method
  • Current Rate Method• All balance sheet items Balance Sheet Local Current (except for Currency Rate stockholder’s Cash DM2,100 $1,050 equity) are Inventory DM1,500 $750 translated at the Net fixed assets DM3,000 $1,500 current Total Assets DM6,600 $3,300 exchange rate. Current liabilities DM1,200 $600• A “plug” equity Long-Term debt DM1,800 $900 account named Common stock DM2,700 $900 cumulative Retained earnings DM900 $360 translation CTA -------- $540 adjustment is Total Liabilities DM6,600 $3,300 used to make and Equity the balance sheet balance
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained 900 DM $700 $150 $550 $360 earningsearningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and Equity Spot exchange rate
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300 BookCurrent 1,200 DM $600 $600 $600 $600 value ofliabilities inventoryLong-Term 1,800 DM $600 historic $900 $900 $900debt rateCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and Book value of inventory Current value of inventory Equity at spot exchange rate at spot exchange rate.
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and historic spot exchange rate. Equity rate
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and spot rate Equity
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and historical rate spot rate Equity
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and historical rate Equity
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and From income statement Equity
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1Balance Sheet Local Current/ Monetary/ Temporal Current Currency Noncurrent Nonmonetary RateCash 2,100 DM $1,050 $1,050 $1,050 $1,050Inventory 1,500 DM $750 $500 $900 $750Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500 Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300Current 1,200 DM $600 $600 $600 $600liabilitiesLong-Term 1,800 DM $600 $900 $900 $900debtCommon stock 2,700 DM $900 $900 $900 $900Retained earnings 900 DM $700 $150 $550 $360earningsCTA -------- -------- -------- -------- $540 Total 6,600 DM $2,800 $2,550 $2,950 $3,300 Liabilities and Under the current rate method, a “plug” equity account named Equity cumulative translation adjustment makes the balance sheet balance.
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1 Local Current/ Monetary/ Temporal CurrentIncome Statement Currency Noncurrent Nonmonetary RateSales 10,000 DM $4,000 $4,000 $4,000 $4,000COGS 7,500 DM $3,000 $2,500 $3,000 $3,000Depreciation 1,000 DM $333 $333 $333 $400Net operating income 1,500 DM $667 $1,167 $667 $600Income tax (40%) 600 DM $267 $467 $267 $240Profit after tax 900 DM $400 $700 $400 $360Foreign exchange gain (loss) $300 -$550 $150Net income 900 DM $700 $150 $550 $360Dividends 0 DM $0 $0 $0 $0Addition to Retained Earnings 900 DM $700 $150 $550 $360Sales translate at average exchange rate over the period, DM2.50 = $1
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1 Local Current/ Monetary/ Temporal CurrentIncome Statement Currency Noncurrent Nonmonetary RateSales 10,000 DM $4,000 $4,000 $4,000 $4,000COGS 7,500 DM $3,000 $2,500 $3,000 $3,000Depreciation 1,000 DM $333 $333 $333 $400Net operating income 1,500 DM $667 $1,167 $667 $600Income tax (40%) 600 DM $267 $467 $267 $240Profit after tax 900 DM $400 $700 $400 $360Foreign exchange gain (loss) $300 -$550 $150Net income 900 DM $700 $150 $550 $360Dividends 0 DM $0 $0 $0 $0Addition to Retained Earnings 900 DM $700 $150 $550 $360Translate at DM2.50 = $1 Translate at new exchange rate, DM3.00 = $1
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1 Local Current/ Monetary/ Temporal CurrentIncome Statement Currency Noncurrent Nonmonetary RateSales 10,000 DM $4,000 $4,000 $4,000 $4,000COGS 7,500 DM $3,000 $2,500 $3,000 $3,000Depreciation 1,000 DM $333 $333 $333 $400Net operating income 1,500 DM $667 $1,167 $667 $600Income tax (40%) 600 DM $267 $467 $267 $240Profit after tax 900 DM $400 $700 $400 $360Foreign exchange gain (loss) $300 -$550 $150Net income 900 DM $700 $150 $550 $360Dividends 0 DM $0 $0 $0 $0Addition to Retained Earnings 900 DM $700 $150 $550 $360Translate at DM3 = $1 Translate at average exchange rate, DM2.5 = $1
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1 Local Current/ Monetary/ Temporal CurrentIncome Statement Currency Noncurrent Nonmonetary RateSales 10,000 DM $4,000 $4,000 $4,000 $4,000COGS 7,500 DM $3,000 $2,500 $3,000 $3,000Depreciation 1,000 DM $333 $333 $333 $400Net operating income 1,500 DM $667 $1,167 $667 $600Income tax (40%) 600 DM $267 $467 $267 $240Profit after tax 900 DM $400 $700 $400 $360Foreign exchange gain (loss) $300 -$550 $150Net income 900 DM $700 $150 $550 $360Dividends 0 DM $0 $0 $0 $0Addition to Retained Earnings 900 DM $700 $150 $550 $360Note the effect on after-tax profit.
  • How Various Translation Methods Deal with a Change from DM3 to DM2 = $1 Local Current/ Monetary/ Temporal CurrentIncome Statement Currency Noncurrent Nonmonetary RateSales 10,000 DM $4,000 $4,000 $4,000 $4,000COGS 7,500 DM $3,000 $2,500 $3,000 $3,000Depreciation 1,000 DM $333 $333 $333 $400Net operating income 1,500 DM $667 $1,167 $667 $600Income tax (40%) 600 DM $267 $467 $267 $240Profit after tax 900 DM $400 $700 $400 $360Foreign exchange gain (loss) $300 -$550 $150Net income 900 DM $700 $150 $550 $360Dividends 0 DM $0 $0 $0 $0Addition to Retained Earnings 900 DM $700 $150 $550 $360Note the effect that foreign exchange gains (losses) has on net income.