Admas univesrity Advance Accounting 2019

UNIT –SEVEN
ACCOUNTING FOR FOREIGN TRANSACTIONS AND TRANSLATION

When a company operates in different countries, parent company located in one country and the
subsidiaries companies located in other countries they have to be consolidated.

When two parties from different countries enter into a transaction, they must decide which of the two
countries’ currencies to use to settle the transaction. For example, if a U.S. computer manufacturer sells
to a customer in Japan, the parties must decide whether the transaction will be denominated (payment
will be made) in U.S. dollars or Japanese yen.

Thus, a transaction that requires payment or receipt (settlement) in a foreign currency is called a foreign
currency transaction. Thus, a transaction of a U.S. firm with a foreign entity to be settled in dollars is
accounted for in the same manner as if the transaction had been with a U.S. company.
A foreign currency transaction will be settled in a foreign currency, and the U.S. firm is exposed to the
risk of unfavorable changes in the exchange rate that may occur between the date the transaction is
entered into and the date the account is settled. For example, assume that a U.S. firm purchased goods
from a French firm and the U.S. firm is to settle the liability by the payment of 20,000 francs. The
French firm would measure and record the transaction as normal because the billing is in its reporting
currency. Because the billing is in a foreign currency (denominated in francs), the U.S. firm must
translate the amount of the foreign currency payable into dollars before the transaction is entered in its
accounts. An increase (decrease) in the direct exchange rate will increase (decrease) the number of
dollars required to buy the fixed number of francs needed to settle the foreign currency liability.
The direct exchange rate is often said to be increasing, or the foreign currency unit to be strengthening,
if more dollars are needed to acquire the foreign currency units. If fewer dollars are needed, then the
foreign currency is weakening or depreciating in relation to the dollar (the direct exchange rate is
decreasing)
Key Terms
Currency is a system of money (monetary units) in common use, especially in a nation. Under this
definition, British pounds, U.S. dollars, and European euros, Ethiopian Birr are different types of
currency, or currencies. Currencies in this definition need not be physical objects, but as stores of value
are subject to trading between nations in foreign exchange markets, which determine the relative values
of the different currencies. Currencies in the sense used by foreign exchange markets are defined by
governments, and each type has limited boundaries of acceptance

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Functional currency: Currency of the country in which the foreign entity is located. It is reporting
currency. The functional currency is the currency in which the company does its principal business. Is
the currency of the primary environment in which it operates, (subject to decision of management).The
facts of each situation will determine the company's functional currency. The general rule of thumb is
that whatever currency the business normally uses will be the functional currency of the business. For
example, a United States business performs most of its transactions in the U.S. dollar. Occasionally, the
company will perform transactions in the euro. The functional currency would be the U.S. dollar

Importing or Exporting of Goods or Services

Three important things are:-
1. At the date the transaction is first recognized in conformity with GAAP. Each asset, liability,
revenue, expense, gain, or loss arising from the transaction is measured and recorded in dollars by
multiplying the units of foreign currency by the current exchange rate. (The current exchange rate
is the spot rate in effect on a given date.)
2. At each balance sheet date that occurs between the transaction date and the settlement date.
Recorded balances that are denominated in a foreign currency are adjusted using the spot rate in
effect at the balance sheet date and the transaction gain or loss is recognized currently in earnings.
3. At the settlement date. In the case of a foreign currency payable, a U.S. firm must convert U.S.
dollars into foreign currency units to settle the account, whereas foreign currency units received to
settle a foreign currency receivable will be converted into dollars. Although translation is not
required, a transaction gain or loss is recognized if the number of dollars paid or received upon
conversion does not equal the carrying value of the related payable or receivable.

Using the spot rate to translate foreign currency receivables and payables at each measurement date
provides an estimate of the number of dollars to be received or to be paid to settle the account. Note
that both gains and losses are result in adjustments to the receivable or payable, approximating a form of
current value accounting. The increase or decrease in the expected cash flow is generally reported as a
foreign currency transaction gain or loss, sometimes referred to as an exchange gain or loss, in
determining net income for the current period.
Importing Transaction. To illustrate an importing transaction, assume that on December 1, 2003, a
U.S. firm purchased 100 units of inventory from a French firm for 500,000 euros to be paid on March 1,
2004. The firm's fiscal year-end is December 31. Assume further that the U.S. firm did not engage in
any form of hedging activity. The spot rate for euros ($/euro) at various times is as follows:
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Spot Rate
Transaction date - December 1, 2003 $1.05
Balance sheet date - December 31, 2003 1.08
Settlement date - March 1, 2004 1.07
The U.S. firm would prepare the following journal entry on December 1, 2003:
Dec. 1 Purchases 525,000
Accounts Payable (500,000 euros x $1.05/euro) 525,000
At the balance sheet date, the accounts payable denominated in foreign currency is adjusted using
the exchange rate (spot rate) in effect at the balance sheet date. The entry is
Dec. 31 Transaction Loss 15,000
Accounts Payable 15,000

Accounts payable valued at 12/31 (500,000 euros x $1.08/euro) $540,000

Accounts payable valued at 12/1 (500,000 euros x $1.05/euro) 525,000
Adjustment to accounts payable needed $ 15,000
Or
[500,000 euros x ($1.08 - $1.05) = $15,000]
If the exchange rate had declined below $1.05, for example to $1.03, the U.S. firm would have
recognized a gain of $10,000 since it would have taken only $515,000 (500,000 euros x $1.03) to settle
the $525,000 recorded liability.
Before the settlement date, the U.S. firm must buy euros in order to satisfy the liability. With a change in
the exchange rate to $1.07, the firm must pay $535,000 on March 1, 2004, to acquire the 500,000 euros.
The journal entry to record the settlement is:

Mar. 1 Accounts Payable 540,000

Transaction Gain 5,000
Cash (500,000 euros x $1.07/euro) 535,000
Over the three-month period, the decision to delay making payment cost the firm $10,000 (the $535,000
cash paid less the original payable amount of $525,000). This net amount was recognized as a loss of
$15,000 in 2003 and a gain of $5,000 in 2004.
Note in the example above that at December 31, the balance sheet date, a transaction loss was
recognized on the open account payable. Such a loss is considered unrealized because the account has
not yet been settled or closed. When an account payable (or receivable) is settled or closed, a transaction
gain or loss on the settlement is considered realized. The FASB reasoned that users of financial
statements are best served by reporting the effects of exchange rate changes on a firm's financial position
in the accounting period in which they occur, even though they are unrealized and may reverse or
partially reverse in a subsequent period, as in the illustration above. This procedure is criticized,

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however, because under GAAP, gains are not ordinarily reported until realized and because the
recognition of unrealized gains and losses results in increased earnings volatility.
Exporting Transaction. Now assume that the U.S. firm sold 100 units of inventory for 500,000 euros to
a French firm. All other facts are the same as those for the importing transaction. The journal entries to
record this exporting transaction on the books of the U.S. Company are:

December 1, 2003 - Date of Transaction

Accounts Receivable (500,000 euros x $1.05) 525,000
Sales 525,000

December 31, 2003 - Balance Sheet Date

Accounts Receivable ($540,000-$525,000) 15,000
Transaction Gain 15,000
The receivable valued at 12/1, 500,000 euros x $1.08 = $540,000
The receivable valued at 12/31, 500,000 euros x $1.05 = $525,000
Change in the value of the receivable $ 15,000

March 1, 2004 - Settlement Date

Cash (500,000 euros x $1.07) 535,000
Transaction Loss 5,000
Accounts Receivable 540,000
A comparison of the entries to record the exporting transaction with those prepared to record an
importing transaction reveals that a movement in the exchange rate has an opposite effect on the
company's reported income. That is, the increase in the exchange rate from $1.05 to $1.08 resulted in a
transaction gain in the case of a foreign currency receivable, whereas a transaction loss was reported in
the case of a foreign currency payable. When the exchange rate decreased from $1.08 to $1.07, a
transaction loss was reported on the exposed receivable, whereas a transaction gain was reported on the
exposed payable. Thus, one tool available to management to hedge a potential loss on a foreign currency
receivable is to enter into a transaction to establish a liability to be settled in the same foreign currency.
Similarly, a liability to be settled in units of a foreign currency can be hedged by entering into a
receivable transaction denominated in the same foreign currency.
These relationships are summarized below.
Balance Sheet
Exposed Effect on Income
Account Balance Statement Effect

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Reported
Increase in direct exchange rate
Importing transaction Payable Increase Transaction loss
Exporting transaction Receivable Increase Transaction gain
Decrease in direct exchange rate
Importing transaction Payable Decrease Transaction gain
Exporting transaction Receivable Decrease Transaction loss

How to Account for Foreign Currency Transactions

Accounting for foreign currency transactions has two sections. The first section is recording the original
transactions. The second section is recording when the company pays or receives the money in a foreign
currency. The foreign currency exchange rate will allow the accountant to translate the foreign currency
to his own currency. Any changes in the foreign currency exchange rate will result in a gain or loss on
the foreign currency.

Instructions
1. Purchases
 Debit "Purchases" and credit "Accounts Payable" by the amount of money owed using the current
exchange rate. For example, if the current exchange rate is 1 euro for $1.50, and a company
purchases a product for 400 euros, then the company would debit and credit $600.
 Debit "Accounts Payable" and credit "Foreign Currency Gain" or debit "Foreign Currency Loss" and
credit "Accounts Payable" at the end of the accounting period to adjust the transaction to the current
exchange rate. In the example, if the exchange rate changed to 1 euro for $1.25, then the company
would owe only $500. Debit and credit $100 to adjust the $600.
 Debit "Accounts Payable" and credit "Cash" and "Foreign Currency Gain" or debit "Accounts
Payable" and "Foreign Currency Loss" and credit "Cash" when paying for the purchase. Use the
exchange rate on the day you exchange the currency.

2. Sales
 Debit "Accounts Receivable" and credit "Sales" by the amount of money owed using the current
exchange rate. For example, if the current exchange rate is 1 euro for $1.50, and a company sells a
product for 400 euros, then the company would debit and credit $600.
 Debit "Accounts Receivable" and credit "Foreign Currency Gain" or debit "Foreign Currency Loss"
and credit "Accounts Receivable" at the end of the accounting period to adjust the transaction to the

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current exchange rate. In the example, if the exchange rate changed to 1 euro for $1.25, then the
company would receive only $500. Debit and credit $100 to adjust the $600.
 Debit "Cash" and credit "Accounts Receivable" and "Foreign Currency Gain" or debit "Cash" and
"Foreign Currency Loss" and credit "Accounts Receivable" when receiving money for the purchase.
Use the exchange rate on the day you received the cash.

Examples:
1. On Nov. 1, 2000 a US. Firm sold merchandise for CN$100,000 to a Canadian firm. On Jan 25,
2001 collected CN$100,000. On Jan 31 converted the CN$100,000 into US$.

Assuming: Nov. 1 Dec. 31 Jan. 25 Jan 31

Spot Rate $0.75 $0.80 $0.78 $0.82

Journal entries:

11/1/00 Account Receivable (fc) $75,000

Sales Rev. $75,000
12/31/00 Account Receivable $ 5,000
Exchange Gain $ 5,000

1/25/01 Cash (fc) $78,000

Exchange Loss $ 2,000
Account Receivable (fc) $80,000
1/31/01 Cash $82,000
Cash (fc) $78,000
Gain on Exchange $ 4,000
Example:
On Nov. 1, 1999 a US firm Sold CN$100,000 to a Canadian company to receive in 90 days.

Assuming: Nov. 1, 1995 Dec. 31 Jan 31, 2000

Spot Rate $0.80 $0.78 $0.74
30-days future $0.78 $0.76 $0.75
60-days future $0.77 $0.73 $0.735
90-days future $0.75 $0.74 $0.745

11/1/99 Account Receivable (fc) $80,000

Sales Revenue $80,000

Contract Receivable ($) $75,000

Contract Payable (fc) $75,000

12/31/99 Exchange Loss $ 2,000

Account Receivable (fc) $ 2,000

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Exchange Loss $ 1,000
Contract Payable (fc) $ 1,000

Jan 31, 2000 Cash (fc) $74,000

Exchange Loss $ 4,000
Account Receivable (fc) $78,000
Contract Payable (fc) $76,000
Cash (fc) $74,000
Exchange Gain $ 2,000

Cash $75,000
Contract Receivable $75,000
Factors cause foreign currency exchange rates to change:
The price of a foreign currency (the exchange rate) is governed by the laws of supply and demand. The
following factors affect supply and demand:
 Relative domestic inflation rates –
 Interest Rates –
 Trade deficit or trade surplus –
 Service deficit or service surplus
 Investment deficit or investment surplus.
 Federal deficits
 Government-imposed restrictions on currency transfers.
 Civil disorders and wars.

ACCOUNTING FORFOREIGN CURRENCY TRANSLATION

Transactions that are to be settled in a foreign currency and financial statements of an affiliate
maintained in terms of a foreign currency are translated (converted) into dollars by multiplying the
number of units of the foreign currency by a direct exchange rate. Thus, translation is the process of
expressing monetary amounts that are stated in terms of a foreign currency in the currency of the
reporting entity by using an appropriate exchange rate. An exchange rate “is the ratio between a unit of
one currency and the amount of another currency for which that unit can be exchanged at a particular
time.”
A direct exchange quotation is one in which the exchange rate is quoted in terms of how many units
of the domestic currency can be converted into one unit of foreign currency. For example, a direct
quotation of U.S. dollars for one British pound of 1.517 means that $1.517 could be exchanged for one
British pound. To translate pounds into dollars, the number of pounds is multiplied by the direct
exchange rate expressed in dollars per pound. Exchange rates are also stated in terms of converting one

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unit of the domestic currency into units of a foreign currency, which is called an indirect quotation. In
the example above, one U.S. dollar could be converted into .6592 pounds (1.00/1.517). To translate
pounds into dollars, the number of pounds could also be divided by the indirect exchange rate.
Exchange rates may be quoted either as a spot rate or a forward rate. The spot rate is the rate currencies
can be exchanged today. The forward or future rate is the rate the currencies can be exchanges at some
future date. The forward rate is an exchange rate established at the time a forward exchange contract is
negotiated.

Translation: Is restatement of financial statements from local currency to functional Currency.

Translation
Parent Subsidiary
$ Br.

Consolidated
Statements Reporting currency.
Need for translation
1. Consolidation- Merging the subsidiary accounts & parent co. accounts.
(a) Principle: to follow the rules and regulations of the parent company.
(b) Language: to put in parent company Language
2. Regulatory: all capital markets are regulated by SEC (vs)
3. Customers: what are the prime customers and is used to report in their respect languages

LEVELS OF EXPOSURES FOR A COMPANY THAT DEALS INTERNATIONALLY

1. Translation /Accounting Exposure

2. Transaction Exposure
3. Operating Exposure

1. Translation Exposure

This exposure is also well known as accounting exposure. Translation exposure arises from the need to
"translate" foreign currency assets or liabilities into the home currency for the purpose of finalizing the
accounts for any given period. It is because the exposure is due to translation of books of accounts into
the home currency. Translation activity is carried out on account of reporting the books to the
shareholders or legal bodies. It makes sense also as the translated financial statements show the position
of the company as on a date in its home currency. Gains or losses arising out of translation exposure do
not have more meaning over and above the reporting requirements. Such exposure can even get reversed

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in the next year translation if currency market moves in the favorable direction. This kind of exposure
does not require too much of management attention.
A typical example of translation exposure is the treatment of foreign currency borrowings. Consider that
a company has borrowed dollars to finance the import of capital goods worth Rs 10000. When the
import materialized the exchange rate was say Rs 30 per dollar. The imported fixed asset was therefore
capitalized in the books of the company for Rs 300000. In the ordinary course and assuming no change
in the exchange rate the company would have provided depreciation on the asset valued at Rs 300000
for finalizing its accounts for the year in which the asset was purchased. If at the time of finalization of
the accounts the exchange rate has moved to say Rs 35 per dollar, the dollar loan has to be translated
involving translation loss of Rs50000. The book value of the asset thus becomes 350000 and
consequently higher depreciation has to be provided thus reducing the net profit.

Exposures, only recorded in books of accounts only, they don’t in evolve any cash inflows and
cash outflows where as transaction. Exposure takes place because of settlement of the
translation.

There are three important dates: Transaction date

Balance sheet date
Settlement date
Translation exposure

Positive exposure Negative exposure

GAIN loss

Exposed assets> Exposed Assets < Exposed

Exposed liability liability

Translation exposure assess due to charge indimansions of balance sheets invent of or on

account of currency translation.
Exposed asset- net increases in assets greater than net increase in liabilities is equal to gain from
translation exposure.
2. Transaction Exposure: involves actual inflows and cash out flows from balance sheet to
settlement date. The simplest kind of foreign currency exposure which anybody can easily think of
is the transaction exposure. As the name itself suggests, this exposure pertains to the exposure due to
an actual transaction taking place in business involving foreign currency. In a business, all monetary
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transactions are meant for profits as its end result. There are all the chances of that final objective
getting hampered if it is a foreign currency transaction and the currency market moves towards the
unfavorable direction.

If you have bought goods from foreign country and payables are in foreign currency to be paid after 3
months, you may end up paying much higher on the due date as currency value may increase. This will
increase your purchase price and therefore the overall costing of the product compelling the profit
percentage to go down or even convert to loss. Transaction exposure normally occurs due to foreign
currency debtors of sale, payment for imported goods or services, receipt / payment of dividend, or
payment towards the EMIs of debts etc. 

3. Operating exposure: (Economy exposure) - very dynamic, important the first two are due to
change in exchange rarest. Here it arises out of unexpected changes in currency exchange rate due to
unexpected sudden or uncertain events in the economy. E.g. inflation.
In simple words, economic exposure to an exchange rate is the risk that a change in the rate affects the
company's competitive position in the market and hence, indirectly the bottom-line. Broadly speaking,
economic exposure affects the profitability over a longer time span than transaction and even translation
exposure. Under the Indian exchange control, while translation and transaction exposures can be hedged,
economic exposure cannot be hedged.
These three types of foreign currency exposures are very important to understand for an international
finance manager. Analyzing the exposure to foreign exchange helps have the right view of the firm’s
business and therefore take informed decisions

BASIC TRANSLATION METHODS

Key terms:

Single rate: If we are using one type of rate, we call it single rate.
(If can be current rate, historical rate or qulrage rate).
Current rate: Is the exchange rate prevailing at the balance sheet date (at the reporting
rate).
Historical rate: Is the exchange rate prevailing at the date on which the asset is or the
transaction had occurred.
Average rate: Is the weighted average of the exchange rates that prevailed during the
period for which financial statements are prepared.

(1) Current rate method

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Under this method all balance sheet items except wares equity are translated at the current exchange
rate.
It is the simplest of all translation methods to apply since a constant rate is used in the balance sheet.
The assumption is that all sasses and liabilities have exposed equally to exchange rates (current rate).
The main invitations of the surreys rate method is that it does not consider differences in the nature of
assets and liabilities that is monetary and non monetary. There fore, there is a need to apply different
exchange rates for different types of assets depending upon tiered nature and duration.

2. Monetary and Non Monetary Methods

Under this method monetary assets such as cash, receivables, payables in the balance sheet of a
foreign subsidiary are translated or a current exchange rate. All non monetary items such as
inventories, fixed assets are translated historical exchange rates. However, most income
statement items are translated at the average exchange rate exchange rate except closing stock
and deprecation which are translated using historical exchange rates.
3. Temporal Method
Under this method, the measurement basis of an asset as a liability determines the exchange rate to be
used for translation. Accordingly monetary hens such as cash, receivables, and payables are translated at
the current exchange rate (expression of one currency in to other currency.)
Non monetary items such as inventories and fixed assets are translated or current exchange rates if they
are carried in the books of records at current VALUE and then are translated at historical rate if they are
carted at HISTORICAL COST.
Temporal Method current Method
Exchange Rate Exchange Rate
Assets
Cash and receivables Current Current
Marketable securities Current Current
Inventory at market Current Current
Inventory at cost Historical Current
Prepaid expenses Historical Current
Property, plant, and equipment Historical Current
Intangible assets Historical Current
Liabilities

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Current liabilities Current Current
Deferred income Historical Current
Long-term debt Current Current
Stockholders’ equity
Capital stock Historical Historical
Additional paid-in capital Historical Historical
Retained earnings Historical Historical
Dividends Historical Historical
Income Statement
Revenues Average Average
Most expenses Average Average
Cost of goods sold Historical Average
Depreciation of property, plant, and equipment Historical Average
Amortization of intangibles Historical Average
Translation of Financial Statements of Foreign Influenced Investee
Assume that on May 31 Year 6, Colossus Company, a US multinational company, acquired 30% of the
outstanding common stock of a corporation in Venezuela, which we term the Venezuela Investee. The
functional currency of the foreign entity is Bolivar (B). Colossus acquired its investment in Venezuela
Investee for B 600,000 when the selling spot rate was 1B=$0.25 for $150,000. Out of pocket costs may
be disregarded. Stockholders equity of Venezuela Investee on May 31, Year 6 was as follows:
B
VENEZUELA INVESTEE
Income statement
FOR YEAR ENDED MAY 31, YEAR 7

Income Statement
Net sales 6,000,000
Costs and expenses 4,000,000
Net income 2,000,000

Statement of Retained Earnings

Retained earnings, beg 900,000
Add: Net Income 2,000,000
Sub totals 2,920,000
Less: Dividends 600,000

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Retained earnings, ending 2,300,000

Balance Sheet
Assets
Current assets 200,000
Plant assets (net) 4,500,000
Other assets 300,000
Total assets 5,000,000
Liabilities & Stockholders’ Equity
Current liabilities 100,000
Long term debt 1,500,000
Common stock 500,000
Additional paid in capital 600,000
Retained earnings 2,300,000
Cumulative translation adj.
Total liab & stockholders’ eq 5,000,000

The exchange rates for the bolivar were as follows:

May 31, Year 6 $0.25
May 31 Year 7 0.27
Average for the year ended May 31, Year 7 0.26

Required TRANSLATE VENEZUELA BOLIVAR TO USA DOLLAR

Solution
VENEZUELA INVESTEE
TRANSLATION OF FINANCIAL STATEMENTS TO US DOLLARS
FOR YEAR ENDED MAY 31, YEAR 7
Venezuelan Exchange (current/historical) US dollars
bolivars rate
Income Statement
Net sales 6,000,000 0.26(1) 1,560,000
Costs and expenses 4,000,000 0.26(1) 1,040,000
Net income 2,000,000 520,000

Statement of Retained Earnings

Retained earnings, beg 900,000 0.25(2) 225,000
Add: Net Income 2,000,000 520,000
Sub totals 2,920,000 745,000
Less: Dividends 600,000 0.27(3) 162,000
Retained earnings, ending 2,300,000 583,000
Balance Sheet
Assets

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Current assets 200,000 0.27(3) 54,000
Plant assets (net) 4,500,000 0.27(3)1,215,000
Other assets 300,000 0.27(3) 81,000
Total assets 5,000,000 1,350,000
Liabilities & Stockholders’ Equity
Current liabilities 100,000 0.27(3) 27,000
Long term debt 1,500,000 0.27(3) 405,000
Common stock 500,000 0.25(2) 125,000
Additional paid in capital 600,000 0.25(2) 150,000
Retained earnings 2,300,000 583,000
Cumulative translation adj. 60,000
Total liab & stockholders’ eq 5,000,000 1,350,000
Translation and Consolidation of Financial Statements of Foreign Subsidiary
To illustrate, assume that on August 31, 1999 SoPac Corporation a US enterprise with no other
subsidiaries, acquired at the selling spot rate of $NZ1=$0.52 a draft for 500,000 New Zealand dollars
($NZ), which it issued to acquire all 10,000 authorized $NZ 50 par common stock of newly organized
Anzac Ltd., a New Zealand enterprise.
So Pac prepared the following journal entry for the investment:
Aug. 31 Investment in Anzac Ltd.
($NZ 500,000*0.52) 260,000
Cash 260,000
To record acquisition of 10,000 shares of $NZ50 par common stock of Anzac, Ltd.
Anzac, Ltd was self contained in New Zealand and its functional currency is the New Zealand dollar.

ANZAC, LTD.
INCOME STATEMENT
FOR THE YEAR ENDED AUGUST 31, 2000
$NZ
Revenue:
Net sales 240,000
Other 60,000
Total Income 300,000
Costs and expenses
Cost of goods sold 180,000
Operating expenses 96,000
Total costs and expenses 276,000

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Net income (retained earnings, ending) 24,000
ANZAC, LTD.
BALANCE SHEET
AUGUST 31, 2000
Assets
Cash 10,000
Trade accounts receivable (net) 40,000
Inventories 180,000
Short term prepayments 4,000
Plant assets (net) 320,000
Intangible assets (net) 20,000
Total assets 574,000
Liabilities and Stockholders’ Equity
Notes payable 20,000
Trade accounts payable 30,000
Total liabilities 50,000
Common stock, $NZ50 par 500,000
Retained earnings 24,000
Total stockholders’ equity 524,000
Total liabilities & stockholders’ equity 574,000

The exchange rates for the New Zealand dollar were as follows:
Aug 31, 1999 $0.52
Aug 31, 2000 $0.50
Average for the year $0.51

ANZAC, LTD.
Translation of Financial Statements to US Dollars
FOR THE YEAR ENDED AUGUST 31, 2000

Exchange USD
$NZ rate

Net sales 240,000 0.51(1) 122,400

Other 60,000 0.51(1) 30,600
Total Income 300,000 153,000
Costs and expenses
Cost of goods sold 180,000 0.51(1) 91,800
Operating expenses 96,000 0.51(1) 48,960
Total costs and expenses 276,000 140,760
Net income (retain ear, ending) 24,000 12,240
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Cash 10,000 0.50(2) 5,000
Trade accounts receivable (net) 40,000 0.50(2) 20,000
Inventories 180,000 0.50(2) 90,000
Short term prepayments 4,000 0.50(2) 2,000
Plant assets (net) 320,000 0.50(2) 160,000
Intangible assets (net) 20,000 0.50(2) 10,000
Total assets 574,000 287,000

Notes payable 20,000 0.50(2) 10,000

Trade accounts payable 30,000 0.50(2) 15,000
Common stock, $NZ50 par 500,000 0.52(3) 260,000
Retained earnings 24,000 12,240
Foreign Curr. Tran. Adj (10,240)
Total liab & stockholders’ equity 574,000 287,000

CHAPTER- 8 SEGMENT REPORTING AND INTERIM REPORTING

Introduction
It is customary for many companies to diversify their operations into a variety of related and unrelated
industry areas. Financial analysts and other users of financial statements face difficulty in analyzing and
interpreting financial statements prepared for diversified companies. The reason is that different industry
segments can have differing growth potentials, capital requirements, and profitability characteristics.
Some segments operate in a stable industry and others in highly cyclical or high demand industry.
In terms of capital requirements, the segment may operate in labor-intensive, modest capital
requirements, or high capital intensive industry. As a result, it is not sound to combine all segments and
evaluate the company’s growth potential and profitability. In order to make meaningful analysis, the
total company financial data should be disaggregated into segments.
Objectives of Segment Reporting and Applicable Accounting Standards

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According to FASB (statement No. 14), diversified companies should separately prepare reporting for
each segment. In the view of the FASB, financial information about business segments will assist
financial statement users in analyzing and understanding the financial statements of the enterprise by
permitting better assessment of the company’s past performance and future prospects.
Generally, segment information is based on the totals of consolidated financial statements. Thus, the
principles governing consolidations are used for segment reporting. In segment reporting, transactions
between segments are not eliminated for purposes of segment disclosures with the exception of inter
segment loans, advances and related interest. These items are generally excluded from segment assets
and revenues.
Generally, segment information is based on the totals of consolidated financial statements. Thus, the
principles governing consolidations are used for segment reporting. In segment reporting, transactions
between segments are not eliminated for purposes of segment disclosures with the exception of inter
segment loans, advances and related interest. These items are generally excluded from segment assets
and revenues.
The objective of segment reporting is to provide information about the different business activities in
which an enterprise engages and the different economic environments in which it operates to help users
of financial statements:
 To better understand the enterprise’s performance.
 To better assess its prospects for future net cash flows.
 To make more informed judgments about the enterprise as a whole
Reportable segment
A reportable segment is a business segment identified on the basis of foregoing definitions for which
segment information is required to be disclosed by this Standard.
After a company has identified its operating segments based on its internal reporting system,
management must decide which segments to report separately. Generally, information must be reported
separately for each operating segment that meets one or more quantitative thresholds. However, if two or
more operating segments have essentially the same business activities in essentially the same economic
environments, information for those individual segments may be combined.
For reportable operating segments of a business enterprise as specifically by the FASB, it mandated
several disclosures, including the following.
(1) factors used to identify reportable segment
(2) Types of products and services from which each reportable segment derives its revenue.

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(3) Segment profit or loss and segment total assets, as measured by the internal financial reporting
system.
(4) Selected components of revenues and expenses included in the management of reportable
segment profit loss, such as interest revenue & interest expense.
(5) Reconciliation of total reportable segments’ profit or loss to the enterprises pretax income from
continuing operations.
(6) Explanation of how segment profit or loss is measured,
(7) Reconciliation of total of reportable segments’ assets to total assets,
(8) Investments influenced investees included assets.
(9) Total expenditures for additions to long lived segment assets.

The Accounting PRINCIPLES BOARD defined a business segment as “a components of an entity

whose activities represent a separate major line of business or class of customers.
Financial analysts and others interested in comparing one diversified business enterprise with another
found that consolidated financial statements did not supply enough information for meaning-full
comparative statistics regarding operations of the diversified enterprises in specific industries.
The concept of segment reporting was controversial because it was opposed to the philosophy that
consolidated financial statements, rather than separate financial statement, fairly present the financial
position and operating results of an economic entity, regardless of the legal or business-segment
structure of the entity.
COVERAGE OF SEGMENTAL REPORTING
According to Financial Accounting Standard Board (statement No. 14), an enterprise may have to
disclose data for one or more of the following areas:
1. Operations in different industries
2. Domestic and foreign operations
3. Export sales
4. Major customer
Operations in different industries
A company may have segments in different industries. The company may not be required to report its
operations in different industries. In order to determine whether the company must report its operations
in different industries, several factors may be considered. The first factor is to identify the industry
segments in which it operates. The aim is to identify a reportable segment. A reportable segment is a


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significant component of a company that provides related products and services primarily to unaffiliated
customers. Besides, in order to be reportable, a segment has to meet one of the three tests  revenue
test, operating profit test, and asset test.
DETERMINATION OF REPORTABLE OPERATING SEGMENTS
Revenue test
An industry segment is reportable if it meets the revenue test. The revenue test is met when an industry
segment’s revenue is 10% or more of the combined revenue of all industry segments. Revenue includes
inter segment sales and transfers. Interest is included in the revenue test if the assets on which the
interest is earned are included in that segment’s identifiable assets. The interest includes interest on inter
segment trade receivables, but does not include interest on intersegment loans and advances.

To illustrate, assume that Muna company has 4 segments; namely, A, B, C, and D. their sales are:
Segments Total
A B C D
Sales to unaffiliated outsiders - $40,000 20,000 50,000 15,000 125,000
Inter segments sales --- 10,000 10,000 20,000 - 40,000

Total sales
50,000 30,000 70,000 15,000 165,000

The benchmark for a 10% revenue test is $16500 (i.e. 10% of 165,000).
= 10% of total sales
Since the sales of segments A, B, and C are greater than the benchmark sales amount, they are
considered as reportable segments where as Segment D is not a reportable segment because its revenue
is less than 10% of the total sales of all segments (i.e 15,000).

Operating profit test

Operating profit is defined as an industry segment’s revenue minus all operating expenses. Operating
profit includes expenses that relate to inter segment sales or transfers and expenses allocated among
segments on a reasonable basis. Operating profit should not include revenues earned at the corporate
level, general corporate expenses, interest expense (except for financial segments), domestic and foreign
income taxes, income or loss from equity, investors, gain or loss on discontinued operations,
extraordinary items, minority interest, and the cumulative effect of an accounting change. Intersegment
interest expenses and revenues of an industry segment that is primarily financial in nature are included
in determining the operating profit or loss of the segment.

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The operating profit test is met when an industry segment absolute amount of its operating profit or loss
is 10% or more of the greater, in absolute amount of (1) the combined operating profits of all industry
segments that do not incur operating loss, or (2) the combined operating loss of all industry segments
that did incur an operating loss.
To illustrate, assume that XYZ company has four segments; namely W, X, Y, & Z.
Segments
W X Y Z
Operating profit (Loss) Br (50,000) Br(10,000) Br. 90,000 Br. 70,000 – Br. 100,000
Equity investment income 15,000 - - - 25,000 ---------- 40,000
Corporate expenses _ _ _ _ (12,000) (12,000)
Interest (5,000) (5,000)
Totals Br (35,000) (10,000) 90,000 70,000 8,000 123,000

In order to determine the reportable segment using the operating profit test, the following steps can be
followd

Step 1: Add the profits of all segments that reported a profit. In this case, segment Y and Z reported a
profit and their total operating profits are Br. 160,000 (i.e. 90,000 + 70,000 = Br. 160,00).
Step 2. Add the losses of all segments that reported a loss. In the forgoing example, segments W and X
have reported a loss. The total losses of both segments are Br. 60,000 (i.e 50,000 + 10,000 =
60,000).
Step 3. Determine the benchmark to identify reportable segment
Benchmark = 10% of total operating profit, or
= 10% of total operating losses, i.e.
= 10% x 160,000 = 16,000
= 10% x 60,000 = 6,000
Step 4. Identify the reportable segment
The greater of the benchmark determined in step 3 is Br. 16,000. Thus, a segment whose
operating profit is 10% or more is reportable. As a result, segment W, Y, and Z are reportable
because their operating profits or losses are greater than Br. 16,000.

Asset test
The asset test is met when an industry segment’s identifiable assets are 10% or more of the combined
identifiable assets of all industry segments. Identifiable assets include tangible and intangible assets
(including good will) used exclusively by an industry segment and an allocated portion of assets used

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jointly by two or more industry segments. In the determination of segment’s identifiable assets, asset
valuation allowances should be taken into account. Asset valuation allowances include allowance for
doubtful accounts, accumulated depreciation, marketable securities valuation allowance, and inventories
valuation allowances. The identifiable assets of the segment should not include assets maintained for
general corporate purposes and inter segment loans, advances, or investments, except for those of a
financial segment.

To illustrate, suppose that the identifiable assets of XYZ company’s segments are shown below (in
1thousands):
Segments
W X Y Z Corporate Total
Identifiable assets Br 40 50 300 90 – 480
Investments (inter segment) - - 20 – 60 80
Corporate _ _ _ _ 10 10
Loans (inter segment) 5 4 - - 8 17
Totals 45 54 320 90 78 587

Besides, it is assumed that none of the segments is financial segment.

To identify reportable segment, the following steps can be followed:

Step 1. Compute the total identifiable assets of all segment
Total identifiable assets = 480,000
Step 2. Determine the benchmark
Benchmark = 10% of total identifiable assets
= 10% x 480,000
= 48,000
Step 3. Identify a reportable segment
A reportable segment is one whose identifiable assets are 10% or more of total identifiable assets of all
segments. Since their identifiable assets are grater than Br. 48,000, segments X, Y, and Z are reportable
segments.

Exercise
1. What is an industry segment?
2. What is reportable industry segment?
3. The following data is selected for the segments of Crown Company for the year ended December
31, 2003:

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Segments
J K L M N
Revenues 21,000 6500 32,000 3100 17,000
Operating profit (loss) 1,200 (300) 7500 200 6700
Identifiable assets 34000 3800 22,000 7200 5900

Required: Determine
a. Which, if any, of these segments would qualify as reportable segments?
b. Whether a substantial portion of crown company’s total operations is represented by reportable
segments.
Foreign operations
According to FASB statement No. 14, multinational companies are required to disclose domestic as well
as significant foreign operations. Multinational companies are those companies that establish their own
plants in different countries over the world. Foreign operations (for multinational companies) include
those operations that are located outside a “home country” and which produce revenue either:
- by unaffiliated customer sales
- by inter company sales
Foreign operations do not include the operation of unconsolidated subsidiaries and investees.
Multinational companies may group operations in individual foreign countries. The basis of grouping
may be:
- proximity
- economic affinity, or
- similarity in business environment

As indicated above, multinational companies are required to disclose only significant foreign operations.
Foreign operation is said to be significant if it meets either of the following two tests:

1. Revenue test
Revenue from sales to unaffiliated customers is 10% or more of consolidated revenue. In this case, if the
revenue from sales to unaffiliated customers is 10% or more of consolidated revenue, the operation
should be reported separately.

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Example
Intel Telecommunication Company has subsidiaries in three different African countries. The sales
results of domestic and foreign operations are shown below (in thousands)

Domestic Kenya Uganda Togo Combined Elim Consoli

nations dated
Sales to unaffiliated
Customers 4000 1500 5000 700 11,200 – 11200
Inter area sales 500 – 200 – 700 (700) –
Total revenue 4500 1500 5200 700 11,900 (700) 11,200

Revenue test benchmark = 10% of consolidated revenues

= 10% x 11,200 = 1120

Domestic operations, Kenya operation, and Uganda operation are reportable operations because their
revenue from sales to unaffiliated customers is greater than 10% of consolidated revenue. Togo’s
operation is not reportable because its sales ($700) are less than 10% of consolidated revenue.

2. Asset test
If asset test is followed, the operation’s identifiable assets should be 10% or more of consolidated assets
in order to be reportable.

Example
Intel Telecommunication Company has subsidiaries in three different African countries. The assets of
domestic and three foreign operations are shown below: (in thousands)

Domestic Kenya Uganda Togo Combined Eliminations

Consolidated
Identifiable assets $20,000 5000 10,000 3000 38,000 – 38,000
Investments Affiliates 7000 – 2000 9,000 – 9000
General corporate assets 12,000 12,000 – 12,000
Inter area advances 4000 1000 - - 5,000 (5000) –
Total assets 43,000 6000 12000 3000 64,000 (5000) 59000

Assets test benchmark = 10% of consolidated assets

= 10% x 59000 = 5900

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On the basis of asset test, only domestic, Kenya and Uganda operations are reportable because their
identifiable assets are greater than the asset test benchmark of $5900. Togo operation is not separately
reported.

Generally, for all separately reportable operations as well as for the combined areas, revenues,
profitability information, and identifiable assets must be disclosed.

Exercise

1. What is meant by foreign operations?

2. What is multinational company?
Assume that more corporation has operations in South Africa and three African countries.
Benin Ghana Cameron Domestic
Sales to unaffi
liated customers 4000 8000 5000 18,000
Inter area sales 2000 3000 – 6000
Identifiable assets 10,000 15,000 11,000 25,000
General corporate assets 16,000

Required
Identify an operation that requires separate disclosure under the following tests:
a. revenue test
b. asset test
Export sales
Are foreign operations and export sales the same? No. Foreign operations and export sales are not the
same although it is not easy to identify the boundary between them. In general, as defined earlier,
foreign operations are those operations that are located outside a “home country” and which produce
revenue from either sale to unaffiliated customers or to members of a group of companies. On the other
hand, export sales represent revenues generated aboard from services provided by domestic offices.
Export sales is said to occur if the company’s domestic operations sell to unaffiliated foreign customers.
Export sales should be disclosed in total and when appropriate by geographic area if such sales are at
least 10% of the company’s consolidated revenue.

Major customer

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According to Statement of Financial Accounting Standard (SFAS No. 30), a major customer is one that
provides a firm with 10% or more of the company’s revenue. Major customer could be business
concerns, domestic government entity, or foreign government entity. According to the statement, the
company has to disclose sales to major customers.
EXERCISE
Lenco Company Segments—Profits and Losses
Soft drinks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,700,000
Wine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (600,000)
Food products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240,000
Paper packaging . . . . . . . . . . . . . . . . . . . . . . . . . . . 880,000
Recreation parks . . . . . . . . . . . . . . . . . . . . . . . . . . . (130,000)
Net operating profit . . . . . . . . . . . . . . . . . . . . . . . $2,090,000
Three of these industry segments (soft drinks, food products, and paper packaging) report profits that
total $2,820,000. The two remaining segments have losses of $730,000 for the year

Profits Losses
Soft drinks . . . . . . . . . . . . $1,700,000 Wine . . . . . . . . . . . . . . . . . $600,000
Food products . . . . . . . . . . 240,000 Recreation parks . . . . . . . . . 130,000
Paper packaging . . . . . . . . 880,000
Total . . . . . . . . . . . . . . . $2,820,000 Total . . . . . . . . . . . . . . . . $730,000

Consequently, $2,820,000 serves as the basis for the profit or loss test because that figure is larger in
absolute terms than $730,000. Based on the 10 percent threshold, any operating segment with either a
profit or loss of more than $282,000 (10% _ $2,820,000) is considered material and, thus, must be
disclosed separately. According to this one test, the soft drink and paper packaging segments (with
operating profits of $1.7 million and $880,000, respectively) are both judged to be reportable, as is the
wine segment, despite having a loss of $600,000. Operating segments that do not meet any of the
quantitative thresholds may be combined to produce a reportable segment if they share a majority of the
aggregation criteria listed earlier

Interim Financial Reports

Interim financial reports are defined as reports prepared for a period of less than a year.
Generally, financial statements are issued for the full fiscal year of a business enterprise. In addition,
many enterprises issue complete financial statements for interim accounting periods during the course of
a fiscal year. For example, a closely held co. with outstanding bank loans may be required to provide

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monthly or quarterly financial statement to the lending bank. However, interim financial statements
usually associated with the quarterly reports issued by publicly owned companies and the stock
exchanges that list their capital stock.
THE NEED FOR INTERIM REPORTS
Stakeholders, like investors, creditors, suppliers, and others, need information about the financial
performance of the enterprise. These users cannot wait for the end of the year to do so. They need
financial information periodically, at the end of either a month, quarter, or semiannually.
Thus, The purpose of preparing interim financial reports is to meet the needs of decision makers.
Decision makers are interested in frequent and timely information about the firm’s financial position and
results of operations. Among decision makers lenders are the common users. They need to closely
monitor the progress of borrowers so that problems can be identified as early as possible. Another
reason for the interest in interim financial reports is to use such reports as a basis for projecting annual
results.
An interim financial report may include either a
a. Selected financial data
b. Complete set of financial statements
APB opinion No. 28
The stated objectives APB opinion No. 28 were to provide guidance on accounting issues peculiar to
interim reporting and to set forth minimum disclosures requirements for interim financial reports of
publicly owned enterprises one part of the opinion dealt with standards for measuring interim financial
information and another covered disclosure of summer zed interim financial data by publicly owned
enterprises. In APB opinion No 28, adopted the integral theory that interim periods should be considered
as integral parts of the annual accounting period. The APB established guideline for the following
components of interim financial reports: revenue, costs associated with revenue, all other costs and
expenses, and income taxes expense. These guidelines are discussed in the following sections.
Revenue
Revenue from products sold or services rendered should be recognized for an interim period on the same
basis as followed for the full year. Further, business enterprises having significant seasonal variations in
revenue should disclose the seasonal nature of their activities.

Other costs and Expenses

Costs and expenses other than product costs should be charged to income in interim periods as incurred,
or be allocated among interim periods bases on an estimate of time expired, benefit received or activity
associated with the periods.
Disclosures of Interim Financial Data
As minimum disclosure, APB opinion No. 28 provided that the following data should be included in
publicly owned enterprises interim financial reports to stockholders. The date, or 12 months to data of
the quarter’ end.

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1. sales or gross revenue, income taxes expense, extra ordinary items (including related income tax
effect) cumulative effect of a change in accounting principle or practice and net income.
2. Basis and diluted EPS data for each period presented
3. Seasonal revenue, costs, or expenses
4. Significant changes in estimates or provisions for income taxes.
5. Disposal of a business segment and extraordinary, Unusual or infrequently accruing item.
6. contingent items
7. Changes in accounting principle or estimate
8. Significant changes in financial position

For enterprises that complete a material business combination in an interim period, the FASB requires
disclosure of the following through the most recent interim period of the relevant fiscal year.
1. The name and a brief description of the acquired entity and the percentage of voting equity
interests acquired.
2. The primary reasons for the acquisition including a description of the factors that contributed to a
purchase price those results in recognition of good will.
3. The period for which the results of operations of the acquired entity are included in the income
statement of the combined entity.
4. The cost of the acquired entity and if applicable, the number of shares of equity interests (such as
common shares, preferred shares, or partnership interests) issued or assumable, the value
assigned to those interests and the basis for determining that value.
5. Supplemental pro-forma information that discloses the results of operations for the current year
up to date of the most recent interim statement of financial position presented (and for the
corresponding periods in the preceding year) as though the business combination had been
competed as of the beginning of the period being reported on. That pro-forma information shall
display, at a minimum, cumulative effect of accounting (changes including those on an interim
basis), net income, and EPS.
6. The nature and amounts of any material, non recurring items included in the reported pro forma
results of operations.

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