Page 448 - Introduction to Business

422 PART 4 Accounting

Foreign Currency Translation

LEARNING OBJECTIVE 4
Explain the steps in foreign currency translation, a necessary element in financial
reporting of multinational business firms.

Many U.S. companies have multinational operations, with foreign subsidiaries
around the globe. For example, McDonald’s Corporation has over 30,000 restau-
rants; over half of these are outside the United States.
When a U.S. corporation owns more than 50 percent of the voting stock of a for-
eign company, a parent-subsidiary relationship exists, and the parent company is
usually required to prepare consolidated financial statements. Before this can be
done, the financial statements of the foreign subsidiary must be recast using U.S.
generally accepted accounting principles. Next, the foreign accounts must be
remeasured (translated) from the foreign currency into U.S. dollars. To make the
translation, the first step is to identify three currencies.

• Currency of books and records (CBR). The CBR is the currency in which the
foreign financial statements are denominated.
• Functional currency (FC). The FC is the currency in which the subsidiary gen-
erally buys, sells, borrows, and repays.
• Reporting currency (RC). The RC is the currency in which the consolidated
financial statements are denominated.
There are basically three approaches to currency trans-
A man makes a cash withdrawal from an unusual ATM lation: the temporal rate method, the current rate method,
machine at the Dusit Zoo in Bangkok, Thailand.
and the use of both methods. The following three rules are
used to determine the method of translation:
Rule 1. If the FC is hyperinflationary (i.e., 100 percent
cumulative inflation within three years), then ignore the
FC and remeasure the CBR into the RC using the temporal
rate method.
Rule 2. If the CBR is different from the FC, then remea-
sure the CBR into the FC using the temporal rate method.
Rule 3. Translate from the FC into the RC using the cur-
rent rate method.
The rules must be sequentially applied, stopping when
the subsidiary’s financial statements have been converted
into the parent’s reporting currency (RC). For example,
when the functional currency (FC) is hyperinflationary,
then Rule 1 applies; that is, the financial statements that are
denominated in the CBR are translated into the RC using
the temporal rate method, and Rules 2 and 3 aren’t used. A
second example is the case in which the CBR is British
pounds, the FC is Dutch guilders (not hyperinflationary),
and the RC is U.S. dollars; then Rule 1 is skipped and Rule 2
is applied. This translates the CBR (pounds) into the FC
(guilders) using the temporal rate method. Since the FC
(guilders) is not the RC (dollars), Rule 3 is then applied to
translate the FC (guilders) into the RC (dollars) using the
current rate method. A third example is when the CBR is the
same as the FC; Rule 3 is applied directly.

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