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ACCTG FA4 – Translation and Consolidation of foreign subsidiaries page 1

FINANCIAL ACCOUNTING 4

Module 8

Foreign Subsidiaries

Canadian companies are required by GAAP to produce consolidated financial statements. Thus,

if the company has operations in England then the company must translate the British statements

into Canadian dollars before consolidation can occur. (you cannot add pounds and dollars

together, its like adding apples and oranges) So now the question is how do we translate a set of

financial statements, that include transactions from various points in the year, when the exchange

rates were different for each transaction?

When a company has foreign operations it is often necessary to translate the financial statements

of the foreign operation into the "home country" currencies for performance evaluation purposes

or for consolidation purposes. Consolidation is the procedure whereby two legally separate

entities combine their financial statements and report as one economic entity. Consolidation is

only required when one company (the parent) controls another company (subsidiary). The

definition of control is a matter of whether the parent company can decide the operating,

financing and investing activities of the subsidiary without the consent of other parties. Control

usually exists when the parent owns more than 50% of the voting common shares of the

subsidiary. Control is equated to ownership.

Accounting Exposure

Any item translated at the current exchange rate will produce translation gains or losses (the

difference between the opening balance (based on older rates) and ending balances (based on

current rates)). The net balance of all items translated at the current rate under a given method is

known as the accounting exposure to exchange rate fluxuations.

Economic Exposure

It is argued that when a foreign asset is held, exchange rate fluxuations will cause an economic

gain. An economic gain is simply an increase in value of an asset, the company holding the

foreign asset realizes an increase in real wealth. Since a company's investment in a foreign

operation is a net asset position (A-L=OE), then an increase in the exchange rate will result in a

gain to the parent (investing) company because the net assets of the foreign operation have

increased.

The preferred accounting translation method for foreign operations is the one that yields an

accounting exposure that best reflects the economic exposure.

There are two basic types of foreign operations,

1. foreign operations where the subsidiary is highly dependent upon the parent

(integrated) - a foreign operation which is financially or operationally interdependent

with the reporting enterprise (the parent) such that the exposure to exchange rate

fluxuations is similar to the exposure which would exist had the transactions been

undertaken by the reporting enterprise (the parent). The Foreign Currency

Transaction Approach best suits the economic exposure of this situation (formally

known as the temporal method).

2. foreign operations where the parent is not involved in daily management (self

sustaining operations) - a foreign operation that is financially and operationally


independent of the parent such that the exposure to exchange rate fluxuations is

limited to the parent's net investment (ie its share of the OE of the foreign operation).

Using the closing rate for the Balance sheet and the transaction rates for the income

statement best suits the economic exposure of this situation (formally known as the

current rate method).

FA4 - Module 8 Example

On January 1, 20X0, CP Co. (a Canadian company) purchased 80% of SF Co. (a US company)

at a cost of US$50,000.

The book values of SF Co.’s net assets were equal to fair market values on this date except for

the building, which had a FMV of US$65,000 with a remaining useful life of 10 years. Goodwill

was not impaired in 20X0.

The balance sheet of SF in US dollars on Jan. 1, 20X0 is as follows:

Cash + A/R 20,000

Inventory 5,000

Building (net) 55,000

80,000

Current liabilities 18,000

Bonds Payable 25,000

Common Shares 10,000

Retained Earnings 27,000

80,000

The following exchange rates were in effect during 20X0:

January 1, 2000 US$1 = $1.40

2000 Average US$1 = $1.38

December 15, 2000 US$1 = $1.41

December 31, 2000 US$1 = $1.39


The financial statement of CP and SF for December 31, 20X0 are as follows:

CP (C$) SF (US$)

Cash + A/R 64,000 32,000

Inventory (purchased Dec. 15, 2000) 45,000 22,000

Equipment (net) 80,000

Building (net) 100,000 49,500

Investment in SF 70,000 -

359,000 103,500

Current Liabilities 50,000 20,000

Bonds Payable 25,000

Mortgage Payable 65,000

Common Shares 60,000 10,000

Retained Earnings, Jan. 1 175,000 27,000

Net Income 19,000 23,500

Dividends (paid Dec. 31) 10,000 2,000

359,000 103,500

Sales 300,000 75,000

Dividend Income 2224

COGS 150,224 20,000

Amortization 18,000 5,500

Other Expenses 115,000 26,000

19,000 23,500

Assume that expenses have been incurred evenly throughout the year.

Required:

a) Prepare consolidated financial statements using the foreign currency transaction

approach.

b) Prepare consolidated financial statements assuming that SF is a foreign operation.


Solution:

A - foreign currency

transaction approach.

Step One: Calculation of Goodwill in $CND and Purchase Price Discrepancy Schedule

Purchase Price (50,000*1.40) 70,000

Implied Value (70,000/0.80) 87,500

BV of SF: (10,000+27,000)*1.40 51,800

AD 35,700

allocation:

Building (65,000-55,000)x1.40 14,000

GW 21,700

amortization of AD: Jan-X0

Amortization or Impairment Dec-X0

Building (10 years ) 14,000 1,400 12,600

Goodwill 21,700 21,700

Step Two: Calculation of Translation Gain/Loss

Net monetary position:

Jan 1 position (20,000-18,000-25,000)x1.40 -32,200

Changes during the year:

Sales (75,000*1.38) 103,500

Purchases (20,000-5,000+22,000) x 1.38 -51,060

Purchase = cogs – BI + EI Other Expenses (26,000 x 1.38) -35,880

Dividends (2,000 x 1.39) -2,780

calculated current monetary position -18,420

actual current monetary position (32,000-20,000-25,000)x1.39 -18,070

Translation gain 350

Step Three: Translated Financial Statements

Translated Income Statement

Sales 103,500

COGS: BI (5,000x1.40) 7,000

Purchases 51,060

EI (22,000x1.41) 31,020 27,040

Amortization (5,500x1.40) 7,700

Other expenses 35,880


NI 33,230


Translated Balance Sheet

Cash + A/R (32,000x1.39) 44,480

Inventory (22,000x1.41) 31,020

Building (49,500x1.40) 69,300

Total 144,800

Current Liab (20,000x1.39) 27,800

Bonds (25,000x1.39) 34,750

Common Shares (10,000x1.40) 14,000

R/E Jan 1 (27,000x1.40) 37,800

NI 33,230

Dividends (2,000x1.39) -2,780

144,800

Step Four: Consolidated Financial Statements Consolidated Income Statement

Sales (300,000+103,500) 403,500

COGS (150,224 + 27,040) 177,264

Amortization (18,000+7,700+1,400) 27,100

Goodwill impairment 0

Other (115,000+35,880) 150,880


NI 48,606

Allocated: NCI (20%x33,230 - (0.20 x 1,400)) 6,366

Parent 42,240

Consolidated Balance Sheet

Cash + A/R (64,000+44,480) 108,480

Inventory (45,000+31,020) 76,020

Equipment 80,000

Building (100,000+69,300+12,600) 181,900

GW 21,700

Total 468,100

Current liab (50,000+27,800) 77,800

Bonds 34,750

Mortgage 65,000

NCI* 23,310

CS 60,000

R/E Jan 1 175,000

NI 42,240

Dividends -10,000

468,100


*NCI

20% of FV: (87,500 x 0.20) 17,500

Net Income 6,366

Dividends (2,000*0.2*1.39) 556

23,310

B - Foreign Operation

Step One: Calculation of Goodwill in $US

Purchase Price 50,000

Implied value (50,000/0.8) 62,500

BV of SF: (10,000+27,000) 37,000

AD 25,500

allocation:

Building (65,000-55,000) 10,000

GW 15,500

Step Two: Calculation of Translation Gains/Losses

Net assets - Jan 1 ((10,000+27,000)x1.40) 51,800

Changes:

Net Income (23,500x1.38) 32,430

Dividends (2,000x1.39) -2,780

Calculated net asset position 81,450

Net assets - Dec. 31 (10,000+27,000+23,500-2,000)x1.39) 81,315

Loss 135

Step Three: Translate Financial Statements

Translated Income Statement

$US Exchange Rate $CND

Sales 75,000 1.38 103,500

COGS 20,000 1.38 27,600

Amortization 5,500 1.38 7,590

Other 26,000 1.38 35,880

23,500 1.38 32,430


Translated Balance Sheet

Cash + A/R 32,000 1.39 44,480

Inventory 22,000 1.39 30,580

Building 49,500 1.39 68,805

103,500 143,865

Current liab 20,000 1.39 27,800

Bonds 25,000 1.39 34,750

Common shares 10,000 1.40 14,000

R/E Jan1 27,000 1.40 37,800

NI 23,500 1.38 32,430

Dividends -2,000 1.39 -2,780

Translation loss AOCI -135

103,500 143,865

Step Four: Acquisition Differential Amortization Schedule

AD schedule Impairment/

Jan-X0 x1.40 Amort x1.38 Dec-X0 x 1.39

Building 10,000 14,000 1,000 1,380 9,000 12,510

GW 15,500 21,700 0 15,500 21,545

35,700 1,380 34,055

translation gain/loss on AD

Jan 1 35,700

Amort 1,380

Calc. Balance 34,320

Dec 31 34,055

LOSS 265

Step Five: Calculation of consolidated cumulative translation adjustment

Total NCI 20% Consolidated

From SF loss 135 27 108

From AD 265 53 212

400 80 320

Step Six: Consolidated Financial Statements

Consolidated Income Statement

Sales (103,500+300,000) 403,500

COGS (27,600+150,224) 177,824

Amortization (7,590+18,000+1,380) 26,970

Goodwill Impairment 0

Other (35,880+115,000) 150,880

47,826

NCI (32,430-1,380)x0.20 6,210

41,616


Consolidated B/S

Cash + A/R (44,480+64,000) 108,480

Inventory (30,580+45,000) 75,580

Equipment (0+80,000) 80,000

Building (68,805+100,000+12,510) 181,315

Goodwill 21,545

466,920

Current liabilities (27,800+50,000) 77,800

Bonds 34,750

Mortgage 65,000

NCI* 23,074

Common shares 60,000

R/E** 206,616

Translation loss (classified with comprehensive income) -320

466,920

*NCI

FV at Jan 1 (62,500*1.40*0.20) 17,500

NI 6,210

Dividends (2,000*1.39*0.20) -556

Translation loss -80

23,074

**R/E

R/E Jan1 175,000

NI 41,616

Dividends -10,000

206,616


Problem 11-13

Calculation, allocation, and amortization of acquisition differential

Cost of 70% investment, Jan. 2, Year 1 FP1,400,000

Implied value of 100% investment FP2,000,000

Carrying amounts of White’s net assets:

Common shares 200,000

Retained earnings 900,000

Total shareholders' equity 1,100,000

Acquisition differential 900,000

Allocation: FV – CA

Building 100,000

100,000

Balance – goodwill 800,000

Balance Amortization/ Balance

Dec. 31 Impairment Dec. 31

Year 5 Year 6 Year 6

Building (10 years) 100,000 10,000 90,000

Goodwill 800,000 80,000 720,000

900,000 90,000 810,000

Goodwill – carrying amount 720,000 x 0.20 = 144,000

(a)

(i) Building – net Canadian $

Black’s building 3,000,000

White’s building (FP2,700,000 x 0.20) 540,000

Unamortized acquisition differential (FP90,000 x 0.20) 18,000

3,558,000

(ii) Goodwill

Carrying amount (FP720,000 x 0.20) 144,000


(iii) Depreciation expense – buildings

Black’s depreciation expense 200,000

White’s depreciation expense (FP300,000 x 0.20) 60,000

Amortization of acquisition differential (FP10,000 x 0.20) 2,000

262,000

(iv) Net income (excluding other comprehensive income)

Black’s income before foreign exchange 150,000

Less: dividend income (FP100,000 x 70% x 0.17) (11,900)

138,100

White’s income before foreign exchange (given) 30,000

Foreign exchange gains on White’s separate F/S 50,000

Amortization of acquisition differential (FP90,000 x 0.20) (18,000)

62,000

Net income 200,100

Attributable to:

Shareholders of Black (138,100 + 70% x 62,000) 181,500

Non-controlling interest (30% x 62,000) 18,600

(v) Other comprehensive income

Not applicable under temporal method 0

(vi) Non-controlling interest on income statement

White’s adjusted net income 62,000

NCI’s share 30% 18,600

(vii) Non-controlling interest on balance sheet

White’s common shares (FP200,000 x 0.20) 40,000

White’s retained earnings, beginning (FP900,000 x 0.20) 180,000

White’s net income (30,000 + 50,000) 80,000

White’s dividends (FP100,000 x 0.17) (17,000)

283,000

Unamortized acquisition differential

- building (FP90,000 x 0.20) 18,000

- goodwill 144,000

445,000

NCI’s share 30% 133,500


(b)

(i) Building – net Canadian $

Black’s building 3,000,000

White’s building (FP2,700,000 x 0.15) 405,000


3,418,500

(ii) Goodwill


(iii) Depreciation expense – buildings

Black’s depreciation expense 200,000

White’s depreciation expense (FP300,000 x 0.18) 54,000

Amortization of acquisition differential (FP10,000 x 0.18) 1,800

255,800

(iv) Net income (excluding other comprehensive income)

Black’s income before foreign exchange 150,000

Less: dividend income (FP100,000 x 70% x 0.17) (11,900)

138,100

White’s income before foreign exchange (FP160,000 x 0.18) 28,800

Amortization of acquisition differential (FP90,000 x 0.18) (16,200)

12,600

150,700

Attributable to:

Shareholders of Black (138,100 + 70% x 12,600) 146,920



(v) Other comprehensive income

FP Rate Dollars

Net assets, beginning of year 1,100,000 0.20 220,000

Net income 160,000 0.18 28,800

Dividends paid 100,000 0.17 (17,000)

Calculated net assets, end of year 231,800

Actual net assets, end of year 1,160,000 0.15 (174,000)

Exchange loss from translation of White’s financial statements 57,800

Acquisition differential, beginning of year 900,000 0.20 180,000

Amortization for year 90,000 0.18 (16,200)

Calculated acquisition differential, end of year 163,800

Actual acquisition differential, end of year 810,000 0.15 (121,500)

Exchange loss from translation of acquisition differential 42,300

Total other comprehensive income (loss) (100,100)

Attributable to:

Shareholders of Black (70% x 101,100) 70,070


(vi) Non-controlling interest on income statement

White’s adjusted net income 12,600


White’s other comprehensive income (loss) (100,100)

NCI’s share 30% (30,030)

(26,250)

(vii) Non-controlling interest on balance sheet

White’s common shares (FP200,000 x 0.20) 40,000

White’s retained earnings, beginning (FP900,000 x 0.20) 180,000

White’s net income (FP160,000 x 0.18) 28,800

White’s dividends (FP100,000 x 0.17) (17,000)

Accumulated foreign exchange adjustments (100,100)


253,200



Problem 11-3

(a) Canadian

AP dollars

Net monetary position

Opening balance* (95,000) $1 = AP2.9 (32,759)

Sales 10,350,000) $1 = AP3.25 3,184,615)

Purchases (Note 1) (6,530,000) Note 1 (2,118,590)

Other expenses (Note 2) (3,467,500) $1 = AP3.25 (1,066,923)

Dividends (200,000) $1 = AP3.6 (55,556)

(89,213)

Less closing balance** 57,500) $1 = AP3.6 15,972

Exchange gain 105,185)

* AP450 + AP405 – AP250 – AP700

** AP820 + AP317.5 – AP380 – AP700

Note 1: 2,000,000 / 3 + 4,530,000 / 3.12

Note 2: 3,590,000 – 122,500

(b) Income Statement

Argentine Canadian

peso dollars

Sales 10,350,000) $1 = AP3.25 3,184,615)

Cost of sales (6,400,000) Note 3 (2,091,513)

3,950,000) 1,093,102)

Other expenses (3,590,000) Note 4 (1,109,164)

(16,062))

Foreign exchange gain from part (a) 105,185

Net income 89,123


Note 3:

Opening inventory 600,000) $1 = AP2.9* $206,897

+ Purchase #1 2,000,000) $1 = AP3.0 666,667

+ Purchase #2 4,530,000) $1 = AP3.12 1,451,923

7,130,000) 2,325,487

– Closing inventory (730,000) $1 = AP3.12 (233,974)

Cost of sales 6,400,000) 2,091,513)

* Both plant assets and the opening inventory would be translated at the rate of exchange on

the date of acquisition by the parent.

Note 4:

Depreciation (122,500) $1 = AP2.9* (42,241)

Other expenses (3,467,500) $1 = AP3.25 (1,066,923)

3,590,000 (1,109,164

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