FOREIGN CURRENCY TRANSLATION

Basic concepts involved

1. Foreign currency translation The conversion of the financial statements of a foreign entity into financial
statements expressed in pesos (it is assumed that the parent company is found in the Philippines, and its subsidiaries
are found outside the country)

2. Currency in which the foreign operations financial statements are in It is generally the local currency unit (the
currency of the country where the subsidiary operates)

2. Functional currency The currency of the primary economic environment in which the entity operates. For foreign
subsidiaries, currencies involved can either be (a) the local currency (b) the parents functional currency (peso) or (c)
a currency of a third country.

3. Presentation currency The currency of the parent, i.e. peso

Currency in which the foreign companys FS are prepared

Temporal Functional currency Current Rate Presentation currency
Method Method

4. Temporal method This method remeasures the financial statements of the entity stated in a currency other than
the functional currency to financial statements stated in the financial currency

5. Current rate or Closing rate method This method translates the financial statements of the entity stated in the
functional currency to financial statements stated in the presentation currency (applies when the functional currency
is not the peso)

Monetary assets and liabilities vs. Non-monetary

Monetary Non-monetary
- Cash - AP, NP, LP - Marketable securities - Non-refundable deposits
- Demand deposits - Bank overdrafts - Inventories - Deferred tax liability
- Time deposits - Refundable deposits liability - Prepaid expenses - Unearned income
- AR, NR, LR - Bonds payable - PPE, and Land
- Allowance for DA - Mortgage payable - Accum. Dep
- Prepaid interest - Tax payable - Intangibles, including GW
- Refundable deposit - Accrued expenses - Deferred expense
- Cash surrender value of life insurance - Deferred tax asset
- Investments

Appropriate exchange rates in the measurement and translation process

A. BALANCE SHEET ITEMS
Temporal method Current rate method
Monetary assets and liabilities Current rate Current rate
Non-monetary items at cost Historical rate Current rate
Non-monetary items at fair value Current rate Current rate
Equity items, like capital stock, APIC Historical rate Historical rate
and pre-acquisition RE
Post-acquisition RE Remeasured by components, or Translated by components, or
accumulatively accumulatively
Translation gain or loss To income statement To OCI
Notes: Deferred tax assets and liabilities are non-monetary items that are remeasured and translated like monetary
assets and liabilities (rate used for both methods is the current rate). For retained earnings, the only time it is
translated by the use of one single rate is at the date of acquisition (pre-acquisition RE).

B. INCOME STATEMENT ACCOUNTS

Temporal Current rate
Generally all items (except below) Average rate Average rate
Bad debts expense Average rate Average rate
Cost of sales Inventory, beg Historical, or the Average rate
average for 4th quarter of the
previous year, whichever is given
Purchases Average for year
Inventory, end Average for 4th qtr
Depreciation and amortization of Historical or actual rate on the date Average rate
intangibles the asset is acquired
Amortization of deferred income tax Current rate Average rate
Dividends and other appropriation Historical or actual rate Historical or actual rate
of profit
PROBLEM 1. Basic concepts. Sanji Corporation, a Philippine company, forms a wholly-owned subsidiary, Franky
Company, in a foreign country on December 31, 2015. On that date, Sanji invested P300 000 in exchange for all of
the subsidiarys common stock. The exchange rate on this date is P0.60 per FCU. The initial capital investment was
500 000 FCU, of which 150 000 FCU was immediately invested in inventory and the remainder held in cash. The
balance sheet of Franky, prepared in the FCU, when it began operations on January 1, 2016 is as follows:
Cash 350 000 Common stock 100 000
Inventory 150 000 APIC 400 000
Total 500 000 Total 500 000
Income statement and RE statement, prepared in the FCU, for the year ended December 31, 2016 is as follows:
Sales 4 000 000 Inventory, beginning 150 000
Cost of goods sold 3 000 000* Purchases 3 250 000
Gross profit 1 000 000 Inv, end (evenly in 4th quarter) (400 000)
Depreciation 100 000 Cost of goods sold* 3 000 000
Amortization 10 000
Other expenses 220 000 RE, beginning -
Income before tax 670 000 Net income 470 000
Income taxes 200 000 Dividends (150 000)
Net income 470 000 RE, end 320 000

Balance sheet, prepared in the FCU, as of December 31, 2016

Cash 130 000 Accounts payable 600 000
Accounts receivable 200 000 Long-term ,debt 250 000
Inventory 400 000 Common stock 100 000
PPE, net 900 000 APIC 400 000
Patents, net 40 000 RE 320 000
Total 1 670 000 Total 1 670 000

The relevant exchange rates in Philippine pesos are as follows:

January 1, 2016 0.60 March 15 (date when property was acquired) 0.61
Average for 2016 0.65 April 24 (date when long-term debt was incurred) 0.63
Average for 4th quarter 0.68 May 10 (date when patent was acquired) 0.62
December 31, 2016 0.70 Oct 1 (date when dividends were declared) 0.67

Requirement 1: Assuming that the FCU is the functional currency, translate FS into the presentation currency.
Requirement 2: Assuming that the peso is the functional currency, remeasure FS into the functional currency.

CURRENT RATE METHOD (Requirement 1)

A. Income Statement
Under the current rate method, simply multiply all income statement accounts (without any distinction) with the
average rate for 2016, i.e. P0.65. So, net income of Franky under the presentation currency is P305 500.

B. Statement of retained earnings

Retained Earnings, 1/1 - Note: Dividends are translated using the historical rate, or
Net income 305 500 the rate on the date of declaration, i.e. P0.67. If there is a
Dividends (100 500) beginning RE, it shall be translated using the historical rate
Retained Earnings, 12/31 205 000 as of the date of acquisition of the subsidiary by the parent.

C. Balance Sheet
Cash 91 000 Accounts payable 420 000
Accounts receivable 140 000 Long-term debt 175 000
Inventory 280 000 Common stock 60 000
PPE, net 630 000 APIC 240 000
Patents, net 28 000 RE 205 000
Total 1 169 000 Total 1 100 000
Foreign currency translation
- 69 000
reserve OCI credit
Total 1 169 000 Total 1 169 000
Notes:
- Under the current rate method, simply translate all assets and liabilities, without distinction as to whether it is a
monetary item or not, using the current rate, or the rate on the balance sheet date, i.e. P0.67
- As to equity accounts, other than RE, translate the figures using the historical rate, or the rate on the date of
acquisition, P0.60. RE is translated by components, meaning the balance of 205 000 is carried over to the next year,
and the net income and dividends are translated accordingly based on the average and historical rate of next year. It
is not simply multiplied by one single translation rate.
- The foreign currency translation reserve, otherwise known as cumulative translation adjustment (CTA), is a
balancing figure, and is charged to the OCI.
FCU Rate Pesos
Net assets, 1/31/16 500 000 0.60 300 000
Net income 470 000 0.65 305 500
Dividends 150 000 0.67 (100 500)
Total 505 000
Net assets, 12/31/16 820 000 0.70 574 000
CHANGE in CTA (Increase) 69 000
CTA, beginning balance -
 CTA, ending balance credit 69 000

TEMPORAL METHOD (Requirement 2)

A. Balance sheet
Under the temporal method, the first step is to always start with the balance sheet.

Cash 91 000 Accounts payable 420 000

Accounts receivable 140 000 Long-term ,debt 175 000
Inventory 272 000 Common stock 60 000
PPE, net 549 000 APIC 240 000
Patents, net 24 800 RE (balancing figure) 181 800
Total 1 076 800 Total 1 076 800

Notes:
- There must now be a distinction between monetary items and non-monetary items under this method. Monetary
items are remeasured using the current rate, P0.70, while non-monetary items are generally remeasured at their own
historical cost.
- Inventory, end is remeasured using the average rate of the 4th quarter, P0.68, since the problem specifically
mentions that it. This assumes that the company uses the FIFO inventory method.
- PPE, net is remeasured using the historical rate at the date of acquisition, P0.61, while the patents, net is
remeasured using the historical rate at its date of acquisition, P0.62. Assuming that the subsidiary already has these
items on the date of acquisition by the parent company, the historical rate for these items will be the date of
acquisition December 31, 2015.
- Long-term debt is a monetary item, so the rate given on the date of its incurrence is irrelevant.
- After remeasuring the assets and liabilities, as well as equity items other than RE, the retained earnings balance
account will then serve as a balancing figure.

B. Statement of retained earnings

Retained earnings, beg
Net income (SQUEEZE) 282 300 From the balance acquired from above, squeeze the
Dividends (100 500) remeasured net income to be used in the preparation of
Retained earnings, end 181 800 the remeasured income statement.

C. Income statement
Since the components of the cost of goods sold are given, it must be remeasured per item.

Inventory, beginning 150 000 0.60 90 000

Purchases 3 250 000 0.65 2 112 500
Inventory, end (400 000) 0.68 (272 000)
Cost of goods sold 3 000 000 1 930 500

Sales 4 000 000 0.65 2 600 000

Cost of goods sold 3 000 000 1 930 500
Gross profit 1 000 000 669 500
Depreciation 100 000 0.61 61 000
Amortization 10 000 0.62 6 200
Other expenses 220 000 0.65 143 000
Income tax expense 200 000 0.65 130 000
Net income before remeasurement 470 000 329 300
Remeasurement loss (SQUEEZE) (47 000)
Net income after remeasurement 282 300

Different rates are used, since under the temporal method, the currency is remeasured to reflect the amounts that
would have appeared, had the foreign company used the functional currency in the first place.

Analysis on the computation of the remeasurement loss

FCU Rate Pesos
Net monetary assets, 1/1/16 350 000 0.60 210 000
ADD: Increase in monetary assets due to
4 000 000 0.65 2 600 000
sales (cash and receivables)
LESS: Decrease in monetary assets or
increase in monetary liabilities
Purchases 3 250 000 0.65 (2 112 500)
Other expenses 220 000 0.65 (143 000)
Income tax expense 200 000 0.65 (130 000)
Dividends declared 150 000 0.67 (100 500)
PPE (outlay of cash upon acquisition) 1 000 000 0.61 (610 000)
Patent, net (outlay of cash) 50 000 0.62 (24 800)
Net monetary liability, since liabilities > assets 317 000
Net monetary liability, 12/31/16 at current rate 520 000 0.70 364 000
Remeasurement loss (47 000)
Note: The PPE and Patent must not be at net amount since the outlay of cash was at gross amount. Simply add the
depreciation and amortization expenses to the net amounts of the said items. Suppose that the balance on January
1, 2016 is a net monetary liability, then the increase in monetary assets is now deducted, and the decrease is added.
An increase in the net liability (i.e. from 317 000 to 364 000) is a loss; an increase in the net asset is a gain.

PROBLEM 2. Computation of balances. On January 1, 2016, Brook company, a Philippine-based company acquired
for $2 000 000 an 80% interest in Robin Corporation, which maintains its books in dollars. On the date of acquisition,
the balance sheet of Robin is as follows:
Cash 500 000 Liabilities (monetary) 1 800 000
Accounts receivable 600 000 Common stock 960 000
Inventory 760 000 APIC 300 000
Fixed assets 1 680 000 Retained Earnings 480 000
Total 3 540 000 Total 3 540 000

Income statement and statement of RE for the year-ended 2016, are as follows
Sales 3 020 000 RE, beg 480 000
Cost of sales Net income 333 000
Inventory, beg 760 000 Dividends (300 000)
Purchases 1 920 000 RE, end 513 000
Inventory, end (830 000) (1 850 000)
Depreciation expense (100 000)
Other expenses (655 000)
Income tax expense (82 000)
Net income 333 000

The balance sheet of Robin, as of December 31, 2016 is as follows:

Cash 930 000 Accounts payable 1 040 000
Accounts receivable 608 000 Bonds payable 1 135 000
Inventory (FIFO) 830 000 Common stock 960 000
Fixed assets 1 580 000 APIC 300 000
RE 513 000
Total 3 498 000 Total 3 498 000

The relevant exchange rates for the 2016 fiscal year are as follows
January 1, 2016 P40.00 Average for the 4th quarter P40.22
December 31, 2016 P40.25 Average for the year P40.20
September 1, 2016 (date when dividends were declared) P40.10

Requirement 1: Compute for the translation gain or loss, assuming that peso is the presentation currency.
Requirement 2: Compute for the remeasurement gain or loss, assuming that peso is the functional currency.

1. Current method rate translation gain or loss reported in OCI (cumulative translation adjustment)
FCU Rate Pesos
Net assets, 1/31/16 1 740 000 40.00 69 600 000
Net income, evenly throughout the year 333 000 40.20 13 386 600
Dividends, declared on 9/1/16 300 000 40.10 (12 030 000)
Total 70 956 600
Net assets, 12/31/16 1 773 000 40.25 71 363 250
CHANGE in CTA (Increase) 406 650
CTA, beginning balance -
CTA, ending balance credit 406 650

2. Temporal method remeasurement gain or loss reported in the income statement

FCU Rate Pesos
Net monetary liability, 1/1/16 700 000 40.00 28 000 000
LESS: Increase in monetary assets due to
3 020 000 40.20 (121 404 000)
sales (cash and receivables)
ADD: Decrease in monetary assets or
increase in monetary liabilities
Purchases 1 920 000 40.20 77 184 000
Other expenses 655 000 40.20 26 331 000
Income tax expense 82 000 40.20 3 296 400
Dividends declared 300 000 40.10 12 030 000
Net monetary liability, since liabilities > assets 25 437 400
Net monetary liability, 12/31/16 at current rate 637 000 40.25 25 639 250
Remeasurement loss 201 850
PROBLEM 3. Treatment of goodwill and fair value differentials. Chloe Company, whose functional currency is the
Philippine peso, acquired the entire common stock of Pink Room Corporation for P2 000 000 on December 31, 2015.

Additional information:
1) At the date of acquisition, Pink Rooms APIC and RE were 3 000 000 FCU and 500 000 FCU, respectively.
2) The assets and liabilities of the subsidiary at the date of acquisition approximated their fair values, except for the
building that was undervalued by 100 000 FCU. The tax rate is 20%; hence, the corresponding deferred tax liability
on this undervalued building was 20 00 FCU.
3) The exchange rate on the date of acquisition is 1 FCU = P0.50
4) The exchange rate on December 31, 2016 is 1 FCU = P0.45, and the average rate for 2016 is 1 FCU = P0.48.
5) The undervalued building has a remaining life of 25 years.

Required: Compute for any translation gain or loss in 2016 under current rate method assuming that Pink Rooms
functional currency is FCU, and remeasurement gain or loss in 2016 under the temporal method assuming that Pink
Rooms functional currency is the Philippine peso.

First, compute for the goodwill arising from Chloes stock acquisition. This is computed at the FCU.
Fair value of consideration 4 000 000
Less: BV of SHE (3 500 000)
Allocated excess 500 000
Less: Undervaluation (100 000)
Add: Deferred tax liability 20 000
Goodwill, at FCU 420 000

A. CURRENT RATE METHOD

On goodwill
FCU Rate Pesos
Goodwill at current rate 420 000 0.45 232 470
Goodwill at historical rate 420 000 0.50 258 300
Translation loss on goodwill OCI 25 830

On fair value differential

FCU (1 tax rate) After-tax Rate Pesos
Undervaluation 100 000 80% 80 000 0.50 40 000
Less: Depreciation 4 000 80% 3 200 0.48 (1 536)
Undervaluation at historical rate 38 464
Undervaluation at current rate 96 000 80% 76 800 0.45 34 560
Translation loss on differential OCI 3 904

B. TEMPORAL METHOD
The remeasurement gain or loss attributed to goodwill and fair value differential is 0. Eggy!