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International Accounting, Chapter 6 ch 06

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International Accounting, 7/e

Frederick D.S. Choi

Gary K. Meek

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Learning Objectives

 Why do firms translate from one currency to another?

 What is the difference between a spot, forward, and swap transaction?

 What exchange rates are used in the currency translation process and what are their financial statement effects?

 How does a translation gain or loss differ from a transactions gain or loss?

 Is there more than one way of translating financial statements from one currency to another? If so, what are they?

 How does the temporal method of currency translation differ from the current rate method?

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Why do Firms Translate?

Facilitates the preparation of consolidated financial

statements that allow readers to see the performance

of a multinational company’s total operations both

domestic and foreign.

Facilitates the measurement of a firm’s exposure to

foreign exchange risk.

Facilitates the recording of foreign currency

transactions; i.e., foreign currency sales, purchases,

borrowing or lending in the consolidated entity’s

reporting currency.

Facilitates reporting domestic accounts to foreign

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Types of

Transaction

Rates

Spot transactions: the physical exchange of one currency for another in which delivery takes place immediately.

Direct quote: the exchange rate specifies the number of

domestic currency units needed to acquire a unit of foreign currency.

Indirect quote: the exchange rate specifies the price of a unit of

the domestic currency in terms of the foreign currency.

Forward transaction: agreements to exchange a specified amount of one currency for another at a future date.

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Accounting for Spot

Transactions

Spot transaction: occurs when an enterprise purchases or sells

goods for which payment is made in a foreign currency, or when it borrows or lends foreign currency.

 At the transaction date, each asset, liability, revenue, and expense

denominated in a foreign currency is measured and recorded in the functional currency of the reporting entity at the spot exchange rate in effect on that date.

Functional currency is the primary currency in which the

reporting entity transacts business and generates and

spends cash; e.g., dollars in the case of a U.S. reporting

entity.

At each balance sheet date, recorded balances denominated

in a currency other than the functional currency of the

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Accounting for Spot

Transactions (contin)

A foreign exchange gain or loss is recorded whenever

the exchange rate changes between the original

transaction date and the settlement date, or between the

original transaction date and the financial statement date

should financial statements be prepared prior to

settlement.

Example: On September 1, a calendar year U.S.

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Types of

Translation Rates

and

their Statement Effects

Historical rate: the exchange rate prevailing when a foreign

currency asset was first acquired or a foreign currency liability first incurred.

 Preserves the original cost equivalent of a foreign currency item in

the reporting currency.

 Use of historical rates do not give rise to translation gains or

losses, which are increases or decreases in the reporting currency equivalent of the foreign currency.

Current rate: the exchange rate prevailing as of the financial

statement date.

 Changes the reporting currency equivalent of a foreign currency

item whenever exchange rates change.

 Use of the current rate gives rise to translation gains and losses.

Average rate:

a simple or weighted average of either

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Translation vs. Transaction

Gains or Losses

Translation gains or losses:

result from a

restatement process.

Transactions gains or losses:

result from the

physical exchange of one currency for another.

Gain or loss on a settled transaction:

arises whenever

the exchange rate used to book the original transaction

differs from the exchange rate used at settlement.

Gain or loss on an unsettled transaction:

arises

whenever consolidated financial statements are prepared

before settlement and the current rate has changed since

the transaction date.

 Is similar to a translation gain or loss as it results from a

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Types of Translation Methods

Single rate method:

applies a single

exchange rate, the current rate, to all foreign

currency assets and liabilities.

Multiple rate methods:

Use some

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Current-Noncurrent Method

Current assets and current liabilities translated at

the current rate.

Noncurrent assets and liabilities translated at the

historical rate.

Revenues and expenses (excluding depreciation

and amortization) translated at average rates.

Depreciation and amortization charges at historical

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Monetary-Nonmonetary

Method

Monetary assets and liabilities translated at current

rates.

Nonmonetary assets and liabilities translated at

historical rates.

Revenues and expenses, excluding depreciation,

amortization and cost of sales, at average rates.

Depreciation, amortization charges, and cost of

sales at historical rates in effect when related assets

are acquired.

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Temporal Method

 Monetary assets and liabilities translated at the current rate.

 Nonmonetary items translated at rates that preserve their original measurement bases.

 Foreign currency balances at historical cost are translated at

historical rates.

 Foreign currency balances at current cost or market value are

translated at the current rate.

 Revenues and expenses, including cost of sales if inventories are carried at market, at average rates.

 Depreciation, amortization charges, and cost of sales when inventories are carried at cost, at historical rates in effect when related assets are acquired.

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Current (Single) Rate Method

All foreign assets and liabilities translated at

the current rate.

All revenues and expenses are translated by

an appropriately weighted average of current

exchange rates for the period.

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Features of FASB 52 and IAS

21

Objectives

Reflect in consolidated statements the financial results and

relationships measured in the primary currency in which

each consolidated entity does business.

Provide information compatible with the expected

economic effects of an exchange rate change on an

entity’s cash flows and equity.

Objectives based on the notion of a

functional currency defined earlier.

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Features of FASB 52 and IAS

21 (contin)

Translation when the parent currency is functional.

Foreign currency financial statements remeasured to

reporting currency using the temporal method.

Translation gains and losses resulting from the translation

process are included in current income.

Translation when the local currency is functional.

Foreign currency financial statements translated to

reporting currency using the current rate method.

Translation gains and losses disclosed as a separate

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Relationship Between Foreign

Currency Translation and Inflation

The external value of a country’s currency is

inversely related to its rate of inflation.

IAS 21 permits restatement for local inflation prior to

currency translation.

FAS 52 requires use of the parent currency as the

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Referensi

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