Deegan6e ch36

Chapter 36
Translating the
financial statements of
foreign operations
Copyright 2010 McGraw-Hill Australia Pty Ltd

PPTs to accompany Deegan, Australian Financial Accounting 6e
36-1
Objectives of this lecture

Understand why it is necessary to translate the financial
statements of foreign subsidiaries to a specific
presentation currency before the consolidation process is
performed
Be able to translate the financial statements of a foreign
operation into a particular functional currency
Be able to translate the financial statements of a foreign
operation into a particular presentation currency
Understand which rates to use when translating the
financial statements of a foreign operation

36-2
Introduction to translating the financial

statements of foreign operations
The consolidation process involves combining the
financial statements of a parent and its controlled
entities (that is, its subsidiaries)
If some of the controlled entities are foreign entities
with account balances denominated in different foreign
currencies, there is a need to translate these accounts
to a given presentation currency (e.g. Australian
dollars) before the consolidation process
Accounting standard relating to the translation of
foreign subsidiaries is AASB 121 The Effects of
Changes in Foreign Exchange Rates

36-3
Introduction to translating the accounts of

foreign operations (cont.)
Note AASB 121 permits selection of a presentation currency,

which need not be Australian dollars
A single method of translation is to be used to translate the
accounts of foreign subsidiaries into a particular presentation
currency

36-4
Different classifications of currencies

Reference can made to three different types of
currencies, these being local currency, functional
currency, and presentation currency. These currencies
can be defined as follows:
Local currency: the currency used in the

country in which the foreign operation is located
Functional currency: AASB 121, paragraph 8,
defines functional currency as the currency of the
primary economic environment in which the entity
operates
Presentation currency: AASB 121, paragraph 8,
defines the presentation currency as the currency in
which the financial statements are presented
.

36-5
Considerations of the functional currency

In this lecture we will consider two situations
First, we will consider translating the financial statements of
an entity into a particular functional currency
Then, we will consider how to translate the financial
statements of an entity from a particular functional currency
into a particular presentation currency (which is required
prior to consolidation)
If the functional currency is the same as the local currency, then
there will be no need to translate the financial statements of the
foreign operation into the functional currency, as the financial
statements prepared in the local currency will already have
been prepared in the functional currency
In such circumstances we will only need to translate the foreign
operations financial statements into the groups presentation
currency (a one-step as opposed to a two-step process)

36-6
Translating the accounts into a particular

functional currency
According to AASB 121, functional currency is the
currency of the primary economic environment in
which the entity operates
According to paragraph 12 of AASB 121,
management uses its judgment to determine the
functional currency that most faithfully represents the
economic effects of the underlying transactions,
events and conditions

36-7
Translating the accounts into a particular functional

currency (cont.)
If a parent entity has a subsidiary located in another country
then the first task to be undertaken prior to the
consolidation process is to determine the functional
currency of the overseas subsidiary
For example, if an Australian parent has a subsidiary that is
located in New Zealand then it is likely that the subsidiary
would maintain its accounts in the local currency, which is
New Zealand dollars
For the functional currency of the subsidiary to be Australian
dollars there would be an expectation that there is a high
degree of dependence between the subsidiary and the
parent entity. Perhaps the entity acquires products directly
from the parent entity and sells the products at prices based
on the Australian dollar

36-8

currency (cont.)
If the functional currency is determined to be Australian
dollars then there will be a need to translate the New
Zealand accounts from New Zealand dollars into Australian
dollars.
By contrast, if the subsidiary operates quite independently
of the Australian parentperhaps because it produces the
goods locally, and sells its products at prices based on
New Zealand dollarsthen the functional currency might
be New Zealand dollars and there would be no need to
translate the accounts into a different functional currency
Once the subsidiarys accounts have been translated into
the appropriate functional currency then the accounts will
need to be translated to the appropriate presentation
currency prior to consolidation (e.g. for BHP Billiton the
presentation is US$)

36-9

currency (cont.)
Paragraphs 21 and 23 of AASB 121 provide the rules for
translating one currency into another currency. In relation
to items included within the statement of
comprehensive income, paragraph 21 states:
A foreign currency transaction shall be recorded, on initial
recognition in the functional currency, by applying to the
foreign currency amount the spot exchange rate between
the functional currency and the foreign currency at the
date of the transaction
There is a general requirement that each item of expense
and revenue shall be translated at the spot exchange rate
between the functional currency and the local currency on
the dates the respective transactions took place

36-10

currency (cont.)
However, this would be an extremely time-consuming and
difficult task and, as such, AASB 121 allows average
rates to be used. For example, an average exchange rate
between the local currency and the functional currency for
a month may be used to translate transactions that
occurred within that month. As paragraph 22 of AASB 121
states:
For practical reasons, a rate that approximates the actual
rate at the date of the transaction is often used, for
example, an average rate for a week or a month might be
used for all transactions in each foreign currency
occurring during that period. However, if exchange rates
fluctuate significantly, the use of the average rate for a
period is inappropriate

36-11

currency (cont.)
The above requirements relate to accounts contained within the
statement of comprehensive income. In relation to accounts that
would generally be presented within the statement of financial
position, paragraph 23 of AASB 121 states:
At each reporting date:
(a) foreign currency monetary items shall be translated using
the closing rate
(b) non-monetary items that are measured in terms of
historical cost in a foreign currency shall be translated
using the exchange rate at the date of the transaction, and
(c) non-monetary items that are measured at fair value in a
foreign currency shall be translated using the exchange
rates at the date when the fair value was determined

36-12

currency (cont.)
In relation to non-monetary assets, such as plant and
equipment, AASB 116 Property, Plant and Equipment allows
that either cost or fair value be used as the basis of
measurement
If the cost basis is used, and consistent with paragraph 23, the
rate to be used to translate the local currency to the functional
currency is the spot rate as at the date the asset was originally
recognised by the subsidiary
If fair values are used by way of undertaking revaluations, then
the exchange rate to be used between the foreign currency and
the functional currency will be the exchange rate in place when
the valuation was made

36-13

currency (cont.)
The rates to be used to translate financial statements into
a given functional currency are summarised in Table 36.1
see the next slide
Applying the requirements of AASB 121 as they relate to
translating the accounts from a local currency to a
particular functional currency means that the final
accounts, after translation, will reflect amounts that would
be recorded had the transactions or events been
originally recorded in the functional currency

36-14
Summary of rates used when translating financial statements

into a functional currency
Category
Rate
Assets
Monetary
Translate at the spot exchange rate at reporting rate (that is, at the
closing rate)
Non-monetaryheld at
historical cost
Translate at the spot rate at the day the asset was recorded by the
subsidiary
Non-monetaryfair value
Translate at the exchange rate at the date of valuation
Liabilities
Monetary
Translate at the closing rate
Non-monetary
Translate at the exchange rate at the date of valuation
Equity
Contributed equityat
acquisition
Translated at the rate when the investment acquired
Reservesat acquisition
Reservespost
acquisition
If the transfer to reserves is the result of a revaluation of property plant

and equipment the rate used is the rate at the date of the revaluation
Retained earningsat
acquisition

36-15
Summary of rates used when translating financial

statements into a functional currency (cont.)
Revenues and expenses
Translated at the rate in place at the

date of the transaction. For practical
purposes, a rate that approximates the
actual rate of the transaction can be
used
Non-monetary related expenses, e.g.

depreciation
Translated at the rate used to translate

the related non-monetary item
Distributions
Dividends paid
Translated at the current rate at the date

of payment
Dividends declared
Translated at the current rate at the date

the dividends are declared

36-16
Worked Example 36.1Translation from a foreign

currency into a functional currency
On 1 July 2011, Kiwi Ltd, a New Zealand company whose
shares are listed on the New Zealand Securities Exchange,
acquired all the equity in Bulldog plc, a company incorporated
in England
Because of the high level of dependence of Bulldog plc on Kiwi
Ltd, the functional currency is deemed to be the New Zealand
dollar
The exchange rates for the reporting period ending 30 June
2012 are shown below:
1 July 2011
Average rate for the year
Ending inventory (acquired before year end)
30 June 2012

UK1 = NZ$3.00
UK1 = NZ$3.10
UK1 = NZ$3.20
UK1 = NZ$3.30
36-17
Worked Example 36.1Translation from a foreign currency

into a functional currency (cont.)
Bulldog plc
Statement of comprehensive income and details of closing retained
earnings for the year ended 30 June 2012
UK000
Sales
2 500
Cost of sales:
Inventory1 July 2011
(500)
Purchases
(2 000)
Inventory30 June 2012
450
Administration expenses
(75)
Depreciation expense
(100)
Profit before tax
275
Income tax expense
(125)
Profit for the year
150
Retained earnings1 July 2011
150
Retained earnings30 June 2012
300

36-18
Worked Example 36.1Translation from a foreign currency

into a functional currency (cont.)
Bulldog plc
Statement of financial position as at 30 June 2012
1 July 2011
30 June 2012
UK000
UK000
Assets
Property, plant and equipment
1 050
950
Cash and debtors
100
800
Inventory
500
450
Total assets
1 650
2 200
Liabilities
Bank loan
1 000
1 000
Trade creditors
400
Total liabilities
1 000
1 400
Net assets
650
800
Equity
Share capital
500
500
Retained earnings
150
300
650
800
REQUIRED
Translate the financial statements of Bulldog plc into the functional currency

36-19
Worked Example 36.1Solution

Bulldog plc
Statement of comprehensive income for the year ending 30 June 2012
Exchange
UK000
rate
NZ$000
Sales
2 500
3.10
7 750.0
Cost of sales:
(500)
3.00
(1 500.0)
Purchases
(2 000)
3.10
(6 200.0)
450
3.20
1 440.0
Administration expenses
(75)
3.10
(232.5)
(100)
3.00
(300.0)
Foreign exchange loss
---
(210.0)
Profit before tax
275
747.5
Income tax expense
(125)
3.10
(387.5)
Profit for the year
150
360.0
150
3.00
450.0
300
810.0

36-20

Bulldog plc
Statement of financial position as at 30 June 2012
Exchange
UK000
rate
Assets
Property, plant and equipment
950
3.00
Cash and debtors
800
3.30
Inventory
450
3.20
Total assets
2 200
Liabilities
Bank loan
1 000
3.30
Trade creditors
400
3.30
Total liabilities
1 400
Net assets
800
Share capital
500
3.00
Equity
Retained earnings
300
800

NZ$000
2 850
2 640
1 440
6 930
3 300
1 320
4 620
2 310
1 500
810
2 310
36-21
Worked Example 36.1Solution (cont.)

Reconciliation of foreign exchange loss
UK000
Net monetary assets at 1/7/2011
Bank loan
(1 000)
Cash and debtors
100
Increases in monetary assetssales
Decreases in monetary assets resulting from:
Purchases
Cash expenses
Income tax expense
UK000
Current rate
less
rate applied
NZ$
gain/
(loss)
(900)
2 500
(3.30 3.00)
(3.30 3.10)
(270)
500
(2 000)
(75)
(125)
(600)
(3.30 3.10)
(3.30 3.10)
(3.30 3.10)
(400)
(15)
(25)
(210)
Reconciled to net monetary items at 30 June 2012 as follows:

Bank loan
(1 000)
Creditors
(400)
Cash and debtors
800
(600)

36-22
Translating the accounts of foreign

operations into the presentation currency
Before consolidating the financial statements of the parent entity
and its subsidiaries it will be necessary to convert the financial
statements of the various foreign subsidiaries from their
respective functional currencies into the presentation currency of
the parent entity
Under the approach required by AASB 121 all assets and
liabilities of a foreign operation are to be translated from the
functional currency to the presentation currency using the spot
rate applicable at reporting date
Income and expenses are translated at the exchange rates in
place at the dates of the various transactions
If expense and revenue transactions are considered to occur
uniformly throughout the period, average rates may be used
Any resulting translation gains or losses are taken directly to
reserves (rather than to profit or loss, which was the case when
we translated the financial statements from a local currency to
the functional currency)

36-23
Translating the accounts of foreign operations into the

presentation currency (cont.)
The approach to translating the accounts of a foreign subsidiary
from a particular functional currency to a particular presentation
currency is as follows:
(a)
Assets and liabilities are translated at the
exchange rate current at reporting date
(b)
Equity at the date of the investment, including in
the case
of a corporation, share capital at acquisition and
preacquisition reserves, is translated at the exchange rate
current at that date of investment
(c)
Post-acquisition movements in equity, other than
retained
earnings (surplus) or accumulated losses
(deficiency), are
translated at the exchange rates current at
the dates of
those movements, except that, where a movement
represents a transfer between items within equity, the
movement is translated at the exchange rate current at the
date that the amount transferred or returned was first
included
in equity

36-24
Translating the accounts of foreign operations into

the presentation currency (cont.)
(d) Distributions from retained earnings (i.e. dividends paid or
declared, or their equivalent) are translated at the exchange
rates current at the dates when the distributions were first
declared
(e) Revenue and expense items are translated at the exchange
rates current at the applicable transaction dates
Table 36.2 (next slide) summarises the approach to translating
the accounts of a foreign subsidiary

36-25
Summary of the method to be applied for translating financial

statements from a given functional currency to a specific
presentation currency
Assets
Monetary assets
Translated at closing rate
Non-monetary assetsmeasured at historical

cost
Non-monetary assetsmeasured at fair value
Liabilities
Monetary
Non-monetary
Equity
Share capital and reserves at date of acquisition
Translated at spot rate when investment

acquired
Post-acquisition movements in share capital and

reserves (excluding retained
earnings/accumulated losses)
Translated at the spot rate at the date they

were recognised in the accounts
Post-acquisition retained earnings
Amount determined from translating the

statement of comprehensive income
(cont.)

36-26
Summary of the method to be applied for translating financial

statements from a given functional currency to a specific
Revenues
Translated at the rate in place as at the time of the

transaction. For practical reasons, however, it is
acceptable to use a rate that approximates the
rate in place when the transactions took place
(e.g. to use an average rate for the year)
Expenses (apart from the amortisation or

depreciation of non-current assets)
Translated at the rate in place as at the time of the

transaction. For practical reasons, however, it is
acceptable to use a rate that approximates the
rate in place when the transactions took place
(e.g. to use an average rate for the year)
Depreciation/Amortisation
Translated at the average rate for the year
Income tax expense
Translated at the average rate for the year
Distributions
Dividends paid/declared
Translated at the spot rate when paid/declared

36-27
Worked Example 36.2Translation of a foreign operations

financial statements from a functional currency into a
presentation currency
On 1 July 2011 Bruce Ltd, an Australian company, acquires all the
issued shares in Nigel plc, a company incorporated in England.
Exchange rates for the year ending 30 June 2012 are as follows:
01 July 2011
Average rate for year
Ending inventory acquired (before year end)
30 June 2012
1.00 = A$2.00
1.00 = A$2.10
1.00 = A$2.20
1.00 = A$2.30
The statement of comprehensive income and statement of

financial position of Nigel plc are shown on the next slides. The
accounts are stated in UK, which is Nigel plcs functional
currency

36-28

Abbreviated statement of comprehensive income for Nigel plc
for the year ending 30 June 2012 and details of closing retained
earnings
UK
Sales
2 500
Cost of sales
(500 )
Purchases
(2 000 )
450
Administration expense
(75 )
(100 )
Profit
275
Income tax expense
(125 )
Profit after tax
150
150
300

36-29

Statement of financial position for Nigel plc as at 30 June 2012
01 July 2011
30 June 2012
(UK)
(UK)
Assets
Plant and equipment
1 050
950
Cash and debtors
100
800
Inventory
500
450
Total assets
1 650
2 200
Liabilities
Bank loan
1 000
1 000
Trade creditors
400
Total liabilities
1 000
1 400
Net assets
650
800
Represented by:
Shareholders funds
Share capital
500
500
Retained earnings
150
300
650
800
REQUIRED
Translate the financial statements of the foreign operation from the functional currency of the
subsidiary into the presentation currency of the group

36-30

Statement of comprehensive income and reconciliation of retained
earnings, for Nigel plc for the year ending 30 June 2012
Sales
Cost of sales
Purchases
Administration expense
Profit
Income tax expense
Profit after tax

(UK)
2 500
(Rate)
2.10
(A$)
5 250
(500 )
(2 000 )
450
(75 )
(100 )
275
(125 )
150
150
300
2.00
2.10
2.20
2.10
2.10
(1 000 )
(4 200 )
990
(157.5 )
(210 )
672.5
(262.5 )
410
300
710
2.10
2.00
36-31

Statement of financial position for Nigel plc as at 30 June 2012
01 July 2011
30 June 2012
(UK)
(UK)
Assets
Plant and equipment
1 050
950
Cash and debtors
100
800
Inventory
500
450
1 650
2 200
Liabilities
Bank loan
1 000
1 000
Trade creditors
400
1 000
1 400
Net assets
650
800
Represented by:
Shareholders funds
Share capital
500
500
Foreign currency translation reserve
Retained earnings
150
300
650
800
*See calculation provided overleaf
**See statement of comprehensive income

(Rate)
(A$)
2.30
2.30
2.30
2 185
1 840
1 035
5 060
2.30
2.30
2 300
920
3 220
1 840
2.00
1 000
130 *
710 **
1 840
36-32

Foreign currency translation reserve
All assets and liabilities of the foreign subsidiary are translated at the reporting
date spot rate. Because we know that assets less liabilities equals owners equity,
it follows that in effect the total of owners equity is translated at the reporting date
spot rate
However, the individual components of owners equity will be translated
differently. The share capital will be translated using the rate in place when the
investment was acquired
Retained earnings will be the balance provided from the statement of
comprehensive income (which might use a variety of rates). The translation gain,
which does not go to the statement of comprehensive income but remains part of
equity, is in effect the balancing item
When the foreign operation is ultimately disposed of, the amount accumulated in
equity as the foreign currency translation reserve will be treated as part of profits
The transfer to the foreign currency translation reserve is determined as follows:
Net assets at 30 June 2012 at closing rate (800 $2.30)
$1 840
less Components of net assets at their historical rates
Share capital 500 $2.00
($1 000 )
Retained earnings from statement of comprehensive income ($710 )
Translation gainto foreign currency translation reserve
$130

36-33
Consolidation subsequent
to translation
After translation of foreign subsidiarys financial statements,

consolidation takes place according to normal principles (refer
to Chapters 28 to 32)
Cost of investment eliminated against pre-acquisition
capital and reserves of controlled entities, with resultant
goodwill or discount being recognised
Pre-acquisition capital and reserves are translated at the
rates in place when the investment was acquired, i.e. same
rates used each year so the goodwill or discount
recognised on consolidation does not fluctuate

36-34
Consolidation subsequent
to translation (cont.)
Non-controlling interests will be determined following
translation of accounts
foreign currency translation reserve will reside in the
subsidiaries statement of financial position before the
consolidation adjustments and the non-controlling
interests will be allocated a proportion of this reserve

36-35

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Chapter 36

Copyright 2010 McGraw-Hill Australia Pty Ltd

Objectives of this lecture

Copyright 2010 McGraw-Hill Australia Pty Ltd

Introduction to translating the financial

Copyright 2010 McGraw-Hill Australia Pty Ltd

Introduction to translating the accounts of

Note AASB 121 permits selection of a presentation currency,

Copyright 2010 McGraw-Hill Australia Pty Ltd

Different classifications of currencies

Local currency: the currency used in the

Copyright 2010 McGraw-Hill Australia Pty Ltd

Considerations of the functional currency

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts into a particular functional

Copyright 2010 McGraw-Hill Australia Pty Ltd

Summary of rates used when translating financial statements

Translate at the exchange rate at the date of valuation

Translate at the closing rate

Translate at the exchange rate at the date of valuation

Translated at the rate when the investment acquired

Translated at the rate when the investment acquired

If the transfer to reserves is the result of a revaluation of property plant

Translated at the rate when the investment acquired

Copyright 2010 McGraw-Hill Australia Pty Ltd

Summary of rates used when translating financial

Translated at the rate in place at the

Non-monetary related expenses, e.g.

Translated at the rate used to translate

Translated at the current rate at the date

Translated at the current rate at the date

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 36.1Translation from a foreign

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 36.1Translation from a foreign currency

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 36.1Translation from a foreign currency

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 36.1Solution

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 36.1Solution

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 36.1Solution (cont.)

Reconciled to net monetary items at 30 June 2012 as follows:

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts of foreign

Copyright 2010 McGraw-Hill Australia Pty Ltd

Translating the accounts of foreign operations into the

Copyright 2010 McGraw-Hill Australia Pty Ltd