Page 183 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes expense items associated with non-current assets (such as depreciation changes) or long-term
liabilities (amortisation of debt discount) are translated at the same rate as the corresponding
balance sheet items.

Self Assessment

Fill in the blanks:
1. CTA account helps in balancing the balance sheet balance, since translation gains or losses
are not adjusted through the …………………… statement.

2. According to …………………… firms must use the current rate method to translate foreign
currency denominated assets and liabilities.
3. FASB Statement No. …………………… provided that cash, receivables and payables were
translated at current exchange rates while fixed assets and liabilities were translated at
historical rates.
4. The basic outcome of FASB 52 was that if a foreign entity’s books are not kept in the
…………………… currency, then the books must be re-measured into the functional
currency prior to translation.
5. Unrealized foreign currency gains or losses, except from re-measurement, are separately
stated as a component of …………………… equity.

11.2 Functional vs Reporting Currency

Financial Accounting Standards Board Statement 52 (FASB 52) was issued in December 1981, and
all US MNCs were required to adopt the statement for fiscal years beginning on or after December
15, 1982. According to FASB 52, firms must use the current rate method to translate foreign
currency denominated assets and liabilities into dollars. All foreign currency revenue and expense
items on the income statement must be translated at either the exchange rate in effect on the date
these items were recognised or at an appropriate weighted average exchange rate for the period.
The other important part about FASB 52 is that it requires translation gains and losses to be
accumulated and shown in a separate equity account on the parent’s balance sheet. This account
is known as the ‘cumulative translation adjustment’ account.
FASB 52 differentiates between a foreign affiliate’s “functional” and “reporting” currency.
Functional currency is defined as the currency of the primary economic environment in which
the affiliate operates and in which it generates cash flows. Generally, this is the local currency of
the country in which the entity conducts most of its business. Under certain circumstances the
functional currency may be the parent firm’s home country currency or some third country
currency.

The reporting currency is the currency in which the parent firm prepares its own financial
statements. This currency is normally the home country currency, i.e., the currency of the country
in which the parent is located and conducts most of its business.
The nature and purpose of its foreign operations must be determined by the management to
decide on the appropriate functional currency. Some of the economic factors that help in selecting
the appropriate functional currency are listed in Table 11.1.
In general, if the foreign affiliate’s operations are relatively self-contained and integrated with
a particular country, its functional currency will be the local currency of that country. Thus, for
example, the German affiliates of Ford and General Motors, which do most of their manufacturing
in Germany and sell most of their output for Deutschmarks, use the Deutschmark as their

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