ACC301 Seminar 5 Slides 30 03 2018

ACC301 Advanced Financial Accounting
Seminar 5
Group reporting V - Equity accounting under FRS28
Translation of Foreign Currency FS

Learning Objectives
1. Appreciate the different accounting policies for investment in an

associate as reflected in investor’s separate FS and the Conso FS
2. Understand the differences between the cost and equity
method of accounting for associates
3. Know how to apply the equity method for investment in associate
4. Perform an analytical check on the investment in associate balance
5. Understand the concept of functional currency
6. Understand the accounting treatment of foreign currency
transactions
7. Understand the procedures for translating foreign currency FS
2
Content
1. Equity method versus cost method

2. Equity method versus consolidation
3. An overview of the methodology of equity accounting
4. Performing an analytical check on the investment in associate
balance
5. Specific procedures relating to the equity method

6. An overview of accounting for foreign exchange exposures
7. Concept of functional currency
8. Translation of foreign currency financial statements
3
Concept of “Significant Influence”
• The power to participate in, but not control or jointly control, the
financial and operating decisions of the investee
• Default assumption:
– Percentage ownership of ≥ 20% and ≤ 50% of investee’s voting rights
deemed as giving rise to “significant influence”
• Other evidence of “significant influence”:

– Representation on the board of directors;
– Participation in policy-making processes;
– Material transactions between the investor and investee;
– Interchange of managerial personnel; or
– Provision of essential technical information
4
Accounting Policy for Investments In Associates
Levels of financial reporting Accounting policy

1. Investor’s separate financial •Cost; or
statements: legal entity •as a financial instrument
(FRS (IAS) 39); or
•Equity method
2. Consolidated financial
statements (has both subsis and Equity method
associates): economic entity
3. Investor’s financial statement in

place of consolidated financial
Equity method
statements (has associates only,
no subsis): economic entity
5
Equity Method
• Equity accounting:
– Investment is initially recognized at cost and adjusted thereafter for
investor’s share of post-acquisition change in equity (which will include
retained earnings)
– Dividends are not treated as income but as repayment of equity-
accounted profit
– Investment account is not eliminated
Does this formula
Investment remind you of
in associate something from
Seminar 3?
Share of BV of Share of
net assets at unamortized Implicit
goodwill
reporting date FV adjustments
6
Equity Method
As at reporting date…
Share of post-
acq REs Implicit
goodwill
Implicit Implicit
goodwill Share of
goodwill unamortised
FV adjustments
CV
Cost = FV of Share of Share of
Consideration FV adjustments FV adjustments
transferred Share of BV of
net assets as at
Share of BV of Share of BV of reporting date
net assets at acq net assets at acq
date date
Subsequent to date
At date of acquisition
of acquisition
7
Cost Method Versus Equity Method
Dimensions Cost Method Equity Method

Income recognition • Dividend income • Share of profits
• Emphasizing reliability • Emphasizing the predictive
and realized income value of information of
unrealized gains
Asset measurement • Historical acquisition • Cost and
cost, less any
impairment loss • Share of post-acquisition
change in equity
• Less any impairment loss
Profit on sale • Large terminal profit • Smaller terminal profit
• Profits are recognized
systematically over
holding period
Nature of the • Economic independence • Economic interdependence
economic
relationship • Investor is deemed as a • Investor has “significant
between investor passive holder of influence” over the
and investee investment investee
8
Content

4. Performing an analytical check on the investment in
associate balance

6. An overview of accounting for foreign exchange
exposures
9
Rationale for Differences in Presentation
• Equity accounting captures the substance of consolidation but not

the form
– Individual line items of investor and associate are not combined
– Results and net assets of associate are recognized in single line
items:
• Share of profit of associate
• Share of tax of associate
• Investment in associate account
– Consolidation and equity method will achieve the same group
retained earnings and net assets
• Decision rights implicit in “significant influence” are not as strong as in

“control”
– Might be misleading to aggregate associate’s individual assets
and liabilities
10
Consolidation Vs Equity Method
Dimensions Consolidation Equity Method
Income • Income statement items • Share of profit and share of tax are
recognition reported as single line items in
of subsidiary are added
with the parent’s the income statement
Non- • NCI is shown • Only investor’s share of profit (net
controlling
interests (NCI) separately as a of tax) in associates is separately
deduction from profit added to the group’s profit before tax
after tax
• NCI allocation is not applicable
Asset • Investment • Investment is carried at cost +
measurement account is share of post-acquisition change
eliminated, and in equity
• Investment account includes:
• Substituted with line
items of each identifiable – Share of book value of net
assets + liabilities, and assets of associate
goodwill of subsidiaries – Share of fair value adjustments
at FV, net of amortisation – Goodwill
and impairment
11

Goodwill on Shown separately as an Implicit in the investment
consolidation asset on the consolidated account
balance sheet
Unamortized Adjustments are made on Unamortized balance is

balance of FV
adjustments the specific assets or implicit in the investment
liabilities on the account
consolidated balance sheet
Profit on sale of Profit on sale = Sales Profit on sale = Sales

investment proceeds – (Share of BV proceeds – (Share of BV
identifiable net assets + identifiable net assets +
goodwill + share of implicit goodwill + share of
unamortized balance of FV unamortized balance of
adjustments) FV adjustments)
12

Economic “Control” “Significant influence”
relationship
between
investor and
investee
Impact on Because of the line by line As the equity method does not
financial ratios
summation, certain entail the aggregation of line
reported items are larger items of an associate, certain
(e.g. assets and liabilities) ratios (e.g. debt-equity ratio)
making some ratios (e.g. may appear more favorable
return on assets and debt- under the equity method
equity) worse off
13
Content

associate balance

exposures
14
Methodology of Equity Accounting
1. Investment is initially recorded at cost

2. Investment at cost comprises of:
• Share of book value of the identifiable net assets of the associate
• Share of fair value adjustments of identifiable net assets
• Goodwill
3. Goodwill is implicit in the investment account and is written
off when the investment in associate is impaired
4. Fair value adjustment included in the cost of investment is
amortized or expensed off and adjusted against investor’s share
of profit in the period when amortization take place
5. Investor’s share of past and current amortization of fair
value adjustments is adjusted against the investment
account through the investor’s share of profit
15
Methodology of Equity Accounting
6. Post-acquisition change in the investor’s share of net assets
is added to the investment account
• Will include share of profit and tax in each reporting period from acquisition
date to disposal date
7. Share of current profit and tax of the associate will be adjusted for
unrealised effects of asset transfers between investor and
assoc:
• Unrealized profit arising from current year transfer
• Realized profit in current year arising from previous year transfer
8. Dividends
• Deemed as a "repayment" of profits
• Since share of profit is already recognized in the P/L by the investor,
dividends should not be recognized as profit
• It will be credited to the investment account as a realization of past
capitalised profit
9. Other changes in equity (e.g. increase in revaluation
reserves) are proportionately recognized in accordance with
the investor’s interest
16
Content

associate balance

exposures
17
Analytical Check
Investment
in associate
(at each reporting date)
Share of
Share of BV of Implicit
unamortized goodwill
net assets
FV adjustments
Investor’s share X (Acquisition cost –

Investor’s share X (Unamortized Share of FV of
(Book value of net balance of excess of FV identifiable net
assets -/+ unrealized over BV of identifiable net assets at acquisition
profit/loss) assets at acquisition date) date) – Impairment
loss
18
Content

associate balance

exposures
19
Conversion from the Cost Method to the Equity
Method
Begin with the investor’s

separate financial statements
and prepare equity accounting
adjustments in associate under
the equity method
Accounting for Investment in Associate

Investor’s separate financial Consolidated financial
statements statements
Cost method Equity method
As a financial instrument under
FRS (IAS) 39 Equity method
20
Reclassification of Dividends
• Dividends and other distributions are deemed as "repayment"

of profits
– These payments will reduce the investment account
• Under the equity method, income is recognized only on the basis of

net profit of the associate
• However, in the investor’s separate financial statements, dividend is

recognized as income
– Hence, to convert from cost to equity method, dividends
have to be reclassified from the income statement to the
balance sheet in the conso FS
– Equity accounting entry at group level :
Dr Dividend income (I/S)

Cr Investment in associate (B/S)
21
Consolidation Procedures NOT Applicable to Equity
Method
1. Elimination of intragroup balances is not required

• Equity method does not entail line-by-line aggregation
• Perfectly offsetting items and balances are not required
2. Investment in associate is not eliminated
• Investment account captures:
– Implicit goodwill
– Share of fair value of identifiable net assets at acquisition
– Share of change in post-acquisition retained earnings and
other equity
– Realization of profit through dividends
22
Specific Illustrations
Illustration 1: Accounting for amortisation of FV differential
Illustration 2: Accounting for impairment loss of investment in

associate
Illustration 3: Accounting for unrealised profit from transfer of

assets to/from Associate:
i) Transfer of inventory to Associate
ii) Transfer of fixed assets by Associate
23
Illustration 1: Amortization of FV
Adjustments of Identifiable Net Assets
• I acquired 20% of A’s share on 1 Jan 20X4

• Excess of FV over BV of a depreciable asset at acquisition date
was $5,000,000
• Depreciation was over remaining life of 10 years
• Retained earnings:
 as at acquisition date = $15,000,000;
 as at 1 Jan 20X5 = $20,000,000
• A’s current year net profit before tax for 20x5 = $10,000,000;
and tax expense = $2,100,000
• Tax rate was 20%
Prepare the equity accounting entries for the year ended 31 Dec 20X5.
24
Current year
One year from date of acquisition
Date of Beginning of End of

acquisition current year current year
1 Jan 20X4 1 Jan 20X5 1 Dec 20X5
Entries in this
period are to
Retained Earnings
EA 1, EA 2 The question
asked for
accounting entries
as at 31 Dec 2015
EA 1: Share of change in retained earnings (RE) in A from acquisition

date to beginning of current period
Dr Investment in associate 1,000,000

Cr Opening RE 1,000,000
RE as at 1 Jan 20X5 20,000,000

RE as at acquisition date 1 Jan 20X4 15,000,000
Change in RE 5,000,000
Share of A’s post-acquisition RE (20%) 1,000,000
Note: This entry capitalizes the share of past profits in the investmentaccount
26
EA 2: Share of past cumulative depreciation on

undervalued fixed assets (after-tax)
20% X (5,000,000 /
Dr Opening RE 80,000 10) X 80%
Cr Investment in associate 80,000
Note:
1) This EA is to account for the Investor’s share in the amortisation of FV
differential (excess of FV over BV). As at 1 Jan 20X5, there was only one
year of amortisation of FV differential from acquisition date
2) Any adjustments relating to associate’s assets or liabilities are made
against the investment account (a proxy for net assets)
3) This entry can be combined with the previous entry (EA 1)
4) Adjustment includes the tax effects
27
EA 3: Share of current profit after tax of associate $2m PBT - $100K FV

differential
Dr Share of tax of associate 400,000
Cr Share of profit before tax 1,900,000
Net profit before tax 10,000,000

Less: excess depreciation (500,000) 5,000,000 / 10
Adjusted net profit before tax 9,500,000

Share of profit before tax (20%) 1,900,000
Tax expense 2,100,000
Less: tax on excess depreciation (100,000) 500,000 x 20%
Adjusted tax expense 2,000,000
Share of tax of associate (20%) 400,000
28
Impairment Test
• Goodwill is not tested for impairment as a stand-alone asset
• Impairment test is performed for the investment in its entirety

– Carrying amount of the investment is compared with recoverable
amount
– Recoverable amount is the higher of:
• Value in use, and
• Fair value less cost to sell
• Impairment losses:
– Will reduce the investment account
– May be attributed to book value of net assets, fair value adjustments or
goodwill
29
Illustration 2: Accounting for impairment loss of
investment in associate
• P owned 20% of A
• Past impairment of investment in A: $250,000
• Current impairment of investment in A: $100,000
• A’s current year net profit before tax: $10,000,000
• Tax expense: $2,100,000
Q: Prepare the equity accounting entries for the current year

EA 1: Share of past impairment loss
Dr Opening RE 250,000
Cr Investment in Associate 250,000
Note:
1) This entry re-enacts past impairment losses
2) The impairment loss relates to the share owned by the investor; hence there
is no need to apply ownership percentage
30
Illustration 2: Accounting for impairment loss of
EA 2: Share of current profit after tax of associate

Cr Share of profit before tax 1,900,000
Share of profit before tax of associate 2,000,000 20% X $10,000,000

Less: current impairment loss (100,000)
Adjusted net profit before tax 1,900,000
Share of tax of associate 420,000 20% X $2,100,000
Impairment loss relating to goodwill is assumed to be non-tax

deductible
Note:
1) This entry is to account for current impairment loss
2) The impairment loss relates to the share owned by the investor; hence there is
no need to apply ownership percentage to the impairment loss of $100,000
31
Transfer of Assets between Investor and Associate
“Upstream sale” “Downstream sale”
Investor Investor
Sales Sales
were were
made from X% made from
X% associate investor to
to investor associate
Associate Associate
In both upstream & downstream sales:

• Investor recognizes profit only to the extent of unrelated investor’s
interest in associate (1-X%)
• Investor’s share of profit arising from transfers is eliminated (X%)
32
Illustration 3: Effect of transfer of assets on
• Investor (I) owned 20% of Associate (A)

• I sells $200,000 of inventory to A. The original cost of inventory is
$140,000.
1/3 remains in A’s warehouse at the end of the year (Total profit = $60,000)
• At the beginning of the year, A sold a plant to I at an invoiced price of
$120,000. The original cost of the equipment was $100,000; the profit on
sale recorded by A from the transfer was $40,000. (NBV would be
$80,000) The equipment had an original useful life of five years with no
residual value. At the point of transfer, the remaining useful life of the
equipment was four years with no change to its estimated residual value.
• A's net profit before tax is $1,000,000 and tax expense is $200,000
• Tax rate is 20%
Prepare the equity accounting entries for I as at the end of the current
year.
33
Workings to compute all the unrealised profits:
1 Calculate realised and Total profit = 60,000
unrealised profit from Realised = 40,000 (2/3)
inventory sale Unrealised = 20,000 (1/3)
2 Determine cost, Cost = 100,000

accumulated depn, NBV Accu depn = 20,000 (only 1 yr of depn over 5 yrs
and profit on transfer of useful life)
FA as at transfer date Proceeds =120,000 – NBV 80,000
Profit = 40,000
3 Determine new New depreciable cost = 120,000
depreciable cost, depn Depn = 30,000 (1 year over 4 years of remaining
and accumulated depn of useful life)
FA at reporting date in A’s Accu depn = 30,000 (only 1 year)
books
4 Calculate the realised and Realised = 10,000 (40,000 / 4 yrs new useful life)
unrealised profit on Unrealised = 30,000 (40,000 – 10,000)
transfer of FA
EA 1: Share of current profit after tax of associate
Dr Investment in associate 152,000

Cr Share of profit before tax 190,000
NPBT of A 1,000,000
Less: unrealized profit on sale of inventory (20,000) 1/3 X $60,000
Less: unrealized profit on sale of plant (30,000)
Adjusted net profit before tax 950,000
I’s share of profit (20%) 190,000
Tax expense of A 200,000

Less: tax on unrealized profit on sale of inventory (4,000) 20% X $20,000
Less: tax on unrealized profit on sale of plant (6,000) 20% X $30,000
Adjusted tax expense 190,000
I’s share of tax (20%) 38,000
35
On the inventory sale from I to A (ignoring the tax effect and

transfer of plant),
I’s profit (at group level) I’s profit (at group level)
Adjusted Unadjusted
Gross profit from downstream sale 60,000 60,000

Share of A’s pre-tax profit 196,000 200,000
Profit effect 256,000 260,000
Of the $20,000 unrealised profit from sale of inventory, I is not able to

recognize its share of $4,000 ($20,000 X 20%). However, I is able to
recognize the 80% of the unrelated investor’s share (i.e. $16,000) as if
it had sold the inventory to unrelated investors of A.
36
Moving along
Translation of foreign currency financial statements

Content

associate balance

exposures
38
Accounting Exposure
Accounting Exposure
Transaction exposure: Translation exposure:

Arises from foreign currency
Arises from translation of foreign currency
transactions e.g. Accounts receivable
denominated in a foreign currency financial statements of foreign operations
Results in "transaction' gains or Results in "translation" gains or

losses – both realised and unrealised losses
Recorded in the books of the Presented in consolidated financial

individual entities (affects cash flows) statements (group level)
(does not affect cash flows)
39
Foreign Currency Transactions of a Stand-
alone Entity
Timeline of a typical foreign currency transaction
Foreign currency Financial year-end Settlement of

transaction recorded Outstanding monetary
at actual (historical) monetary asset/liability
exchange rate giving asset/liability translated at rate on
rise to monetary translated at year-end settlement date
asset or monetary rate (realised exchange
liability (unrealised exchange gain/loss)
gain/loss)
40
alone Entity
• Monetary Vs Non-monetary items from foreign currency transactions:

– Monetary items are “units of currency held and assets and liabilities to be
received or paid in fixed or determinable number of units of currency”
– E.g. of monetary assets and liabilities:
• Cash
• Time deposits in the bank
• Accounts and loans receivable/payable
• Tax payable (including deferred tax)
– E.g. of non-monetary assets and liabilities:
• Prepayments
• Unearned revenue
• Intangible assets
• Inventories
• PPE
• Liabilities to be settled by non-monetary assets
41
alone Entity
• At foreign currency transaction date:

– The transaction is recorded at actual spot rate
• At subsequent balance sheet dates:

– Monetary items:
• Are adjusted using the closing rate at balance sheet date
• Rationale: monetary items are contractual amounts that will be settled in a
specific currency which needs to be adjusted for a change in spot rate
– Non-monetary items:
• No adjustment made at balance sheet date
• Items are measured at historical rate (i.e. date of transaction)
– Non-monetary items measured at fair value

• Are translated using the exchange rate at date of fair value
determination
42
Transaction Exposure
• Items exposed to foreign exchange risks

– Foreign currency monetary items
– Non-monetary items carried at fair value
– Remeasurement at balance sheet and settlement date will give rise to
exchange gains or losses
Foreign currency Foreign currency

depreciates appreciates
Exposed asset Exchange loss Exchange gain
Exposed liability Exchange gain Exchange loss
43
Treatment of Transaction Gains and Losses
• Monetary items:
– Exchange gains or losses are recognized in profit or loss of the entity
– Exceptions: exchange gains or losses on an intercompany loan that is
an extension of the parent’s net investment are taken to equity in the
consolidated financial statements
• Non-monetary items carried at fair value:

– Exchange gain or losses are recognized in the same way as the gain or
loss on the non-monetary item recognized
– E.g. Available-for-sale investment (equity): exchange differences
are recognized in equity
44
Illustration 1:
Foreign currency transaction – Accounts Payable
Alpha Company, whose functional currency is the dollar, purchased

goods with an invoiced value of FC250,000 on 1 November 20x1 to
be settled on 31 January 20x2. Alpha Company’s financial year –
end is 31 December.
Exchange rates 1FC =
1 November 20x1 $1.50
31 December 20x1 $1.45 Depreciate
31 January 20x2 $1.48 Appreciate
1/11/20x1 31/12/20x1 31/1/20x2

Delivery date Year-end Settlement date
1FC = $1.50 1FC = $1.45 1FC = $1.48

Exchange gain Exchange loss
of $12,500 of $7,500
45
Illustration 1:
Foreign currency transaction
1 November 20x1
Dr Inventory 375,000
Cr Accounts payable 375,000
Record purchase of goods at spot rate USD$250,000 x 1.5
31 December 20x1
Dr Accounts payable 12,500
Cr Exchange gain (USD250k* 12,500
1.50-1.45 )
Record exchange gain on outstanding accounts payable
31 January 20x1
Dr Accounts payable 362,500
Dr Exchange loss (1.48-1.45)*250k 7,500
Cr Cash/Bank 370,000
To record exchange loss on settlement of accounts payable
46
Content

associate balance

exposures
47
Concept of Functional Currency
• The determination of functional currency has to be done in

accordance with FRS 21; it is NOT by choice
• Functional currency under FRS (IAS) 21:

– Currency of the “primary economic environment in which the entity
operates”
– The currency that influences the sales prices of goods and services
– Normally the currency that sales prices are denominated and settled in
– The currency in which the costs are accumulated in
• A firm’s “primary economic environment” is not determined by

national or political boundaries
• All currencies other than the functional currency are considered as

foreign currencies
– The effects of exchange rate changes on a firm’s cashflows is
measured and reported with reference to the functional currency
48
Factors to Indicate an Entity’s Functional Currency
FRS (IAS) 21 Para 9: (primary factors)

1. The currency that mainly influences the sale prices of goods and
services (currency in which sales prices are denominated and
settled)
2. The currency of country whose competitive forces and regulations
determine the sales prices of goods and services
3. The currency that mainly influences the labour, material and other
cost of goods and services (currency in which costs are
denominated and settled)
FRS (IAS) 21 Para 10: (secondary factors)

4. The currency in which financing is obtained
5. The currency in which receipts from operating activities are retained
49
Factors to Indicate an Entity’s Functional Currency
Factors to Determine the Functional Currency of a
Foreign Operation SU5-31
Indicators that foreign

Indicators that foreign
operation’s functional
Indicators operation’s functional
currency is parent’s
currency is local currency
functional currency
The foreign operation has
Operating relationship The foreign operation is an
significant degree of
with the parent extension of the parent
autonomy from the parent
Transactions with the
Low proportion High proportion
parent
Foreign operation’s cash Foreign operation’s cash
Cashflow
flows do not directly affect flows directly affect the
interdependencies
the parent company parent company
Foreign operation is self- Foreign operation is
Financial independence sufficient and not dependent dependent on the parent
on the parent company for company for financing
financing
51
Determination of Functional Currency
Nature of operating and financial relationship

between a parent and its foreign operation
Foreign operation operates

Foreign operation is
independently in economic
integrated with parent’s operation
and financial matters
Functional currency should be Functional currency

either local or a 3rd currency should be parent’s currency
If translation to parent’s
presentation currency is Remeasurement /Temporal Method
required, Closing rate will be used to translate the books kept
method shall be used in foreign currency to the functional
currency
52
Determination of Functional Currency
Closing rate method and temporal method

will be discussed in the upcoming slides
Content

associate balance

exposures
54
Presentation Vs Functional Currency
• A company may choose any currency as its presentation
currency
• For the group entity:

– The presentation currency of the group is the presentation currency of
the parent company
• FRS (IAS) 21 outlines two approaches to translate the financial

statements
Foreign Functional Presentation

Currency Currency Currency
Remeasurement / Closing Rate Method

Temporal Method
55
Foreign Currency to Functional Currency
• Remeasurement or “Temporal method” is used to translate

financial statements from a foreign currency to the functional
currency
• This method is applicable to an entity that records its books in a
currency other than its functional currency.
• Possible scenarios:
• Scenario 1: A stand-alone entity whose FC has been
determined to be US$ but it records its books in S$ only
because it operates in Singapore
• Scenario 2: It is an integral foreign operation of a US company
and has to remeasure its S$ books to the FC of its Head Office,
usually US$
• Remeasurement will enable the entity to achieve the same
results as if the transactions had been originally recorded in the
functional currency
56
Re-measurement from foreign currency to
functional currency
• Under Scenario 2, parent and the foreign operation operates

as a single economic entity
– Foreign operation’s transactions are deemed to be the parent’s

foreign currency transactions
– Translation differences have a direct impact on the parent’s

cashflows, thus they are taken to income statement
– Remeasurement procedures are the same as those applied to

foreign currency transactions of a stand-alone entity
57
Functional Currency to Presentation Currency
• Closing rate method is used to translate financial statements

from the functional to the presentation currency
• This method is applicable to:
– Scenario 3: Stand-alone entity that records its books in its

functional currency but presents its financial statements in
another currency
– Scenario 4: Foreign operation ("independent” branch, subsidiary or

associate) that records its books in its functional currency but
needs to translate its financial statements into the parent’s
presentation currency for consolidation purposes
58
Functional to Presentation Currency
• Features of closing rate method:

Items Rate
Assets and liabilities (both monetary and non-monetary) Closing rate
Income and expense items Actual or average rate
Translation gain or losses are taken to equity until disposal of foreign operation
• Foreign operation is viewed as a passive investment by the parent

– Parent’s returns are in the form of dividends and capital appreciation
– Value of investment is influenced by:
• Profitability of foreign operation
• Change in exchange rates
– Effect of exchange rate movements is measured using closing rate

– Translation differences will not have a direct impact on the parent’s
cashflow; therefore, they are taken to equity
59
Temporal Method or Closing Rate Method???
PC = Presentation Currency
Incorporated in Australia FC = Functional Currency
PC = AUD
FC = USD
Prepares conso FS
Integrated with HO
Autonomous entity
A branch
Incorporated in registered in
Singapore Msia
PC = SGD PC = RM
FC = SGD FC = USD
Books in USD Books in RM
Exchange Rates Used for Translating Balance Sheet
Items
Balance sheet Items Closing Rate Method Remeasurement /

Temporal method
Share capital and pre-
acquisition retained earnings Historical rate Historical rate
Post-acquisition retained Not translated using a Not translated using a

earnings single exchange rate. single exchange rate.
This is a cumulative This is a cumulative
figure that is carried figure that is carried
forward from year to forward from year to
year year
Monetary assets and liabilities Closing rate Closing rate

(eg. Receivables, payables,
cash and bank balances)
Historical rate
Non-monetary assets and (For a subsi acquired by a
liabilities at historical rate (eg. Closing rate
parent, the forex rate at
PPE, investments, prepayment, acquisition date serves as
inventory) the new historical rate for
items of the subsi existing
prior to the acquisition
date)
61
Exchange Rates Used for Translating Balance Sheet
Items
Balance sheet Items Closing Rate Method Remeasurement /

Temporal method
Non-monetary items at fair Rate at the date of the

value (eg. Trading Closing rate revaluation or FV
securities and revalued determination
PPE)
Taken to income statement

Recognised in OCI and
Translation gains or losses shown as an equity (except for translation
(foreign currency gain/loss arising from the
translation reserve) reval of non-monetary item
FCTR is taken to equity if the
revaluation gain/loss is
taken to equity)
62
Exchange Rates Used for Translating Income
Statement Items
Remeasurement /
Income Statements Items Closing Rate Method
Temporal method
Sales, purchases, expenses

and income statement items
Actual / average rate Actual / average rate
that result in inflow/outflow
of monetary items
Historical rate of original
Costs of sales Actual / average rate purchase of inventory
Historical rate of original

Depreciation, amortization acquisition (if items existed
and other allocation of non- Actual / average rate before acquisition date of
monetary items subsi, use rate at
acquisition date as
historical rate)
Dividends and other

Actual rate Actual rate
appropriation of profits
63
Translation Exposure
• Translation exposure = Net amount of assets or liabilities in a

foreign currency balance sheet that is translated at the closing
exchange rate.
• Under closing rate method, ALL assets and liabilities are translated
at closing rate. So exposed items are the NET ASSETS (assets –
liabilities)
• Under the remeasurement method, ONLY MONETARY assets

and liabilities & NON-MONETARY @ FAIR VALUE assets and
liabilities that are translated at closing rate are “exposed“ (i.e. net
monetary assets and assets measured on a fair value basis)
64
Sources of Translation Differences Under Closing
Rate Method ( FCTR )
• Under the closing rate method, the exposed item is the entire net
assets.
• Thus, sources of translation difference are:
• Effect of exchange rate change on opening net assets; and
• Effect of exchange rate on increase or decrease in net

assets or equity during the year, which would include some
or all of the following:
– Net profit or loss for the year,
– Dividends paid during the year,
– Injection of new capital during the year
– Other changes in equity during the year
65
Translation Difference under Temporal method
• Under remeasurement / temporal method, monetary items and non-

monetary items that are measured at fair value are the exposed
items as they are translated at closing rate.
• Thus, sources of Translation Difference:
 Effect of exchange rate change on opening net monetary assets;
 Effect of exchange rate changes on:

•Increase/decrease in monetary items during the year
•Non-monetary items revalued during the year
66
Illustration 2:
Translation example
On 31 December 20x3 Alpha Corporation acquired the entire share

capital of Beta Company, a foreign company whose currency is the
FC. At the date of acquisition, Beta’s Balance Sheet was as follows:
Beta Company – Opening BS

Balance sheet at 31.12.20x3
FOREIGN
Assets & liabilities FC CURRENCY
Plant & equipment 200,000
Inventories 100,000
Accountsreceivable 150,000
Monetary items
Accountspayable (80,000)
Net assets 370,000
Share capital 200,000

Retained earnings 170,000
Equity 370,000
67
Illustration 2:
Translation example
Beta’s financial statements for the year ended 31 December 20x4

are as follows:
Income statement
FC
Sales 800,000
Cost of goods sold (470,000)
Gross profit 330,000
Depreciation (25,000)
Operating expenses (200,000)
Profit before tax 105,000
Taxation (20,000)
Profit after tax 85,000
Dividends paid (25,000)
Retained profit for year 60,000
Retained profit at 1 Jan 04 170,000
Retained profit at 31 Dec 04 230,000
68
Illustration 2:
Translation example
Beta Company - closing BS

FC
Assets & liabilities
Plant and equipment 225,000
Inventories 120,000
Accounts receivable 200,000
Monetary
Cash 5,000
items
Accounts payable (120,000)
Net assets 430,000
Share capital 200,000

Retained earnings 230,000
430,000
69
Illustration 2:
Translation example
Additional information:
1. Assets are depreciated using the straight line method at the rate of 10%.
During 20x4, equipment costing FC50,000 was purchased. A full
year’s depreciation is recorded in the year of purchase.
2 Relevant exchange rates are as follows:

1FC =
At 31.12.20x3 1.50
At date of purchase of equipment 1.48
At date of payment of dividends 1.40
Closing inventories (20x4) purchased 1.38
Equipment purchased (new in 2004) 1.45
Average rate for 20x4 1.42
At 31.12.20x4 1.35
70
Illustration 2:
Translation example
Required:
1. Translate the financial statements of Beta Company into S dollars
assuming that Beta’s functional currency is the FC (foreign
currency)
USE CLOSING RATE METHOD
2. Remeasure the financial statements of Beta Company into S dollars

assuming that Beta’s functional currency is the S dollar
USE TEMPORAL METHOD
71
Illustration 2:
Translation example – closing rate method
Translated Income Statement (Closing Rate method)

FC Rate S$
Sales 800,000 1.42 & 1,136,000
COGS (470,000) 1.42 (667,400)
Gross profit 330,000 468,600
Depreciation (25,000) 1.42 (35,500)
Operating expenses (200,000) 1.42 (284,000)
Profit before tax 105,000 1.42 149,100
Taxation (20,000) 1.42 (28,400)
Profit after tax 85,000 1.42 120,700
Dividends paid (25,000) 1.40# (35,000)
Retained profit for year 60,000 85,700
Retained profit at 1 Jan 170,000 1.50* 255,000
Retained profit at 31 Dec 230,000 340,700
& average rate # Rate as at dividend payment * Rate at acquisition date A
72
Illustration 2:
Translation example- closing rate method
Beta Company
Assets & liabilities FC Rate S$
FX AS AT Plant and equipment 225,000 1.35 303,750
31/12/03 Inventories 120,000 1.35 162,000
1.50 Accounts receivable 200,000 1.35 270,000
Cash 5,000 1.35 6,750
Accounts payable (120,000) 1.35 (162,000)
31/12/04 Net assets 430,000 1.35 580,500
1.35
A
Share capital 200,000 1.5 300,000
Retained earnings 230,000 From I/S 340,700
Translation reserves Bal. figure (60,200)
(proof is next slide) 430,000 580,500
73
Illustration 2:
Alternative 1
Movement in net exposed Items FC Rate S$
Net assets on 1 Jan 2004 370,000 1.50 555,000

Increase in net assets:
Net profit after tax 85,000 1.42 120,700
Decrease in net assets:
Dividends paid (25,000) 1.40 (35,000)
640,700 (A)
Net assets on 31 Dec 2004 430,000 1.35 580,500 (B)
Translation difference for the year (B – A) (60,200)
74
Illustration 2:
Alternative 2 A B (B – A) X FC
Movement in net exposed FC Opening/Ave S$
Items /Tranx Rate Closing rate
Net assets on 1 Jan 2004 370,000 1.50 1.35 (55,500)

Increase in net assets:
Net profit after tax 85,000 1.42 1.35 (5,950)
Decrease in net assets:
Dividends paid (25,000) 1.40 1.35 1,250
(60,200)
Net assets on 31 Dec 2004 430,000
75
Illustration 2:
Translation example –Temporal method
Remeasured Income Statement (Functional currency is S$)

FC Rate S$
Sales 800,000 1.42 1,136,000
COGS (470,000) Note (a) (680,200)
Gross profit 330,000 455,800
Depreciation (25,000) Note (b) (37,250)
Remeasurement loss Note (c) (10,550)
Profit before tax 105,000 124,000
Taxation (20,000) 1.42 (28,400)
Profit after tax 85,000 95,600
Dividends paid (25,000) 1.40 (35,000)
Retained profit for year 60,000 60,600
Retained profit at 1 Jan 170,000 1.50 (Acq date) 255,000
Retained profit at 31 Dec 230,000 315,600
76
Illustration 2:
Note (a) – Cost of goods

sold (COGS)
FC Rate $
Opening inventories 1/1/04 100,000 1.50 150,000

Purchases 2004 (average) 490,000 1.42 695,800
Closing inventories
31/12/04 special rate (120,000) 1.38 (165,600)
COGS 470,000 680,200
Note (b) – Depreciation expense

FC Rate S$
Existing equipment 20,000* 1.50 30,000
New equipment (2004) 5,000# 1.45 7,250
25,000 37,250
*S$200,000 ÷ 10 years
# $50,000 ÷ 10 years
77
Illustration 2:
Translation example – Temporal method
Note (c): Remeasurement loss

Movement in net exposed items FC Rate S$
Net monetary assets, 1 Jan 70,0001 1.50 105,000
∆ in monetary assets/liabilities:
Sale 800,000 1.42 1,136,000
Purchase of equipment (50,000) 1.45 (72,500)
Purchases (490,000) 1.42 (695,800)
Taxation (20,000) 1.42 (28,400)
Dividends paid (25,000) 1.40 (35,000)
125,300 (A)
Net monetary assets, 31 Dec 85,0002 1.35 114,750 (B)
Remeasurement loss (B-A) (10,550)
78
Illustration 2:
1. Opening exposed monetary items:

FC
Net monetary assets, 1 Jan 70,000
2. Closing exposed monetary items:

Cash 5,000
Net monetary assets, 31 Dec 85,000
79
Illustration 2:
See next slide
Beta Company
Assets & liabilities FC Rate S$
Plant/Equipment 225,000 Note (d) 335,250
Inventories 120,000 1.38 165,600
Accounts receivables 200,000 1.35 270,000
Cash 5,000 1.35 6,750
Accounts payables (120,000) 1.35 (162,000)
Net assets 430,000 1.35 615,600
Share capital 200,000 1.5 300,000

Retained earnings 230,000 From I/S 315,600
430,000 615,600
80
Illustration 2:
Note (d) - Equipment

Existing equipment: FC Rate S$
Cost 200,000
Accumulated depreciation (20,000)
Net carrying value 180,000 1.5 270,000
New equipment
Cost 50,000
Accumulated depreciation (5,000)
Net carrying value 45,000 1.45 65,250
Total 225,000 335,250
81
Conclusion
• The equity method is applied to accounting for associates in the

consolidated financial statements
– It does not involve line by line summation of an associate’s financial
statements
– Investment account is not eliminated, instead it comprises:
• Share of book value of net assets
• Share of unamortized fair value adjustments
• Implicit goodwill
– Dividend is a repayment of profit and not income to the investor
under the equity method
• Transfer of assets between investor and associate

– In both upstream and downstream sales:
• Investor’s share of unrealized profit arising from transfers is eliminated
82
Conclusion
• Functional currency should be determined in relation to the primary

economic environment of the entity but presentation currency is a
“free choice”
• Remeasurement is used to translate the foreign currency financial

statements of a stand-alone entity or the financial statements of a
foreign operation (integral to its parent’s operations) to its
functional currency
• Apply the closing rate method when translating the functional

currency financial statements of a foreign operation (independent
of its parent’s operations) or the subsidiary’s functional currency
financial statements to the parent’s presentation currency
83
Additional Exercises
Problems P6.2, P6.4 and P6.5 (part 3 only)

Textbook pages 382 to 387
Problems P8.2, P8.3 and P8.4

Textbook pages 698 and 702
84

ACC301 Seminar 5 Slides 30 03 2018

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ACC301 Advanced Financial Accounting

Group reporting V - Equity accounting under FRS28

Translation of Foreign Currency FS

1. Appreciate the different accounting policies for investment in an

1. Equity method versus cost method

5. Specific procedures relating to the equity method

• Other evidence of “significant influence”:

Levels of financial reporting Accounting policy

3. Investor’s financial statement in

Dimensions Cost Method Equity Method

1. Equity method versus cost method

5. Specific procedures relating to the equity method

• Equity accounting captures the substance of consolidation but not

• Decision rights implicit in “significant influence” are not as strong as in

Dimensions Consolidation Equity Method

Unamortized Adjustments are made on Unamortized balance is

Profit on sale of Profit on sale = Sales Profit on sale = Sales

Dimensions Consolidation Equity Method

1. Equity method versus cost method

5. Specific procedures relating to the equity method

1. Investment is initially recorded at cost

1. Equity method versus cost method

5. Specific procedures relating to the equity method

Investor’s share X (Acquisition cost –

1. Equity method versus cost method

5. Specific procedures relating to the equity method

Begin with the investor’s

Accounting for Investment in Associate

• Dividends and other distributions are deemed as "repayment"

• Under the equity method, income is recognized only on the basis of

• However, in the investor’s separate financial statements, dividend is

Dr Dividend income (I/S)

1. Elimination of intragroup balances is not required

Illustration 1: Accounting for amortisation of FV differential

Illustration 2: Accounting for impairment loss of investment in

Illustration 3: Accounting for unrealised profit from transfer of

• I acquired 20% of A’s share on 1 Jan 20X4

Date of Beginning of End of

1 Jan 20X4 1 Jan 20X5 1 Dec 20X5

EA 1: Share of change in retained earnings (RE) in A from acquisition

Dr Investment in associate 1,000,000

RE as at 1 Jan 20X5 20,000,000

EA 2: Share of past cumulative depreciation on

EA 3: Share of current profit after tax of associate $2m PBT - $100K FV

Net profit before tax 10,000,000

Adjusted net profit before tax 9,500,000

• Goodwill is not tested for impairment as a stand-alone asset

• Impairment test is performed for the investment in its entirety

Q: Prepare the equity accounting entries for the current year

EA 2: Share of current profit after tax of associate

Share of profit before tax of associate 2,000,000 20% X $10,000,000

Share of tax of associate 420,000 20% X $2,100,000

Impairment loss relating to goodwill is assumed to be non-tax

“Upstream sale” “Downstream sale”

In both upstream & downstream sales:

• Investor (I) owned 20% of Associate (A)

2 Determine cost, Cost = 100,000

EA 1: Share of current profit after tax of associate

Dr Investment in associate 152,000

Tax expense of A 200,000

On the inventory sale from I to A (ignoring the tax effect and

Gross profit from downstream sale 60,000 60,000

Of the $20,000 unrealised profit from sale of inventory, I is not able to