Question

Case: ABC Corp. International Company, a manufacturer of medical device, assembles a particular product line at a wholly owned facility in Singapore. The product is designed at XYZ’s headquarters in the United States, but the different components used in the assembly process are manufactured throughout Asia and shipped to Singapore for final assembly. Some of the components are manufactured in multiple locations, so the customer can actually designate where ABC Corp. should source the components. The final product is assembled in Singapore and then shipped via FedEx Freight to customers in European Union and throughout Asia. ABC Corp. Singapore does not purchase any major components from the United States, but it invoices all of the components from Asian suppliers in U.S. dollars. Moreover, it sells the product to Asian customers in U.S. dollars. However, all of its major expenses in Singapore are paid in Singapore currency. Most of the key executive marketing decisions are made by the U.S. marketing headquarter staff, although the Singapore staff acts as a liaison with FedEx Freight personnel and deals with the local employees, most of whom come from the European Union on short-term work visas.

Part II: When it comes to translating the financial statements of entities in highly inflationary countries, which of the following approaches makes more sense and why? What are the implications of this for ABC Corporation?

1st option – Remeasure using the temporal method, even though the functional currency is the local currency for operation purposes.

2nd option – Restate for inflation and translate using the current rate method.

Answer 1

The first step is to determine which one to use.

Companies encounter the need to translate foreign currencies when they trade in those currencies and when they have foreign operations.

First option:

If the functional currency is local currency, entity should apply current rate method. ABC corporation remeasures using temporal method. It adjusted income generating assets and related income statement items using historical exchange rates from the transaction dates or from the date company last assessed the fair market value. This adjustment is recognize as current earrings.

It does not eliminate the variability of net earnings due to translation gains or losses.

Option 2:

When company operate in hyperinflationary environment, it apply the temporal rate method.

ABC corporation restate for inflation and translate using the current rate method. It translated assets and liabilities using current exchange rates on the date of translation or the balance sheet date. It also translates translates equity items excluding retained earnings.

As a result, accounting capital gains or losses will arise from these items. And the net gain is not included in the consolidated income statement of parent company but goes to special reserve account on the balance sheet i.e cumulative translation adjustment.