ADVANCED FINANCIAL

ACCOUNTING STUDIES
Lecture 12
Foreign Currency Transactions
Group Reporting VI

Angie Wang
School of Accountancy
Types of Foreign Exchange Exposures-Recap
How changes in FX rates affect a firm’s exposures:
Market rate movements Firm’s strategies and
(due to macro-economic, operations (including
political forces and govt. foreign transactions and
monetary policies) operations)
Jointly determine

FX exposures

Accounting exposure Operating exposure

Impacts the reported Affects the competitive

earnings and statement of position of entity and value
financial position items of the firm
Types of Foreign Exchange Exposures-Recap
Accounting Exposure (Quantifiable)

Transaction exposure:
Translation exposure:
Arises from foreign currency
Arises from translation of foreign currency
transactions e.g., account receivable
financial statements of foreign operations
denominated in a foreign currency

Results in transaction gains or losses Results in translation gains or losses

Recorded in the books Presented in consolidated

of the individual entity financial statements (group level)
Translation Process Summary-Recap
IAS 21 specific two approaches to translate the financial statement:

Foreign Functional Presentation

Currency Currency Currency

Remeasurement Method Closing Rate Method

Translation Process Summary-Recap
➢ Remeasurement/temporal method is used to translate a foreign currency to the functional currency.
― Stand-alone entity with foreign currency transactions. (Transaction Exposure)
― Foreign operations integrated with parent (functional currency = parent’s currency; deemed to
be the parent’s foreign currency transactions): remeasure its financial statements which has been
presented in its local currency into the functional currency. (Transaction Exposure)
Translation Process Summary-Recap
➢ Closing rate method is used to translate financial statements from functional to the presentation
currency using the closing rate method.
― Stand-alone entity that records books in its functional currency but presents its financial
statements in another currency. (Translation exposure)
― Foreign operation as an independent entity (functional currency = local currency): translate its
financial statements which has been recorded in its functional currency into parent’s presentation
currency for consolidation. (Translation exposure)
Translation Process Summary
Assume that parent’s functional and presentation currency is the dollar (US$)
Translation or Remeasurement (Assume
Foreign operation’s financial Foreign operation’s
that presentation currency is parent’s
statement functional currency
currency)
Functional currency (LC) is ≠ group’s
presentation currency ($).
The local currency (LC) The local currency (LC)
Translate into $ using the closing rate
method.
Functional currency is ≠ LC. All transactions
The local currency (LC) The parent’s functional currency recorded in LC are deemed foreign currency
($) transactions. Transactions recorded in LC need
to be remeasured from LC to $.
The parent’s functional currency The parent’s functional currency No translation or remeasurement; FS
($) ($) presented in $
The local currency (LC) Remeasure from LC into the functional
A third currency
currency; then translate into $
Any questions?
Exchange Rates:
Used for Translating Income Statement Items
Income Statements Items Closing Rate Method Remeasurement method

Sales, purchases, expenses, revenues and

income statement items that result in Actual / average rate Actual / average rate
inflow/outflow of monetary items

Historical rate of original purchase

Costs of sales Actual / average rate
of inventory
Historical rate of original acquisition
Depreciation, amortization and other
Actual / average rate (if acquired before acquisition date,
allocation of non-monetary items
use rate at acquisition date)
Dividends and other appropriation of
Actual rate Actual rate
profits
Exchange Rates:
Used for Translating Balance Sheet Items
Balance Sheet Items Closing Rate Method Remeasurement Method
Share capital and pre-
Historical rate Historical rate
acquisition retained earnings

Post-acquisition retained
Not translated using a single exchange rate Not translated using a single exchange rate
earnings

Monetary assets and liabilities Closing rate Closing rate

Historical rate
Non-monetary assets and
Closing rate (If acquired before acquisition date, use
liabilities
rate at acquisition date)
Non-monetary items at fair Rate at the date of the revaluation or FV
Closing rate
value determination

Taken to equity (foreign currency Taken to income statement (except for

Translation gains or losses
translation reserve) non-monetary items at fair value)
Illustration 2:
Translation of a foreign subsidiary’s financial statements
On 31 December 20x0 Durian Pie Ltd, whose functional and presentation currency is the dollar ($),
acquired entire share capital of Mango Pie, a foreign company whose financial statements are prepared
in local currency (FC).
MANGO PIE
Statement of financial position at 31.12.20x0
Assets FC
Fixed assets 290,000
Prepaid insurance 18,000
Inventories 60,000
Account receivables 50,000
Cash 14,000
Accounts payable (100,000)
Net assets 332,000

Share capital 300,000

Retained earnings 32,000
Total Equity 332,000
Illustration 2:
Translation of a foreign subsidiary’s financial statements
Additional information
a. Fixed assets comprised of the following

Net book value (FC) Annual depreciation

Land 50,000 0
Building 100,000 5,000
Equipment 140,000 28,000
290,000 33,000

b. Prepaid insurance expired on 30 June 20x2.

c. During 20x2, additional plant and equipment costing FC 100,000 were purchased. The exchange
rate at the date of purchase was FC 1 = $0.73. The plant and equipment were depreciated on a
straight-line basis over 10 years. Assume that a full year’s depreciation was recorded in 20x2.

d. Land was revalued from FC 50,000 to FC 70,000 on 30 September 20x2.

Illustration 2:
Translation of a foreign subsidiary’s financial statements
Mango Pie’s financial statements for the year ended 31 December 20x1 and 20x2 are as follows:

Income statement for years 31 Dec 20x1 31 Dec 20x2

FC FC
Sales 600,000 800,000
COGS (380,000) (430,000)
Gross profit 220,000 370,000
Depreciation (33,000) (43,000)
Insurance (12,000) (6,000)
Operating expenses (78,000) (84,000)
Profit before tax 97,000 237,000
Taxation (20,000) (48,000)
Profit after tax 77,000 189,000
Dividend paid (25,000) (50,000)
Profit retained 52,000 139,000
Illustration 2:
Translation of a foreign subsidiary’s financial statements
Balance sheet at 31 Dec 20x1 31 Dec 20x2
FC FC
Fixed assets (net) $257,000 $334,000
Inventories 80,000 100,000
Prepaid insurance 6,000 0
Account receivables 70,000 105,000
Cash 89,000 150,000
Accounts payable (98,000) (116,000)
Tax payable (20,000) (30,000)
Net assets $384,000 $543,000

Share capital 300,000 300,000

Retained earnings 84,000 223,000
Revaluation surplus 0 20,000
Total equity $384,000 $543,000
Illustration 2:
Translation of a foreign subsidiary’s financial statements
Additional information:
1. Sales and expenses were incurred evenly throughout each reporting period

2. Relevant exchange rates are as follows:

1FC =
At 31.12.20x0 $0.81
Average for 20x1 $0.78
At 31 Dec 20x1 $0.76
Average rate when closing inventories (20x1) acquired $0.77
Average rate when closing inventories (20x2) acquired $0.74
Average rate for 20x2 $0.75
Dividends paid (20x1) $0.77
Dividends paid (20x2) $0.72
30.09.20x2 $0.71
At 31.12.20x2 $0.70
Illustration 2:
Translation of a foreign subsidiary’s financial statements
Required:
(a) Translate the 20x1 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the local currency (FC).
(b) Translate the 20x2 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the local currency (FC).
(c) Remeasure the 20x1 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the dollar.
[a] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Translated Profit & Loss Account for 20x1 (Closing Rate method)

FC Rate $
Sales 600,000 0.78 468,000
COGS (380,000) 0.78 (296,400)
Gross profit 220,000 171,600 Sales and
Depreciation (33,000) 0.78 (25,740) expenses occur
evenly
Insurance expense (12,000) 0.78 (9,360) throughout year
Operating expenses (78,000) 0.78 (60,840)
Profit before tax 97,000 75,660
Taxation (20,000) 0.78 (15,600)
Represent
Profit after tax 77,000 60,060 entirely pre-
Dividend paid (25,000) 0.77 (19,250) acquisition
earnings
Retained profit for year 52,000 40,810
(translated at
Retained profit b/f (1.1.20x1) 32,000 0.81 25,920 rate as at
Retained profit c/f (31.12.20x1) 84,000 66,730 acquisition)
[a] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Statement of Financial Position at 31.12.20x1
Assets FC Rate $
Fixed assets 257,000 0.76 195,320
Inventories 80,000 0.76 60,800
Prepaid insurance 6,000 0.76 4,560
Accounts receivable 70,000 0.76 53,200
Cash 89,000 0.76 67,640
Liabilities
Accounts payable (98,000) 0.76 (74,480)
Tax payable (20,000) 0.76 (15,200)
Net assets 384,000 291,840
[a] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Statement of Financial Position at 31.12.20x1 (continued)
FC Rate $
Share capital 300,000 0.81 243,000
Retained earnings 84,000 From P/L 66,730
Foreign Currency Translation
Reserve (FCTR) Bal. fig. (17,890)
Total Equity 384,000 291,840

➢ The foreign currency translation reserve (FCTR) contains the

accumulated foreign exchange differences from the translation of the
financial statements of the Group's foreign operations that are not considered
integral to the operations of the parent company, arising when the Group's
entities are consolidated.
➢ Two ways of determining the translation loss
✓ Balancing figure as shown above
✓ Reconciliation check (or proof of translation gain or loss)
 [a] Illustration 2: Translation of a foreign subsidiary’s
financial statements
• Reconciliation check (or proof of translation gain or loss)

Exposed Items FC Rate $

Net assets b/f 332,000 0.81 268,920

Increase in net assets:
Net profit after tax 77,000 0.78 60,060
Decrease in net assets:
Dividend paid (25,000) 0.77 (19,250)
Net assets c/f 309,730 (A)
384,000 0.76 291,840 (B)
Translation difference for the year (B – A) (17,890)
[b] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Translated Profit & Loss Account for 20x2 (Closing Rate method)

FC Rate $
Sales 800,000 0.75 600,000
COGS (430,000) 0.75 (322,500)
Gross profit 370,000 277,500 Sales and
Depreciation (43,000) 0.75 (32,250) expenses occur
evenly
Insurance expense (6,000) 0.75 (4,500) throughout year
Operating expenses (84,000) 0.75 (63,000)
Profit before tax 237,000 177,750
Taxation (48,000) 0.75 (36,000)
Profit after tax 189,000 141,750
Dividend paid (50,000) 0.72 (36,000)
Retained profit for year 139,000 105,750
Retained profit b/f (1.1.20x2) 84,000 66,730
Retained profit c/f (31.12.20x2) 223,000 172,480
[b] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Statement of Financial Position at 31.12.20x2
Assets FC Rate $
Fixed assets 334,000 0.70 233,800
Inventories 100,000 0.70 70,000
Accounts receivable 105,000 0.70 73,500
Cash 150,000 0.70 105,000
Liabilities
Accounts payable (116,000) 0.70 (81,200)
Tax payable (30,000) 0.70 (21,000)
Net assets 543,000 380,100

22
[b] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Statement of Financial Position at 31.12.20x2 (continued)
FC Rate $
Share capital 300,000 0.81 243,000
Retained earnings 223,000 From P/L 172,480
Revaluation surplus 20,000 0.71 14,200
Foreign Currency Translation
Reserve (FCTR) (Note 1) (49,580)
Total Equity 543,000 380,100
[b] Illustration 2: Translation of a foreign subsidiary’s
financial statements
FCTR check (Note 1)

FC Rate $

Net assets at start of the year 384,000 0.76 291,840

Increase in net assets:
Net profit after tax 189,000 0.75 141,750
Revaluation surplus 20,000 0.71 14,200
Decrease in net assets:
Dividend paid (50,000) 0.72 (36,000)
Net assets at the end of year 411,790 (A)
543,000 0.7 380,100 (B) a component of accumulated other
Translation difference for the year (B – A) (31,690) comprehensive income, presented in
a company's consolidated statements
FCTR, 1 January (17,890) of shareholders' equity and carried
over to the consolidated balance
FCTR, 31 December (49,580) sheet under shareholders' equity.
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Remeasured Profit & Loss Account (functional currency is $)
FC Rate $
Sales 600,000 0.78 468,000
COGS (380,000) Note 1 (299,000)
Gross profit 220,000 169,000
Depreciation (33,000) 0.81 (26,730)
Insurance expense (12,000) Note 2 (9,720)
Operating expenses (78,000) 0.78 (60,840)
Remeasurement loss Note 3 10
Profit before tax 97,000 71,720
Taxation (20,000) 0.78 (15,600)
Profit after tax 77,000 56,120
Dividend paid (25,000) 0.77 (19,250)
Retained profit for year 52,000 36,870
Retained profit b/f 32,000 0.81 25,920
Retained profit c/f 84,000 62,790
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Note 1 – COGS
FC Rate $
Opening inventories 60,000 0.81 48,600
Purchases 400,000 0.78 312,000
Closing inventories (80,000) 0.77 (61,600)
COGS 380,000 299,000

Note 2 – Insurance expense

Insurance expense is amortized from prepaid insurance arising as at 31.12.20x0
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Remeasured Profit & Loss Account (functional currency is $)
FC Rate $
Sales 600,000 0.78 468,000
COGS (380,000) Note 1 (299,000)
Gross profit 220,000 169,000
Depreciation (33,000) 0.81 (26,730)
Insurance expense (12,000) 0.81 Note 2 (9,720)
Operating expenses (78,000) 0.78 (60,840)
Remeasurement loss Note 3 10
Profit before tax 97,000 71,720
Taxation (20,000) 0.78 (15,600)
Profit after tax 77,000 56,120
Dividend paid (25,000) 0.77 (19,250)
Retained profit for year 52,000 36,870
Retained profit b/f 32,000 0.81 25,920
Retained profit c/f 84,000 62,790
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Note 3: Remeasurement loss
Exposed item FC Rate S$
Net monetary liabilities b/f (36,000)1 0.81 (29,160)
∆ in monetary assets/liabilities:
Sale 600,000 0.78 468,000
Purchases (400,000) 0.78 (312,000)
Operating expenses (78,000) 0.78 (60,840)
Taxation (20,000) 0.78 (15,600)
Dividend paid (25,000) 0.77 (19,250)
31,150 (A)
Net monetary assets c/f 41,0002 0.76 31,160 (B)
Remeasurement gain (B–A) 10
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
1 Opening exposed monetary items:
FC
Accounts Receivable 50,000
Cash 14,000
Accounts payable (100,000)
Net monetary item (36,000)

2 Closing exposed monetary items:

Accounts receivable 700,000
Cash 89,000
Accounts payable (98,000)
Tax payable (20,000)
Net monetary item c/f 41,000
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Note 3: Remeasurement loss
Exposed item FC Rate S$
Net monetary liabilities b/f (36,000)1 0.81 (29,160)
∆ in monetary assets/liabilities:
Sale 600,000 0.78 468,000
Purchases (400,000) 0.78 (312,000)
Operating expenses (78,000) 0.78 (60,840)
Taxation (20,000) 0.78 (15,600)
Dividend paid (25,000) 0.77 (19,250)
31,150 (A)
Net monetary assets c/f 41,0002 0.76 31,160 (B)
Remeasurement gain (B–A) 10
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Remeasured Profit & Loss Account (functional currency is $)
FC Rate $
Sales 600,000 0.78 468,000
COGS (380,000) Note 1 (299,000)
Gross profit 220,000 169,000
Depreciation (33,000) 0.81 (26,730)
Insurance expense (12,000) 0.81 Note 2 (9,720)
Operating expenses (78,000) 0.78 (60,840)
Remeasurement gain Note 3 10
Profit before tax 97,000 71,720
Taxation (20,000) 0.78 (15,600)
Profit after tax 77,000 56,120
Dividend paid (25,000) 0.77 (19,250)
Retained profit for year 52,000 36,870
Retained profit b/f 32,000 0.81 25,920
Retained profit c/f 84,000 62,790
[c] Illustration 2: Translation of a foreign subsidiary’s
financial statements
Mango Pie
Statement of Financial Position at 31.12.20x1
FC Rate $
Fixed assets (net) 257,000 0.81 208,170
Inventories 80,000 0.77 61,600
Prepaid insurance 6,000 0.81 4,860
Accounts receivables 70,000 0.76 53,200
Cash 89,000 0.76 67,640
Accounts payables (98,000) 0.76 (74,480)
Tax payables (20,000) 0.76 (15,200)
Net assets 384,000 305,790

Share capital 300,000 0.81 243,000

Retained earnings 84,000 From P/L 62,790
384,000 305,790
Illustration 2:
Translation of a foreign subsidiary’s financial statements
Think about after class:
(a) Translate the 20x1 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the local currency (FC).
(b) Translate the 20x2 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the local currency (FC).
(c) Remeasure the 20x1 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the dollar.
(d) Remeasure the 20x2 financial statements of Mango Pie into dollars assuming that Mango Pie’s
functional currency is the dollar.
Foreign Subsidiary Consolidation
-Goodwill arising from the acquisition of foreign subsidiaries

Goodwill (GW), as an asset, belongs to whom?

If GW is an asset of the acquiree If GW is an asset of the acquirer

(the foreign operation) (parent)

Need to be translated No translation required

Foreign Subsidiary Consolidation
-Goodwill arising from the acquisition of foreign subsidiaries
➢Goodwill on date of acquisition = Purchase Price – Acquirer’s interest in FV of net
identifiable assets of acquiree

➢IAS 21 Para 47 states that goodwill arising on acquisition of foreign operation shall be
treated as assets of the foreign operation.

35
Foreign Subsidiary Consolidation
-Goodwill arising from the acquisition of foreign subsidiaries
➢If functional currency of the foreign operation is the local currency:
- Goodwill translated at the closing rate

➢If functional currency of foreign operation is parent’s currency:

- Goodwill is treated as non-monetary assets and remeasured at exchange rate at
acquisition date
Illustration 3
― Acquirer’s functional and presentation currency is the dollar ($).
― Acquisition of X Co on 31 Dec 20x3 at $2,000,000.
― X Co (functional currency is RM) had paid-up capital and retained earnings of RM 3,000,000 and RM
500,000 respectively.
― Assets and liabilities of acquiree at date of acquisition were approximated at fair value except for a
building that was undervalued by RM 100,000.
― Assume that building is depreciated on a straight-line basis over 25 years.
― Deferred tax liability of building was RM 20,000 (tax rate is 20%).

Date Exchange rate

31 Dec 20x3 RM 1 = $0.50
31 Dec 20x4 RM 1 = $0.45
Average rate for 20x4 RM 1 = $0.48
Illustration 3
Goodwill (in dollars and RM)
Goodwill calculation
Cost of investment in RM ($2,000,000/0.5) $4,000,000
Fair value of net identifiable assets 3,580,000
Goodwill in RM 420,000
Goodwill in $ (RM 420,000*0.5) $210,000
Illustration 3
Consolidation journal entry (in dollars)
31 Dec 20x3
Dr Share capital (3,000,000x0.5) 1,500,000
Dr Retained earnings (500,000x0.5) 250,000
Dr Building (100,000x0.5) 50,000
Dr Goodwill 210,000
Cr Investment in Y Co 2,000,000
Cr Deferred tax liability (20,000x0.5) 10,000
Acquisition of X Co and recognition of goodwill on 31 Dec 20x3
Illustration 3
Translation adjustments on goodwill and FV differentials

Goodwill
Goodwill at 31 Dec 20x3 (RM 420,000 x 0.5) $210,000
Goodwill at 31 Dec 20x4 (RM 420,000 x 0.45) 189,000
Translation adjustment on goodwill (21,000)

FV differential (Building)
Differential at 31 Dec 20x3 (RM 100,000 x 0.5) 50,000
Depreciation (RM 4,000 x 0.48) (1,920)
48,080
Differential at 31 Dec 20x4 (RM 96,000 x 0.45) 43,200
Translation adjustment on building before tax (4,880)
Tax effect 976
Translation adjustment after tax (3,904)
Illustration 3
Consolidation journal entry (in dollars)

31 Dec 20x4
Dr Foreign currency translation reserve (Equity) 21,000
Cr Goodwill 21,000
Translation adjustment on goodwill

31 Dec 20x4
Dr Foreign currency translation reserve (Equity) 3,904
Dr Deferred Tax Liability 976
Cr Building 4,880
Translation adjustment on building
Any questions?
For next time…
• Read McGraw Hill Ch6, Wiley Online Chapter D