Accounting for Multinational Operations (I)

 

Summaries

 

Flow Effect – Impact on income statements due to the change of exchange rate (To find out the increase of revenue due to the exchange rate)

 

Holding Effect – Impact on cash balance due to the change of exchange rate

 

Local Currency – The currency of the subsidiary’s location

Functional Currency – The currency of the primary economic environment the subsidiary generates cash flow. This is managerial decision.

Reporting Currency -The one used in financial reporting

 

Current rate – exchange rate on balance sheet date

Average rate – average rate over the reporting period

Historical rate – rate when the transaction happened

Remeasurement – translation of local currency to functional currency

Translation – conversion of functional currency to reporting currency

 

Temporal Method

1)      Monetary Assets and Liabilities (Cash, A/R, A/P, short/long term debts) – current rate

2)      Non-Monetary Assets and Liabilities – Historical Rate

3)      Revenues and Expenses – Average Rate

4)      Inventory, depreciation – historical rate (COGS = Beginning – Ending +Purchase)

5)      Common stock – historical rate

6)      Translation gain and loss showed in the income statement

7)      Equity and Net income are results of mixed rates

 

All Current Method

1)      Income statement accounts: Average rate

2)      Balance sheet accounts: current rate/ Except common stock at historical rate

3)      Dividends -  rate when they are paid

4)      Cumulative translation adjustment (CTA)– included as part of equity in the balance sheet (make equity equivalent to be translated at the current rate)

5)      *** So Equity is translated at current rate (Equity = Asset – Liability)

 

Defining Functional Currency:

1)      independent subsidiary – Local Currency

2)      integrated into the parent – parent’s currency

3)      operating environment is highly inflationary – parent’s currency

 

If the functional currency is local currency => all-current method (Translation: functional to reporting)

If the functional currency is parent’s or other currency => temporal method (Remeasurement: local to functional)

If 3^rd currency served as the functional currency => temporal method: local to functional, then all-current: functional to reporting

 

Translation Gain and Loss

 

Net Asset Exposure

= Share holder’s Equity (all-current method)

= monetary asset – monetary liability (temporal method)

 

Translation Gain and Loss

= Holding effect of Net Asset Exposure (change of rate x beginning exposure)

+ Flow effect of Net Asset Exposure (change of exposure x (ending rate – average rate))

 

*** using average rate is because the retained earning is calculated based on previous retained earning and the net income from income statement (where average rate is used)

 

Temporal Method Inventory and Asset and Depreciation

 

Theoretically, all in historical rates.

 

Beginning inventory: historical rate

Ending inventory, purchase: average rate

COGS: plug-in

Initial asset: historical rate

Asset investment: average rate

Initial depreciation: historical rate

Net depreciation: Blended rate

 

Blended rate = (initial asset/ ending asset * historical rate) + (asset investment/ending asset * average rate)

 

Summary of All-current Method

 

Find the translation G/L

Complete income statement

Complete the balance sheet (adjust the retained earning using the net income value)

 

Summary of temporal Method

 

Find COGS by plugging-in

Find additional depreciation by blended rate

Find the flow effect and cash effect

Complete income statement and add the translation G/L

Complete the balance sheet (adjust the retained earning using the net income value)