Question

Measure the accounting for foreign currency and its translation.

Scenario

CM Corporation (CMC) was founded six years ago by Phil Connor and Eric Martin. The company designs, installs, and services security systems for high-tech companies. The founders, who describe themselves as "entrepreneurial geeks," met in a computer lab when they were teenagers and found they had common interests in working on security systems for critical industries. CMC hired you as a junior accountant this year.

Lately, Connor and Martin have been working with "radio frequency identification" (RFID) technology. They have developed a detailed system designed to track inventory items using RFID tags embedded invisibly in products. This technology has numerous inventory applications in multiple industries.

One of the most basic applications is tracking manufacturing components; if tagged components "go walking" (if employees attempt to take them), companies can easily track and find them. Connor and Martin have sold their system to several high-tech companies in the area. These companies have a number of government contracts that require extensive security systems to protect sensitive data from infiltration by terrorists and others. To date, CMC's cash flow from sales and services has adequately funded its operations.

CMC expects much growth potential for its products. As a result, they are considering going public and expanding internationally in the near future.

Instructions

Connor and Martin are contemplating international business in their industry and feel that global expansion is a great transition for the company. They feel they understand IFRS much better in addition to having a greater technical grasp of GAAP. They have decided to go public and also expand internationally within the next two to three years. With making such bold moves, they are also seriously considering a switch to IFRS as their accounting standards for financial statements. Connor and Martin have requested your assistance in creating a PowerPoint presentation that summarizes information on the impact of foreign currency should the firm expand internationally.

Presentation Mechanics should be as follows:

Prepare a 5-8 slide PowerPoint presentation, including slide notes.

Summarize the impact foreign currency will have on a firm expanding internationally.

Explain the advantages and disadvantages to foreign currency translation of financial statements.

Explain different reasons for the firm to continue with accounting under US GAAP or switching to IFRS standards.

Answer 1

Impact Of Foreign Currency on a firm expanding internationally

1) Be on top of the exchange rate

It goes without saying that following exchange rates is extremely important. International business requires having a very good sense of how your local currency is affected by other currencies and how that, in turn, has an impact on your exports, imports, suppliers, clients, etc.

2) Research past rates

There is no need to do deep level research here. Simply pull up a chart of the past 6 months for the currency pair you are interested in and see the high and low rates. Keep those in mind as the best and worst case scenarios for your upcoming conversion of funds as the rate will most likely not move past either of those marks in the short term. This can help you decide when to convert funds and when not to.

3) Timing your foreign purchases

Timing is everything. You may run a business that just has a standing order to purchase or export a certain amount of units of product each month. If this is the case, look into how you can make the order more dynamic so you get the most out of the possible rate fluctuations.

4)Currency Options

A foreign currency option is a financial instrument that allows the owner of the option the right, but not the obligation to exchange funds from one currency into another at a pre-agreed exchange rate on a specific date in the future.

Advantages and Disadvantages to foreign currency translation:

Accounting for currency translation is the result of a company having a branch or other operation that prepares its financial statements in a currency other than the currency of the parent company. Consolidated financial statements will be in the currency used by the parent company, so restatement of the other currency is required. The key elements of currency translation will be discussed through a hypothetical case study. Translation can be straightforward for many entities, but it can be complex if multiple countries are involved.

When multiple currencies are involved, one key element is to determine the functional currency of the operation being consolidated. The original standard issued by FASB in 1981 (now Topic 830 in the Accounting Standards Codification) states that if the foreign operation is in control of its operations and financing, then the functional currency would be the local currency of the branch. Also, this is a matter of fact and should be based on the currency where the majority of the cash is received and expended. In some cases, the facts do not make the functional currency decision clear.

When transactions are conducted in multiple currencies, all transactions not in the functional currency must first be translated to the functional currency. Foreign currency transactions that are recorded and translated at one rate and then result in transactions at a later date and different rate give rise to gains or losses. Gains or losses from foreign currency transactions are included in current income.

Switching to IFRS from US GAAP:

1. A well-developed and ‘living’ plan, including realistic timelines and clear accountability.
2. Buy-in from senior management and members of the audit committee from the outset.
3. Sufficiently focused and appropriately engaged company resources, including a designated Project Management Office.
4. A comprehensive and detailed accounting gap analysis, leading to an impact assessment of process, data and systems, people and change, and other potentially impacted business areas.
5. Timely involvement of the external auditor.
6. Tailored training delivered throughout all phases of the IFRS implementation project – designed to meet the various needs of specific company personnel.
7. Early assessment of regulatory requirements, such as pro forma financial information, prospectuses, specific disclosures, number of comparative years, etc.