Advanced Accounting by Hoyle et al, 6th Edition

Chapter EightTranslation of Foreign Currency Financial Statements

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objective 8-2Describe guidelines as to when foreign currency financial statements are to be translated using the current rate method and when they are to be translated using the temporal method.8-8 Describe guidelines as to when foreign currency financial statements are to be translated using the current rate method and when they are to be translated using the temporal method.Worldwide Consolidated Financial StatementsThis conversion and translation process is required whether the foreign operation is a branch, joint venture, majority-owned subsidiary, or affiliate accounted for under the equity method. Two major related theoretical issues are: which translation method should be used and where the resulting translation adjustment should be reported in the consolidated financial statements.8-3 To prepare worldwide consolidated financial statements a U. S. parent must:(1) convert the foreign GAAP financial statements of its foreign operations into U.S. GAAP and (2) translate the financial statements from the foreign currency into U.S. dollars. This conversion and translation process is required whether the foreign operation is a branch, joint venture, majority-owned subsidiary, or affiliate accounted for under the equity method. Two major theoretical issues are related to the translation process: (1) which translationmethod should be used and (2) where the resulting translation adjustment shouldbe reported in the consolidated financial statements.Learning Objective 8-1Explain the theoretical underpinnings and the limitations of the current rate and temporal methods.8-4 Explain the theoretical underpinnings and the limitations of the current rate and temporal methods.Translation Methods: Temporal and Current Rate Two major translation methods are currently used: the current rate (or closing rate) method and the temporal method.

Each method is presented from the perspective of aU.S.based multinational company translating foreign currency financial statements into U.S. dollars.8-5 Two major translation methods are currently used: (1) the current rate (or closing rate)method and (2) the temporal method. We discuss each method from the perspective of aU.S.based multinational company translating foreign currency financial statements intoU.S. dollars.Comparison of the Two Translation Methods

8-6 Marketable debt securities classified as held to maturity are carried at amortized cost and translated at the historical exchange rate under the temporal method.

Treatments for Translation AdjustmentThe two major translation methods and the two possible treatments for the translation adjustment give rise to four possible combinations:Two issues arise related to the translation of foreign currency financial statements: selecting the appropriate method. (2) deciding where to report the resulting translation adjustment in the consolidated financial statements.

8-7 The first issue related to the translation of foreign currency financial statements is selectingthe appropriate method. The second issue in financial statement translation relates todeciding where to report the resulting translation adjustment in the consolidated financialstatements.The two major translation methods and the two possible treatments for the translation adjustment give rise to four possible combinations:

Two Translation CombinationsSome subs are so closely tied to their U.S. parents. They use a U.S. dollar perspective to translation, so most of their transactions are recorded in U.S. dollars using the temporal method. Other subs use the local currency perspective; they operate relatively independent of their U.S. parents and use the current rate method for translation. Translation adjustment appears in the equity section.FASB does not express preference for either of the two theoretical views

8-9 Two Translation CombinationsSome subs are tied closely to their U.S. parents so they use a U.S. dollar perspective to translation, so most of their transactions are recorded in U.S. dollars using the temporal method. Other subs use the local currency perspective; they operate relatively independent of their U.S. parents and use the current rate method for translation. Translation adjustment appears in the equity section. Interestingly enough, the FASB chose not to express preference for either of these theoreticalViews.

Functional CurrencyTo determine whether a subsidiary is integrated with the parent or operates independently, we look at the functional currency.A companys functional currency is the primary currency of the foreign entitys operating environment.

8-10 To determine whether a subsidiary is integrated with the parent or operates independently, we look at the functional currency.A companys functional currency is the primary currency of the foreign entitys operating environment.

Determining Subsidiarys Functional Currency

8-11 In addition to introducing the concept of the functional currency, the FASB introducedsome new terminology. The reporting currency is the currency in which the entityprepares its financial statements. For U.S.based corporations, this is the U.S. dollar. If aforeign operations functional currency is the U.S. dollar, foreign currency balances mustbe remeasured into U.S. dollars using the temporal method with translation adjustmentsreported as remeasurement gains and losses in net income. When a foreign currency isthe functional currency, foreign currency balances are translated using the current ratemethod and a translation adjustment is reported on the balance sheet.The functional currency is essentially a matter of fact. However, in some cases thefacts will not clearly indicate a single functional currency. Managements judgment isessential in assessing the facts to determine the functional currency. Indicators to guideparent company management in its determination of a foreign entitys functional currencyare presented in Exhibit 10.2 . Current authoritative literature provides no guidanceas to how to weight these indicators in determining the functional currency. Leavingthe decision about identifying the functional currency up to management allows someleeway in this process. Research has shown that the weighting schemes used by U.S. multinationals to determine the functional currency might be biased toward selection of the foreign currency asthe functional currency. This would be rational behavior for multinationals because, when the foreign currency is the functional currency, the translation adjustment is reported in stockholders equity and does not affect net income.Functional Currency TerminologyReporting currency the currency in which the entity prepares its financial statements. U.S. based corporations use the U.S. dollar.Remeasurment If a foreign operations functional currency is the U.S. dollar, the currency balances must be remeasured into U. S. dollars using the temporal method resulting in remeasurement gains and losses.Translation Adjustment If a foreign currency is the foreign operations functional currency, the currency balances must be translated using the current rate method and a translation adjustment is reported on the balance sheet.

8-12 In addition to introducing the concept of the functional currency, the FASB introduced some new terminology. The reporting currency is the currency in which the entity prepares its financial statements. For U.S.based corporations, this is the U.S. dollar. If a foreign operations functional currency is the U.S. dollar, foreign currency balancesmust be remeasured into U.S. dollars using the temporal method with translation adjustments reported as remeasurement gains and losses in income. When a foreign currency is the functional currency, foreign currency balances are translated using the current rate method and a translation adjustment is reported on the balance sheet.Highly Inflationary EconomiesIn highly inflationary economies, the Temporal Method for translation is required.A country has a highly inflationary economy when its cumulative three year inflation exceeds 100 percent. With compounding, it equates to an average of approximately 26 percent per year for three years in a row. A country may or may not be classified as highly inflationary, depending on its most recent three-year experience with inflation.8-13 In highly inflationary economies, the Temporal Method for translation is required.A country has a highly inflationary economy when its cumulative three year inflation exceeds 100 percent. With compounding, it equates to an average of approximately 26 percent per year for three years in a row. A country may or may not be classified as highly inflationary, depending on its most recent three-year experience with inflation.

Learning Objective 8-3Translate a foreign subsidiarys financial statements into its parents reporting currencyusing the current rate method and calculate the related translation adjustment.8-14 Translate a foreign subsidiarys financial statements into its parents reporting currency using the current rate methodand calculate the related translation adjustment.Current Rate MethodThe first step in translating foreign currency financial statements is to determine the functional currency. Under the current rate method, all revenues and expenses are translated at the exchange rate in effect at the date of accounting recognition. The weighted average exchange rate is used when revenues and expenses have been recognized evenly throughout the year. 8-15 The first step in translating foreign currency financial statements is to determine the functional currency. Under the current rate method, all revenues and expenses are translated at the exchange rate in effect at the date of accounting recognition. The weighted average exchange rate is used when revenues and expenses have been recognized evenly throughout the year. Current Rate MethodHowever, when an income account, such as a gain or loss, occurs at a specific point in time, the exchange rate as of that date is applied. Depreciation and amortization expenses also are translated at the average rate for the year. These expenses accrue evenly throughout the year even though the journal entry could be delayed until year-end for convenience.8-16 The weighted average exchange rate is used when revenues and expenses have been recognized evenly throughout the year. However, when an income account, such as a gain or loss, occurs at a specific point in time, the exchange rate as of that date is applied. Depreciation and amortization expenses also are translated at the average rate for the year. These expenses accrue evenly throughout the year even though the journal entry could be delayed until year-end for convenience.

Learning Objective 8-4Remeasure a foreign subsidiarys financial statements using the temporal method andcalculate the associated remeasurementgain or loss.8-17 Remeasure a foreign subsidiarys financial statements using the temporal method and calculate the associated remeasurement gain or loss.Temporal Method If the subs functional currency is the US dollar, then any balances denominated in the local currency, must be remeasured.Remeasurement requires the application of the temporal method.The remeasurement gain or loss appears on the income statement.8-18 Temporal MethodIf the subs functional currency is the US dollar, then any balances denominated in the local currency, must be remeasured.Remeasurement requires the application of the temporal method.The remeasurement gain or loss appears on the income statement.

Temporal MethodThe temporal method remeasures cash, receivables, and liabilities into U.S. dollars using the current exchange rate. Inventory, property and equipment, patents, and contributed capital accounts are remeasured at historical rates resulting in differences in total assets and liabilities plus equity which must be reconciled resulting in a remeasurement gain or loss.

8-19 The temporal method remeasures cash, receivables, and liabilities into U.S. dollars using the current exchange rate. Inventory, property and equipment, patents, and contributed capital accounts are remeasured at historical rates resulting in differences in total assets and liabilities plus equity which must be reconciled resulting in a remeasurement gain or loss.

Temporal MethodIn remeasuring the statement of cash flows, the U.S. dollar value for net income is taken from the remeasured income statement. Depreciation and amortization are remeasured at the rates used in the income statement, and the remeasurement loss, a noncash item, is added back to net income. Increases in accounts receivable and accounts payable, related to sales and purchases, are remeasured at the average rate. The increase in inventory is determined by the remeasurement of cost of goods sold. 8-20 In remeasuring the statement of cash flows, the U.S. dollar value for net income is taken from the remeasured income statement. Depreciation and amortization are remeasured at the rates used in the income statement, and the remeasurement loss, a noncash item, is added back to net income. Increases in accounts receivable and accounts payable, related to sales and purchases, are remeasured at the average rate. The increase in inventory is determined by the remeasurement of cost of goods sold.

Nonlocal Currency BalancesIf any accounts of the foreign subsidiary are denominated in a currency other than the local currency, they would first have to be restated into the local currency.Both the foreign currency balance and any related foreign exchange gain or loss would then be translated (or remeasured) into US dollars.8-21 Nonlocal Currency BalancesIf any accounts of the foreign subsidiary are denominated in a currency other than the local currency, they would first have to be restated into the local currency.Both the foreign currency balance and any related foreign exchange gain or loss would then be translated (or remeasured) into US dollars.

Comparison of Results from Applying the Two MethodsThe determination of the foreign subsidiarys functional currency (and the use of different translation methods) can have a significant impact on consolidated financial statements. The current rate method does not always result in higher net income and a higher amount of equity than the temporal method and a higher amount of equity than the temporal method.

8-22 The determination of the foreign subsidiarys functional currency (and the use of different translation methods) can have a significant impact on consolidated financial statements. The current rate method does not always result in higher net income and a higher amount of equity than the temporal method and a higher amount of equity than the temporal method.Comparison of Results from Applying the Two MethodsFor example, a company with Swiss francs as the local currency reports the values for selected financial ratios calculated from the original foreign currency financial statements and from the U.S. dollartranslated statements using the two different translation methods.

8-23 For example, a company with Swiss francs as the local currency reports the values for selected financial ratios calculated from the original foreign currency financial statements and from the U.S. dollartranslated statements using the two different translation methods. Comparison of Results from Applying the Two MethodsThe temporal method distorts all of the ratios measured in the foreign currency. The subsidiary appears to be less liquid, more highly leveraged, and more profitable than it does in Swiss franc terms. The current rate method maintains the first three ratios but distorts return on equity because income was translated at the average-for-the-period exchange rate, but total equity was translated at the current exchange rate. 8-24 The temporal method distorts all of the ratios measured in the foreign currency. The subsidiary appears to be less liquid, more highly leveraged, and more profitable than it does in Swiss franc terms. The current rate method maintains the first three ratios but distorts return on equity.The distortion occurs because income was translated at the average-for-the-periodexchange rate whereas total equity was translated at the current exchange rate. In fact,the use of the average rate for income and the current rate for assets and liabilities distortsany ratio combining balance sheet and income statement figures, such as turnover ratiosLearning Objective 8-5Understand the rationale for hedging a net investment in a foreign operation and describethe treatment of gains and losses on hedges used for this purpose.8-25 Understand the rationale for hedging a net investment in a foreign operation and describe the treatment of gains andlosses on hedges used for this purpose.Hedging Balance Sheet ExposureWhen the U.S. dollar is the functional currency or when a foreign operation is located in a highly inflationary economy, remeasurement gains and losses are reported in the consolidated income statement.Translation adjustments and remeasurement gains or losses are functions of two factors: changes in the exchange rate and balance sheet exposure.8-26 When the U.S. dollar is the functional currency or when a foreign operation is located ina highly inflationary economy, remeasurement gains and losses are reported in the consolidatedincome statement.Translation adjustments and remeasurement gains or losses are functions of twofactors: (1) changes in the exchange rate and (2) balance sheet exposure.Hedging Balance Sheet ExposureBalance sheet exposure can be hedged through derivatives (forward contracts or foreign currency options) or through nonderivative instruments (foreign currency borrowings).Ironically, in seeking to avoid unrealized translation adjustments, realized foreign exchange gains and losses can occur!A company can do little to influence exchange rates, but parent companies can use several techniques to hedge the balance sheet exposures of their foreign operations. 8-27 A company can do little to influence exchange rates, but parent companies can use several techniques to hedge the balance sheet exposures of their foreign operations. Translation adjustments and re-measurement gains / losses arise from:(1) Exchange rate changes and(2) Balance sheet exposureBalance sheet exposure can be hedged through derivatives (forward contracts or foreign currency options) or through nonderivative instruments (foreign currency borrowings).Ironically, in seeking to avoid unrealized translation adjustments, realized foreign exchange gains and losses can occur!

Hedging Balance Sheet ExposureA hedge of a net investment in a foreign operation eliminates the possibility of reporting a negative translation adjustment in Accumulated Other Comprehensive Income, but gains and losses realized in cash can result.Current standards provide that the gain or loss on a hedging instrument designated and effective as a hedge of the net investment in a foreign operation should be reported in the same manner as the translation adjustment being hedged.

8-28 A hedge of a net investment in a foreign operation eliminates the possibility of reporting a negative translation adjustment in Accumulated Other Comprehensive Income, but gains and losses realized in cash can result.Current standards provide that the gain or loss on a hedging instrument designated and effective as a hedge of the net investment in a foreign operation should be reported in the same manner as the translation adjustment being hedged.Hedging Balance Sheet ExposureCurrent standards also require firms to present an analysis of the change in the cumulative translation adjustment account in the financial statements or notes thereto. Many companies comply with this requirement directly in their statement of comprehensive income. Other companies provide separate disclosure in the notes8-29 Current standards require firms to present an analysis of the change in the cumulativetranslation adjustment account in the financial statements or notes thereto. Many companiescomply with this requirement directly in their statement of comprehensive income.Other companies provide separate disclosure in the notesLearning Objective 8-6Prepare a consolidation worksheet for a parent and its foreign subsidiary.8-30 Understand the rationale for hedging a net investment in a foreign operation and describe the treatment of gains andlosses on hedges used for this purpose.Consolidation of a Foreign SubsidiaryOn January 1, 2014, Altman, Inc., a U.S.-based manufacturing firm, acquired 100 percent of Bradford Ltd. in Great Britain. Altman paid 25 million british pounds (25,000,000), which was equal to Bradfords fair value. Bradfords balance sheet on January 1, 2014, was as follows:Cash . . . . . . . .. . . . . . . . . . 925,000 Accounts payable .. . 675,000Accounts receivable . . . . . 1,400,000 Long-term debt . . . . .4,000,000Inventory . . . . . . . . . . . . . 6,050,000 Common stock. . . . .20,000,000Plant & equipment (net) 19,000,000 Retained earnings . . 2,700,000Total . . . . . . . . . . . . . . . . 27,375,000 Total . . . . . . . . . . . . 27,375,000The 2,300,000 excess fair value over book value results from undervalued land (part of plant and equipment) and is not subject to amortization. Altman uses the equity method to account for its investment in Bradford.8-31 Consolidation of a Foreign SubsidiaryOn January 1, 2014, Altman, Inc., a U.S.-based manufacturing firm, acquired 100 percent of Bradford Ltd. in Great Britain. Altman paid 25 million british pounds (25,000,000), which was equal to Bradfords fair value. Bradfords balance sheet on January 1, 2014, was as follows:Cash . . . . . . . .. . . . . . . . . . 925,000 Accounts payable .. . 675,000Accounts receivable . . . . . 1,400,000 Long-term debt . . . . .4,000,000Inventory . . . . . . . . . . . . . 6,050,000 Common stock. . . . .20,000,000Plant & equipment (net) 19,000,000 Retained earnings . . 2,700,000Total . . . . . . . . . . . . . . . . 27,375,000 Total . . . . . . . . . . . . 27,375,000The 2,300,000 excess fair value over book value results from undervalued land (part of plant and equipment) and is not subject to amortization. Altman uses the equity method to account for its investment in Bradford.

Consolidation of a Foreign SubsidiaryOn December 31, 2015, two years after the acquisition date, Bradford submitted the following trial balance for consolidation (credit balances are in parentheses):Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600,000Accounts Receivable . . . . . . . . . . . . . . . . . . . . 2,700,000Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000,000Plant and Equipment (net) . . . . . . . . . . . . . 17,200,000Accounts Payable. . . . . . . . . . . . . . . . . . . . . . . (500,000)Long-Term Debt. . . . . . . . . . . . . . . . . . . . . . .(2,000,000)Common Stock . . . . . . . . . . . . . . . . . . . . . . (20,000,000)Retained Earnings, 1/1/15 . . . . . . . . . . . . . . (3,800,000)Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (13,900,000)Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . 8,100,000Depreciation Expense. . . . . . . . . . . . . . . . . . . . . 900,000Other Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 950,000Dividends Declared, 6/30/15 . . . . . . . . . . . . . . . 750,000 -0-8-32 On December 31, 2015, two years after the acquisition date, Bradford submitted the following trial balance for consolidation (credit balances are in parentheses):

Consolidation of a Foreign SubsidiaryAlthough Bradford generated net income of 1,100,000 in 2014, it declared or paid no dividends that year. Other than the payment of dividends in 2015, no intra-entity transactions occurred between the two affiliates. Altman has determined the British pound to be Bradfords functional currency.Relevant exchange rates for the British pound were:

January 1 June 30 December 31 Average2014 $1.51 0 $1.56 $1.542015 1.56 $1.58 1.53 1.558-33 Although Bradford generated net income of 1,100,000 in 2014, it declared or paid no dividends that year. Other than the payment of dividends in 2015, no intra-entity transactions occurred between the two affiliates. Altman has determined the British pound to be Bradfordsfunctional currency.Relevant exchange rates for the British pound are presented in the table.

January 1 June 30 December 31 Average2010 $1.51 0 $1.56 $1.542011 1.56 $1.58 1.53 1.55

Consolidation of a Foreign SubsidiaryThe initial step in consolidating the foreign subsidiary is to translate its trial balance from British pounds into U.S. dollars. Because the British pound is the functional currency, the translation uses the current rate method. The historical exchange rate for translating Bradfords common stock and January 1, 2014, retained earnings is the exchange rate that existed at the acquisition date$1.51.8-34 Consolidation of a Foreign SubsidiaryThe initial step in consolidating the foreign subsidiary is to translate its trial balance from British pounds into U.S. dollars. Because the British pound is the functional currency, the translation uses the current rate method. The historical exchange rate for translating Bradfords common stock and January 1, 2014, retained earnings is the exchange rate that existed at the acquisition date$1.51.

Consolidation of a Foreign SubsidiaryTranslation of Foreign Subsidiary Trial Balance

8-35 Translation of Foreign Subsidiary Trial BalanceThe initial step in consolidating the foreign subsidiary is to translate its trial balancefrom British pounds into U.S. dollars. Because the British pound has been determined tobe the functional currency, this translation uses the current rate method. The historicalexchange rate for translating Bradfords common stock and January 1, 2014, retainedearnings is the exchange rate that existed at the acquisition date$1.51.

Consolidation of a Foreign Subsidiary

A positive (credit balance) cumulative translation adjustment of $401,500 is required in 2014 to make the trial balance actually balance because the British pound appreciated against the U.S. dollar. The translation adjustment in 2015 is negative because the British pound depreciated against the U.S. dollar that year.8-36 A positive (credit balance) cumulative translation adjustment of $401,500 is required in 2014 to make the trial balance actually balance because the British pound appreciated against the U.S. dollar. The translation adjustment in 2015 is negative because the British pound depreciated against the U.S. dollar that year.

Determination of Balance in Investment

As a result of these two journal entries, Altman has a Cumulative Translation Adjustment of $401,500 on its separate balance sheet.8-37 The original value of the investment in Bradford, the net income earned by Bradford,and the dividends paid by Bradford are all denominated in British pounds. Relevantamounts must be translated from pounds into U.S. dollars so Altman can account for itsinvestment in Bradford under the equity method. In addition, the translation adjustmentcalculated each year is included in the Investment in Bradford account to update theforeign currency investment to its U.S. dollar equivalent. The counterpart is recorded asa translation adjustment on Altmans books.As a result of these two journal entries, Altman has a Cumulative Translation Adjustment of $401,500 on its separate balance sheet.

Investment in Foreign Subsidiary Account

The carrying value of the investment account in U.S. dollar terms at December 31, 2015, is $44,783,000. In addition, Altman reports equity income on its December 31, 2015, trial balance in the amount of $6,122,500.8-38 The carrying value of the investment account in U.S. dollar terms at December 31,2015, is determined as shown. In addition to Altmans $44,783,000 investment in Bradford, it has equity income on its December 31, 2015, trial balance in the amount of $6,122,500.Consolidation Worksheet with Foreign Subsidiary

8-39 Translation Adjustment with Foreign Subsidiary

When the foreign currency is the functional currency, theexcess is translated at the current exchange rate with a resulting translation adjustment. Neither the parent nor the subsidiary has recorded the translation adjustment related to the excess, and it also must be entered in the consolidation worksheet.8-40 Once the subsidiarys trial balance has been translated into dollars and the carryingvalue of the investment is known, the consolidation worksheet at December 31, 2015,can be prepared. As is true in the consolidation of domestic subsidiaries, the investmentaccount, the subsidiarys equity accounts, and the effects of intra-entity transactionsmust be eliminated. The excess of fair value over book value at the date ofacquisition also must be allocated to the appropriate accounts (in this example, plantand equipment). Unique to the consolidation of foreign subsidiaries is the fact that the excess of fairvalue over book value, denominated in foreign currency, also must be translated into theparents reporting currency. When the foreign currency is the functional currency, theexcess is translated at the current exchange rate with a resulting translation adjustment.The excess is not carried on either the parents or the subsidiarys books but is recognizedonly in the consolidation worksheet. Neither the parent nor the subsidiary has recorded thetranslation adjustment related to the excess, and it also must be entered in the consolidationworksheet. Explanation of Consolidation EntriesS Eliminates the subsidiarys stockholders equity accounts as of the beginning ofthe current year along with the equivalent book value component within the originalvalue of the Investment in Bradford account.A Allocates the excess of fair value over book value at the date of acquisition toland (plant and equipment) and eliminates that amount within the original value ofthe Investment in Bradford account.I Eliminates the amount of equity income recognized by the parent in thecurrent year and included in the Investment in Bradford account under the equitymethod.D Eliminates the subsidiarys dividend payment that was a reduction in the Investmentin Bradford account under the equity method.T Eliminates the cumulative translation adjustment included in the Investment inBradford account under the equity method and eliminates the cumulative translationadjustment carried on the parents books.E Revalues the excess of fair value over book value for the change in exchangerate since the date of acquisition with the counterpart recognized as an increase inthe consolidated cumulative translation adjustment.IFRS and TranslationsIFRS and US GAAP are consistent on most points. Significant differences between IFRS and U.S. GAAP relate to: the hierarchy of factors used to determine the functional currency and the method used to translate the foreign currency statements of a subsidiary located in a hyperinflationary country.

8-41 Significant differences between IFRS and U.S. GAAP relate to (a) thehierarchy of factors used to determine the functional currency and (b) the method usedto translate the foreign currency statements of a subsidiary located in a hyperinflationarycountry.IFRS and TranslationsIAS 21 indicates that the primary factors to be considered in determining the functional currency of a foreign subsidiary are:1. The currency that mainly influences sales price.2. The currency of the country whose competitive forces and regulations mainly determine sales price.3. The currency that mainly influences labor, material, and other costs of providing goods and services.

8-42 IAS 21 indicates that the primary factors to be considered in determining the functionalcurrency of a foreign subsidiary are:1. The currency that mainly influences sales price.2. The currency of the country whose competitive forces and regulations mainly determinesales price.3. The currency that mainly influences labor, material, and other costs of providinggoods and services.IFRS and TranslationsOther factors to be considered are:1. The currency in which funds from financing activities are generated.2. The currency in which receipts from operating activities are retained.3. Whether the foreign operation carries out its activities as an extension of the parent or with a significant degree of autonomy.8-43 Other factors to be considered are:1. The currency in which funds from financing activities are generated.2. The currency in which receipts from operating activities are retained.3. Whether the foreign operation carries out its activities as an extension of the parent orwith a significant degree of autonomy.

IFRS and TranslationsOther factors to be considered (continued):4. The volume of transactions with the parent.5. Whether cash flows generated by the foreign operation directly affect the cash flows of the parent. 6. Whether cash flows generated by the foreign operation are sufficient to service its debt.8-44 Other factors to be considered are:4. The volume of transactions with the parent.5. Whether cash flows generated by the foreign operation directly affect the cash flows ofthe parent.6. Whether cash flows generated by the foreign operation are sufficient to serviceits debt.s.IFRS and TranslationsIAS 21 states that when the above indicators are mixed and the functional currency is not obvious, the parent must give priority to the primary indicators in determining the foreign entitys functional currency.U.S. GAAP is silent with respect to weights to be assigned to various indicators to determine the functional currency and no hierarchy is provided.It is possible that a foreign subsidiary could be determined to have a different functional currency under IFRS than under U.S. GAAP.8-45 IAS 21 states that when the above indicators are mixed and the functional currency isnot obvious, the parent must give priority to the primary indicators in determining theforeign entitys functional currency.As noted earlier, U.S. GAAP is silent with respect to weights to be assigned tovarious indicators to determine the functional currency and there is no hierarchy provided.Because of this difference in the functional currency determination process, itis possible that a foreign subsidiary could be determined to have a functional currencyunder IFRS that would be different from the functional currency determined underU.S. GAAP.IFRS and TranslationsUnder IAS 21, financial statements of a foreign subsidiary located in a hyperinflationary economy are translated into the parents currency using a two-step process. Neither the temporal method nor the current rate method is used.(1) the financial statements are restated for local inflation in accordance with IAS 29, Financial Reporting in Hyperinflationary Economies. (2) each financial statement line item, which has been restated for local inflation, is translated using the current exchange rate. 8-46 Under IAS 21, the financial statements of a foreign subsidiary located in a hyperinflationaryeconomy are translated into the parents currency using a two-step process.First, the financial statements are restated for local inflation in accordance withIAS 29, Financial Reporting in Hyperinflationary Economies. Second, each financialstatement line item, which has now been restated for local inflation, is translated usingthe current exchange rate. In effect, neither the temporal method nor the current ratemethod is used when the subsidiary is located in a country experiencing hyperinflation.