HI5020

Corporate Accounting
Session 12a
Translating the Financial Statements
of Foreign Operations
Chapter 29
 Session Objectives

• 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
 Introduction to translating the financial statements of foreign
operations

• The consolidation process involves combining the

financial statements of a parent and its controlled
entities (i.e. 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
 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’
 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
 Considerations of the functional currency

• In these sessions 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
operation’s financial statements into the group’s presentation
currency (a one-step as opposed to a two-step process)
 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 judgement ‘to determine the
functional currency that most faithfully represents
the economic effects of the underlying transactions,
events and conditions’
 Translating the accounts into a particular functional currency

• 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
 Translating the accounts into a particular functional currency

• 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 parent—perhaps because it produces the goods
locally, and sells its products at prices based on New Zealand
dollars—then 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 subsidiary’s 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$)
 Translating the accounts into a particular functional currency

• 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
profit or loss and other 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
 Translating the accounts into a particular functional currency

• 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
 Translating the accounts into a particular functional currency

The above requirements relate to accounts contained within the

statement of profit or loss and other 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 period:
(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 measured
 Translating the accounts into a particular functional currency

• 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
 Translating the accounts into a particular functional currency

• The rates to be used to translate financial statements

into a given functional currency are summarised in
Table 29.1 —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
Summary of rates used when translating financial statements
into a functional currency
 Worked Example 29.1—Translation from a foreign
currency into a functional currency

• On 1 July 2018, 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
2019 are shown below:

1 July 2018 UK£1 = NZ$3.00

Average rate for the year UK£1 = NZ$3.10
Ending inventory (acquired before year end) UK£1 = NZ$3.20
30 June 2019 UK£1 = NZ$3.30
 Worked Example 29.1—Translation from a foreign currency into
a functional currency (cont.)

Bulldog plc
Statement of profit or loss and other comprehensive income for
the year ended 30 June 2019
UK£000
Sales 2 500
Cost of sales:
Inventory—1 July 2018 (500)
Purchases (2 000)
Inventory—30 June 2019 450
Administration expenses (75)
Depreciation expense (100)
Profit before tax 275
Income tax expense (125)
Profit for the year 150
Other comprehensive income -
Total comprehensive income 150
 Worked Example 29.1—Translation from a foreign currency into
a functional currency (cont.)
Bulldog plc
Statement of financial position as at 30 June 2019
1 July 2018 30 June 2019
UK£000 UK£000
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
Translate the financial statements of Bulldog plc into the functional currency.
THE END