 Hello, and welcome to the session. This is Professor Farhad. In this session, we would look at the translation of financial statement using the current rate method. In this session, I'm gonna have an illustration. What does that mean? It means in the prior session, I explain what the current rate method is. In this session, I will just go through an example to show you how it works in the real world. Now this is topic that could be covered in international accounting course, advanced accounting CPA as well as the ACCA exam. As always, I would like to remind you if you have not connected with me only then to please do so. YouTube is what I have 1,500 plus accounting, auditing, tax and finance lectures. So if you like my lectures, please like them, share them, put them in play, let the world know about them. Thank you for your contribution. Also on my website, I do have additional resources. You can visit my website. And if you'd like to access the PowerPoint slides, additional practices for your CPA exam, CMA exam or your accounting lessons, you can do so on my website. If you are, if you're looking for a study pal, I suggest studypal.com.co where they connect you with other people who are studying for the CPA or CFA exam. They are located in 85 countries in 2,800 cities. Now what is the prerequisite for this session? It's helpful if you watch the temporal method and the current rate method, basically the theory, and also when to use the temporal and when to use the current rate method. So I'm also gonna have links for those. So in this session, I'm gonna go over an example illustrating this current rate method. So if you have any doubts about what is the current rate method, when is it used, I'll have the link in the description explaining this process. So to illustrate the concept, we're gonna assume, it's a, we are working with a multi-U.S. multi-national company and it's based in the U.S. And what they did is they bought a subsidiary in Italy, so Italian code, the Italian company on December 31st, year zero. On that date, what we did, the parent company invested 1,350,000 U.S. dollar in exchange for all the stocks of the subsidiary. So we bought the subsidiary for 1,350,000. The exchange rate was one euro equal to 135, simply put, we made an investment of a million euro. Of that investments, $600,000, 600 euros was immediately invested in inventory and remainder, which is $400,000, was held in cash. So after we put the money, that's what happened. The Italian company began operation on January 1st with the stockholder net asset of a million dollar, sorry, million euros, million euros and not net monetary asset of 400,000, which is cash. And this is what the beginning balance sheet looks like. This is how much we invested, of which immediately we purchased inventory, worth of $600,000 and the remaining we kept in cash. 600,000 euros, sorry, euros, we're dealing with euros. So this is the beginning of the year, January 1st, net asset. So we're gonna look at this number later on. So the beginning net asset of this company is a million euro. This is January 1st, when the company started. Now throughout the year, what happened? The company operated their business and they purchased property and equipment. They purchased a patent. They made additional purchases of inventory, primarily on account. They also negotiated a five year loan to help purchase the equipment. That's fine, so they have a loan. They made sales primarily on account when expenses were incurred. Income after taxes were 825,000 euros and dividend was 325 euros declared on December 1st. And this is what the Italian income statement looked like. So the sales were 8 million, cost of goods sold 6 million, gross profit two. Then they had selling an administrative half a million, depreciation expense, amortization expense, interest expense. Income before taxes, they have paid income taxes and this is their net income. Their beginning retained earnings is obviously zero. The company did not exist prior. They have net income, net income of 825 euros minus the 325 dividend. So their ending retained earnings in euros is half a million. So this is their income statement. Let's take a look at their balance sheet. This is their balance sheet at year end. This is their balance sheet at year end. So they have cash, receivable inventory. Inventory is reported at cost using FIFO. And all the inventory was purchased in December. And we're gonna assume it was evenly purchased in December, property, plant and equipment, accumulated depreciation. And this is their total assets. They have accounts payable long-term note. You remember they used the note to buy the equipment. Capital stock of a million and retained earning of 500,000 notice. The end of the year net asset, which is equity, is 1,500,000. Just copy these numbers down. You're gonna see them later on when I do a quick reconciliation. So the ending year net asset is 1.5 million. The beginning year net asset is, what was the beginning year balance sheet? The beginning year balance sheet net asset is a million. So that's what happened. You'll see why I'm using these numbers. So to properly translate the euros, financial statement into US dollar, we must gather exchange rate between the euros and the US dollar at various dates. So we need to know that the euro was at the beginning of the year dollar 35. Rate when the property and equipment were acquired, 1,33. Rate when the patent was acquired, 1,32. Those are not very important for this session, but for the next session, those rates are important. The average for the year is 1,1.3. Rate when the dividend was declared, 1,27. The average for the month of December, 1,26. And the December 31st is 1,25. Okay, so those were the rates. Now, I want you to notice and there's a reason for this. The euro is steadily declining and you'll see why we set up the example this way to make a point, but it doesn't have to be constantly declining. We made it declining so we can make a point at the end. So those are, if you don't have the balance, you still don't have this data copy, this information down. So we're gonna assume the euro is the functional currency and we're gonna be using the current rate method. Now, you're gonna be saying why the euro is the functional currency? Why are we using the current rate method? Look in the description for why, when to use the current rate method, okay? So here's what's gonna happen. We're gonna first, using the current rate method, first you translate the income statement. Pretty straightforward. I mean, yeah, that makes sense. You translate the income statement first. Well, you're gonna see later that may not be the case under the other method. So, but let's go ahead and start. So, which rate do we use or which rate or rates do we use to translate the income statement? Well, guess what? If we're using the current rate method, we're gonna be using the average, $1.30. Let me show you where this is coming from. This is the average. We're gonna assume that the sales and the expenses took place throughout the year. Therefore, we use the average. So we're gonna take sales times the average rate, cost of goods, soul times the average rate. They'll give us gross profit. Selling times the average rate. Depreciation expense times the average rate. And you'll see this is gonna be a little bit different when we look at the other illustration. Amortization expense, interest expense, income before taxes, income taxes, and this is net income. So this is net income. Notice we used all the average rate to translate the financial statements. Now we'll do the same. Let's go move on to the statement of retained earning. Beginning retained earning is zero. Net income, net income coming from above. We don't have to do anything. Now dividend, dividend times the historical rate. Why 127? Because the rate, the rate was 127 when the dividend was declared. So we have to use that historical, we have to use that historical rate, okay? Then we come up with ending retained earning of 659. Now remember ending retained earnings, it's gonna go to the balance sheet. So let's move to the balance sheet. So before we proceed, just nothing, nothing unusual here. We took the income statement. We translate everything on the income statement using the average rate and the dividend using the historical rate. Pretty straightforward. Now on the balance sheet. For the balance sheet, we use the current rate. So cash times the current rate. Current means the December 31st. Let me show you. Current rate is the December 31st rate, which is the last day of the year. So we're gonna be using this for the assets and the liabilities using the current, current, current rate, current rate. And this is total assets. So total assets is 4,000,000,000. Total asset is 4,000,000,000, 700,000, 4,000,000, 700,000, 8,000,000, 500. We'll do the same thing with liabilities. We translate it at current rate. Translate the long-term debt at current rate. Total liabilities is 2,912,500 dollars. This is liabilities, 2,112,500. Now if we have assets and liabilities, let's do this real quick. Our equity, let me just show you what's gonna happen here. Before we proceed any further, so we have 4,787,500. That's the assets minus the liabilities of liabilities of 2,912,500. 2,912, so let's go back to the calculator. The answer is 1,875. So equity should be 1,875. Before we even show the equity, but hopefully you can see this. If we have assets translated and we have liabilities translated, now equity should be that much. Now, first thing is we have capital stock, capital stock based on the historical rate, okay? Then we have retained earning. Retained earning is coming from the statement of retained earning above. So this number is coming from the statement of retained earning above. So what we are saying is equity should be 1,875. Let's see how much equity do we have based on these two figures, the historical rate and the rate, the statement of retained earning computation. So let's do this, 1,350 plus 659,750. That's gonna give us 2,009,750. 2,009,750, hold on a second. But equity should be 1,875 because we translated assets, we translated liabilities. Now, here comes what we called the cumulative translation adjustment or simply it's a translation adjustment, but it's a cumulative. Means it stays with us from year to year. What do we have to do now? Well, think about it. If equity should be this figure, let's see. If equity should be, you know what we're saying, we said based on assets and liabilities, equity should be this figure, right? Assets, we computed assets, current rate, liabilities to current rate, the equity at the current rate should be that much, but it's not, it's 2,009,750. Guess what? We have to make a negative adjustment. What does it mean a negative adjustment? It means you have to plug a number to reduce, to reduce this 2,009,750 to 1,875,000. Well, what's the difference between them? The difference is 134,750. So notice we have to reduce our equity by 134,750. Simply put, this is a plug and this is the translation adjustment and the translation adjustment took place on the balance sheet for the current rate method. This is what we did. We translated the adjustment on the balance sheet and it's a negative adjustment. Now if we keep on going, now total equity 1,807,750 as it's supposed to be right here based on current asset and current liability rate and total equity is equal to total asset. So this is equal to this. So basically what we had to do, we had to plug a figure and in this situation we had to reduce our equity. Sometime we have to increase our equity. Now let's take a look at some overall observation. So no, the first thing is the adjustment is negative. It's a debit balance. So basically we debited this account. Now the question is why? Why is it a debit balance? Well, the adjustment is a function of two factors. So the translation adjustment whether it's positive or negative, it's a function of the nature of the balance sheet exposure. Does the company have more assets than liabilities or more liabilities than assets in the direction of change in the exchange rate? That the exchange rate appreciated or the exchange rate depreciated? Well, let's go back up here. Let me ask you this. Let me erase everything here before we proceed. Does this company have an asset exposure or a liability exposure? Does it have more assets than liabilities or more liabilities than assets? Well, we have that much assets, that much liabilities. Well, we have, the difference is we have an asset exposure, that's the first thing. Well, if we have an asset exposure, that's one. Okay, we have an asset exposure. Now the next thing is what happened to the, what happened to the foreign currency? Remember what I told you? The foreign currency went down. The foreign currency went down. Remember the euros going down because we're the US company. The euros going down. So what happened if you have a lot of assets and the currency going down? Think about receivable. Well, if you have receivable, you are receiving, you're expected to receive the money but you have an asset exposure that's not good for you because now, because your foreign currency going down and you're waiting to be paid when you translate that money into your home currency, into the US dollar, you're gonna get less because you have an asset exposure and the currency went down, depreciated. So what happened here is this. We have an asset exposure and the currency depreciated. The reaction of the change in the currency, the euro depreciated. So again, in this illustration, the Italian company has an asset exposure and the euro has depreciated, thus creating a negative translation adjustment. So basically we had to write down our equity a little bit to make sure it balances. Now, is there another way to compute this translation adjustment? Sometime you might be asked to compute the translation adjustments without going through the whole income statement and balance sheet. So basically the translation adjustment can be derived, can be obtained as a balance in figures that bring the balance sheet back into balance. The translation adjustment also can be computed by considering the impact of exchange rates, changes on the beginning, balance and subsequent changes in net asset position. So simply put what we're saying, if you can study your net asset position, the beginning net asset position and the ending net asset position and you could explain the difference, you can find this plug. So let's see if we can do that. Let's see how we do that. The net asset, when we started the year, remember we had one million of euros and I told you copy this number down, this is what we're gonna be using it. We have one million of euros, US dollar, one million, 350. The changes in net asset, we have net income of euros of 825, US dollar translated at 1,072,500 at the average rate, 1.3. We had dividend, which was translated at historical rate 1.25, okay? Now we have net asset balance, 1231 year one, 1 million, 1.5 million, but US is 2 million, 9,750. Now, if the net asset is 1,050, if the net asset 1,050, if we use the current rate, what do we get? Well, if we use the current rate, here's what's gonna happen. If we use the current rate, okay, which is for using the current method, the ending equity should be 1,875,000. Do you remember this number? This is the number that we should have and this is the number that we came up with. And what we needed to do, we need to write down this number down, we need to brought this number down by 1,34750, 1,34750. So rather than going through the whole income statement and balance sheet, well, if you are giving the income statement, if you are giving net income, if you are giving dividend, then you can basically kind of reconcile or confirm all this is shortcut, whatever you want to call it. But I know some professors, they do require it. I don't require it in my classes, but here's the explanation for it. If you wanna back into your translation adjustment, translation adjustment, okay? If you have any questions, any comments by all means, please email me. In the next session, we would look at the temporal method. If you happen to visit my website for additional lectures for different courses, you're gonna see more resources. Consider subscribing. It's an investment in your career. Good luck and study hard for your CP.