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CHAPTER 19TRANSLATING FOREIGN STATEMENTS: THE TEMPORAL METHOD & THE FUNCTIONAL CURRENCY CONCEPT

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19

FOCUS OF CHAPTER 19

The Temporal Method of Translation The Objectives of Translation under FAS 52 The Functional Currency Concept U.S. Taxation of Foreign Subsidiary Earnings

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The Temporal Method: 19 The Definition of TemporalThe 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.Slide 19-3

The Temporal Method: 19 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).

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The Temporal Method: 19 Dont 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 12/31/04.... $1.44

Assets

carried at historical cost are expressed in dollars using historical rates.

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The Temporal Method: 19 Identifying The Driver SUMMARY: The valuation

basis is the

driver--that is, the determinant of theexchange rate to use to translate an asset or liability. Thus the driver must be identified.

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The Temporal Method: 19 Whats Relevant and Whats NOT What

is relevant?

Sustained

How

it is valued (cost, LCM, NRV, FMV).Overruled

Whats not relevant? Whether it

is current or noncurrent (in the balance sheet). Maintaining the account item relationships that exist in the foreign currency statements.Slide 19-7

The Temporal Method: 19 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 = Assets < Monetary Liabilities =

A net monetary asset position. Monetary

A net monetary liability position.Slide 19-8

The Temporal Method: 19 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). OilSlide 19-9

The Temporal Method: 19 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 4/15/04.... $1.61

Items Having Passed Through the B/S: Use

historical spot rate--the rate at the date the item entered the balancesheet.

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The Temporal Method: 19 Just Passing Through to P/LItems That Pass Through the B/S on Their Way to the Income Statement: Inventory Depreciable

fixed assets Intangible assets Prepaid expenses Deferred charges Unearned incomeSlide 19-11

The Temporal Method: Compared 19 With the Current Rate Method--P/LCurrent 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 EXIT CR HR ENTRY

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The Temporal Method: 19 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.

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The Temporal Method: 19 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 .Slide 19-14

The Temporal Method Method: 19 Achieves Inflation Adjusted ReportingAssumptions: Foreign unit buys land on 1/1/04 when the direct exchange rate is $1.00. Foreign country has 25% inflation in 2004. Exchange rate at 12/31/04 is $.80--the $.20 decrease is due entirely to the foreign inflation.

LCUs Exchange Rate 1/1/04.............. 1,000 HC x $1.00 HR =Inflation adj.. +250 x (.20) $ .80 CR = =

U.S. Dollars $1,000 HC-0$1,000

12/31/04.......... 1,250 CV xSlide 19-15

The Functional Currency Concept: 19 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.Slide 19-16

The Functional Currency Concept: 19 Presumed Types of Foreign Operations Relatively Autonomous Units: Expected

to have the foreign currency as the functional currency. to have the U.S. dollar as the functional currency.

Relatively Nonautonomous Units: Expected

Observation: In the real world, its not that cut and dried.Slide 19-17

The Functional Currency Concept: 19 When To Disregard FASBs 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.Slide 19-18

Distinguishing Translation 19 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)

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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.Slide 19-20

19

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.Slide 19-21

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End of Chapter 19 (Appendix material follows)

Time to Clear Things Up-Any Questions?

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U.S. Taxation of Foreign Subsidiary 19 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.Slide 19-23

U.S. Taxation of Foreign Subsidiary 19 Earnings: FASBs RulesFASB Says: Record parent-level taxes on foreign subs income in the year the income is earned. Exception: If subs earnings are expected to be REINVESTED INDEFINITELY, no parent-level taxes need be recorded.Slide 19-24

U.S. Taxation of Foreign Subsidiary 19 Earnings: We Changed Our MindsChange 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.Slide 19-25

U.S. Taxation of Foreign Subsidiary 19 Earnings: The Fly in the OintmentThe 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 parents books-it is a tax to the RECIPIENT.

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