Report for Management Foreign Currency Risk Order Instructions: Assignment 2: Report for Management-Foreign Currency Risk

XYZ, Inc. is a U.S.-based company in the process of acquiring a subsidiary in a country whose functional currency is not the U.S. dollar.

Use the report template, located in the online course shell, to create a report for management that details the risks involved in operating a subsidiary in a functional currency with the U.S. dollar as the reporting currency. Note: You may create and /or make all the necessary assumptions needed for the completion of this assignment.

Write a four to five (4-5) page report in which you:
1. Specify the potential foreign subsidiary’s business operation, the functional currency used, and the type of intercompany transactions anticipated between the acquiring company and the potential subsidiary. Describe the two

(2) Major financial statement translation methods currently used in US GAAP (i.e. the current rate method and the temporal method). Determine the major procedural differences inherent in applying each method. Analyze the fundamental manner in which balance sheet exposure differs under the two (2) methods in question. 2.

Compare and contrast the effects on income that result from the use of both the current rate method and the temporal method to translate the cost of goods sold.
Determine the key inherent risks and discuss the related impact on the investors from the use of each method in question
.
3. Suggest one (1) strategy for determining and disclosing a translation adjustment when parent company management has translated the financial statements of a foreign subsidiary into its reporting currency. Determine the main steps that you would take in order to determine a translation adjustment, and indicate the places within the financial statements where you would report the amount of the translation adjustment in question
.
4. Recommend one (1) way by which to translate the subsidiary’s financial statements
. Include consideration of the foreign exchange risk within your recommendation. Provide a rationale for your response.

5. Use at least two (2) quality academic resources in this assignment. Note: Wikipedia and other Websites do not qualify as academic resources.

The assignment must follow these formatting requirements:
• Be typed in the report template located in the online course shell. The specific course learning outcomes associated with this assignment are:
• Examine the similarities and differences between US GAAP and IFRS, and the related
requirements for accounting in the international marketplace.
•Analyze the accounting requirements for the translation of financial statements of foreign affiliates.
•Use technology and information resources to research issues in advanced accounting.
•Write clearly and concisely about advanced accounting using proper writing mechanics

Report for Management Foreign Currency Risk Sample Answer

Introduction

The differences in foreign exchange occur when transactions are recorded on an accrual basis and in foreign currencies. The problems in foreign exchange and the differences in currency fluctuations can be avoided by dealing in a single currency, fixing the rates of exchange to be applied and converting the currencies into local currencies when required.

1. Home park plc is a company that has its head office in New York, USA. Home Park plc is a multinational company that manufactures toys and dolls for children in the US and for its subsidiary in London, UK. All the transactions are converted into US dollars before being recorded in the company books of accounts. The subsidiary company sells the toys at ₤10 each while the manufacturing costs are estimated to cost ₤6 per unit. The conversion rate for the dollar to pounds is ₤1 = $1.6. (Ross, Westerfield & Jaffe, 2013)

The subsidiary company has a manufacturing department that manufactures the toys for sale in for the local market under license from the parent company in the US. All the profits are repatriated back to their mother company in the US. (Ross, Westerfield & Jaffe, 2013)

The financial year for the Home Park plc ends in November while the sales were made in October when the British pound was at the rate provided above. The current rate of the British pound to the dollar is ₤1 = $ 1.2, a difference of $4 dollars.

The records in October, 2014 indicated that the sales of 100 units amounted to in $ 1600 while the costs were $600 hence a profit of $1000 was recorded in the books of the subsidiary. The accounting system being accrual, the debtors were entered as $1600 being the accounts receivable in the balance sheet. However, at the end of the year, the British sterling pound was operating at the rates shown above i.e. ₤1 = $ 1.2. The debtor paid $1200 and the Home Park sales revenue dropped by 25% i.e. the revenues dropped by $400.

2. Under the Foreign Currency Translation of the Financial Accounting Statement No. 52 which sets forth and guides the right accounting treatment for the US GAAP.

The temporal method uses the effective rate of translation at the time of the transaction and different rates are applied for a different transaction. For example, the sales in October for the Home Park subsidiary in the UK will be recorded as follows:

Home Park Subsidiary

Income and Expenditure for the Month of Oct 2014

Oct-14	$
Sales	1600
Costs	960
Profits	640

Home Park Subsidiary

Balance Sheet Extract as at the end of Oct 2014

Oct-14	$
Current Assets
Accounts receivable	1600

 

At the end of December the following entries will be entered for the sales of 100 units:

Home Park Subsidiary

Income and Expenditure for the Month of Dec 2014

Dec-14	$
Sales	1200
Costs	720
Profits	480

 

Home Park Subsidiary

Balance Sheet Extract as at the end of Oct 2014

Dec-14	$
Current Assets
Accounts receivable	1200

 

Under the functional currency method, the current rate is applied and the assets and liabilities are translated at the rates that are prevailing as at the time of the translation. All the equity accounts are translated at the historical rates while the income and expenditure are translated at the weighted-average rate for the financial period.

3. The major strategy would be to check for adjustments for foreign exchanges in the income and expenditure accounts for the subsidiary company. The major steps would be first check the income and expenditure account and identify the contra entries that have been made to counter the effects of the fluctuations on foreign currencies. (Garrison, Noreen & Brewer, 2009)
4. The best way according to me would be to use the fixed rate of translation for a particular financial period. For instance, Home Park plc may decide to use the initial exchange rates of

₤1 = $1.6. The fix rate method would avoid the confusions that may arise because of different rates of exchange and also would simplify the accounting work. (Khan, 1993)

The similarities and differences of IFRS and US GAAP in the international marketplace;

The components of the financial statements two years of comparative data when filling reports and returns under the IFRS while the US GAAP requires three years of comparative data except for the balance sheet, the other financial statements are income and expenditure, cash flow, changes in equity, accounting policies and notes. The IFRS does not insists on a particular format for financial statements however US GAAP insists that the balance sheet has to be classified or non classified with a decreasing order of liquidity while the income and expenditure has to classify all the expenditure by function in a single or multiple step format. The extraordinary items are prohibited in IFRS while in US GAAP they are classified as rare and unusual items. Negative goodwill is also recorded as an extraordinary item under US GAAP. The IFRS cash flows may include bank overdrafts while the US GAAP excludes all overdrafts. In IFRS, items like correction of errors, changes in accounting policies and accounting estimates, presentation and disclosures of associates, acquisitions and mergers are all similar to US GAAP.

The following are the accounting requirements that relate to translation and treatment of financial statements for foreign subsidiaries or affiliates;

The policies that guide the accounting practice in the US and relating to the US GAAP are all included in the Financial Accounting Board (FASB) Accounting Standard Codification (ASC) on foreign currency issues topic 830 while the International Financial Reporting Standards (IFRS) relating to foreign currency treatment and translation issues are contained in the IAS 21 and 29.

A number of differences and similarities between IFRS and US GAAP in respect to the accounting treatment of foreign currency translation matters. For instance, both GAAP and IFRS accounting standards require that all the income, expenses, assets and liabilities to be remeasured using the entity’s currency i.e. the functional currency that’s applicable in the host country’s economy before translating it to the reporting country. (Hilton, 2005)

The other differences between the US GAAP (ASC 830) and IFRS (IAS 21 and 29) is that in cases of  hyperinflation all the financial statements have to be remeasured using the reporting country’s currency i.e. as if the currency was the functional currency. The IFRS insists on using only the functional currency even if there is hyperinflation.

To determine a country’s functional currency, the US GAAP considers several of indicators which are basically not set up while the IFRS has a hierarchy of indicators that lists all the secondary and primary indicators that are applied to determine the county’s functional currency.

To conclude, different countries have different approaches of dealing with foreign currencies however the US GAAP and the IFRS guide the accounting policies in the US and internationally respectively.

Report for Management Foreign Currency Risk References

Garrison, R., Noreen, W. & Brewer, P. (2009) Managerial Accounting, New York, NY: McGraw-Hill Irwin. 65 -70

Hilton, R.W., (2005) Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill.

Khan, M. (1993) Theory & Problems in Financial Management, New York, NY: McGraw Hill

Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013) Corporate finance (10th Ed.) New York, NY: McGraw-Hill Irwin. 175.

Warren, C.S., Reeve, J.M. and Fess, P.E. (2005) Accounting, 21st ed. Thomson

South-Western