 Hello and welcome to this session. This is Professor Farhat and this session we will look at the temporal method and illustration of that method in Translating the financial statement. This topic is covered in international accounting advanced accounting course CPA exam as well as the ACC exam as always if you haven't connected with me on LinkedIn, please do so and make sure you subscribe to my YouTube I have 1500 plus Accounting auditing finance and tax Lectures, I also have my channel a website for my channel Farhat lectures dot com where you can access additional information resources powerpoint slides quizzes so on and so forth If you are planning to study It's good to study with more than one individual study pal.co will give you their option It's an artificial intelligence driven study by the platform. They have users in 85 countries in 2500 cities So what is helpful for this session? It's helpful if you know what the temporal method is and the current rate methods are and When to use the temporal method and when to use the current rate method? I have the links for those sessions in the description now to illustrate this concept once again We're going to be working now the reason I say once again because we're ready that the current rate method Illustration we're going to be in the same kind of the dick same type of data, but it's going to be It's going to be the temporal method So it's going to be u.s. Company that purchase an Italian subsidiary. So assume a u.s. Based company Purchased an Italian company on December 31st year zero on that date the company invested 1,350,000 and they bought 100% of the stock of the Italian company The exchange rate was one $1.35 sent to a euro simply put we invested 1 million euros in terms of euros immediately We invested 600,000 in inventory and the remaining $400,000 was in cash The Italian company began operation on January 1st with net asset of a million euros and net monetary asset position of 400,000 that means cash and receivable. So what's the net monetary position? Cash and receivable minus the current liabilities and that we have we only have 400,000 of cash. So basically this is the net monetary position This is the net asset and we have inventories of 600,000. This is what we started with now throughout the year year one The company purchase the Italian company purchase property plant and equipment They acquire a patent and they purchase additional inventory primarily on account They negotiated a five-year loan to help purchase the equipment. So they borrowed money for the equipment Sales are made primarily on account and expenses were incurred income after taxes was 825 euros and Dividend was 325,000 declared now if you don't have this data write it down It's helpful any data that if you don't have the PowerPoint slides, which you can download from my website You know copy the data down and this is the income statement for year one So they have sales minus cost of goods sold gives them gross profit Minus selling depreciation amortization interest gives them income before taxes. They pay taxes and this is net income in euros Retained earning the beginning was zero plus net income, which is 825 Plus net income minus the dividend gives them ending retained earning of half a million This is what their balance sheet looks like cash receivable. This is their monetary net monetary asset Inventory at cost using FIFO property plant and equipment that they purchase using the loan Patent of 80,000 accounts payable long-term debt Capital stock the initial investment retained earning from coming from the coming from the retained earning statement and the total Total liabilities and equity of 3,830 total assets equal total liabilities and equity And I want to point out that their net asset position net liability position So they have one million one million one hundred and ten thousand of of net monetary assets cash and And receivable and they have liabilities of 330 plus 2 million so the difference between those two figures in this figure is the net Monetary position would happen to be a liability exposure liability exposure and we'll see why that's important later This is the data about the foreign currency foreign currency Rates and this is important. This isn't that's more important than the current rate method because here we're gonna be using many Methods so January 1st This was the rate when we initially invested in the company when we bought the property plant and equipment This was the rate when we bought the patent This was the rate the average for the year was this much Rate one dividend declare was this much average for the month of December this much in December 31st Year one at the end of the year 125 so notice again the same as in the prior example We gave the example where the euro is declining and the reason is to make a point just to kind of hopefully you can see the point Okay, so this is the data if you don't have go to my website. Otherwise copy it down Re-measurement or financial statement the temporal method now, let's assume just that the euro That the euro financial statement will be measured into US dollars in the temporal method now if you if you are If you're saying why again go why when do we use the temporal method when do we use the current rate method and the Re-measurement gain or loss would be reported in that income and you're gonna see how this work now remember in the prior method the Translation adjustment was in the balance sheet now. It's gonna be in the it's gonna be an income So it's gonna be interesting to see the difference compare and contrast So to ensure that the remeasurement gain or loss is reported in that income We're gonna start by re-measuring the balance sheet. So when you use the temporal method the first thing you do is you Re-measure the balance sheet. So let's re-measure the balance sheet work Well, first we're gonna start with cash or monetary asset monetary assets. They are Translated at the current exchange rate 125 account receivable at the current exchange rate 125 So this is how we're getting these figures Now inventory will be will be translated using the historical rate then we're gonna get total current assets Property plant and equipment are gonna be translated on the date that they were purchased when we purchased property plant and equipment rate was 133 Same thing with accumulated depreciation because it's related to that the patent the rate was 132 when we purchased it Therefore total asset is four million nine hundred forty five thousand one hundred dollar liabilities Which are the financial monetary assets? Liabilities are Yes, liabilities. They are basically monetary monetary liabilities. They are Translated at the current rate just like Cash and receivable Liabilities again at the current rate just like cash and receivable We're gonna get to total liabilities now We have assets and We have liabilities What can we find if we have assets and liabilities? We have equity So what's gonna happen from equity? We know one part of equity is common stock and we know common stock is one million three hundred and fifty Okay, because it's translated at the historical rate then now we know that the total equity that the total equity should be four million nine hundred a Fort four million nine hundred forty five thousand one hundred dollar because liabilities and equity should equal to the assets Now we have everything except retained earnings What does that mean? It means retained earnings is going to be a plug now. How do you find retained earnings? Well We said first more than one way well if you say the difference between assets if we take four million nine hundred forty five thousand one hundred minus liabilities liabilities are Two million nine hundred twelve thousand Five hundred let's find out how much is equity. Just give me one moment, please. I'm gonna do this computation Then we're gonna back into Retained earnings. Okay, and this is important. So first we're gonna prepare the balance sheet To find the retained earnings. So we have four million nine hundred forty five thousand one hundred minus two million nine hundred twelve thousand five hundred So equity should be two million thirty two thousand six hundred two million thirty two thousand six hundred now we know we have one million three hundred and fifty in equity So if we subtract one million three hundred and fifty That's what's gonna keep us with six hundred Eighty two thousand six hundred. So this must be the plug Six hundred eighty two thousand six hundred. So this is the plug to balance so and so basically we completed everything and we Plug this figure to balance which is six eighty two six hundred which is retained earnings So retained earnings is the plug here now. This is important. You're gonna see how we're gonna be using retained earnings to find the Adjustment for gain or loss now Remember on the balance sheet cash receivable and liabilities are measured at the current rate Those are the monetary assets and liabilities Inventory carried at cost Property plan equipment are carried at historical rate. Whatever whenever that transaction occur this spreadsheet this procedure resulted in four million nine hundred forty five thousand one hundred in assets and Liabilities and capital stock of four million two hundred sixty two five hundred the plug was retained earnings. So this is just basically a Summary of what I just did and this is gonna help us compute the remeasurement the remeasurement gain So let's take a look now on the income statement. This is the income statement that we are given This is the income statement. Let's take a look at it and see what happened Sales are assumed to be occurring throughout the year use the average Cost of goods sold here. We have to do a little bit more of work cost of goods. So we're gonna take beginning inventory Multiplied by the beginning rate. So beginning inventory multiplied by the beginning rate 810 Purchases we're gonna assume they they were they occur throughout the year. Therefore, we use the average rate purchases 620 times the average rate 860,000 and ending inventory. We're gonna be using the average in December. We assume we bought them throughout December We have 800,000 times one to six. So beginning inventory plus purchases minus ending inventory gives us cost of goods sold of seven million of 7,860,000 so the cost of goods sold There's three components and each component is used a different rate. What 782 is the 782 is the answer So let's go ahead and use 782 7 7,862,000 Okay, so sales minus cost of goods sold gives us gross profit minus selling which is the average minus depreciation expense we use historical rate because we when we bought them we use historical rate same thing with Amortization when we bought the patent the interest is the average rate Then the income tax is the average Okay, so pretty much we accounted for everything we stop now We stop now we know retained earning is zero for this example We know ending retained earning is 680 to 680 to 600 which which this was a plug You remember plug in the from the balance sheet. We also know that dividend was 352 translated at At 127 that's gonna give us dividend in US dollar 412 750 So now we're gonna have to find out net income. So net income now is the plug So how much is net income? So basically what number do we need? So what's zero plus what number minus 412 750 equal to 680 to 600? So simply put zero plus x minus 412 750 it's gonna give us 680 to 600 the x is net income. So let's see what that figure is that income is 1,000,000 1,095,350 this is what net income should be. So simply put net income should be 1,091,095,350 Well, what does that mean? It means you have to go through this through the whole computation take sales minus cost of goods sold Gives you gross profit gross profit minus selling minus depreciation minus amortization minus interest expense minus minus minus income taxes And that should give us 1,095,350. So let's see what this will give us if we went through this computation So now we're gonna be back in into this remeasurement gain. So we have sales of 10,400,000 minus cost of goods sold of seven hundred seven million eight hundred sixty two thousand That gives us gross profit of two million 350 minus 650 with that 650 selling and administrative minus 650 minus 266 depreciation minus 26400 amortization minus interest of 234 minus taxes of 357 500 and now we came up to 1,401,000,000 $4,100. Well, the answer should be 1,095,352 Okay, so what's the difference between 1,004,100 and 1,095,350 I hope I did I did miss anything so the Remeasurement plug should be 90 90 1,250 so the answer should be 90 90 1,250 so simply put we have to add Again, okay of 91,250 now why it's again. We're gonna see why but this it's a plug So basically this is the plug so first So first we find net income as a first we find retained earning as a plug from retained earning We're gonna find that income from net income will find the plug on the income statement Whether it's supposed to be gain again or a loss now what happened when we did all of this when we took Sales minus all the known numbers what we find out is we took too much We have to kind of add 91,250 and this will be a remeasurement gain a remeasurement gain Why is it a remeasurement gain? We're gonna see why we have a gain why it what why why it happens to be a gain Now on the prior example remember we had a loss Because we had a net asset exposure. Let's see what happened in this example. So we have again So this is the mechanics of it. Let's review real quick revenues and expenses occurred evenly That's why you use the average rate same as selling administrative interests and income taxes Expenses related to historical exchange rates such as depreciation and amortization are themselves measured at historical rate But we talked about this now retained earning the ending balance and retained earning on the balance sheet and in this in the Statement of retained earning must reconcile with one another so balance So first we found the balance sheet and it should be the same in retained earning Given dividend are we measured a new as dollar of equivalent of 412 750 in the ending balance and retained earning should be 682 And this is how we found net income in order for the amount of net income reported an income statement and the In the in the statement of retained earning and the income statement to reconcile with one another We had to plug again a remeasurement gain of 912 250 Okay, without this remeasurement gain the income statement statement of retained earning and the balance sheet will not be consistent with Each other so remember first we found retained earnings. It was a plug from retained earning. We find out what net income should be Well, then from that income we had to make an adjustment We had to make a remeasurement gain or the measurement loss sometime But this is how we went through this. So this is how you how you do this using the temporal method Now, is there an alternative method to compute the remeasurement gain? Well, there is one I'm going to go over it. Although I don't you know Just try to get the most out of it. But let me show you how it works Remeasurement gain or loss for that matter, which is the remeasurement Calculated by considering the impact of the exchange rate changes on the subsidiaries balance sheet exposure What are we talking about here under the temporal method the italian The italian company balance sheet exposure is defined by its net monetary asset or net monetary position Now, what is net monetary asset net monetary position net monetary asset is Cash and receivable not monetary liabilities Is if you have more liabilities current liabilities than cash and receivable So the italian company started with a not monetary asset. We had everything in cash 400 000 then throughout the year Expenditure for cash and in currents of liabilities caused monetary liabilities accounts fable and long-term debt of two million three hundred and thirty and those exceeded The cash and receivable which were one million one hundred and fifty so overall We had a net monetary liability position So in this example in this example We had a net monetary liability position because we had more liabilities Than cash and receivable. So overall we had a not net monetary Liability position at december 31st. So now what we can do the remeasurement gain is computed by translating the beginning net monetary asset position In subsequent changes in monetary items at appropriate exchanges And then comparing this with the us dollar value of not net monetary liability at year end based on the current exchange Uh, well, let's take a look at how we do this. So what's going to happen? We're going to start with our net monetary asset one one year one, which was only cash of 400 000 multiplied by the rate at that time 135 that's five hundred and forty thousand Sales of 800 000 translated at the average that's 10 400 000 simply put our net monetary asset simply went up Then we purchase inventory of six six point two million. That's going to be translated at the average rate Our net monetary asset went down eight million and sixty thousand Selling expenses also translated at the average rate payment of interest at the average rate income taxes at the average rate Property plant and equipment that's translated at the historical rate at that point dividend Patent at the historical rate In dividend at the historical rate. So it's what's going to happen overall. We have a net monetary liability We have not monetary liability Okay, net monetary liabilities because we have more liabilities than Then uh, then cash and receivables now if we look at at us dollar This is the position in us dollar if we take the net monetary liabilities and we translate it at the current rate It should we should give us one million four hundred and seventy five But our net monetary position is one million five hundred sixty six Simply put simply put because we have a lot of liabilities Okay, we have more liabilities than asset And the currency went down in value Is this good for us or bad? This is good for the parent company. It's good if we have liabilities and a foreign currency And that foreign currency weakened Which will happen in the euro here. So us comes us company would say that's good We have a gain. Why we have a gain because we have liabilities and a foreign currency But that foreign currency Value went down. Therefore. It's easier for us our local currency the us dollar will be able to to buy To buy more euros to cover the liabilities. Therefore, we have a re-measurement gain And that's why we have a re-measurement gain in this example of 91,250 So this example was designed that you have a net monetary liabilities You have more liabilities than a monetary assets By one million one hundred and eighty And as a result if you want to pay that liability at the current rate at 125 You are only responsible for one million seven hundred one million four hundred and seventy five thousand But on the balance sheet you're reporting one million five hundred sixty six Well, you have a re-measurement gain on the income stated on the income statement You would say you would this gain would reflect if you happen to pay the liabilities today at the current rate Which you'll only have to pay that much it means you have a gain and the opposite would have been true If you had to pay more Okay, if this answer if the rate was different if the rate was different if the rate was 1.4 This will be more then you'll have to pay more. You this will be a loss okay, um So let's just kind of to illustrate what we're talking about here Hopefully this makes sense if the italian company has maintained its cash position of 400 000 for the entire year Then they will have a re-measurement loss of 40 000 and you might be saying why well think about it The euro amount held in cash was worth 540 000 at the beginning of the year which is 400 000 times 1.35 At the end of the year That cash is only worth half a million because they still have a sum in 400 000 in cash Times 1.25 i'm just showing you How did we do this now bear in mind in this example The net monetary asset is not maintained. We had at the end. We had a not monetary liability Okay, we had a not monetary liability And the depreciation of the foreign currency What happened to the currency because we have a liability and the foreign currency went down That was good for us coupled with an increase in net monetary liabilities So that helped us have Very a gain remeasurement again the remeasurement simply put remeasurement gain of 91 000 250 and we computed this but i just want you to understand if you got a multiple choice question Should I have a remeasurement gain or a remeasurement loss? Well, what's my exposure is my exposure liabilities if the answer is yes The deferring currency went down in value if the answer is yes great. I want this Well, the opposite would be true if the currency went down and you have a net asset position Then you you would have a remeasurement loss Okay, if you have any questions any comments about this session email me if you happen to visit my website for additional lectures Please consider subscribing if you're studying for your CPA exam as always study hard that's worth it Good luck