Chapter 36

Translation of the accounts of foreign operations

36.1

Where an entity controls other entities there is a requirement to consolidate the financial
statements of the parent entity with those of the controlled entities (the subsidiaries). Prior to
consolidation it is necessary that all the financial statements are denominated in the same
currency (the presentation currency), otherwise the consolidated amounts would tend
towards being meaningless. Translation of accounts is required where the presentation
currency is different to the functional currency.

36.2

Often the foreign operation performs its operations in a currency other than that of the parent
entity, a currency which is independent of the effects of movements in their parent entitys
domestic currency. As such, the foreign operation insulates itself from the effects of variations
in the exchange rates between the parents currency and its own currency. The parent entity
will not be exposed to foreign exchange gains and losses in relation to the foreign operations
cash flows. Any increase or decrease in the Australian dollar equivalent of the foreign
operations assets will at least in part be offset by changes in the Australian dollar equivalent
of the foreign operations liabilities. The exposure will be limited to the difference between
the assets and the liabilities, that is, limited to the net assets of the foreign operation.
Because the foreign operation often acts independently, with limited cash flow influences on,
or interactions with the parent entity, any gains or losses related to translating the net assets
will not be treated as part of income, but will be transferred to reserves. The gains or losses
are considered to be unrealised from the parent entitys perspective. AASB 121, paragraph
41, states:
These exchange differences are not recognised in profit or loss because the changes in
exchange rates have little or no direct effect on the present and future cash flows from
operations.

36.3

Presentation currency is defined in AASB 121 as the currency in which the financial report is
presented. Functional currency is defined as the currency of the primary economic
environment in which the entity operates.
AASB 121 provides very little guidance in terms of determining the appropriate presentation
currency. As a general principle, in determining the presentation currency consideration needs
to be given to the currency in which the general purpose financial report should be prepared.
We need to consider the needs of the financial statement readers who are dependent upon the
general purpose financial reports. If, for example, the entitys shareholders primarily reside
within Australia, then there would be an expectation that the presentation currency would be
Australian dollars. As we know, the presentation currency might not be the same as the
functional currency. This might happen, for example, when a parent company residing within
Australia controls a subsidiary company that resides in a foreign country, for example, within
South Africa. If the subsidiary operates within South Africa, and that entity sells its goods and
purchases its factors of production in South African currency, then its functional currency is
South African rands. However, for the purposes of translating the results for Australian
purposes, the presentation currency would probably be Australian dollars.

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36.4

All assets and liabilities of the foreign operation are translated using the spot rate applicable
at reporting date. Specifically, paragraph 39 of AASB 121 states:
The results and financial position of an entity whose functional currency is not the
currency of a hyperinflationary economy shall be translated into a different
presentation currency using the following procedures:
(a) assets and liabilities for each balance sheet presented (i.e. including
comparatives) shall be translated at the closing rate at the date of that balance
sheet;
(b) income and expenses for each income statement (i.e. including comparatives)
shall be translated at exchange rates at the dates of the transactions; and
(c) all resulting exchange differences shall be recognised as a separate component
of equity.
While paragraph 39 of AASB 121 outlines the method of translating the assets, liabilities,
income and expenses of a foreign entity, AASB 121 does not address the translation of:

equity at the date of the investment, i.e. pre-acquisition capital and reserves;
post-acquisition movements in equity other than retained profits or accumulated losses;
and
distributions from retained profits.

This lack of guidance is in contrast with AASB 1012the superseded standard. AASB 1012
did provide guidance on how to translate the above equity items. These prior requirements
also would be allowable under AASB 121, so in the absence of guidance in AASB 121, we
will apply the contents of AASB 1012 as they relate to equity items. AASB 1012 required:

equity at the date of the investment, including in the case of a corporation, share capital at
acquisition and pre-acquisition reserves, is translated at the exchange rate current at that
date;
post-acquisition movements in equity, other than retained profits (surplus) or accumulated
losses (deficiency), are translated at the exchange rates current at the dates of those
movements, except that where a movement represents a transfer between items within
equity, the movement is translated at the exchange rate current at the date that the amount
transferred or returned was first included in equity;
distributions from retained profits (that is, dividends paid or proposed, or their equivalent)
are translated at the exchange rates current at the dates when the distributions were first
proposed.

36.5 Income and expenses are translated at the exchange rates in place at the dates of the various
transactions. If expense and revenue transactions are considered to occur uniformly throughout
the period, then average rates may be used. As paragraph 40 of AASB 121 states:
For practical reasons, a rate that approximates the exchange rates at the dates of the
transactions, for example an average rate for the period, is often used to translate
income and expense items. However, if exchange rates fluctuate significantly, the use
of the average rate for a period is inappropriate.
36.6
Felicity Plc
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362

Income Statement
for the year ended 30 June 2009
Sales
Cost of sales
Inventory 1/7/08
Purchases
Inventory 30/6/09
Administration expense
Depreciation expense
Foreign exchange loss
Profit before tax
Income tax expense
Profit after tax
Retained earnings 1/7/08
Retained earnings 30/6/09

UK
5 000

Rate
2.10

(1 000)
(4 000)
900
(150)
(200)
_____
550
(250)
300
300
UK 600

2.00
2.10
2.20
2.10
2.10

$A
10 500

(2 000)
(8 400)
1 980
(315)
(420)
______
1 345
2.10
(525)
820
2.00
600
$A1 420

Felicity Plc
Balance Sheet
as at 30 June 2009

Share capital
Foreign currency
translation reserve
Retained earnings
Bank loan
Trade creditors
Plant and
equipment
Cash and debtors
Inventory

1/7/08
UK
1 000

30/6/09
UK
1 000

Rate
2.00

300

600

FROM
I.S.

2 000
________
UK3 300
2 100

2 000
800
UK4 400
1 900

2.30
2.30

200
1 000
UK3 300

1 600
900
UK4 400

2.30
2.30

2.30

$A
2 000
260
1 420
4 600
1 840
$A10 120
4 370
3 680
2 070
$A10 120

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Foreign currency translation reserve

The transfer to the foreign currency translation reserve is determined as follows:
Net Assets at 30/6/09 at current rate
(1 600 2.30)
Less components of net assets at their historical rates:
Share capital 1 000 2.00
Retained earnings
Translation gainto foreign currency translation reserve

$ 3 680
(2 000)
(1 420)
$260

36.7
Ching Ltd
Income Statement
for the year ended 30 June 2009
Sales
Cost of sales
Inventory 1/7/08
Manufacturing costs
Inventory 30/6/09
Gross profit
Selling and admin. expense
Depreciation expense
Foreign exchange gain
Profit before tax
Income tax expense
Profit after tax
Retained earnings 1/7/08
Dividends
Retained earnings 30/6/09

HK$
250 000
(25 000)
(152 500)
27 500
100 000
(20 000)
(30 000)
_______
50 000
(10 000)
40 000

40 000
(10 000)
30 000

Rate
1.00/3.00
1.00/4.00
1.00/3.00
1.00/2.00
1.00/3.00
1.00/3.00

1.00/3.00
1.00/4.00
1.00/2.00

$A
83 333
(6 250)
(50 833)
13 750
40 000
(6 667)
(10 000)
________
23 333
(3 333)
20 000

20 000
(5 000)
$A15 000

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Ching Ltd
Balance Sheet
as at 30 June 2009

Share capital
Foreign currency
Translation reserve
Retained earnings
Current liabilities
Long-term bonds
Cash
Accounts receivable
Inventory
Plant and equipment
Accumulated depreciation
Land

30/6/06
HK$
150 000
30 000
22 500
50 000
252 500
34 000
46 000
27 500
125 000
(30 000)
50 000
252 500

Rate
1.00/4.00

FROM I.S.
1.00/2.00
1.00/2.00
1.00/2.00
1.00/2.00
1.00/2.00
1.00/2.00
1.00/2.00
1.00/2.00

$A
37 500
37 500
15 000
11 250
25 000
$A126 250
17 000
23 000
13 750
62 500
(15 000)
25 000
$A126 250

Foreign currency translation reserve

The transfer to the foreign currency translation reserve is determined as follows:
Net assets at 30/6/09 at current rate
(180 000 2.00)
Less components of net assets at their historical rates:
Share capital 150 000 4.00
Retained earnings from the statement of financial performance
Translation lossto foreign currency translation reserve

Solutions Manual t/a Australian Financial Accounting 5/e by Craig Deegan

$ 90 000
(37 500)
(15 000)
($37 500)

365