FOREIGN

CURRENCY
TRANSLATIONS
CHAPTER 8
Introduction

This section shows are a parent of a foreign subsidiary or an investor of foreign

associate company should translate the foreign currency financial statements of a
foreign operation for the purpose of preparing consolidated financial statements
or financial statements that incorporate equity accounted results of a foreign
associate. Foreign operations include subsidiaries, associates, joint-ventures or
branches.
Conversion versus Translation

Conversion is the process of exchanging amounts of one foreign currency for another. For
foreign currency transactions with and without hedging, the more appropriate term used is
conversion to determine gain or loss on foreign currency brought about by the fluctuation in
exchange rates.

Foreign currency translation, as distinguish from conversion , does not involve the act of
exchanging one currency for another. Translation is required at the end of the accounting
period when a company still holds assets or liabilities in its balance sheet which were obtained
or incurred in a foreign currency.
Presentation Currency versus Functional Currency

For the purpose of translation , it is necessary to distinguish between the presentation currency
and the functional currency .

A stand-alone entity is required to determine its functional currency and record its
transactions in that currency . It is free, however, to present its financial statements in any
currency. The currency in which the financial statements are presented is called the
presentation currency .

In most cases, a stand-alone entity’s presentation currency is also its functional currency . For
example, International Container Terminal and Services, Inc (ICTSI) the functional and
presentation currency is the US dollar . It may, if it chooses, present its financial statements in
Philippine peso.

In the case of a group entity (a parent and its subsidiaries), the presentation currency of the
group is the presentation currency of the parent company , which is the reporting entity . It can
be reasonably assumed that the parent's functional currency is also its presentation currency .
Thus, the presentation currency of a foreign operation (subsidiary) of a Philippine parent
company is the parent's reporting currency (the Philippine peso).
Translation of Financial Statements of Foreign Operations

A foreign operation is an entity that is a subsidiary, associate, joint venture, or a branch of the
reporting entity, the activities of which are based or conducted in a country or currency other than
those reporting entity.
For a Philippine parent entity:

It is not necessary that its foreign operation must be located in another country . It may own a
subsidiary that is incorporated and located in the Philippines, but if that subsidiary conducts its business
in a functional currency other than that of the parent, that subsidiary is a foreign operation .

On the other hand, the Philippine parent may own a subsidiary located in another country , but if that
subsidiary conducts its business in the same functional currency as that of the parent , that subsidiary,
although a foreign operation, is considered to be an integral part of the parent's operations.

With regard to selecting a translation method, PAS 21 changes the requirements of the original PAS 21
by not distinguishing between integral foreign operations and foreign entities. Instead, all overseas
subsidiaries, branches, associates and joint ventures are now classified as foreign operations.
As a result of applying the functional currency concept :

• There is no longer a distinction between integral operations and foreign entities, and

• Only one translation method is prescribed for foreign operations, i.e., the current/closing
rate method that was applied to foreign entities
An ISSUE: What if the Accounting Records of the Foreign Operations Not Kept in the Functional
Currency - Remeasurement

In the early implementation of PAS 21, majority believes that there is only one method requires in
translating the financial statements of foreign operations and that is the use of current/closing rate method
(translation from functional currency into presentation currency)

Difficulty may arise if a Philippine overseas subsidiary keeps its accounting records in its local currency
(normally required for compliance with the local statutes), which is not its functional currency .

PAS 21 further clarifies that "when an entity keeps its books and records in a currency other than its
functional currency , at the time the entity prepares its financial statements all amounts are translated into
the functional currency, so as to produce the same amounts in the functional currency as would have
occurred had the items been recorded initially in the functional currency".

In this case, a remeasurement (translation into functional currency) of the items in the entity's accounts is
required.

Exchange differences (gains and losses) arising on shall be recognized in profit or loss . Such translation
procedures for remeasurement are often known as the "temporal method" in the accounting literature.
For example, assume that a U.S. based subsidiary (a Philippine firm):
• keeps its accounting records in dollars
• its functional currency is the Japanese yen .

In such cases, the U.S. dollars accounts of the subsidiary should first be remeasured to the
Japanese yen functional currency accounts before they are translated to the Philippine peso for
consolidation at the parent's group or consolidated accounts, and/or translated to other currencies
for presentation purposes.

Similarly , if a subsidiary of a Philippine parent keeps its accounting records in peso, but its
functional currency is the US $, the peso financial statements of the subsidiary shall first be
remeasured in the US $, and then translated to the peso for consolidation.

Note that the need for remeasurement can be avoided if an entity , in such circumstance,
implements a dual accounting system by maintaining two sets of accounts, one to comply with
the local laws and the other to comply with PAS 21
Therefore, PAS 21 specifies two approaches:
• current rate method and
• temporal method to translation and the conditions under which each approach should be
used.

The translation approach (current or temporal method) to be used depends on whether the
functional currency of the foreign subsidiary is the same as the presentation currency and
whether the books are kept in the functional currency .

It is also assumed that these two approaches are in a functional currency which is not the
currency of a hyperinflationary economy .
Functional Currency is Not the Currency of a Hyperinflationary Economy

Method 1: Translation into the Presentation Currency (Translation from the Functional Currency to the
Presentation Currency) – Current Rate Method

The financial statements of an entity are prepared in its functional currency and translated into
the presentation currency , when it is different from the functional currency (it means that the
presentation currency is parent’s presentation currency – the Philippine peso but its functional currency
is the LCU – local currency unit) .

This method, as set out in PAS 21 paragraph 39, is applicable to the following cases:
• A stand-alone entity that records its books in its functional currency and presents its financial
statement in another currency, or
• A foreign operation such as a foreign subsidiary, branch, joint venture or associate that records its
books in its functional currency and translates its financial statements into the parent's reporting
currency for the purpose of consolidation .

The method whereby the financial statements are translated from the functional currency into
the presentation currency is known as the current/closing rate method (translated method or net
investment method).
Method 2: Translation Into the Functional Currency (Remeasurement from a Foreign Currency to the Functional
Currency or known as Temporal Method)

This process is applicable when the financial statements of the entity are prepared in a currency other than its
functional currency . The following cases fall under this situation:
• A stand-alone entity that records its books in a currency other than its functional currency but presents its
financial statements in its functional currency ; or
• A foreign operation that records its books in its local currency (for example, because of tax or local reporting
requirements) but its functional currency is the parent's currency (the Philippine peso)

The approach that should be used in this situation is a remeasurement process similar to that prescribed for recording
foreign currency transactions of a stand-alone entity which is discussed in the Chapter 6 (PAS 21:20-26) .

The purpose of the remeasurement process is to achieve the same result as would have been the case had the
transactions been originally recorded in the functional currency.

The term "remeasurement” is used in the US standards but PAS 21 does not use this term . We use the term
"remeasurement" to describe this translation method. The set of procedures used in the remeasurement process is
also referred to as the "temporal method" in academic literature.

As most stand-alone entities are likely to have the same functional and presentation currency, the discussion on
translation methods from this point is focused on foreign operations in consolidated financial statements.

It is clear that the choice of functional currency of a foreign operation determines the translation method. However,
this is not a free choice as PAS 21 paragraphs 9-11 sets out the conditions that should determine the choice of a foreign
operation's functional currency
Factors That Determine the Choice of a Foreign Operation's Functional Currency

A foreign operation’s functional currency can be one of the following:

• The local currency, that is, the currency of the country where the subsidiary operates
(Local Currency Unit or LCU);
• The parent's functional currency (peso); or
• A currency of a third country

In most situations, the functional currency of a foreign operation is either the local currency unit or the parent's
functional (and presentation) currency, the peso.

In addition to the guidelines set out in PAS 21 paragraphs 9-10, the identification of the functional currency of a foreign
subsidiary will also be determined by the nature of the operating relationship between the parent company and the
foreign operation as shown in Figure 8.1 and Table 8.2

The translation procedures applicable when the foreign operation's functional currency is the local currency , the
parent's currency (peso) or a currency of third country are summarized in Table 8.1. It is assumed that the parent’s
functional and presentation currency is the Philippine peso

It should be noted that based on Table 8.1, the standard seems to imply that the functional currency of a foreign
operation is predominantly the local currency , and the impression is that the translation procedures are mainly with
respect of the current/ closing rate method. The US standard seems to take a similar view ; it considers the case where
the functional currency of the foreign operation is the parent's reporting currency as an exceptional case.
Figure 8.1: Choice of Functional Currency – the Applicable Translation Method

Where: 1 – remeasure first,

2 – then translate
XG – exchange gain; XL – exchange loss
 The following table summarizes what is in Figure 8.1:
Table 8.1: Functional Currency and Translation Process
Foreign Operation’s Translation or *Remeasurement (Assume that the
Financial Foreign Operation’s Presentation Currency in Each Scenario is the
Statements are in: Functional Currency Parent’s Currency (Peso)
The local currency The local currency Functional currency (LCU)is different from the
unit (LCU) unit (LCU) group's presentation currency (peso).

Translate into peso using current/closing rate

method according o PAS 21:39.
The local currency Functional currency is different from local currency
unit (LCU) The parent’s units (LCU) in which transactions are recorded. All
functional currency transactions recorded in LCU are deemed foreign
currency transactions (PAS 21:8). The transactions
recorded in LCU need to be remeasured from LCU
to peso according to PAS 21:20-26.

Effectively, the foreign operation is viewed as an

extension of the parent (the parent and the
subsidiary are regarded as one entity). As such,
the foreign operation's transactions are deemed
foreign currency transactions undertaken by the
parent itself. The foreign operation's assets and
liabilities are remeasured as if they are the parent’s.
When remeasuring into the functional currency,
consideration is given as to whether the item is a
monetary or non-monetary item, and whether it
is measured at cost or at fair value.
The local currency A third currency Remeasure from LCU into the functional currency;
unit (LCU) then translate into peso.
The peso The peso No translation or remeasurement necessary;
financial statements ar e already presented in
peso.

* Remeasurement is necessary if the books of the foreign operations are kept in a currency that is not its functional currency.
Source: Advanced Financial Accounting, IFRS Approach 3rd Edition by Pearl Tan, Lim Cheu Yeong and Kuah Ee Wen
The following table presents additional to determine functional currency:
Table 8-2: Additional Factors Indicating whether a Foreign Operation’s Functional Currency is the Local Currency or
the Parent’s Currency (PAS 21:11)

Factors that indicate that the

Factors that indicate that the
foreign operation’s functional
foreign operation’s functional
Indicator currency is the Parent’s
currency is the Local Currency
Functional Currency (the
Unit (LCU)
Philippine Peso)
Activities of the foreign
operation are carried out as
Operating Operations are carried out with
an extension of the parent; for
relationship a "significant degree of
example, the foreign operation
with the parent autonomy" from the parent; for
acts as a processing center
example, the foreign operation
that obtains its materials mainly
sources its own materials and
from its parent and then sells
labor, and sells its products in
its finished goods back to
its own markets.
parent.

Transactions with the parent form

Transactions with the parent
Transactions a proportion of the foreign
form a low proportion of the
with the parent operation's total transactions.
foreign operation's activities.
Cash flows from the activities of
Cash flows from the activities of
Cash flow the
a foreign operation directly affect
interdependenci foreign operation do not
the flows of the parent.
es directly affect the parent
company.
The foreign operation is self- The foreign operation is
Financial sufficient and is not dependent dependent on the parent
independence on the parent company for company for financing
financing
Source: Advanced Financial Accounting, IFRS Approach 3rd Edition by Pearl Tan, Lim Cheu Yeong and Kuah Ee Wen
Translation from Functional to Presentation Currency (Current/Closing Rate Method)

The main features of the current/closing rate method are summarized as follows:
1. Assets and liabilities, both monetary and non-monetary, are translated at current/closing rate (CR) ;
2. Income and expense items of the foreign operation are translated at exchange rates at the dates of the
transactions, i.e. actual or historical spot rates (HR) .
For practical reasons, the average rate (AR) is usually used for ·items whose transactions are numerous
and occur EVENLY throughout the year, for example, sales, purchases and operating expenses; and
3. Translation gains or losses are taken to other comprehensive income until the investment is disposed of.

The cumulative translation difference (often referred to as translation adjustments or foreign

currency translation reserves) is taken to net income when the foreign operation is disposed of.
Remeasurement of Foreign Currency Financial Statements to the Functional Currency (Temporal
Method)

The subsidiary's operations in a foreign country are closely integrated with those of the parent such
that they are deemed to be merely an extension of the parent's domestic operations. Therefore, the
functional currency of the subsidiary is the parent's currency.

The following items should be strictly observed relative to applying remeasurement process:
1. The parent and the foreign subsidiary’s operation are treated as a single economic entity ;
2. The transactions of the foreign operation are believed to be the foreign currency transactions of the
parent (as these transactions are denominated in the currency of the country where the foreign subsidiary
operation is located)
3. The economic effects of a change in exchange rates on the foreign operation relate to individual assets
and liabilities that impact the parent's cash flows directly .
4. The exchange gains and losses from remeasuring the operation's financial statements are taken to
income statement and not to other comprehensive income
5. The objective of remeasurement of a foreign operation's financial statement is to achieve the same
results as the case where the parent, as a stand-alone entity , transacts directly in foreign currency
transactions entered into by the foreign operation
Translation Exposure

A translation gain or loss arises when the exchange rates used in translating the present year’s financial
statements are diverse from those used in translating the previous year’s financial statements.

Assets and liabilities translated at the current/closing rates are considered to be exposed while those that
are translated at historical rates preserve their original carrying amounts and do not give rise to
translation differences.
1. Current rate method - translation exposure (eventually it is either a gain or loss) is measured by the
net amount of assets or liabilities in a foreign currency balance sheet translated at the
current/closing exchange rate. Under the current/closing rate method, since assets and liabilities are
translated at the current/closing rate, the net assets (total assets minus total liabilities = shareholders'
equity of the foreign operation) are exposed to changes in exchange rates.
2. Temporal method - translation exposure are mainly the monetary assets and the monetary liabilities.
The net exposed position is either a net monetary asset (monetary assets exceeding monetary
liabilities) or a net monetary liability (monetary liabilities exceeding monetary assets).

However, certain non-monetary items also give rise to translation differences . These are:
• non-monetary items measured at fair value (such as investments );
• items whose basis of measurement has changed during the year, for example, inventory (from
historical cost to net realizable value); and
• land, buildings and equipment that have been revalued during the year.

The exchange gain or loss on such non-monetary items is accounted for in the same way that
the gain or loss on the revalued item is recognized. For instance, a gain or loss on the revaluation
of building or an financial asset such as equity instrument classified as if taken to other
comprehensive income. In the same way, the exchange component of the gain or loss on the non-
monetary item is also taken to other comprehensive income.
Illustration 8-1 shows the process of:
1. Translation of the foreign currency financial statements of a foreign operation to the presentation
currency using the current/closing rate method, and
2. Remeasurement of the foreign currency financial statements to the foreign operation’s functional
currency using the temporal method.
Illustration 8-1: Translation of Foreign Subsidiary’s Financial Statements

Assume that on January 2, 20x4, P Company, a Philippine based company, acquired for US$2,000,000 an 80%
interest in S Company maintains its books in U.S. dollars and they are in conformity with GAAP in the
Philippines (parent’s functional and presentation currency is the peso).

S Company’s financial statements are prepared in the local currency unit (the foreign currency unit – dollars.
The translation process will be illustrated under two different assumptions: (1) the U.S. dollars is the
functional currency, and (2) the Philippine peso is the functional currency.

Exchange rates for the US dollars for the 20x4 fiscal year are as follows:
Date Spot Rate
January 2, 20x4 (date of acquisition) . . . . . . . . P40.00
September 1, 20x4 . . . . . . . . . . . . . . . . . . . . . . . . 40.10
December 31, 20x4 . . . . . . . . . . . . . . . . . . . . . . . . 40.25
Average for the fourth quarter . . . . . . . . . . . . . . . 40.22
Average for the year . . . . . . . . . . . . . . . . . . . . . . . 40.20

In translating the income statement accounts, it is assumed that revenues were generated and expenses were
incurred evenly during the year. It is also assumed that the company uses the FIFO cost flow assumption, and
that the ending inventory was acquired during the last quarter.

Entries made on the books of P Company to account for the investment and the preparation of a
consolidated statements workpaper based on the translated account balances are illustrated in the appendix
to this chapter.
Functional Currency Is the Local Currency Unit – Translation Into the Presentation Currency (Current/Closing Rate Method)
Year-end financial statements at December 31 in US dollars for the subsidiary and the translation of the account balances into pesos using
the current/closing rate method are presented as follows:
Figure 8-2: Workpaper – Translation into the Presentation Currency (Current/Closing Rate Method); Functional Currency Is Local
Currency Unit – US Dollars
Translation
Combined Statement of Income and Adjusted Trial Exchange Adjusted Trial
Retained Earnings Balance ($) Rate Balance (Pesos)
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,020,000 (A) 40.20 121,404,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 (A) 40.20 74,370,000
Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 (A) 40.20 4,020,000
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 655,000 (A) 40.20 26,331,000
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82,000 (A) 40.20 3,296,400
Net Income to Retained Earnings . . . . . . . . . . . . . . . . 333,000 13,386,600
Retained earnings, 1/1 . . . . . . . . . . . . . . . . . . . . . . . . . . 480,000 (1) 19,200,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 813,000 32,586,600
Less: Dividends declared, 9/1/20x4 . . . . . . . . . . . . . . . . 300,000 (H) 40.10 12,030,000
Retained earnings, 12/31 to Balance Sheet . . . . . . . . . 513,000 20,556,600
Balance Sheet
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 930,000 (C) 40.25 37,432,500
Accounts receivable (net) . . . . . . . . . . . . . . . . . . . . . . . 608,000 (C) 40.25 24,472,000
Inventory (FIFO) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830,000 (C) 40.25 33,407,500
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000 (C) 40.25 20,125,000
Buildings (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650,000 (C) 40.25 26,162,500
Equipment (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 430,000 (C) 40.2 17,307,500
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,948,000 158,907,000
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640,000 (C) 40.25 25,760,000
Short-term notes payable . . . . . . . . . . . . . . . . . . . . . . . . 635,000 (C) 40.25 25,558,750
Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900,000 (C) 40.25 36,225,000
Common stock, P10 par . . . . . . . . . . . . . . . . . . . . . . . . . 960,000 (H) 40.00 38,400,000
Paid-in capital in excess of par . . . . . . . . . . . . . . . . . . . 300,000 (H) 40.00 12,000,000
Retained earnings, from above . . . . . . . . . . . . . . . . . . _ 513,000 20,556,600
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,948,000 158,500,350
Foreign Currency Translation Reserve Gain OCI) –
credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _________ B/A ___406,650
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,948,000 158,907,000
*Include as a component of other comprehensive income
(1) Retained earnings in pesos on January 2 (date of acquisition)
(A) Average exchange rate used to approximate the rate on the date these elements were recognized.
(H) Historical exchange rate
(C) Current exchange rate
B/A – balancing amount
An Analysis of Foreign Currency Translation Reserve

When some accounts in a trial balance are translated using one rate and other accounts are translated using
a different rate, an inequality will result between the total of the debit account balances and the total of the
credit account balances.

In Illustration 8-1 the foreign currency translation reserved is a balancing amount that reconciles the
total debit balances with the total credit balances after the individual accounts have been translated
and is reported as a component of stockholders’ equity .
The foreign currency translation reserved for the period results from an entity’s accounting exposure to
exchange risk, which in an accounting sense is related to the set of accounts that are translated at the
current/closing rate. Fluctuations in the exchange rate have no effect on the translated amount of an account
translated at a historical rate on two balance sheets.

The foreign currency translation reserved under the current/closing rate method may be verified by a
direct computation as in Figure 8-3.
Figure 8-3: Verification of the Translation Adjustment – Current/Closing Rate Method (Functional Currency – US Dollars) – Direct Method
Translation Reporting
Exchange Currency
US $ Rate (Pesos)
1/2 Exposed net asset position . . . . . . . . . . . . . . . . . . . . *1,740,000 40.00 69,600,000
Adjustments for changes in net asset position
during year:
Net income for year . . . . . . . . . . . . . . . . . . . . . . . . . . 333,000 40.20 13,386,600
Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . . . . (300,000) 40.10 ( 12,030,000)
Net asset position translated using rate in
effect at date of each transaction . . . . . . . . . . . . . 70,956,600
12/31 Exposed net asset position . . . . . . . . . . . . . . . . . . 1,773,000 40.25 71,363,250
Change in cumulative translation adjustment
during year—net increase . . . . . . . . . . . . . . . . . . . . . 406,650
1/2 Cumulative translation adjustment** . . . . . . . . . . . -0-
12/31 Cumulative translation adjustment . . . . . . . . . . 406,650
* A condensed balance sheet for S Company on January 2, 20x4 was as follows:
US $ US $
Monetary assets . . . . . . . . . . . . . . . . . . . . . . . . . 1,100,000 Monetary Liabilities . . . . . . . . . . . . . 1,800,000
Nonmonetary assets . . . . . . . . . . . . . . . . . . . . . Common stock . . . . . . . . . . . . . . . . 960,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 760,000 Paid-in capital in excess of par . . 300,000
Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . 1,680,000 Retained earnings . . . . . . . . . . . . . 480,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,540,000 Total . . . . . . . . . . . . . . . . . . . . . . . 3,540,000
1/1 Net assets = $3,540,000 - $1,800,000 = 1,740,000
** The beginning balance is zero since this was the first year the investment was held.
Statement of Comprehensive Income and Statement of Shareholders’ Equity

Opinions remain divided as to the appropriateness of excluding foreign currency translation

reserved gain or loss from net income, as currently done under the “current/closing rate”
method.

These adjustments represent one of several items of concern to the IASB because of their
frequency of occurrence and relative importance, coupled with their exclusion from reported
earnings. The IASB labeled such items as “other comprehensive income.”

In Figure 8-4 the statement of comprehensive income and the reconciliation of changes in all
shareholders’ equity accounts for the year 20x4 for S Company in pesos.

Definitely, these amounts would be added to the parent’s balances for preparation of a
consolidated statement of comprehensive income (and a consolidated statement of shareholders’
equity).
Figure 8-4: Statement of Comprehensive Income and Statement of Shareholders’ Equity
Functional Currency Is Local Currency Unit – US$ ; Translation into the Presentation Currency (Current/Closing Rate
Method)

S Company
Statement of Comprehensive Income
For the Year Ended, December 31, 20x4
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P13,386,600
Other comprehensive income:
Foreign currency translation reserve gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 406,650
Comprehensive Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P13,793,250

S Company
Statement of Shareholders’ Equity
For the Year Ended, December 31, 20x4
Paid-in capital
Common in excess of Retained
Stock par Earnings OCI* Total
Balance, 1/1/20x4 . . . . . . . P38,400,000 P12,000,000 P19,200,000 P 0 P69,600,000
Comprehensive Income:
Net income . . . . . . . . . . 13,386,600 13,386,600
Other comprehensive
Income . . . . . . . . . . . 406,650 406,650
Comprehensive Income. . P83,393,250
Dividends declared . . . . . . _______ ___________ (12,030,000) ________ (12,030,000)
Balance, 12/31/20x4 . . . . . P38,400,000 P12,000,000 P20,556,600 P 406,650 P71,363,250
* OCI – other comprehensive income
Functional Currency Is the Philippine Peso – Translation into the Functional Currency
(Remeasurement or Temporal method)

The temporal method is used to remeasure the accounts of a foreign entity when its books are
maintained in a currency other than its functional currency.

The objective of the remeasurement process is to produce the same results as if the
transactions of the foreign entity had been recorded initially in its functional currency .

To accomplish this, the historical exchange rate is used to translate accounts carried at historical
cost, while the current exchange rate is used to translate other accounts.
Figure 8-5: Workpaper – Translation into the Functional Currency (Remeasurement or Temporal Method)/Functional Currency Is
Philippine Peso –
Remeasurement
Adjusted Trial Exchange Adjusted Trial
Balance Sheet Balance ($) Rate Balance (Pesos)
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 930,000 (C) 40.25 37,432,500
Accounts receivable (net) . . . . . . . . . . . . . . . . . . 608,000 (C) 40.25 24,472,000
Inventory (FIFO) . . . . . . . . . . . . . . . . . . . . . . . . . . . 830,000 Schedule 33,382,600
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000 (H) 40.00 20,000,000
Buildings (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650,000 (H) 40.00 26,000,000
Equipment (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . 430,000 (H) 40.00 17,200,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,948,000 158,487,100
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . 640,000 (C) 40.25 25,760,000
Short-term notes payable . . . . . . . . . . . . . . . . . . . 635,000 (C) 40.25 25,558,750
Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900,000 (C) 40.25 36,225,000
Common stock, P10 par . . . . . . . . . . . . . . . . . . . . 960,000 (H) 40.00 38,400,000
Paid-in capital in excess of par . . . . . . . . . . . . . . 300,000 (H) 40.00 12,000,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . _ 513,000 (B/A) 20,543,350
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,948,000 158,487,100
Combined Statement of Income and
Retained Earnings
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,020,000 (A) 40.20 121,404,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 Schedule 74,201,400
Depreciation expense . . . . . . . . . . . . . . . . . . . . . . 100,000 (H) 40.00 4,000,000
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 655,000 (A) 40.20 26,331,000
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . 82,000 (A) 40.20 3,296,400
Net income before remeasurement loss . . . . . . . 13,575,200
Remeasurementloss - debit . . . . . . . . . . . . . . . . 0 201,850
Net Income to Retained Earnings . . . . . . . . . . . 333,000 13,373,350
Retained earnings, 1/1 . . . . . . . . . . . . . . . . . . . . . . 480,000 (1) 19,200,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 813,000 32,573,350
Less: Dividends declared, 9/1/20x4 . . . . . . . . . . . 300,000 (H) 40.10 12,030,000
Retained earnings, 12/31 from balance sheet. . 513,000 20,543,350
*Include as a component of other comprehensive income
(1) Retained earnings in pesos on January 2 (date of acquisition)
(A) Average exchange rate used to approximate the rate on the date these elements were recognized
(H) Historical exchange rate; (C) Current exchange rate; B/A – balancing amount

Schedule: Translation of Cost of Goods Sold

Remeasurement
Exchange
Accounts ($) Rate Pesos
Beginning inventory (assumed) . . . . . . . . . . . . . . 760,000 (H) 40.00 30,400,000
Purchases (assumed) . . . . . . . . . . . . . . . . . . . . . . 1,920,000 (A) 40.20 77,184,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,680,000 107,584,000
Less: Ending inventory . . . . . . . . . . . . . . . . . . . . . . 830,000 (A) 40.22 33,382,600
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 74,201,400
An Analysis of the Translation/Remeasurement Gain or Loss
The translation/remeasurement loss in the temporal method of translation is derived from a direct calculation in Figure 8-6. Procedurally, the
approach is based on the same underlying concept as that used to verify the translation adjustment reported when the current rate method was
used.
The translation loss is related to those accounts translated at the current exchange rate. However, in applying the temporal method, in general,
monetary items only are translated at the current rate while most nonmonetary items are translated at historical rates.
Figure 8-6: Verification of the Translation Adjustment –Remeasurement or Temporal Method (Functional Currency – Philippine Peso) – Direct
Method

Translatio
n Reporting
Exchange Currency
US $ Rate (Pesos)
40.00 28,000,000
1/2 Exposed net monetary liability position . . . . . . . . . *700,000
Adjustments for changes in net monetary position
during year:
Less: Increase in cash and receivables from sales . . . (3,020,000 40.20 121,404,000
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 taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82,000 40.20 3,296,400
Dividends declared . . . . . . . . . . . . . . . . . . . . . . . . 300,000 40.10 12,030,000
Net monetary liability position translated using rate
in effect at date of each transaction . . . . . . . . . . . 25,437,400
Less: 12/31 Exposed net monetary liability position . . **637,000 40.25 25,639,250
Remeasurement gain (loss) . . . . . . . . . . . . . . . . . . . . . . ( 201,850)
*The January 2, 20x4 condensed balance sheet is given in Figure 8-3:

US $
Monetary liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000
Less: Monetary assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100,000
Net monetary liability position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . __700,000

**See Figure 8-5:

US $
Monetary liabilities (640,000 + 635,000 + 900,000) . . . . . . . . . . . . . . . . . . . . . 2,175,000
Less: Monetary assets (930,000 + 608,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,538,000
Net monetary liability position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _637,000
Trial Balance Approach in Translation of Financial Statements

An alternative approach to translation (which is simpler) is to reformat the financial statements into a trial balance and translate the debit
and credit columns. The difference between the aggregate debit amount and the aggregate credit amount is the translation difference. A
translation loss appears on the debit side and a translation gain appears on the credit side.

Refer to Illustration 8-2: Translation Using a Trial Balance Approach

Figure 8-7: Workpaper – Translation into the Presentation Currency (Current/Closing Rate Method)/Functional Currency - Is Local
Currency Unit – US Dollars
Adjusted Trial
Adjusted Trial Balance Balance
Accounts ($) Exchange (Pesos)
Debit Credit Rate Debit Credit
Sales . . . . . . . . . . . . . . . . . . . . . . . . 3,020,000 (A) 40.20 121,404,000
Cost of goods sold . . . . . . . . . . . . 1,850,000 (A) 40.20 74,370,000
Depreciation expense . . . . . . . . 100,000 (A) 40,20 4,020,000
Other expenses . . . . . . . . . . . . . . 655,000 (A) 40.20 26,331,000
Income tax expense . . . . . . . . . . 82,000 (A) 40.20 3,296,400
Retained earnings, 1/1 . . . . . . . . 480,000 (1) 19,200,000
Dividends declared, 9/1 . . . . . . . 300,000 (H) 40.10 12,030,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . 930,000 (C) 40.25 37,432,500
Accounts receivable (net) . . . . 608,000 (C) 40.25 24,472,000
Inventory (FIFO), 12/31 . . . . . . . . 830,000 (C) 40.25 33,407,500
Land . . . . . . . . . . . . . . . . . . . . . . . . 500,000 (C) 40.25 20,125,000
Buildings (net) . . . . . . . . . . . . . . . . 650,000 (C) 40.25 26,162,500
Equipment (net) . . . . . . . . . . . . . . 430,000 (C) 40.25 17,307,500
Accounts payable . . . . . . . . . . . . 640,000 (C) 40.25 25,760,000
Short-term notes payable . . . . . . 635,000 (C) 40.25 25,558,750
Bonds payable . . . . . . . . . . . . . . . 900,000 (C) 40.25 36,225,000
Common stock, P10 par . . . . . . . 960,000 (H) 40.00 38,400,000
Paid-in capital in excess of par. _________ __300,000 (H) 40.00 ___________ _12,000,000
Sub-totals . . . . . . . . . . . . . . . . . . 6,935,000 6,935,000 278,954,400 278,547,750
Foreign Currency Translation
Reserve Gain OCI) – credit . . . _________ _________ ___________ 406,650
Totals . . . . . . . . . . . . . . . . . . . . . 6,935,000 6,935,000 278,954,400 278,954,400

*Include as a component of other comprehensive income

(1) Retained earnings in pesos on January 2 (date of acquisition)
(A) Average exchange rate used to approximate the rate on the date these elements were recognized.
(H) Historical exchange rate
(C) Current exchange rate
Note: In the pre-closing trial balance approach, the following should be observed:
1. The retained earnings should be of beginning balance
2. In the event that there are details as to the component of cost of goods sold purchases should be translated using average and inventory should be of a beginning balance translated at the
appropriate rate existing at the date of inventory acquired
Figure 8-8: Workpaper – Translation into the Functional Currency (Remeasurement or Temporal Method)/ Functional
Currency Is Philippine Peso –
Adjusted Trial
Adjusted Trial Balance Balance
Accounts ($) Exchange (Pesos)
Debit Credit Rate Debit Credit
Sales . . . . . . . . . . . . . . . . . . . . . . . . 3,020,000 (A) 40.20 121,404,000
Purchases . . . . . . . . . . . . . . . . . . . 1,920,000 (A) 40.20 77,184,000
Depreciation expense . . . . . . . . 100,000 (A) 40.00 4,000,000
Other expenses . . . . . . . . . . . . . . 655,000 (A) 40.20 26,331,000
Income tax expense . . . . . . . . . . 82,000 (A) 40.20 3,296,400
Retained earnings, 1/1 . . . . . . . . 480,000 (1) 19,200,000
Dividends declared, 9/1 . . . . . . . 300,000 (H) 40.10 12,030,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . 930,000 (C) 40.25 37,432,500
Accounts receivable (net) . . . . 608,000 (C) 40.25 24,472,000
Inventory (FIFO), 1/1 (assumed) 760,000 (H) 40.00 30,400,000
Land . . . . . . . . . . . . . . . . . . . . . . . . 500,000 (C) 40.00 20,000,000
Buildings (net) . . . . . . . . . . . . . . . . 650,000 (C) 40.00 26,000,000
Equipment (net) . . . . . . . . . . . . . . 430,000 (C) 40.00 17,200,000
Accounts payable . . . . . . . . . . . . 640,000 (C) 40.25 25,760,000
Short-term notes payable . . . . . . 635,000 (C) 40.25 25,558,750
Bonds payable . . . . . . . . . . . . . . . 900,000 (C) 40.25 36,225,000
Common stock, P10 par . . . . . . . 960,000 (H) 40.00 38,400,000
Paid-in capital in excess of par . _________ __300,000 (H) 40.00 ___________ 12,000,000
Sub-totals . . . . . . . . . . . . . . . . . 6,935,000 6,935,000 278,345,900 278,547,750
Remeasurement loss - debit . . . _________ _________ 201,850 ___________
Totals . . . . . . . . . . . . . . . . . . . . . 6,935,000 6,935,000 278,954,400 278,954,400

*Include as a component of other comprehensive income

(1) Retained earnings in pesos on January 2 (date of acquisition)
(A) Average exchange rate used to approximate the rate on the date these elements were recognized.
(H) Historical exchange rate
(C) Current exchange rate
Note: In the pre-closing trial balance approach, the following should be observed:
1. The retained earnings should be of beginning balance.
2. In the event that there are details as to the component of cost of goods sold purchases should be translated using average and inventory should be of a beginning balance translated at the
appropriate rate existing at the date the inventory was acquired, refer to schedule below

Schedule: Translation of Cost of Goods Sold

Remeasurement
Exchange
Accounts ($) Rate Pesos
Beginning inventory (assumed) . . . . . . . . . . . . . . . 760,000 (H) 40.00 30,400,000
Purchases (assumed) . . . . . . . . . . . . . . . . . . . . . . . 1,920,000 (A) 40.20 77,184,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,680,000 107,584,000
Less: Ending inventory . . . . . . . . . . . . . . . . . . . . . . . 830,000 (A) 40.22 33,382,600
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 74,201,400
Alternatively, the cost of goods sold will be lump into one amount, and the inventory ending balance will be the amount
presented in the trial balance the way it was presented under the current/closing rate method (see Figure 8-7)
Adjusted Trial Balance Adjusted Trial Balance
($) Exchange (Pesos)
Accounts Debit Credit Rate Debit Credit
Sales . . . . . . . . . . . . . . . . . . . . . . . . 3,020,000 (A) 40.20 121,404,000
Cost of goods sold . . . . . . . . . . . . 1,850,000 Schedule 74,201,400
Depreciation expense . . . . . . . . 100,000 (A) 40.00 4,000,000
Other expenses . . . . . . . . . . . . . . 655,000 (A) 40.20 26,331,000
Income tax expense . . . . . . . . . . 82,000 (A) 40.20 3,296,400
Retained earnings, 1/1 . . . . . . . . 480,000 (1) 19,200,000
Dividends declared, 9/1 . . . . . . . 300,000 (H) 40.10 12,030,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . 930,000 (C) 40.25 37,432,500
Accounts receivable (net) . . . . . 608,000 (C) 40.25 24,472,000
Inventory (FIFO), 12/1 . . . . . . . . 830,000 (H) 40.00 33,382,600
Land . . . . . . . . . . . . . . . . . . . . . . . . 500,000 (C) 40.00 20,000,000
Buildings (net) . . . . . . . . . . . . . . . . 650,000 (C) 40.00 26,000,000
Equipment (net) . . . . . . . . . . . . . . 430,000 (C) 40.00 17,200,000
Accounts payable . . . . . . . . . . . . 640,000 (C) 40.25 25,760,000
Short-term notes payable . . . . . . 635,000 (C) 40.25 25,558,750
Bonds payable . . . . . . . . . . . . . . . 900,000 (C) 40.25 36,225,000
Common stock, P10 par . . . . . . . 960,000 (H) 40.00 38,400,000
Paid-in capital in excess of par. _________ __300,000 (H) 40.00 ___________ 12,000,000
Sub-totals . . . . . . . . . . . . . . . . . . 6,935,000 6,935,000 278,345,900 278,547,750
Remeasurement loss - debit . . _________ _________ 201,850 ___________
Totals . . . . . . . . . . . . . . . . . . . . . 6,935,000 6,935,000 278,547,750 278,547,750

Schedule: Translation of Cost of Goods Sold

Remeasurement
Accounts ($) Exchange Rate Pesos
Beginning inventory (assumed) . . . . . . . . . . . . . . . 760,000 (H) 40.00 30,400,000
Purchases (assumed) . . . . . . . . . . . . . . . . . . . . . . . 1,920,000 (A) 40.20 77,184,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,680,000 107,584,000
Less: Ending inventory . . . . . . . . . . . . . . . . . . . . . . . 830,000 (A) 40.22 33,382,600
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000 74,201,400
 Comparison of the Two Methods
Table 8-3: Balance Sheet Accounts
Remeasurement
Balance Sheet Current/Closing Rate Method (or Temporal) Method
Current/closing rate Current/closing rate
Monetary assets and
liabilities (e.g.
receivables, payables,
cash and fixed deposits)
Non-monetary items at Current/closing rate Historical rate
historical cost (e.g. fixed For subsidiaries that have been
assets, investments at acquired by the parent, the exchange
cost, prepaid items, rate on the date of acquisition serves
inventories and as the historical rate for items that were
intangible assets). acquired before the date of
acquisition of the subsidiary by the
parent.
Non-monetary items at Current/closing rate Rate at the date of the revaluation or
fair value(e.g. equity fair value determination.
investment and revalued
fixed assets)
Capital stocks and pre- Historical (or actual) rate Historical (or actual) rate
acquisition retained
earnings
Post-acquisition retained Not translated using a single
Not translated using a single exchange
earnings exchange rate. This is a cumulative
rate. This is a cumulative figure that is
figure that i s carried f o r w a r d f r o m
carried forward from year to year
year to year.
Translation gains or Direct to OCI- Taken to income statement as gains
losses Other Comprehensive Income (e.g. or losses; remeasurement gain or loss
Foreign Currency Translation Reserve arising from the revaluation of a non-
or the Foreign Currency Translation monetary item is taken to OCI if the
Gain/Loss. revaluation gains or losses are taken
to OCI.
 Table 8-4: Income Statement Accounts
Remeasurement
Income Statement Current/Closing Rate Method (or Temporal) Method
Historical rate or Actual rate;
Sales, purchases, however, for practical Historical or Actual rate;
expenses and purpose, an average rate however, for p r a c t i c a l
income items that may be used on the purpose, an average rate
result to outflow or assumption that the items are maybe used
inflow of monetary evenly spread out over the
items. period.
Historical rate or Actual rate
Cost of sales at the date when inventory Historical or Actual rate at the
is sold or average rate if the date when inventory is sold or
cost of sales is evenly average rate if the cost of
spread out. sales is evenly spread out.
Depreciation, Historical rate of original
amortization and Historical or Actual rate at acquisition (either at the
any other allocation the date when the expense date of purchase for
of non-monetary is incurred or average rate if historical cost i t e m s or the
items the expense is incurred date of valuation for items
evenly throughout the year. carried at fair value).
Dividends and other
appropriation of Historical or Actual rate Rate at the date of the
profits revaluation or fair value
determination

The following are list of monetary and non-monetary items that will be translated to the reporting entity on
an account classification basis.
Table 8-5: Translation to Currency of Reporting Entity Per Account Classification (with distinction as to
monetary items and non-monetary items)
Current Rate
Method Temporal Method
Exchange Rate Exchange Rate
Assets
Cash, demand deposits, and time deposits (M) Current Current
Marketable securities carried at cost (N)
Equity securities Current Historical
Debt securities Current Historical
Marketable securities carried at fair value (N) Current Current
Accounts and notes receivable and related unearned
discounts (M) Current Current
Allowance for uncollectible accounts and notes (M) Current Current
Inventories (N) Current
Carried at cost Current Historical
Carried at lower of cost or market Current *
Prepaid insurance, advertising, and rent (N) Current Historical
Prepaid interest (M) Current Current
Refundable deposits (M) Current Current
Property, plant, and equipment (N) Current Historical
Accumulated depreciation on property, plant, and Current Historical
Equipment (N)
Cash surrender value of life insurance (M) Current Current
Patents, trademarks, licenses, and formulas (N) Current Historical
Goodwill (N) Current Historical
Other intangible assets (N) Current Historical
Deferred charges and credits, except deferred income
taxes and policy acquisition costs for life insurance
companies(N) Current Historical
Deferred income tax assets (N)a Current Current

(M) – monetary; (N) – non-monetary

a PFRIC 7 – Applying the Restatement Approach under PAS 29 – Deferred tax items are considered non-monetary items that need to be remeasured.
* When the books are not maintained in the functional currency and the lower-of-cost-or-market rule is applied to inventories, inventories at cost are
remeasured using historical rates. Then the historical cost in the functional currency is compared to market in the functional currency
 Current Rate Temporal
Method Method
Liabilities Exchange Rate Exchange Rate
Accounts and notes payable and overdrafts (M) Current Current
Accrued expenses (M) Current Current
Liability of refundable deposits (M) Current Current
Non-refundable deposits (N) Current Historical
Deferred income tax liabilities(N)a Current Current
Deferred/unearned revenue (N) Current Historical
Other deferred credits (N) Current Historical
Bonds payable and other long-term debt (M) Current Current
Stockholders’ Equity
Common stock (N) Historical** Historical
Preferred stock carried at issuance price (N) Historical** Historical
Other paid-in capital (N) Historical** Historical
Retained earnings (it is a residual amount and should not be
classified as monetary or non-monetary item) Not translated Not remeasured
Income Statement Items Related to Monetary Items
Sales, purchases expenses and income items that
result to outflow or inflow of monetary Items Average**** Average***

(M) – monetary; (N) – non-monetary

** Translation at historical rates is necessary for elimination of reciprocal parent investment and subsidiary equity accounts. It should be noted that
conversion of all asset, liability, and equity accounts at current exchange rates would obviate the “equity adjustment from translation” component.
*** Income statement items related to monetary items are translated ore remeasured at weighted average exchange rates to approximate the exchange
rates in existence at the time of the related transactions. Intercompany dividends are converted at the rate in effect at the time of payment under both
there measurement and translation approaches.
**** For practical reasons, the average rate is usually used for ·items whose transactions are numerous and occur evenly throughout the year, for
example, sales, purchases and operating expenses.
 Income Statement Items Related to Nonmonetary Items
Cost of goods sold Average**** Historical
Depreciation on property, plant, and equipment Average**** Historical
Amortization of intangible items (patents, etc.) Average**** Historical
Amortization of deferred income taxes Average**** Current
Amortization of deferred charges and credits Average**** Historical
Amortization of policy acquisition costs for life
Average**** Historical
insurance Ccompanies

(M) – monetary; (N) – non-monetary

**** For practical reasons, the average rate is usually used for ·items whose transactions are numerous and occur evenly throughout the year,
for example, sales, purchases and operating expenses
Date of Acquisition

When an over the acquirer's interest in the fair value of identifiable net assets of the acquired
company acquires a controlling equity interest in another company, the excess of the purchase
price company is recognized as goodwill on consolidation. In the context of the acquisition of a foreign
company, the issue arises as to whether goodwill is an asset of the acquired company or an asset in the
acquirer’s books. If it is an asset of the acquired subsidiary, the goodwill is a foreign asset which should be
translated in the same manner as any other asset of the acquired subsidiary, which may give rise to a
translation difference. However, if it is treated as an asset in the acquirer's books, there is no need for
translation.

PAS 21 paragraph 47 states: “Any goodwill arising on the acquisition of a foreign operation and any
fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that
foreign operation shall be treated as assets and liabilities of the foreign operation.” Thus, they shall be
expressed in the functional currency of the foreign operation (meaning their functional currency is the
LCU) , and shall be translated at the “current/closing rate.”
Illustration 8-3: Translation of Goodwill and Fair Value Differential under PAS 21.
Espenilla Corporation, whose functional currency is the Philippine peso, acquired the entire common stock of Elirie Company, a Japanese company, on
December 31, 20x4 at a cost of P2,000,000. At the date of acquisition, Elirie Company's paid-up capital and retained earnings were 3,000,000 yen and 500,000 yen,
respectively. The assets and liabilities of Elirie Company at the date of acquisition by Espenilla Corporation approximated their fair values except for a building that
was undervalued by 100,000 yen. Deferred tax liability on the undervalued building was 20,000 yen. The exchange rate on December31, 20x4 was P.50 = 1 yen. The
resulting ownership situation can be viewed in the schedule of determination and allocation of excess. Goodwill in pesos on the date of acquisition is computed as
follows:
Date of Acquisition – December 31, 20x4

Fair value of Subsidiary (100%)

Consideration transferred:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P2,000,000
Less: Book value of stockholders’ equity of Elirie:
Common stock (3,000,000 yen x P.50 x 100%) . . . . P1,500,000
Retained earnings (500,000 yen x P.50 x 100%) . . . 250,000 1,750,000
Allocated excess (excess of cost over book value) . . . P 250,000
Less: Over/under valuation of assets and liabilities:
Increase in building (100,000 yen x P.50 x 100%). . P 50,000
Increase in deferred tax liability on building
(20,000 yen x P.50 x 100%) . . . . . . . . . . . . . . . . . __(10,000) ___40,000
Positive excess: Goodwill (excess of cost over
fair value) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 210,000
Goodwill in yen (P210,000 x 1 yen / P.50) . . . . . . . . . . . . Yen 420,000

It should be noted that on the date of acquisition (i.e., December 31, 20x4) “goodwill arising on the acquisition of a foreign operation and any fair
value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation shall be treated as assets and
liabilities of the foreign operation.” Thus, they shall be expressed in the “functional currency of the foreign operation (meaning their functional currency is the
LCU) , and shall be translated at the current/closing rate.”

The following consolidation journal entries are recorded in the workpaper in pesos:
Consolidation Workpaper – First Year after Acquisition
The schedule of determination and allocation of excess presented above provides complete guidance for the worksheet eliminating entries on December 31, 20x4:
(E1) Common stock – ElirieCo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500,000
Retained earnings – ElirieCo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250.000
Investment in Son Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,750,000
To eliminate intercompany investment and equity accounts
of subsidiary on date of acquisition. ; and to establish non-controlling
interest (in net assets of subsidiary) on date of acquisition.
(E2) Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210,000
Deferred tax liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000
Investment in Elirie Co . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000
To allocate excess of cost over book value of identifiable assets
acquired, with remainder to goodwill
Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the
carrying amount of assets and liabilities arising on the acquisition of that foreign operation shall be treated
as assets and liabilities of the foreign operations. They shall be expressed in the functional currency of the
foreign operation and shall be translated at the current/closing rate.

Assume that the building is depreciated on a straight line basis over a period of 25 years. The exchange rate
on December 31, 20x5 was 1 yen = P0.45; and the average rate for 20x5 was 1 yen = P0.48.

The accounting treatments under translation (current/closing rate method) and remeasurement method are
as follows:

Current/Closing Rate Method

Under the current/closing rate method (the functional currency of Elirie Company is the yen), the retranslation
adjustments on the goodwill and the fair value differential relating to the building and deferred tax liability as
they are considered net assets of Elirie Company and are translated at the closing rate.
The translation adjustments are as follows:
On Goodwill:
Goodwill on December 31, 20x4 (420,000 yen x P.50/ yen) . . . P 210,000
Goodwill on December 31, 20x5 (420,000 yen x P.45/ yen) . . . 189,000
Translation adjustment loss on goodwill (OCI) . . . . . . . . . . . . . . . . (P 21,000)
On the fair value differential (after tax):
Undervalued building on December 31, 20x4 [100,000 yen x
P.50/ yen x 80% (net of tax)] . . . . . . . . . . . . . . . . . . . . . . . . . . P 40,000
Less: Depreciation expense [4,000* x P0.48 x 80% (net of tax).. ( 1,536)
Undervalued building, net on 12/31/20x4 . . . . . . . . . . . . . . . . . P 38,464
Undervalued building, net on 12/31/20x5 [96,000 yen
x P0.45/yen x 80% (net of tax)] . . . . . . . . . . . . . . . . . . . . . . . . 34,560
Translation adjustment loss on undervalued building (OCI) . . . . . (P 3,904)
Accordingly, goodwill has to be measured in the functional currency of the foreign operation.

If the functional currency of the foreign operation is the local currency , the goodwill on acquisition is to
be translated at the current/closing rate.

In the consolidated financial statements, any goodwill arising on the acquisition of a foreign operation
should be treated as an asset of the foreign operation .

The goodwill should therefore be expressed in the functional currency of the foreign operation and
translated at the current/closing rate at the date of each statement of financial position .

The same treatment is required of any fair value adjustments to the carrying amounts of assets and
liabilities arising on the acquisition of a foreign operation.

In both cases exchange differences are recognized in other comprehensive income, rather than as part of
the profit or loss for the period.

If the subsidiary is partially-owned, non-controlling interests will be allocated a share of the translation
adjustment (of goodwill and undervalued building) and the foreign currency translation reserves (FCTR)
from the translation workpaper
Remeasurement or Temporal Method

On the other hand, if the functional currency of the foreign operation is the parent’s currency (or the presentation
currency – functional currency of Elirie Company is the peso), goodwill and fair value differentials on acquisition is
treated as a non-monetary asset and remeasured at the exchange rate of the date of acquisition (historical or actual
rate) of the foreign operation. Since both are translated at historical rates, the translation adjustment is zero.

Foreign Operations in a Hyperinflationary Environment

The hallmark of a hyperinflationary economy is rampant and continuing inflation over a number of years resulting in a
massive loss of purchasing power.

PAS 29 Financial Reporting in Hyperinflationary Economies lists a number of indicators of a hyperinflationary economy.

These indicators include:

• An inflation rate of 100% or more over a period of three years;
• Interest rates, wages and prices that are linked to a price index ;
• Prices that are quoted in a stable currency ;
• Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during
the credit period, even if the period is short; and
• A general population that prefers to keep its wealth in non-monetary assets or in a relatively stable
foreign currency.
PAS 29 considers that in a hyperinflationary economy, financial statements which are not restated (adjusted
for inflation) are not useful as the loss of purchasing power at a rapid rate results in a misleading comparison
of "amounts from transactions and other events that have occurred at different times, even within the same
accounting period.”

Where the functional currency of a foreign operation is the currency of a hyperinflationary economy, PAS 21
requires a restate-then-translate approach in translating the financial statements of the foreign operation.

It should be noted that PAS 29 paragraph 8 states "the financial statements of an entity whose functional
currency is the currency of a hyperinflationary economy, whether they are based on a historical cost
approach or a current cost approach, shall be stated in terms of the measuring unit current at the
balance sheet date. ”
Restatement of Financial Statements

The basic principle in PAS 29 is that the financial statements of an entity that reports in the currency of a hyperinflationary economy
should be stated in terms of the measuring unit current at the balance sheet date. Comparative figures for prior period(s) should be
restated into the same current measuring unit.

Historical Cost Financial Statements

Restatements are made by applying a general price index.

1. Monetary items are not restated that are already stated at the measuring unit at the balance sheet date are not restated
2. Assets and liabilities linked by agreement to changes in prices should be adjusted in accordance with the agreement.
3. All other assets and liabilities are non-monetary. Some non-monetary items are carried at amounts current at the balance sheet
date, such as net realizable value and market value, so they are not restated. All other non-monetary assets and liabilities are
restated
4. All items in the income statement are expressed in terms of the measuring unit current at the balance sheet date. Therefore, all
amounts need to be restated by applying the change in the general price index from the dates when the items of income and
expenses were initially recorded in the financial statements
5. Any gain or loss on the restatement of non-monetary items is included in the income statement. It is a requirement to disclose
separately this net gain or loss

The Standard does not establish an absolute rate at which hyperinflation is deemed to arise - but allows judgment as to when
restatement of financial statements becomes necessary

When an economy ceases to be hyperinflationary and an enterprise discontinues the preparation and presentation of financial
statements in accordance with PAS 29, it should treat the amounts expressed in the measuring unit current at the end of the
previous reporting period as the basis for the carrying amounts in its subsequent financial statements.
Functional Currency is the Currency of a Hyperinflationary Economy

For an entity whose is functional currency the currency of a hyperinflationary economy , and for which the
comparatives amounts are translated into the currency of a different hyperinflationary shall be translated
into a different presentation currency using the following procedures:
a. All amounts (i.e., assets, liabilities, equity items, income and expenses, including comparatives) shall be
translated at the current/closing rate at the date of the most recent balance sheet (i.e., last year’s
comparatives, as adjusted for subsequent changes in the price level, are translated at this year’s closing
rate), except that
b. When amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts
shall be those that were presented in the prior year financial statements (i.e., not adjusted for subsequent
changes in the price level or subsequent changes in exchange rates).
Illustrative 8-4: Functional Currency is the Currency of a Hyperinflationary Economy
Elirie Company operates in a hyperinflationary economy. Its balance sheet at December 31, 20x4, follows:
FC
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,700,000
Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,950,000
Current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 700,000
Non-current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200,000
Common stock (issued 20x0) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,350,000
Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,750,000
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,950,000

The general price index and exchange rates of peso to FC are as follows:
Price Index Exchange rate
20x0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 100
20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 130
20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 150
20x3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 240
20x4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 300

The property, plant and equipment were purchased on December 31, 20x2 and there is a six-month inventory held. The noncurrent
liabilities were a loan raised on March 31, 20x4
Figure 8-9: Workpaper – Translation of Financial Statements of Hyperinflationary Economy/Functional Currency Is the
Currency of a Hyperinflationary Economy
Price Restated Exchange Translated
FC Index (in FC) Rate (in Pesos)
Cash (M) . . . . . . . . . . . . . . . . . . . . . . 350,000 * 350,000 (C) 1.75 612,500
Inventory (N) . . . . . . . . . . . . . . . . . . . 2,700,000 300/270 3,000,000 (C) 1.75 5,250,000
Property, plant and equipment (N) 900,000 300/150 1,800,000 (C) 1.75 3,150,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . 3,950,000 5,150,000 9,012,500

Current liabilities (M) . . . . . . . . . . . . 700,000 * 700,000 (C) 1.75 1,225,000

Non-current liabilities (M) . . . . . . . . 500,000 * 500,000 (C) 1.75 875,000
Common stock (issued 20x0) (N) . . 400,000 300/100 1,200,000 (C) 1.75 2,100,000
Retained earnings . . . . . . . . . . . . . . 2,350,000 2,750,000 (C) (B/A) 4,812,500
Total . . . . . . . . . . . . . . . . . . . . . . . . . . 3,950,000 5,150,000 9,012,500

M – monetary; N – non-monetary; C – current rate; B/A – balancing amount; * refer to (1) below
Hedge of Net Investment in a Foreign Operation

A hedge of net investment in a foreign operation shall be accounted for similar to a cash flow hedge.
When translating the assets and liabilities of the foreign operation under the current/closing rate method.
The exchange gain or loss arising shall be recognized in other comprehensive income.

Hedge of a net investment in a foreign operation (as defined in PAS 21), including a hedge of a
monetary item that is accounted for as part of the net investment , is accounted for similarly to cash flow
hedges: the portion of the gain or loss on the hedging instrument that is determined to be an effective
hedge is recognized in OCI ; and the ineffective portion is recognized in profit or loss.

For both cash flow hedges and net investment hedges , the ineffectiveness recorded is limited to over-
hedges. PFRS 7 contains certain disclosure requirements related to hedge ineffectiveness.

Accounting standards permits a non-derivative to be used as a hedging instrument for a hedge of a net
investment in a foreign operation . For example, a US dollar loan taken to hedge a net investment in a US$
foreign operation would qualify for the special hedge accounting in the Standard, although the loan is a non-
derivative instrument.

The cumulative gain or loss on the hedging instrument relating to the effective portion of the hedge is
reclassified to profit or loss on the disposal or partial disposal of the foreign operation.
Illustration 8-5: Hedge of Net Investment in a Foreign Operation

On January 1, 20x4, Kim Phils., incorporated a wholly owned foreign subsidiary, Drei Ltd., in U.S. for $1,000,000. On this
date, the exchange rate was P40 per unit of U.S. $. In Kim Phils’s accounts, the investment in the subsidiary was recorded
at P40,000,000.

To hedge the investment, Kim Phils., took an offshore foreign currency loan of $800,000 on the same day the investment
was made. Kim Phils., designated the hedge as a cash flow hedge of $800,000 of the net investment in Drei Ltd.

Assume that for the year ended December 31, 20x4, Drei Ltd. made exactly no profit and its net assets on that year end
date was $1,000,000.

However, the exchange rate on December 31, 20x4 increased to P40.50 per unit of U.S. $.
The exchange differences shall be dealt with the Kim Phils., separate accounts and in its consolidated or group accounts.

At inception of the investment and the loan:

Parent Company Entry (in the separate financial statements of Kim Phils):
January 1, 20x4:
Investment in Subsidiary ($1,000,000 x P40) . . . . . . . . . . . . . . . . . . . . . 40,000,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000,000
To record the investment in a foreign subsidiary.

Cash ($800,000 x P40) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000,000

Loan payable – foreign currency . . . . . . . . . . . . . . . . . . . . . . . . . . 32,000,000
To record foreign currency loan and designate as it as hedging
instrument.
In Kim Phils., separate accounts, the foreign currency loan is a monetary item, which should be translated at
year end using the spot rate on that date (i.e., the current/closing rate). This will result to an exchange loss of
P400,000 [i.e. $800,000 x (P40.50 – P40.00)].

The journal entries in Kim Phils.’s accounts are as follows:

December 31, 20x4:

Foreign currency transaction loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000
Loan payable – foreign currency [$800,000 x (P40.50 – P40.00)]. . 400,000
To record the foreign currency loss in a foreign subsidiary.

At the consolidated or group level, translating the opening net assets of $1,000,000 million will result to a
P500,000 exchange gain, which, under the current/closing rate method, shall be recognized in other
comprehensive income and retained in a foreign currency translation reserve.

Thus, at the consolidated/group level, the exchange loss on the loan recognized in the separate accounts of
Kim Phils., should be offset with the exchange gain on the net investment in other comprehensive income
and retained in the foreign currency translation reserve account.
Consolidation Workpaper (in the consolidated financial statements of Kim Phils.):
Stockholders’ equity of Drei Ltd ($1,000,000 x P40.50) . . . . . . . . . . . . 40,500,000
Investment in Drei Ltd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000,000
Foreign currency translation reserve – OCI . . . . . . . . . . . . . . . . . . . 500,000
To translate net assets and recognize exchange difference.

Foreign currency translation reserve – OCI . . . . . . . . . . . . . . . . . . . . . 400,000

Foreign currency transaction loss . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000
To reverse parent’s foreign currency transaction loss and
recognized loss as an offset in a cash flow hedge.

The movement in the consolidated/group’s other comprehensive income from the translation would be as
follows:
Balance on January 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P -0-
Gain on translation one net investment in OCI . . . . . . . . . . . . . . . . . . . . 500,000
Loss on translation of foreign currency loan in OCI . . . . . . . . . . . . . . . . . . . . . _(400,000
Balance on December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 100,000
Disposal of a Foreign Operation

PAS 21 prescribes that "on disposal of a foreign operation, the cumulative amount of the exchange differences
relating to that foreign operation, recognized in other comprehensive income, shall be reclassified from other
comprehensive income to profit or loss (as a reclassification adjustment) when a gain or loss on disposal Is
recognized.”

In other words, the foreign currency translation reserves shall be recycled to profit or loss upon disposal of the
foreign operation.

The reclassification of reserves to profit or loss on derecognition of a subsidiary applies only to foreign currency
translation reserve, fair value other comprehensive income and cash flow hedge other comprehensive income. For
revaluation surplus of a related property, plant and equipment, the realization should be by a direct transfer to retained
earnings in the statement of changes in equity.

In the case of a partial disposal, the investment retained shall be measured at fair value at the date control is lost .
This requirement effectively gives the investment a fresh-start measurement at the disposal date. All previously
consolidated post-acquisition reserves shall be reclassified to profit or loss or transferred to retained earnings.

The amount reclassified to profit or loss, together with the gain or loss arising on remeasurement, is included in the
calculation of the gain or loss on derecognition (refer to Chapter 3 for example on derecognition/dilution of
subsidiary).