Transcript Document 7792440

CHAPTER
16
TRANSLATING
FOREIGN
STATEMENTS:
THE TEMPORAL
METHOD &
THE FUNCTIONAL
CURRENCY
CONCEPT
FOCUS OF CHAPTER 16
• The Temporal Method of Translation
• The Objectives of Translation under
FAS 52
• The Functional Currency Concept
• U.S. Taxation of Foreign Subsidiary
Earnings
The Temporal Method:
The Definition of Temporal
• The dictionary defines temporal as “of or
near the temples (of the head).”
Not much help there!
• Furthermore, the term temporal is not
specifically used in FAS 52.
The Temporal Method:
Temporal—The Defining Moment
• The term “temporal” first appeared as
an accounting term in AICPA Research
Study No. 12 (1972).
– Defined: Expressing foreign currency
amounts in dollars without changing
their attributes.
– Attribute: The manner of valuing an
item (such as “cost,” “LCM,” “NRV,”
“FMV”).
The Temporal Method:
“Don’t Make Any Changes”
• Use exchange rates for assets and
liabilities that result in preserving the
VALUATION BASIS.
– Assets carried at value-based prices
are expressed in dollars using the spot
rate.
WSJ 12/31/06.... $1.44
–
Assets carried at historical cost are
expressed in dollars using historical
rates.
The Temporal Method:
Identifying The Driver
• SUMMARY: The valuation basis is the
“driver”—that is, the determinant of the
exchange rate to use to translate an asset
or liability. Thus the driver must be
identified.
The Temporal Method:
What’s Relevant and What’s NOT
• What is relevant?
– How it is valued (cost, LCM, NRV, FMV).
• What’s not relevant?
– Whether it is current or noncurrent (in
the balance sheet).
– Maintaining the account item
relationships that exist in the foreign
currency statements.
The Temporal Method:
What Winds Up Being the Focus?
• The result of applying the temporal method
generally enables one to view the method
as a focus on the net monetary position:
– Monetary Assets > Monetary Liabilities =
A net monetary asset position.
– Monetary Assets < Monetary Liabilities =
A net monetary liability position.
The Temporal Method:
Is It Monetary or Is It Nonmonetary?
• Monetary Items:
– Cash and accounts obligated to be
settled in cash (includes investments in
BONDS [they have a “due date”]).
• Nonmonetary Items:
– Accounts that are not monetary items
(includes investments in STOCKS).
The Temporal Method:
The Income Statement—Which Rates?
• Items Not Having Passed Through the
B/S:
– Use spot rate at date when the item was
recognized in the income statement.
WSJ 4/15/06.... $1.61
• Items Having Passed Through the B/S:
– Use historical spot rate—the rate at the
date the item entered the balance sheet.
The Temporal Method:
Just Passing Through to P/L
• Items That Pass Through the B/S on
Their Way to the Income Statement:
– Inventory
– Depreciable fixed assets
– Intangible assets
– Prepaid expenses
– Deferred charges
– Unearned income
The Temporal Method: Compared
With the Current Rate Method—P/L
Current Rate Temporal
Method
Method
Rates to be used for :
Items not having passed
through the B/S......................
Items having passed
through the B/S......................
Type of rate for items having
passed through the B/S.........
CR
CR
CR
HR
EXIT
ENTRY
The Temporal Method:
What and Where Time!
• WHAT are the effects of exchange rate
changes called?
– “Remeasurement Gains and Losses”
• WHERE are the effects of exchange rate
changes reported?”
– In earnings.
The Temporal Method:
Again, The FASB Is NOT Consistent
• FASB says:
– Whether the effects of exchange rate
changes as a result of using the temporal
method are unrealized is not relevant—
MUST REPORT CURRENTLY IN
EARNINGS.
– Whether the effects of exchange rate
changes as a result of using the current
rate method are unrealized is relevant—
CANNOT REPORT CURRENTLY IN
EARNINGS .
The Temporal Method Method:
Achieves Inflation Adjusted Reporting
Assumptions: Foreign unit buys land on 1/1/06 when the
direct exchange rate is $1.00. Foreign country has 25%
inflation in 2006. Exchange rate at 12/31/06 is $.80—the
$.20 decrease is due entirely to the foreign inflation.
LCUs
Exchange Rate
1/1/06.............. 1,000 HC x
$1.00 HR =
Inflation adj.. +250
x
12/31/06.......... 1,250 CV x
(.20)
$ .80 CR
=
=
U.S. Dollars
$1,000 HC
-0$1,000
The Functional Currency Concept:
Created By A Mere 4:3 Vote
• SUMMARY OF FUNCTIONAL CURRENCY
CONCEPT:
– For each foreign unit, identify the
currency it primarily uses to generate
and expend cash.
– If a foreign currency, use the current
rate method.
– If the U.S. dollar, use the temporal
method.
The Functional Currency Concept:
Presumed Types of Foreign Operations
• Relatively Autonomous Units:
– Expected to have the foreign currency as the
functional currency.
• Relatively Nonautonomous Units:
– Expected to have the U.S. dollar as the
functional currency.
Observation: In the real world, it’s not that cut and dried.
The Functional Currency Concept:
When To Disregard FASB’s Indicators
• When Operating in a Highly Inflationary
Economy (approximately 100%
cumulative inflation over 3-year period)
Currency depreciates
in value.
–
Must use the temporal method.
Distinguishing “Translation”
from “Remeasurement”
• TRANSLATION (current rate method):
Functional
Currency
(Francs)
Reporting
Currency
(U.S. Dollar)
• REMEASUREMENT (temporal method):
Nonfunctional
Currency
(Pesos)
Functional
(& Reporting)
Currency
(U.S. Dollar)
Review Question #1
Under the temporal method, which of the
following accounts is translated into dollars
using only the current exchange rate?
A. Purchases.
B. Cost of sales.
C. Depreciation expense.
D. Gain on equipment disposal.
E. Retained earnings (ending balance).
F. Injury loss settlement.
G. None of the above.
Review Question #1
With Answer
Under the temporal method, which of the
following accounts is translated into dollars
using only the current exchange rate?
A. Purchases.
B. Cost of sales. [not translated by itself]
C. Depreciation expense.
D. Gain on equipment disposal. [HR & CR used]
E. Retained earnings (ending balance).
F. Injury loss settlement.
G. None of the above.
Review Question #2
Under the temporal method, which of the
following accounts is translated into
dollars using the historical exchange rate?
A. Inventory (LIFO).
B. Income tax expense.
C. Patent amortization expense.
D. Deferred income taxes payable.
E. Deferred charges.
F. Bonds Payable (long-term).
G. None of the above.
Review Question #2
With Answer
Under the temporal method method, which of
the following accounts is translated into
dollars using the historical exchange rate?
A. Inventory (LIFO).
B. Income tax expense.
C. Patent amortization expense.
D. Deferred income taxes payable.
E. Deferred charges.
F. Bonds Payable (long-term).
G. None of the above.
End of Chapter 16
(Appendix 16A follows)
• Time to Clear Things Up—Any
Questions?
Appendix
U.S. Taxation of Foreign Subsidiary
Earnings: Overall Perspective
• FOREIGN SUBSIDIARIES:
– Cannot file a consolidated tax return
with their U.S. parent.
• U.S. PARENTS OF FOREIGN
SUBSIDIARIES:
– Cannot use the “dividends received
deduction.”
– Can use foreign tax credits.
Appendix
U.S. Taxation of Foreign Subsidiary
Earnings: FASB’s Rules
• FASB Says:
– Record parent-level taxes on foreign
sub’s income in the year the income is
earned.
• Exception: If sub’s earnings are
expected to be REINVESTED
INDEFINITELY, no parent-level
taxes need be recorded.
Appendix
U.S. Taxation of Foreign Subsidiary
Earnings: “We Changed Our Minds”
• Change in Circumstances Concerning
Reinvestment of Earnings:
– Treat as a change in estimate.
– Unrecord taxes already recorded or
record taxes that have not been
recorded.
– Do not restate prior periods.
Appendix
U.S. Taxation of Foreign Subsidiary
Earnings: The Fly in the Ointment
• The Dividend Withholding Tax:
– The tax is paid to the foreign
government at the time of the dividend
payment.
– The taxes paid are recorded as tax
expense on the parent’s books—it is a
tax to the RECIPIENT.