ACCOUNTING

TRANSLATION
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We are..
1. Fathinus Syafrizal
2. Tefi Putri Meliska
3. Amelia Saddana
4. Dinda Tria Lestari
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1.
OVERVIEW OF TRANSLATION
Let’s start with the first set of slides
OVERVIEW OF TRANSLATION 4

» Translation exposure, also called accounting exposure,

arises because financial statements of foreign
subsidiaries – which are stated in foreign currency –
must be restated in the parent’s reporting currency for
the firm to prepare consolidated financial statements.
» The accounting process of translation, involves
converting these foreign subsidiaries financial
statements into US dollar-denominated statements.
OVERVIEW OF TRANSLATION (CONT’D) 5

» Translation exposure is the potential for an increase or

decrease in the parent’s net worth and reported net
income caused by a change in exchange rates since the
last translation.
» While the main purpose of translation is to prepare
consolidated statements, management uses translated
statements to assess performance (facilitation of
comparisons across many geographically distributed
subsidiaries).
OVERVIEW OF TRANSLATION (CONT’D) 6

Translation in principle is simple:

» Foreign currency financial statements must be restated in the
parent company’s reporting currency
» If the same exchange rate were used to remeasure each and every
line item on the individual statement (I/S and B/S), there would be
no imbalances resulting from the remeasurement
» What if a different exchange rate were used for different line items
on an individual statement (I/S and B/S)?
» An imbalance would result
OVERVIEW OF TRANSLATION (CONT’D) 7

Why would we use a different exchange rate in remeasuring

different line items?
» Translation principles in many countries are often a
complex compromise between historical and current
market valuation.
» Historical exchange rates can be used for certain equity
accounts, fixed assets, and inventory items, while
current exchange rates can be used for current assets,
current liabilities, income, and expense items.
SUBSIDIARY CHARACTERIZATION 8

» Most countries today specify the translation method used by a

foreign subsidiary based on the subsidiary’s business operations
(subsidiary characterization).
» For example, a foreign subsidiary’s business can be categorized
as either an integrated foreign entity or a self-sustaining foreign
entity.
» An integrated foreign entity is one that operates as an extension
of the parent, with cash flows and business lines that are highly
interrelated.
» A self-sustaining foreign entity is one that operates in the local
economic environment independent of the parent company.
FUNCTIONAL CURRENCY 9

» A foreign subsidiary’s functional currency is the currency of

the primary economic environment in which the subsidiary
operates and in which it generates cash flows.
» In other words, it is the dominant currency used by that
foreign subsidiary in its day-to-day operations.
» The US, requires that the functional currency of the foreign
subsidiary be determined based on the nature and purpose
of the subsidiary.
EXHIBIT 13.1
ECONOMIC INDICATORS FOR DETERMINING THE FUNCTIONAL CURRENCY 10

» Go to next slide
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2.
TRANSLATION METHOD,
PROCEDURE, AND PRACTICE
Let’s start with the first set of slides
TRANSLATION METHOD 13

Two basic methods for the translation of foreign subsidiary

financial statements are employed worldwide:
» The current rate method
» The temporal method
Regardless of which method is employed, a translation method
must not only designate at what exchange rate individual
balance sheet and income statement items are remeasured, but
also designate where any imbalance is to be recorded (current
income or an equity reserve account).
CURRENT RATE METHOD 14

The current rate method is the most prevalent in the world today.
» Assets and liabilities are translated at the current rate of exchange
» Income statement items are translated at the exchange rate on the
dates they were recorded or an appropriately weighted average
rate for the period
» Dividends (distributions) are translated at the rate in effect on the
date of payment
» Common stock and paid-in capital accounts are translated at
historical rates
CURRENT RATE METHOD (CONT’D) 15

» Gains or losses caused by translation adjustments are not

included in the calculation of consolidated net income.
» Rather, translation gains or losses are reported separately and
accumulated in a separate equity reserve account (on the B/S)
with a title such as cumulative translation adjustment (CTA).
» The biggest advantage of the current rate method is that the
gain or loss on translation does not pass through the income
statement but goes directly to a reserve account (reducing
variability of reported earnings).
TEMPORAL METHOD 16

» Under the temporal method, specific assets are translated at

exchange rates consistent with the timing of the item’s
creation.
» This method assumes that a number of individual line item
assets such as inventory and net plant and equipment are
restated regularly to reflect market value.
» Gains or losses resulting from remeasurement are carried
directly to current consolidated income, and not to equity
reserves (increased variability of consolidated earnings).
TEMPORAL METHOD (CONT’D) 17

If these items were not restated but were instead carried at historical cost,
the temporal method becomes the monetary/nonmonetary method of
translation.
» Monetary assets and liabilities are translated at current exchange
rates
» Nonmonetary assets and liabilities are translated at historical rates
» Income statement items are translated at the average exchange
rate for the period
» Dividends (distributions) are translated at the exchange rate on the
date of payment
» Equity items are translated at historical rates
US TRANSLATION PROCEDURE 18

The US differentiates foreign subsidiaries on the basis of functional currency, not

subsidiary characterization.
» IfUSthe financial statements of the foreign subsidiary are maintained in
dollars, translation is not required
» Ifcurrency
the statements are maintained in the local currency, and the local
is the functional currency, they are translated by the current
rate method
» Ifthethefunctional
statements are maintained in local currency, and the US dollar is
currency, they are remeasured by the temporal method
» IfthetheUSstatements are in local currency and neither the local currency or
dollar is the functional currency, the statements must first be
remeasured into the functional currency by the temporal method, and
then translated into US dollars by the current rate method
EXHIBIT 13.2
PROCEDURE FLOW CHART FOR UNITED STATES TRANSLATION PRACTICE 19
INTERNATIONAL TRANSLATION PRACTICE 20

Many of the world’s largest industrial countries – as well as the

relatively newly formed International Accounting Standards
Committee (IASC) follow the same basic translation procedure:
» A foreign subsidiary is an integrated foreign entity or a self-
sustaining foreign entity
» Integrated foreign entities are typically remeasured using
the temporal method
» Self-sustaining foreign entities are translated at the current
rate method, also termed the closing-rate method.
EXHIBIT 13.3
COMPARISON OF TRANSLATION METHODS EMPLOYED IN SELECTED COUNTRIES 21
 22

3.
TRANSLATION EXAMPLE
Let’s start with the first set of slides
TRIDENT EUROPE 23

The functional currency of Trident Europe is the euro,

and the reporting currency of its parent, Trident
Corporation, is the U.S. dollar
» Plant and equipment and long-term debt and
common stock issued some time in the past when
the exchange rate was $1.2760/€
» Inventory currently on hand was purchased or
manufactured during the immediately prior quarter
when the average exchange rate was $1.2180/€
EXHIBIT 13.4 TRIDENT EUROPE:
TRANSLATION LOSS JUST AFTER DEPRECIATION OF THE EURO 24

» Go to next slide
25
EXHIBIT 13.5 TRIDENT EUROPE:
TRANSLATION LOSS OR GAIN: COMPARISON OF CURRENT RATE AND
TEMPORAL METHODS 26
TRIDENT EUROPE (CONT’D) 27

» As seen in exhibit 13.4 and 13.5, the translation loss or gain is

larger under the current rate method because inventory and
net plant and equipment, as well as all monetary assets, are
deemed exposed
» The managerial implications of this fact are very important
» Depending on accounting method of the moment,
management might select different assets and liabilities for
reduction or increase – as a result impacting “real” decisions
EXHIBIT 13.6
COMPARISON OF TRANSLATION EEXPOSURE WITH OPERATING EXPOSURE,
DEPRECIATION OF EURO FROM $1.200/€ to $1.0000/€ FOR TRIDENT EUROPE 28
 29

4.
MANAGING TRANSLATION
EXPOSURE
Let’s start with the first set of slides
MANAGING TRANSLATION EXPOSURE 30

» The main technique to minimize translation exposure is called a balance sheet

hedge.
» A balance sheet hedge requires an equal amount of exposed foreign currency
assets and liabilities on a firm’s consolidated balance sheet.
» If this can be achieved for each foreign currency, net translation exposure will be
zero.
» If a firm translates by the temporal method, a zero net exposed position is called
monetary balance.
» Complete monetary balance cannot be achieved under the current rate method.
MANAGING TRANSLATION EXPOSURE (CONT’D) 31

» The cost of a balance sheet hedge depends on

relative borrowing costs.
» These hedges are a compromise in which the
denomination of balance sheet accounts is altered,
perhaps at a cost in terms of interest expense or
operating efficiency, to achieve some degree of
foreign exchange protection.
WHEN COULD A BALANCE SHEET HEDGE BE JUSTIFIED? 32

If a firm’s subsidiary is using the local currency as the functional currency,

the following circumstances could justify when to use a balance sheet
hedge:
» The foreign subsidiary is about to be liquidated, so that the value
of its CTA would be realized
» The firm has debt covenants or bank agreements that state the
firm’s debt/equity ratios will be maintained within specific limits
» Management is evaluated on the basis of certain income statement
and balance sheet measures that are affected by translation losses
or gains
» The foreign subsidiary is operating in a hyperinflationary
environment
EXHIBIT 13.7
TRIDENT EUROPE, BALANCE SHEET EXPOSURE 33
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BIG
CONCEPT
Bring the attention of your audience over
a key concept using icons or illustrations
YOU CAN ALSO SPLIT YOUR CONTENT 35

White Black
Is the color of milk and fresh Is the color of coal, ebony, and
snow, the color produced by of outer space. It is the darkest
the combination of all the color, the result of the absence
colors of the visible spectrum. of or complete absorption of
light.
IN TWO OR THREE COLUMNS 36

Yellow Blue Red

Is the color of gold, Is the colour of the Is the color of blood,
butter and ripe clear sky and the and because of this it
lemons. In the deep sea. It is located has historically been
spectrum of visible between violet and associated with
light, yellow is found green on the optical sacrifice, danger and
between green and spectrum. courage.
orange.
A PICTURE IS WORTH A THOUSAND WORDS 37

A complex idea can be

conveyed with just a
single still image,
namely making it
possible to absorb large
amounts of data
quickly.
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Want big impact?

USE BIG IMAGE.
USE CHARTS TO EXPLAIN YOUR IDEAS 39

White Gray Black

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THANKS! 41

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