B301 Unit 8 Foreign currency translations and branch accounting

HKSSAP11 Foreign Currency Translation (1986)                           

• IAS21 The effects of changes in foreign exchange rates.
• Consolidated financial statements -- dealt with B402 "Advanced Financial Reporting and Analysis".
• Conversion: exchanging a certain amount of one currency for its equivalent in another currency.
• Translation: the expression of accounts in local currency that were originally denominated in a foreign currency, by using exchange rates specified by the translation method used.
• Monetary items: those in which the dollar value is maintained over time, such as cash, loans, debtors and creditors.

Exchange differences -> Income statement.

• Non-monetary items: those in which the dollar value of the assets may vary over time, such as fixed assets, equity investment and inventory.

They are translated at the exchange rate ruling at transaction dates or at contracted rates. No Exchange gain or loss.

Foreign currency assets financed by foreign currency borrowing 

• Providing a hedge against exchange risk.
• Foreign currency assets
  • translated at the closing rate.
  • Exchange differences -- taken to reserves
• Exchange differences arising on borrowings should then be offset (as a reserve movement) against those exchange differences in foreign investment.
• Conditions:
  • foreign currency borrowing is designated as a hedge against foreign currency assets; and
  • the offset can only be made up to the extent of the exchange difference on foreign currency assets.
• Example: see Self-test question 1b(iv), pg.46-47.

Forward Contract: an agreement to exchange different currencies at a specified future date and at a specified rate (forward rate).

• A non-speculative forward contract is one which is designated and effective as a hedge against future receipt or payment of foreign currencies.
  • Hedge of foreign currency transactions and investments (i.e. net monetary assets or liabilities):
    • Exchange difference -- taken into the income statement at the end of the year. 
    • Premium or discount -- either be written off to the income statement immediately or amortized over the life of the contract.
  • Hedge of a firm commitment:
    • Exchange difference -- not be recognized during the commitment period, but should be included in the relevant committed transactions. 
    • Premium or discount -- be amortized over the life of the contract or deferred with the forward exchange contract. 
• All other forward contracts, or parts of forward contracts in excess of the amount hedged, are speculative.

  • Exchange gains or losses -- wholly taken to the income statement at the time of the purchase of the contract, at the end of the year and at maturity of the contract.

Disclosure requirements:

• the amount of exchange difference on foreign currency borrowing in respect of:
  • the amount set off in reserves
  • the amount charged or credited to income statement;
• the amount of exchange gains or losses on forward contracts and related discount or premium offset in reserves; and
• the movement on reserves arising from exchange difference (i.e. translation reserve).

Branch Accounting                                                                           

• Non-autonomous branches:
  • is not regarded as a separate entity to that of the head office, e.g. Giordano's
  • the objective for recording branch accounts is to maintain good internal control.
  • specific accounts used by the Head Office:
    • Goods sent to branch account: recorded at cost
    • Branch stock account: at selling price of merchandise
    • Branch mark-up account: record the gross sales revenue
    • Branch debtors account: to record credit sales

    　

  Goods sent to branch	Dr. Branch stock account (at selling price)
  	Cr. Branch mark-up account (profit margin)
  	Cr. Goods sent to branch account (at cost)
  Goods return to head office	Dr. Branch mark-up account (profit margin)
  	Dr. Goods sent to branch (at cost)
  	Cr. Branch stock account (at selling price)
  Cash sales by branch	Dr. Bank / Cash (HO/Branch)
  	Cr. Branch stock account (at selling price)
  Credit sales by branch	Dr. Branch debtors
  	Cr. Branch stock account (at selling price)
  Expenses of branch	Dr. Branch expenses
  	Cr. Bank / Cash (HO/ Branch)

• Autonomous branches:
  • A separate entity to that of head office although it is not a separate legal entity.
  • Some branches are large in size, and serving the various functions of the companies.
  • Specific accounts:
    • Branch current account: maintained by the head office to record net investments in a particular branch, i.e.. an asset account
    • Head office current account: maintained in the branch's books to keep track of transactions with head office, i.e. a liability account
    • At any point of time, the branch current account should reconcile with the head office current account.
    • Any difference is usually caused by shipment of goods in transit, or cash in transit.
    • The head office will open a 'provision for unrealized profit' account in its P & L a/c to charge off any unrealized profit in ending  stock.

  Overseas branches                                                                               

• Always necessary to keep its own set of books in local currency.
• The foreign branch's accounts need to be translated into the same currency as that of the head office by using the temporal method or closing rate method.

• Temporal method (recommended for foreign branch or individual company):
  • Where the trade of the foreign enterprise is more dependent on the economic circumstances of the investing company reporting currency than on its own reporting currency.
  • Foreign branch operates as an extension of a company's trade (e.g. as a selling agent) and depends on the head office for its finances.
  • Rules for translation:
    • Revenue & expense -- average rate
    • Goods transferred from head office -- actual amount shown in head office books
    • Fixed assets & depreciation -- the rate ruling at the date when the assets are acquired
    • Current assets (excluding stock) and current liabilities -- monetary items are translated at closing rate
    • Inventory -- the rate ruling at the time the stock is acquired (generally, the closing rate is used for closing inventory)
    • Head office current account -- actual amount shown in head office books
    • Exchange difference -- taken to income statement.
• The closing rate/net investment method (recommended for subsidiary company):
  • An investment in a foreign enterprise is in its net worth (i.e. the enterprise as whole) rather than a direct investment in its individual assets and liabilities.
  • A foreign branch operates as a separate business.
  • Rule of translation:
    • Revenue and expenses -- closing rate or average rate (IAS21 permits average rate only)
    • Good transferred from head office -- actual amount shown in head office's books
    • Assets and liabilities -- closing rate
    • Head office current account -- actual amount shown in head office
    • Exchange difference -- balancing figure

Activity 8.11 (Revised answer)

The closing rate method should be used for translation of branch's account balances if the foreign branch operates as a separate business with foreign finance. On the other hand, the temporal method should be adopted if the foreign branch operates as an extension of the company's trade (e.g. selling agent) and depends on the finance of head office.

If the closing rate method is adopted, all account balances of foreign branch are translated by closing exchange rate (however, the revenue and expense items can be translated either by closing rate or average exchange rate). As to temporal method of translation, non-monetary items should be translated by the exchange rate ruling at the time they are incurred, whilst monetary items are translated by the closing exchange rate.