ACCOUNTING FOR BUSINESS COMBINATIONS

Translation of Financial Statements of a Foreign Subsidiary

PAS 21 — The Effects of Changes in Foreign Exchange Rates
Translation from the Functional Currency to the Presentation Currency
The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy are translated into a different presentation currency using the following procedures: [PAS 21.39]
 assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet. This would include any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of
assets and liabilities arising on the acquisition of that foreign operation are treated as part of the assets and liabilities of the foreign operation [PAS 21.47];
 income and expenses for each income statement are translated at exchange rates at the dates of the transactions; and
 all resulting exchange differences are recognised in other comprehensive income.
ASSETS & LIABILITIES CURRENT/CLOSING
EQUITY ACCOUNTS:
SHARE CAPITAL & APIC HISTORICAL/DATE OF ISS.
RETAINED EARNINGS:
RE, BEG. TRANS. RE-PY/HISTORICAL
PROFIT/LOSS (REVENUES & EXPENSES) DATE OF TRANS. /AVERAGE
DIVIDENDS DATE OF DECLARATION
DEBIT CREDIT
ASSETS 10M
LIABILITIES 3.5M
SC & APIC 6.0M
RE 1.2M
TOTAL 10M 10.7M
TRANSLATION ADJ.-DEBIT 0.7M
TOTAL 10.7M 10.7M
CUMMULATIVE
CUM. TRANS. ADJ., BEG. – EQUITY 800,000 - DEBIT
TRANS. ADJ.-CY – OCI 100,000 - CREDIT
CUM. TRANS. ADJ., END – EQUITY 700,000 - DEBIT
Special rules apply for translating the results and financial position of an entity whose functional currency is the currency of a hyperinflationary economy into a different presentation currency. [PAS 21.42-43]
Where the foreign entity reports in the currency of a hyperinflationary economy, the financial statements of the foreign entity should be restated as required by PAS 29 Financial Reporting in Hyperinflationary Economies, before translation into the reporting currency. [PAS
21.36]

ILLUSTRATIVE PROBLEM 1:

On January 3, 2020, Pilipino Company acquired a 100% interest in the common stock of Arigato Company, a Japanese firm, when Arigato’s shareholders’ equity was:
Common stock 200,000 yen
Retained earnings 400,000 yen

On December 31, 2020, Arigato’s trial balance was:

DEBIT CREDIT

Cash ¥ 40,000
Accounts receivable 120,000
Inventory 100,000
Plant and equipment 700,000
Accumulated depreciation ¥ 240,000
Accounts payable 80,000
Common stock 200,000
Retained earnings 400,000
Sales 600,000
Cost of sales 360,000
Operating expenses 140,000
Depreciation 60,000 .
TOTAL ¥ 1,520,000 ¥ 1,520,000

Exchange rates were:

January 3, 2020 P1 = ¥2.2727

December 31, 2020 P1 = ¥2.5000
Average for 2020 P1 = ¥2.3529

Revenues and expenses were incurred evenly during 2020.

Required: Prepare a schedule translating the December 31, 2020 trial balance from Japanese yen to Philippine pesos.

ILLUSTRATIVE PROBLEM 2:

On January 1, 2020, Davao Company organized Durian Company as a subsidiary in Thailand with an initial investment cost of 60,000 Baht. Durian Company’s December 31, 2020 trial balance in Thailand baht is as follows:
DEBIT CREDIT

Thailand Baht

Cash 7,000
Accounts receivable (net) 20,000
Receivable from Davao Company 5,000
Inventory 25,000
Plant and equipment 100,000
Accumulated depreciation 10,000
Accounts payable 12,000
Bonds payable 50,000
Common stock 60,000
Sales 150,000
Cost of goods sold 70,000
Depreciation expense 10,000
Operating expenses 30,000
Dividends paid 15,000 .
TOTAL 282,000 282,000

Additional information:
1. The receivable from Davao is denominated in Thailand baht. Davao’s books show a P4,000 payable to Durian.
2. Purchases of inventory goods are made evenly during the year. Items in the ending inventory were purchased November 1.
3. Equipment is depreciated using straight-line method with a 10-year life and no residual value. A full year’s depreciation is taken in the year of acquisition. The equipment was acquired on March 1, 2020.
4. The dividends were declared and paid on November 1.
5. Exchange rates were as follows:
January 1, 2020 1 baht = P 1.46
March 1, 2020 1 baht = P 1.48
November 1, 2020 1 baht = P 1.54
December 31, 2020 1 baht = P 1.60
2020 average 1 baht = P 1.50

Required:
1. Prepare a schedule translating the December 31, 2020 trial balance from Thailand baht to pesos.

1
 2. Prepare a proof of the translation adjustment.
EXERCISES
PROBLEM 1
The following data were taken from the trial balance on December 31,2020 of Foreign Co., a subsidiary of Manila Co.
Total Assets 21,750
Total Liabilities 11,500
Shareholders’ Equity:
Ordinary shares 5,000
Retained earnings (1/1/ 2020) 2,500
Sales 90,000
Cost of goods sold 80,000
Depreciation expense 1,500
Other operating expenses 5,750
Additional Information:
a. The balance of the exchange differences in translating foreign financial statements at December 31, 2019 was P50,000 credit.
b. The translated balance of retained earnings in Philippine peso at December 31, 2019 was P119,500.

c. When Foreign Co. was incorporated, the exchange rate was 1FC = P67.20. No ordinary share changes had occurred since then.

d. The following data were the exchange rates during the year:
January 1, 2020 1FC = P67.40
December 31, 2020 1FC = P67.60
Average for 2020 1FC = P67.50

1. Compute the cumulative translation adjustment to be reported on December 31, 2020

a. 51,775 credit b. 51,775 debit c. 50,775 credit d. 50,775 debit

2. Compute the translation adjustment for the year 2020

a. 1,775 debit b. 1,775 credit c. 775 debit d. 775 credit

PROBLEM 1 – Foreign Co.:

1)
Total Assets: 21,750 x P67.60 P 1,470,300
Total Liabilities: 11,500 x P67.60 P 777,400
Total SHE:
O/S: 5,000 x P67.20 336,000
*RE, end 305,125
Cumulative Translation Adjustment (Cr) 51,775 (balancing figure)
Total Liabilities & SHE P 1,470,300
*RE, 12/31/20:
RE, 12/31/19 P 119,500
Add: Net Income (2,750 x 67.50) 185,625
RE, 12/31/20 P 305,125
2)
Cumulative translation adjustment, December 31, 2019 P 50,000 credit
Translation adjustment for 2020 (balancing figure) 1,775 credit
Cumulative translation adjustment, December 31, 2020 P 51,775 credit
PROBLEM 2
The following data are taken from the records of Elite Imports Company, a foreign subsidiary in New Zealand:
NZ dollar
Total Assets 12/31/20 146,000
Total Liabilities 12/31/20 45,000
Common Stock 12/31/20 60,000
Retained Earnings 01/01/20 29,000
Net Income 2020 15,000
Dividends Declared 12/31/20 3,000

Exchange rates:
Closing/Current rate P 10
Historical rate 11
Weighted Average Rate 12

The peso balance of retained earnings on December 31, 2019 is P325,000.

Compute the Cumulative Translation Adjustment reported in the Consolidated Statement of Financial Position on December 31, 2020
a. 122,000 debit b. 116,000 credit c. 125,000 debit d. 125,000 credit

PROBLEM 2 – Elite Imports Co.:

Total Assets: 146,000 x P10 P 1,460,000

Total Liabilities: 45,000 x P10 P 450,000
Total SHE:
O/S: 60,000 x P11 660,000
*RE, end 475,000
Cumulative Translation Adjustment (Dr) (125,000) (balancing figure)
Total Liabilities & SHE P 1,460,000
*RE, 12/31/20:
RE, 12/31/19 P 325,000
Add: Net Income (15,000 x P12) 180,000
Deduct: Dividends (3,000 x P10) (30,000)
RE, 12/31/20 P 475,000

PROBLEM 3

Cleared Corp. owns a subsidiary in Singapore whose Statement of Financial Position in Singapore Dollars for the last two years follow:

Dec 31, 2020 Dec 31, 2021

Assets

Cash and Cash equivalents S$ 90,000 S$ 75,000

Receivables 367,500 442,500

Inventory 480,000 510,000

Property and Equipment, net 765,000 690,000

Total Assets S$ 1,702,500 S$ 1,717,500

Liabilities and Equity

Accounts Payable S$ 165,000 S$ 225,000

Long-term debt 967,500 855,000

2
 Common stock 345,000 345,000

Retained earnings 225,000 292,500

Total Liabilities and Equity S$ 1,702,500 S$ 1,717,500

Relevant exchange rates are:

January 1, 2020 S$ 1 = P 45.00

December 31, 2020 S$ 1 = P 42.50

December 31, 2021 S$ 1 = P 47.50

Average 2020 S$ 1 = P 43.75

September 12, 2020 S$ 1 = P 40.00

Cleared formed the subsidiary on January 1, 2020. Income of the subsidiary was earned evenly throughout the years and the subsidiary declared dividends worth S$15,000 on September 12, 2020 and none were declared during 2021.
Compute the cumulative translation adjustment in 2021
A. P1,818,750 B. P1,706,250 C. P3,018,750 D. P2,625,000

PROBLEM 3 – Cleared Corp.:

December 31, 2020:

Total Assets: 1,702,500 x P42.50 P 72,356,250
Total Liabilities: 1,132,500 x P42.50 P 48,131,250
Total SHE:
O/S: 345,000 x P45 15,525,000
*RE, end 9,900,000
Cumulative Translation Adjustment (Dr) (1,200,000) (bal. figure)
Total Liabilities & SHE P 72,356,250
*RE, 12/31/20:
Net Income, 2020 (240,000 x 43.75) P 10,500,000
Deduct: Dividends, 2020 (15,000 x 40) (600,000)
RE, 12/31/20 P 9,900,000

December 31, 2021:

Total Assets: 1,717,500 x P47.50 P 81,581,250

Total Liabilities: 1,080,000 x P47.50 P 51,300,000
Total SHE:
O/S: 345,000 x P45 15,525,000
*RE, end 12,937,500
Cumulative Translation Adjustment (Cr) 1,818,750 (bal. figure)
Total Liabilities & SHE P 81,581,250
*RE, 12/31/21:
Net Income, 2020 (240,000 x P43.75) P 10,500,000
Add: Net Income, 2021 (67,500 x P45) 3,037,500
Deduct: Dividends, 2020 (15,000 x P40) (600,000)
RE, 12/31/21 P 12,937,500

EXERCISES

THEORIES:
1. Under PAS 21, which of the following statements pertains to functional currency?
A. It refers to the currency of the primary economic environment in which the entity operates.
B. It refers to the currency in which the financial statements are presented.
C. It refers to the currency other than the functional currency of the entity.
D. It refers to the type of currency in a given jurisdiction which a creditor may be compelled to accept.
2. Under PAS 21, what is the initial measurement of foreign currency denominated transaction?
A. Both monetary and nonmonetary items are measured initially at transaction or historical rate.
B. Monetary items are measured at closing rate while nonmonetary items are measured at transaction rate.
C. Monetary items are measured at transaction rate while nonmonetary items are measured at closing rate.
D. Both monetary and nonmonetary items are measured initially at closing rate.
3. Under PAS 21, what is the subsequent measurement of nonmonetary items?
A. Closing rate C. Average rate
B. Transaction rate D. Monthly rate
4. Under PAS 21, what is the subsequent measurement of monetary items?
A. Closing rate C. Average rate
B. Transaction rate D. Monthly rate
5. PAS 21 provides that exchange differences/(gain/loss) arising on the settlement or remeasuring foreign currency transaction shall be recognized in
A. Profit or loss C. Share premium
B. Other comprehensive income D. Retained earnings
6. Which of the following items will result to foreign currency transaction gain/loss due to settlement or remeasurement?
A. Foreign currency denominated income statement accounts such as revenue, income, expense or loss.
B. Foreign currency denominated non-monetary assets such as inventory, PPE, intangible asset or prepaid asset.
C. Foreign currency denominated monetary items such as accounts payable, accounts receivable, notes payable, loans receivable or interest payable.
D. Foreign currency denominated non-monetary liabilities such as unearned revenue, warranty liability, premium liability and deferred tax liability.
E. Foreign currency denominated equity accounts such as ordinary shares, preference shares, treasury shares and share premium.
7. PAS 21 provides that an entity may present its financial statements in any currency even different from its functional currency. When the company translates its financial statements from its functional currency to its selected presentation currency, how shall
the exchange differences arising from the translation be recognized?
A. It shall be recognized in profit or loss.
B. It shall be recognized in other comprehensive income with reclassification adjustment to profit or loss if realized.
C. It shall be recognized in other comprehensive income without reclassification adjustment and reclassified directly to retained earnings if realized.
D. It shall be recognized directly to retained earnings.
8. When translating the financial statements of an entity from its functional currency to its selected presentation currency, which of the following translation measurements is incorrect?
A. Assets and liabilities are translated at the closing rate at the date of statement of financial position.
B. Income and expenses are translated at (1) exchange rates at the date of the transaction or (2) Average rate for the period for practicality.
C. Equity accounts other than retained earnings are translated at the date of the transaction resulting in that equity item.
D. Retained earnings are translated using the average rate during the period.

PROBLEMS:

9. CC Corp. owns a subsidiary in Japan whose statement of financial position in Japanese Yen for the last years follow:

December 31, 2019 December 31, 2020

Assets
Cash and cash equivalents ¥ 30,000 ¥ 25,000
Receivables 122,500 147,500
Inventory 160,000 170,000
Property and equipment, net 255,000 230,000
Total Assets ¥ 567,500 ¥ 572,500
Liabilities and Equity
Accounts payable ¥ 55,000 ¥ 75,000
Long-term debt 322,500 285,000

3
 Common stock 115,000 115,000
Retained earnings 75,000 97,500
Total Liabilities and Equity ¥ 567,500 ¥ 572,500

Relevant exchange rates are:

January 1, 2019 ¥1 = P45.00 Average for 2019 ¥1 = P43.75
December 31, 2019 ¥1 = P42.50 September 12, 2019 ¥1 = P40.00
December 31, 2020 ¥1 = P47.50

CC formed the subsidiary on January 1, 2019. Income of the subsidiary was earned evenly throughout the years and the subsidiary declared dividends worth ¥15,000 on September 12, 2019 and none were declared during 2020.

How much is the cumulative translation adjustment for 2020?

a. P625,000 b. P568,750 c. P1,006,250 d. P875,000

Items 10 and 11 are based on the following information:

A subsidiary of Salisbury, Inc. located in a foreign country whose functional currency is the foreign currency (which is not the currency of a hyperinflationary economy). The subsidiary acquires inventory on credit on November 1, 2012, for 100,000 foreign
currencies that is sold on January 1, 2013 for 130,000 foreign currencies. The subsidiary pays for the inventory on January 31, 2013. Currency exchange rates for 1 FC are as follows:
November 1, 2012 P 0.16 = 1 FC
December 31, 2012 P 0.17 = 1 FC
January 17, 2013 P 0.18 = 1 FC
January 31, 2013 P 0.19 = 1 FC
Average for 2013 P 0.20 = 1 FC

10. What amount does Salisbury’s consolidated balance sheet report for this inventory at December 31, 2012?
a. P16,000 b. P17,000 c. P18,000 d. P19,000

11. What amount does Salisbury’s consolidated income statement report for cost of goods sold for the year ending December 31, 2013?
a. P16,000 b. P17,000 c. P18,000 d. P19,000

12. Certain balance sheet accounts of a foreign subsidiary of Rose Company have been stated in Philippine pesos as follows:
Current rates Historical rates
Accounts receivable, current P 200,000 P 220,000
Accounts receivable, long-term 100,000 110,000
Prepaid insurance 50,000 55,000
Goodwill 80,000 85,000
P 430,000 P 470,000

The subsidiary’s functional currency is a foreign currency which is not the currency of a hyperinflationary economy. What amount should Rose’s balance sheet include for the preceding items?
a. P430,000 b. P435,000 c. P440,000 d. P450,000

13. On January 1, 2020, Kiner Company formed a foreign branch. The branch purchased merchandise at a cost of 720,000 LCU on February 15, 2020. The purchase price was equivalent to P180,000 on this date. The branch’s inventory at December 31, 2020
consisted solely of merchandise purchased on February 15, 2020, and amounted to 240,000 LCU. The exchange rate was 6 LCU to P1 on December 31, 2020, and the average exchange rate was 5 LCU to P1 for 2020. In Kiner’s December 31, 2020 balance
sheet, the branch inventory balance of 240,000 LCU should be translated into Philippine pesos at (using closing rate method).
a. P40,000 b. P48,000 c. P60,000 d. P84,000